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BPP revision kit sample answers

Estoil : Q pg 47

Changes in circumstances

Rapid changes in business environment could mean more than one impairment test
may be required in an annual period. For goodwill and certain other intangible assets,
impairment test to be performed at any time during the period, provided it is
performed at the same time every year.

Volatility in financial statements may indicate impairment. For example, falls or rises
in commodity prices may affect impairment indicators for energy and mining entities,
and require those assets to be tested for impairment in the next interim financial

If an entity has to test for impairment at the end of the reporting date as well as at the
scheduled annual date, it does not necessarily mean that the whole budget process
needs to be redone, as top-down adjustments may be sufficient to assess any changes
in the period since the latest goodwill impairment review.

Market capitalisation as a special impairment indicator

Market capitalisation (total shares value) if it shows a lower figure than the book
value of net assets, it suggests the market considers that the business is overvalued.

However a market capitalisation below book equity will not necessarily always lead
to an equivalent impairment loss. Entities should examine their cash generating units
(CGUs) in these circumstances and may have to test goodwill for impairment.

Formal reconciliation between market capitalisation of the entity, fair value less costs
to sell (FVLCS) and value in use (VIU) are not required. However, entities need to be
able to understand the reason for the shortfall.

Allocating and reallocating goodwill to cash generating unit (CGU)

The identification of CGUs and the allocation of acquired goodwill is unique to each
entity and requires significant judgement.

This allocation process in itself determines the total carrying amount to test and
should be a reasonable and supportable method. Acquired goodwill is allocated to
each of the acquirer’s CGUs, or to a group of CGUs, which are expected to benefit
from the synergies of the combination.

If CGUs are subsequently revised or disposed of, this requires goodwill to be

reallocated which needs the exercise of judgement again.

Valuation issues

Recoverable amount of an asset or CGU to be measured as the higher of the asset’s or

CGU’s FVLCS and VIU. Measuring the FVLCS and VIU of an asset or CGU
requires the use of assumptions and estimates:

(a) The use of a discounted cash flow (DCF) methodology to estimate FVLCS.

(b) An asset or CGU to be tested in its current status, not the status which
management wishes it was in or hopes to get it into in the near future. Therefore, the
standard requires VIU to be measured at the net present value of the future cash flows
the entity expects to derive from the asset or CGU in its current condition over its
remaining useful life. This means ignoring many management plans for enhancing the
performance of the asset or CGU.

(c) Determining the appropriate discount rate to apply. Discount rate is supposed to
appropriately reflect the risks specific to the asset or CGU.

Alternative rate may be used such as (WACC). To calculate the WACC is a complex

(d) VIU is measured using pre-tax cash flows and discount rates. VIU is primarily an
accounting concept and not necessarily a business valuation of the asset or CGU. For
calculating VIU, IAS 36 requires pre-tax cash flows and a pre-tax discount rate.

Impairment disclosures

Disclosure is a key communication to investors by management. Disclosures which

describe the factors which could result in impairment become even more important
when value has been eroded.

The key question is whether sufficient disclosure has been made about the uncertainty
of the impairment calculation. Sensitivity disclosures about adverse situations, such as
those triggered by volatile prices, provide useful information and whether a possible
change in a key assumption, such as the discount rate, could lead to recoverable
amount being equal to carrying amount, or result in impairment losses.

(b) (i) The discount rate used by Estoil has not been calculated in accordance with the
requirements of IFRS. The future cash flows are estimated in the currency in which
they will be generated and then discounted using a discount rate appropriate for that

The present value to be translated using the spot exchange rate at the date of the value
in use calculation. Furthermore, the currency in which the estimated cash flows are
denominated affects many of the inputs to the WACC calculation, including the risk
free interest rate.

Also, government bond rates differ between countries due to different expectations
about future inflation, value in use could be calculated incorrectly due to the disparity

between the expected inflation reflected in the estimated cash flows and the risk free

(ii) Cash flow projections used in measuring value in use shall be based on reasonable
and supportable assumptions which represent management’s best estimate of the
range of economic conditions which will exist over the remaining useful life of the

Management must assess the reasonableness of the assumptions by examining the

variance analysis. Management should ensure that the assumptions on which its
current cash flow projections are based are consistent with past actual outcomes.

Despite the fact that the realised cash flows for 2014 were negative and far below
projected cash flows, the directors had significantly raised budgeted cash flows for
2015 without justification. There are serious doubts about Fariole’s ability to establish
realistic budgets.

Projected cash outflows should include future cash outflows to maintain the level of
economic benefits expected to arise from the asset in its current condition. It is highly
unlikely that no investments in working capital or operating assets would need to be
made to maintain the assets of the CGUs in their current condition. Therefore, the
cash flow projections used by Fariole are not in compliance with IFRS.

Panel : Q pg 58 (b)

(b) (i) The tax deduction is based on the option’s intrinsic value (market price and
exercise price of the share). Deferred tax asset (DTA) will arise because the carrying
amount of the employee’s service received is zero (already charged to profit or loss),
but tax base remains a value due to the pending claims.

DTA is recognised to PL. If the estimated tax claim exceed the cumulative recognised
staff costs, then the excess is recognised to equity (eg retained earnings) directly.

Year 20X4

Staff costs recognised 40 x 1/2 (2 years vesting) = $20m

Estimated tax claim 16 x 1/2 (2 years vesting) = $8m

As the tax claim is less than staff costs, the DTA of $8m x 30% is recognised to PL.

At year end 20X5, the options were exercised. DTA is not needed and is reversed to
PL (as income tax expense). The actual tax claim of $46m x 30% = $13.8m is
recognised to PL as tax relief.

(ii) Rights of use (ROU) and lease liability (LL) are recognised at $12m. At inception
of the lease. The ROU is depreciated over its useful life of 5 years, while the LL is
carried at amortise cost model.

As the tax treatment differs from the IFRS on leases, temporary difference will arise
between the net assets (or liability) of the lease in financial statements (F/S) and its
tax base, which is zero, as tax law does not recognise the asset and liability, but allow
the rental to be deductible.

The deferred tax for year 2005 :-

Carrying amount $m
ROU (12 / 5 x 4) 9.6
LL (12 x 1.08 - 3) 9.96
Net liability 0.36
Tax base 0
Deductible temp diff 0.36

Deferred tax asset at year end = $0.36m x 30% = $0.108m

(iii) The profit made by Pins of $2m is recognised in its F/S, but this is regarded as
unrealised profit of $2m arising from intra group transaction. In consolidated F/S the
$2m is eliminated by reducing group inventory and increasing group cost of sales.

However, this adjustment is not acceptable by tax law, and the tax base of the
inventory remains at $9m. This creates a deductible temporary difference of $9m -
$7m = $2m, and lead to a DTA $2m x 30% = $0.6m recognised to profit or loss of the

DTA is not recognised in Pins F/S.

(iv) Impairment loss is first allocated to goodwill of $1m, and the balance $0.8m is
used to reduce the PPE.

No deferred tax would have been recognised on the goodwill. Therefore, the
impairment loss relating to the goodwill does not cause an adjustment to the deferred
tax position.

Tax base of PPE remains at $4m as the impairment loss is not tax deductible in
current year.

The deferred tax for year 2005 :-

Carrying amount $m
PPE (6 - 0.8) 5.2
Tax base 4
Taxable temp diff 1.2

Deferred tax liability at year end = $1.2m x 30% = $0.36m

Leigh : Q pg 65

(a) Equity consideration to acquire sub is measured at fair value of $6m. This is used
to calculate goodwill in consol F/S.

The 5,000 share options per director requires employee services in return and
is not accounted for as business combination. This is employee benefit given for
a vesting period of 1 year. Leigh should value the share option at grant date, and
recognised the value as staff cost and credit to equity over the vesting period.
Estimated number of directors who might leave before the vesting date also
needs to be factored in the calculation.

The fully paid shares grant does not require any vesting condition means this relates
to past performance of the employees. The fair value of shares at grant date of $3m is
recognised immediately to staff cost and credit to equity. The average share price is

The expected share price movement over the next three years will not create any
accounting implication to Leigh as the share options are not remeasured after the
initial recognition.

(b) If the outsider (supplier and director in this case) can choose between equity
settled and cash settled for the share based payment, Leigh will have to account for
the transaction based on the following guideline :-

Can the fair value of goods

and services be measured
Yes No

Dr Goods or services Dr Goods or services

(residual amount) (residual amount)

Cr Liability Cr Liability
The lower of : Fair value of cash alternative
Fair value of cash alternative, or
Fair value of goods or services

Cr Equity Cr Equity
The difference The difference
Fair value of cash alternative, and Fair value of cash alternative, and
Fair value of goods or services Fair value of equity

Transaction with independent supplier means the fair value of PPE can be measured
reliably,while IFRS assume employee services cannot be measured reliably.

Transaction with supplier
Dr PPE 4.55
Cr Liability 4
Cr Equity (1.3 x 3.5) - 4 0.55

Transaction with directors

Dr Director service cost 125,000
Cr Liability (40,000 x 3) 120,000
Cr Equity (50,000 x 2.5) - 120,000 5,000

(c ) Inv in assoc is accounted for using equity accounting : cost of inv + share of post
acquisition reserves of assoc.

Leigh has significant influence over Handy, and Handy is an assoc of Leigh.
Goodwill acquired in assoc is not separately presented, but to include in the
investment amount in Leigh's F/S.

If a the purchase resuts in a bargain purchase (BP) Leigh will recognised BP to PL of

Leigh at date of acquisition :-

Consideration transferred (1 x 2.5) 2.50
Fair value of net assets acquired (30% x 9) (2.70)
Bargain purchase (0.20)

Electron Q pg 63

Oil Contracts

The revenue recognition policy currently used is inflating revenue in the first year of
the contract with 50% of the revenue being recognised, but a smaller proportion of the
costs are recognised in the form of depreciation.

Revenue and expenses that relate to the same transaction or event should be
recognised simultaneously, but Electron oil sales result in revenue whilst purchases of
oil result in a tangible non-current asset. The current accounting practice seems to be
out of line with IFRS.

In the short term there is a bias towards a more immediate recognition of revenue
against a straight line cost deferral policy.
Power Station

Provision should be made for the removal of the power station because of the legal
obligation imposed by license for removal is unavoidable after the station was built.

The costs to be incurred will be treated as part of the cost of the facility to be
depreciated over its production life. However, the costs relating to the damage caused
by the generation of energy should not be included in the provision, until the power is
generated which in this case would be 5% of the total discounted provision.

$m $m
Present value of obligation at 1 July 2005 (15÷1.05) 14.3
Provision for decommissioning (95% x 14.3) 13.6
Provision for damage through extraction (5% x 14.3) 0.7

Power station (100 + 13.6) x 19/20 107.92

Decommisioning 13.6 x 1.05 14.28
For damage (0.7 / 20 yrs) 0.035

Operating Leases

To lessor, a lease is classified as a finance lease if it transfers substantially all the risks
and rewards of ownership to lessee. All other leases are classified as operating leases.

In this case, the beneficial and legal ownership remains with Electron and Electron
can make use of the power station if it so wishes.

Also for a lease asset to be a finance lease the present value of the minimum lease
payments should be substantially all of the fair value of the leased asset. In this case
this amounts to 57.1% ($40 million ÷ $70 million) which does not constitute
“substantially all”. Thus the lease is an operating lease.

Lease income from operating leases should be recognised on a straight line basis over
the lease term unless another systematic basis is more representative. The present
policy of recognising the total lease income as if it were immediate income would be
difficult to justify.

As regards the deposit received, revenue should only be recognised when there is
performance of the contract. Thus as there has been no performance under the
contract, no revenue should be accrued in the period.

Proposed dividend

The dividend was proposed after the year end. Therefore a liability arose only after
year end. No provision for the dividend should be recognised.

The approval by the directors and the shareholders are enough to create a valid
expectation that the payment will be made and give rise to an obligation. However,
this occurred after the current year end and, therefore, will be charged against the
profits for the year ending 30 June 2007.

The existence of a good record of dividend payments and an established dividend
policy does not create contractual obligation, which is required by financial
instruments. However, the proposed dividend will be disclosed in the notes to the
financial statements as the directors approved it prior to the authorisation of the
financial statements.

Share options

In share option grant, the fair value of option at grant date is recognised to profit or
loss over the vesting period as staff costs, and correspondingly credit to option

In this case, the company has granted to employees share options that vest in three
years’ time on the condition that they remain in the entity’s employ for that period.
These steps will be taken:

(i) the fair value of the options will be determined at the date on which they were

(ii) this fair value will be charged to the income statement equally over the three year
vesting period with adjustments made at each accounting date to reflect the best
estimate of the number of options that eventually will vest

$940,000 ($3 million x 94% x 1/3) will be charged in the profit or loss and to equity
at 30 June 2006.