Deloitte Guide IASs

DELOITTE TOUCHE TOHMATSU GUIDANCE
Q&A IAS 2: 6-1 — ACCOUNTING FOR PIPELINE FILL —

CLASSIFICATION
[Added 14 October 2005]
Background
Entity A operates a pipeline to transport crude oil. Entity A does not produce or
distribute crude oil; it merely provides the use of its pipeline to the buyer and seller
in a contract for a usage fee. The seller and buyer will independently determine the
sales price, and either the buyer or the seller will pay a fee to Entity A for
transporting the crude oil via its pipeline.
In order to be operational at all times, the pipeline must be full of crude oil;
therefore, Entity A purchases oil to fill the pipeline. When crude oil is pushed into the
pipeline at an entry point, it is then pushed out at the other end. When a seller of
crude oil pushes product into the line, the end customer receives different oil, albeit
of the same grade and quality.
Entity A charges a fixed rate for its transportation services, and literally swaps crude
oil at the entry point for crude oil at the exit point. In the course of transportation,
Entity A bears the risk of loss due to theft or line loss, up to the maximums allowed
under the contract. Losses such as these are rare and normally surround a pipeline
spill, which is covered by Entity A's insurance.
Question
How should Entity A classify the pipeline fill for accounting purposes?
Answer
The pipeline fill meets the definition of an asset and should be recognised at cost
when acquired. In accordance with paragraph 6 of IAS 16 Property, Plant and
Equipment, the pipeline fill does not meet the definition of property, plant and
equipment. Rather, it should be classified as inventories because it is held “in the
form of materials or supplies to be consumed in the production process or in the
rendering of services” and, therefore, satisfies the definition of inventories in IAS
2.6.
Because an accounting transaction does not take place at the time of each swap of
Confidential and Proprietary — for Use Solely by Authorised Personnel Only
This accounting manual provides comprehensive guidance; however, the manual does not address all possible fact
patterns and the guidance is subject to change. Consult a Deloitte Touche Tohmatsu professional regarding your
specific issues and questions.
Copyright© 2010 Deloitte Services Limited. All rights reserved.
crude oil, no step-up in the value of inventories is recognised. The pipeline fill is
measured at the lower of cost and net realisable value throughout the term of the
pipeline's operations in accordance with IAS 2.9.
See Q&A IAS 18: 12-2 for information on the revenue recognition aspects of this fact
pattern.
Q&A IAS 2: 6-2 — NET REALISABLE VALUE — COSTS TO SELL

Question
When estimating the net realisable value of inventories, how should the “costs
necessary to make the sale” be determined?
Answer
The costs necessary to make the sale should be determined in a manner consistent
with the definition of 'costs of disposal' in IAS 36 Impairment of Assets, which states
that these are “incremental costs directly attributable to the disposal of an asset . . .,
excluding finance costs and income tax expense”. An incremental cost is one which
would not be incurred if the activity was not undertaken. General overheads,
therefore, may not be allocated for the purposes of determining costs to sell. Direct
transaction costs must be allocated for the purposes of determining costs to sell.
Q&A IAS 2: 6-3 — RENUMBERED

[Renumbered to IAS 16: 6-5 on 9 July 2010]
Renumbered
Q&A IAS 2: 6-4 — CLASSIFICATION OF ASSETS ACQUIRED FOR SALE

IN THE ORDINARY COURSE OF BUSINESS
[Added 16 March 2007]
Background
Entity X, a lessor, leases assets ordinarily under three-year agreements. At the end
of the lease term, the lessee has the option either to return or to acquire the asset.
Some of the leases contain an extension option, which allows the lessee an
additional three months to return or acquire the asset. The extension option must be
exercised prior to the end of the main lease term.
Entity X enters into 'residual value guarantee' contracts with Entity A, a third party.
Under these contracts, Entity A will purchase the assets from Entity X at the end of
each lease term at a predetermined price. Entity A receives a fee in return for
providing the residual value guarantee.
When an extension option is exercised by the lessee, ownership of the asset is

transferred to Entity A at the end of the main lease term for the predetermined
price. During the extension period, Entity X passes the rental income to Entity A. At
the end of the extension period, Entity A sells the asset either in the market or to the
lessee. Rental income received by Entity A during the extension period is considered
incidental to Entity A's operating activities, which are providing residual value
guarantee contracts and selling the assets acquired.
Question
How should Entity A recognise the asset in the period from acquisition at the end of
the main lease term to the point of sale?
Answer
In order to determine the appropriate accounting in the period from acquisition at
the end of the main lease term to the point of sale, Entity A must establish how the
assets are used in the business, i.e. whether they represent inventories or property,
plant and equipment.
In the circumstances described, Entity A acquires the assets at the end of the main
lease term to profit from selling them in the market. In accordance with IAS 2, the
assets are classified as inventories because they are assets “held for sale in the
ordinary course of business”.
The assets acquired do not represent property, plant and equipment, in accordance
with IAS 16 Property, Plant and Equipment because they are not held primarily for
rental by Entity A to others and are not expected to be used during more than one
period.
Q&A IAS 2: 6-5 — INVENTORIES ON CONSIGNMENT

[Added 7 May 2010]

Background
In some industries it is common for a manufacturer to supply goods to a distributor

'on consignment'; the manufacturer retains the substantial risks and rewards of
ownership and legal title to the goods until some future predetermined event occurs
(e.g. sale to a third-party customer) which triggers transfer of the legal title to the
distributor.
Question
At what stage in the arrangement should the distributor (i.e. the buyer) recognise
inventories on consignment as an asset in its statement of financial position?
Answer
The distributor should recognise the goods as an asset only when the substantial
risks and rewards of ownership have been transferred. IAS 18 Revenue provides
specific guidance on consignment sales under which the recipient of the goods (the
buyer) undertakes to sell goods on behalf of the shipper (the seller) and requires
that revenue be “recognised by the shipper when the goods are sold by the recipient
to a third party” [paragraph 2(c) of IAS 18 IE Appendix]. Equally, the risks and
rewards of consignment inventories may not pass to the distributor until it has sold
the inventories to a third-party customer and the manufacturer (the seller) would
therefore not derecognise the inventories until that stage in the arrangement.
IFRSs do not provide any other guidance on accounting for consignment

arrangements and, therefore, in accordance with IAS 8 Accounting Policies, Changes
in Accounting Estimates and Errors, the distributor (the buyer) should determine the
accounting treatment for inventories on consignment so as to reflect the economic
substance of the arrangement, not merely its legal form. Until it is established that
the transfer to the distributor is substantive and that the risks and rewards of the
inventories have passed to the distributor, the goods should be treated as the
manufacturer's inventories and excluded from the distributor's statement of financial
position.
Q&A IAS 2: 10-1 — IS IT ACCEPTABLE TO INCLUDE EXCHANGE

DIFFERENCES IN THE COST OF INVENTORIES?
[Issued 14 May 2004]
Question
Is it acceptable to include exchange differences arising from the recent acquisition of
inventories invoiced in a foreign currency in the cost of purchase of those

inventories?
Answer
No. Although this matter is not addressed directly in the body of IAS 2, the
introduction to the Standard states that the capitalisation of such exchange
differences is not permitted. [IAS 2.IN10] Prior to the revision of IAS 21 The Effects
of Changes in Foreign Exchange Rates in 2003, that Standard had permitted
exchange differences to be captialised in very limited circumstances. Nonetheless,
that exception to the general rule has now been removed from IAS 21.
However, when the purchase of inventories in a foreign currency has been cash flow
hedged and the entity has a policy of basis adjusting, then the effective portion of
hedging gains and losses previously accumulated in equity can be included in the
amounts initially recognised for the inventories.
Q&A IAS 2: 10-2 — LEASE COSTS INCLUDED IN THE COST OF

INVENTORIES
[Added 4 April 2008]
Background
An entity enters into a 50-year lease of land with the intention of constructing a
building. The building will be sold together with any remaining lease interest over the
land and is, therefore, classified as inventories when construction commences.
Because of various required legal permits, construction begins in Year 6 of the lease
and is completed in Year 10.
Question
Should the operating lease payments for the land be included in the cost of
inventories?
Answer
Yes. IAS 2.10 states that the cost of inventories should include all costs of “bringing
the inventories to their present location and condition”. The operating lease cost of
the land is required to construct the building and is, therefore, a cost of bringing the
building to a condition in which it can be sold. However, only the operating lease
payments made during the period of construction (i.e. Years 6 to 10) shall be
capitalised. All operating lease payments made outside of this period must be
recognised in profit or loss in accordance with paragraph 33 of IAS 17 Leases.

Q&A IAS 2: 10-3 — DISTRIBUTION COSTS INCLUDED IN THE COST OF
INVENTORIES
[Added 23 May 2008]
Question
Is it acceptable to include in the cost of inventories the costs of distribution and
transportation associated with moving inventories to their present location or
condition for sale?
Answer
Costs of moving inventories to their intended point of sale may include the following:
• transportation of goods from the supplier;
• transportation or distribution at an intermediate stage in the production

process;
• transportation or distribution of inventories to a temporary storage location

(e.g. warehouse), including costs incurred for receiving, marking,
processing, picking and repackaging; and
• transportation or distribution of inventories from a warehouse or

distribution centre to the initial point of sale.
Costs incurred in transporting an item from a warehouse to its initial point of sale
should be included in the costs of inventories. However, costs associated with
moving inventories from one point of sale to another (e.g. transport of goods
between stores) should not be included in the cost of inventories because the goods
were already in a condition and location for sale before the move.
Q&A IAS 2: 11-1 — DISCOUNTS AND REBATES

Question
Entity A is granted a 10 per cent settlement discount by its main supplier on all
purchases of inventories settled within 30 days of purchase. How should the prompt
settlement discount be recognised by Entity A?

Answer
In accordance with IAS 2.11, rebates and discounts that have been received as a
reduction in the purchase price of inventories should be taken into consideration in
the measurement of the cost of those inventories. Rebates that specifically and
genuinely refund selling expenses should not be deducted from the cost of
inventories.
Entity A should deduct the prompt settlement discount from the cost of the
inventories. When measuring the cost of the inventories, the purchaser should
estimate the expected settlement discount to be received from the supplier.
This is consistent with the accounting by the supplier required by paragraph 10 of

IAS 18 Revenue, which states that a transaction should be measured “at the fair
value of the consideration received or receivable taking into account the amount of
any trade discounts and volume rebates allowed by the entity”. See also Q&A IAS
18: 10-1.
Note: IFRIC agenda rejection published in the August 2002 IFRIC Update.
Q&A IAS 2: 12-1 — IS IT ACCEPTABLE TO OMIT OVERHEADS FROM THE

COST OF INVENTORIES ON THE BASIS OF PRUDENCE?
Question
Is it acceptable to omit overheads from the cost of inventories on the basis of
prudence?
Answer
No. Such an approach (sometimes called 'direct costing') is not acceptable under IAS
2, which requires a systematic allocation of production overheads.
Q&A IAS 2: 12-2 — 'MARGINAL COSTING' APPROACHES TO

INVENTORY VALUATION
Question
Is it acceptable to use a 'marginal costing' approach to inventory valuation, whereby
only costs that vary directly with volume of output are included in the measurement
of inventories, and costs that accrue on a time basis (such as some overheads) are
excluded?
Answer
No. IAS 2.10 requires that “the cost of inventories shall comprise all costs of
purchase, costs of conversion and other costs incurred in bringing the inventories to
their present location and condition”. Furthermore, IAS 2.12 requires that the cost of
conversion should include a systematic allocation of fixed and variable production
overheads (fixed production overheads being the indirect costs of production that
remain relatively constant regardless of the volume of production).Therefore,
marginal costing approaches to inventory valuation are not acceptable because they
fail to allocate fixed production overheads.
Q&A IAS 2: 12-3 — BORROWING COSTS INCLUDED IN THE COST OF

INVENTORIES
[Added 14 May 2004]
Question
To what extent should borrowing costs be included in the cost of inventories?
Answer
The extent to which borrowing costs should be included in the cost of inventories is
determined on the basis of the requirement of IAS 23 Borrowing Costs.
IAS 23(2007).7 expressly states that “inventories that are manufactured, or

otherwise produced, over a short period of time, are not qualifying assets”. Only
inventories that take a 'substantial' period of time to get ready for their intended sale
or use can meet the definition of a qualifying asset. (See Q&A IAS 23(2007): 5-2 for
a discussion of what should be considered a 'substantial' period of time).
An example of circumstances when it is appropriate to include borrowing costs in the

cost of inventories is when the reporting entity holds maturing inventories (such as
whisky). The maturing period is a necessary part of the period of production and
borrowing costs incurred during that period are attributable to bringing the product
to its existing condition. Such borrowing costs are therefore appropriately included in
the cost of inventories under IAS 2.
IAS 23(as revised in 2007) (effective from 1 January 2009) introduced a new
optional scope exemption which allows an entity not to apply that Standard to
inventories that are manufactured, or otherwise produced, in large quantities on a
repetitive basis. The exemption is optional; therefore, an entity can choose, as a
matter of accounting policy, whether to apply the requirements of IAS 23(2007) to
borrowing costs that relate to inventories produced in large quantities on a repetitive
basis.
Q&A IAS 2: 12-4 — DELETED

[Deleted 11 June 2010]
Deleted
Q&A IAS 2: 12-5 — DIRECT MATERIALS AND WASTAGE

[Added 9 July 2010]
Question
When raw material is unavoidably subject to wastage and spoilage during
production, is it appropriate to include the cost of such normal wastage and spoilage
as part of the direct materials cost of the product?
Answer
Yes. It is generally appropriate to include the cost of such normal scrapping and
wastage as part of the material cost of the product. Alternatively, if more practicable,
the cost of direct materials unavoidably wasted or spoiled may be included in
overheads as part of the costs of conversion. It is not appropriate, however, to
include abnormal wastage in the carrying amount of inventories (see IAS 2.16(b)).
Q&A IAS 2: 12-6 — ALLOCATION OF OVERHEADS TO THE COST OF

INVENTORIES
[Added 9 July 2010]
Question
How should overheads be allocated to the cost of inventories?

Answer
IAS 2.12 requires that the costs of inventories should include "a systematic allocation
of fixed and variable production overheads that are incurred in converting materials
into finished goods".
Overheads that are properly classified as selling costs should not be included in the
cost of inventories.
Other non-production overheads should only be included when this is justified by

exceptional circumstances. When firm sales contracts have been entered into for the
provision of goods or services to customer specification, overheads (other than
selling costs) relating to design, incurred before manufacture, may be included in
arriving at cost.
The process for determining the amount of overheads to be carried forward in

inventories can be considered under two headings: (1) identifying the overheads to
be included and (2) allocating those overheads to production in a logical manner. It
is necessary first to analyse overheads by function between production, marketing
and distribution, and administration. There are practical problems in performing this
analysis. For example, management salaries may include an element of supervision
of production as well as of administration, and pension costs are likely to cover
employees in the production function as well as those in sales and general
administration departments. Central services departments, such as accounts, may
provide identifiable services for production. Costs should be allocated over the
functions on a reasonable basis, which should be consistently applied and reviewed
regularly.
The method for allocating overheads to production should be one that is appropriate
to the nature of the product and the method of production. The most popular
methods for allocating overheads are:
• by way of a labour-hour or machine-hour rate;
• in proportion to direct labour costs;
• in proportion to material costs;
• in proportion to prime costs; and
• equally to each unit of production. (This is only appropriate where a single

product is being produced in a given cost centre.)
Whichever method for allocating overheads is adopted, the overheads should be

allocated on the basis of the entity's normal level of activity. Overhead costs that are
the result of operating inefficiencies, such as abnormal idle capacity or abnormal
rectification work, should not be included in the inventory carrying amount.

Q&A IAS 2: 12-7 — TRANSFER PRICING
[Added 9 July 2010]
Question
When a manufacturing process involves the transfer of work from one department to
another, and the transfer is made at a price different from the cost incurred by the
transferring department, should the effect of any profit or loss recognised by the
transferring department be eliminated to determine the appropriate carrying amount
for inventories in the entity's statement of financial position?
Answer
Yes. Such transfer arrangements are common in manufacturing entities, either for
reasons of convenience in accounting or as part of the system of management
control. In the circumstances described, it is necessary for the purpose of
determining the cost of closing inventories to adjust the carrying amount to actual
cost, by eliminating any profits or losses arising at the transferring department level.
Q&A IAS 2: 15-1 — OTHER COSTS INCURRED IN BRINGING

INVENTORIES TO THEIR PRESENT LOCATION AND CONDITION
[Added 9 July 2010]
Background
Company A, which redevelops and sells real estate, purchases a disused petrol
station and obtains planning permission from the local authority to redevelop the site
for residential purposes. Planning permission is granted subject to the condition that
Company A will also develop a recreation amenity on an adjacent site owned by the
local authority.
Question
How should Company A account for the costs incurred in developing the recreation
amenity?
Answer
Company A should include the costs incurred in developing the adjacent recreation
amenity in the cost of its development property inventories. These costs meet the
definition of "costs incurred in bringing the inventories to their present location and
condition" because they were a necessary cost of redeveloping the disused petrol
station into a residential site.
Q&A IAS 2: 22 -1 — RETAIL METHOD FOR THE MEASUREMENT OF THE

COST OF INVENTORIES
[Added 9 July 2010]
Question
Under what circumstances is it acceptable to use the retail method for the
measurement of the cost of inventories?
Answer
IAS 2.22 states that the retail method is often used by retailers who sell a large
number of relatively homogeneous items with similar gross profit margins. The cost
of inventories is determined by deducting the average margin from the selling price
of the inventories. Such average margins take into account any reductions from the
original selling price of items due to sales or other promotions. When the retail
method is used, average margins are often determined on a departmental basis.
This method results in a valuation of inventories that approximates to average price

and is, therefore, acceptable subject to certain constraints. The method only works
satisfactorily for an entire department or shop if all of the lines held are expected to
generate similar profit margins. For example, the inventories of a newsagent and
confectioner normally include lines of widely differing profit margins; therefore, to
arrive at an acceptable inventory valuation using the retail method, it is necessary to
divide the inventories into categories according to the profit margin achieved. A
further problem with the retail method arises if the selling price on slow-moving
items has been marked down. If the normal gross profit percentage is then deducted
from such items, this will result in their being valued below cost, giving a result that
may well be excessively prudent and, therefore, unacceptable. It is, therefore,
necessary to ensure that the volume of marked-down items is insignificant or,
alternatively, they should be segregated and valued separately.
See Q&A IAS 2: 22-EX-1 for an illustration of the calculation of the cost of
inventories using the retail method.
Q&A IAS 2: 22-EX-1 — RETAIL METHOD FOR THE MEASUREMENT OF

THE COST OF INVENTORIES — EXAMPLE
[Added 9 July 2010]

Example
To convert closing inventories at retail value to closing inventories at cost, multiply

by the ratio of cost: retail price for the year as follows.
CU1,300,000 / CU2,000,000 = 65%
65% × CU500,000 = CU325,000 = closing value of inventories
Q&A IAS 2: 23-1 — CHANGE FROM ONE COST FORMULA TO ANOTHER

[Added 9 July 2010]
Background
A reporting entity decides to change from one cost formula to another (e.g. from the
weighted average formula to FIFO) on the basis that the latter is more widely used in
its particular industry and will therefore enhance comparability and provide more
relevant information.
Question
Does this change constitute a change in accounting policy or a change in estimate?
Answer
It is sometimes argued that changing from one cost formula to another merely
represents a change in estimate, in that it is a revision of the method of estimating
cost. On balance, however, it seems appropriate to treat this as a change of
accounting policy, for the following reasons.
• For inventories that are ordinarily interchangeable, IAS 2.24 states that a
specific identification approach is inappropriate. Accordingly, the use of
cost formulas is not merely a method of estimating the aggregate actual
cost of individual items, because otherwise a specific identification
approach would not be inappropriate, but would instead give the best
possible estimate. Rather, cost formulas are used to arrive at a different
figure that avoids the unacceptable distortions that would occur if a specific
identification approach were adopted.
• IAS 2.36(a) requires disclosure of the accounting policies used for

measuring inventories "including the cost formula used", which reinforces
the view that the cost formula selected is a matter of accounting policy.
Requirements and disclosures relating to changes in accounting policy are set out in
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Other changes to the way in which inventories are measured (e.g. any changes in
the basis for allocation of overheads or other costs of conversion to inventories) are
likely to be changes of estimate rather than matters of accounting policy. Under IAS
8.39, the effect of a change in estimate should be separately disclosed, where
material.
Q&A IAS 2: 27-EX-1 — WEIGHTED AVERAGE COST FORMULA —

EXAMPLE
[Added 9 July 2010]
Example
The weighted average cost formula assigns a value to each item of inventory based
on the weighted average of items in inventories at the beginning of the period and
the weighted average of items of inventories purchased or produced during the
period.
An entity had opening inventories of 15,000 units at a weighted average cost of CU4
per unit, and made the following purchases during the year.

Closing inventories are 20,000 units.
Under the weighted average formula, the number of units in closing inventories is
multiplied by the weighted average cost per unit for the year.
Therefore, the weighted average cost per unit for the year is calculated as follows.
CU382,000 / 90,000 = CU4.24
The value of closing inventories is CU4.24 × 20,000 = CU84,800.
Q&A IAS 2: 27-EX-2 — FIFO COST FORMULA — EXAMPLE

[Added 9 July 2010]
Example
The FIFO cost formula assumes that the items of inventory that were purchased or
produced first are sold first. Therefore, at the end of the period, the items in
inventory are valued using the prices for the most recent purchases.
An entity had opening inventories of 15,000 units, and made the following purchases
during the year.
Closing inventories are 20,000 units.
Under the FIFO formula, the first units held are the first units sold. Therefore, closing
inventories are valued at the cost per unit of the latest purchases.
Therefore, if 20,000 units are on hand at year end, the value of closing inventories is
calculated as follows.

Thus, closing inventories are valued at CU87,000.
Q&A IAS 2: 30-1 — SALES AFTER THE REPORTING PERIOD

[Added 9 July 2010]
Question
An item of inventory which cost CU100 is sold after the reporting period for CU80.
Should the sales price obtained from the sale of the goods after the end of the
reporting period be taken into consideration when measuring the inventories in the
statement of financial position at the end of the reporting period?
Answer
Generally, yes. A sale after the reporting period at a lower price generally provides
evidence of the net realisable value of inventories at the end of the reporting period
and the closing inventories should therefore be measured at CU80 less any costs to
sell.
However, this will not always be the case. If, for example, further investigation
shows that the decrease in sales price arose because of damage to the inventories
that occurred after the reporting period, this would indicate that the CU80 sales price
did not reflect conditions existing at the end of the reporting period and that the loss
in value should not be recognised until the next period. In these circumstances, it
would be necessary to assess whether the item could have been sold undamaged for
an amount at or in excess of its cost (CU100) less any costs to sell. If so, no
write-down of inventories would be required.
Q&A IAS 2: 30-2 — NET REALISABLE VALUE FOR INVENTORIES

UNDER DEVELOPMENT
[Added 23 July 2010]
Background
Entity P is a property developer. It is preparing its financial statements for the year
ended 31 December 20X0, which will be authorised on 31 March 20X1.
At 31 December 20X0, Entity P holds a property as development work in progress.

Costs incurred to date are CU20 million. Estimated costs to complete are CU10
million (therefore, total costs will be CU30 million). Completion and sale of the
development are expected within 18–24 months.
Entity P estimates net realisable value (NRV) for developments work in progress
based on the projected sales price for the property when it is complete, discounted
back to current value. Based on market information on sales prices for similar,
finished properties at 31 December 20X0, NRV is estimated at CU32 million (implying
a net development profit of CU2 million).
However, property prices in the relevant market are falling. At 31 March 20X1 (date
of authorisation of financial statements), the observed sales prices for similar,
finished properties have declined to CU27 million (implying a net development loss of
CU3 million). Estimated costs to complete (and other applicable factors) are
unchanged since year end.
Question
Should Entity P recognise an inventory write-down in its 31 December 20X0 financial
statements?
Answer
Yes. The development property is not available for sale at the year end. IAS 2.30
acknowledges that “fluctuations of price or cost directly relating to events occurring
after the end of the period” are relevant to NRV estimates “to the extent that such
events confirm conditions existing at the end of the period”. Because Entity P
estimates NRV based on projected sales prices of completed property, discounted
back to current value, information received after the end of the reporting period
(including revised sales price estimates) provides further evidence as to conditions
that existed at the end of the reporting period, unless the changes in sales prices
clearly relate to a separate event subsequent to the period end.
Q&A IAS 7: 6-1 — MEANING OF "DEMAND DEPOSITS"

[Issued 25 July 2003]
Question
IAS 7.6 states that cash comprises “cash on hand and demand deposits”. What are
“demand deposits”? Are they restricted to deposits with banks or financial
institutions?
Answer
The term 'demand deposits' is not defined in IAS 7 but the term may be taken to
refer to deposits where the reporting entity can withdraw cash without giving notice
and without suffering any penalty. A seven-day call deposit would therefore not
qualify as cash, because seven days notice of withdrawal is required. The deposit
could, however, be reported as a cash equivalent.
Similarly, if an entity has an account with its bank under which the entity has to give
90 days notice to the bank before it can withdraw any money, the account does not
meet the definition of cash (because it is not a demand deposit). However, only 90
days notice is required and, therefore, it may meet the definition of cash equivalents.
The term is not restricted to deposits with banks or financial institutions. Therefore,
deposits placed with other corporate entities to which the reporting entity has
immediate access may meet the definition of cash under IAS 7.
Q&A IAS 7: 6-2 — MINIMUM AVERAGE CASH BALANCE

Background
Some entities have banking arrangements that require them to maintain a minimum
average cash balance over a specified period instead of a constant minimum balance
at the end of each day. It is therefore possible to have balances below the threshold
for certain days provided that the average balance over the period is in excess of the
minimum requirement.
Question
Do such cash balances meet the definition of cash for the purposes of IAS 7?
Answer
For such arrangements, it is necessary to consider whether the balance can be
withdrawn on demand, in a manner similar to demand deposits (see Q&A IAS 7:
6-1); i.e. can the entity withdraw cash without giving any notice and without
suffering any penalty? If these criteria are met, the cash balances will meet the
definition of cash in IAS 7.

Q&A IAS 7: 7-1 — CLASSIFICATION OF A TWO-YEAR BOND PURCHASED
THREE MONTHS BEFORE MATURITY
Background
An entity purchases a two-year bond in the market when the bond only has three
months remaining before its redemption date.
Question
Does the bond qualify as a cash equivalent under IAS 7?
Answer
Yes. IAS 7.7 clarifies that an investment normally qualifies as a cash equivalent
when it has a maturity of three months or less from the date of acquisition.
Assuming that (1) there are no other factors that would subject the instrument to a
significant risk of change in value, and (2) the underlying purpose of holding the
bond is to meet short-term cash commitments (rather than for investment or other
purposes as required by IAS 7.7 (see Q&A IAS 7: 7-3)), the bond can be classified as
a cash equivalent.
Q&A IAS 7: 7-2 — CLASSIFICATION OF A TWO-YEAR BOND

PURCHASED FOUR MONTHS BEFORE MATURITY
Background
An entity purchases a two-year bond in the market when the bond only has four
months remaining before maturity.
Question
Answer
The bond would only qualify in very exceptional circumstances. IAS 7 implicitly
suggests that only in unusual cases will investments with more than three months to
maturity nevertheless be free from significant risk of changes in value (arising, for
example, from changes in interest rates).
The definition of cash equivalents includes the requirement that they be held for the
'short-term'. In order to qualify as such, IAS 7 states that the investment will
normally have a maturity of three months or less from the date of acquisition (IAS
7.7). Therefore, the requirement for a three-month maturity is not part of the
definition, but will nevertheless be a presumption except in very exceptional
circumstances.
The entity could not classify the bond as a cash equivalent either at the date of
purchase or once it has less than three months remaining to maturity (unless it could
justify a departure from the three-month guideline, in which case the instrument
would be classified as a cash equivalent throughout the entire four months).
The three month limit may appear somewhat arbitrary, but the intention is to
promote consistency between entities.
Q&A IAS 7: 7-3 — CLASSIFICATION OF A BOND ACQUIRED WITHIN

THREE MONTHS OF MATURITY FOR INVESTMENT PURPOSES
Background
An entity purchases a two-year bond in the market when the bond only has two
months remaining before its redemption date. The purchase is made for investment
purposes.
Question
Answer
No.
IAS 7.7 explains that cash equivalents are held for the purpose of meeting
short-term cash commitments rather than for investment or other purposes.
Therefore, in order to determine whether a particular investment qualifies for
classification as a cash equivalent, it is necessary to look at the purpose for which it
is held. Even though the investment may meet the definition of a cash equivalent set
out in IAS 7.6, unless it is held for the purpose of meeting short-term cash
commitments, it will not be classified as a cash equivalent.

Q&A IAS 7: 7-4 — REPURCHASE AGREEMENTS AS CASH EQUIVALENTS
Background
An entity invests excess funds in short-term repurchase agreements with a term of

two months. The underlying debt securities involved in the transaction have
maturities in excess of three months.
Question
Should these repurchase agreements be classified as cash equivalents?
Answer
Yes. The critical factor is the maturity of the repurchase agreements themselves, not
the underlying debt securities.
IAS 7.6 defines cash equivalents as “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”.
IAS 7.7 clarifies that an investment normally qualifies as a cash equivalent when it
has a maturity of three months or less from the date of acquisition.
These repurchase agreements will be classified as cash equivalents provided that (1)
there are no other factors that would subject the instruments to a significant risk of
change in value, and (2) the underlying purpose of holding the repurchase
agreements is to meet short-term cash commitments.
Q&A IAS 7: 7-5 — DETERMINATION OF CASH EQUIVALENTS — UNITS

OF MONEY MARKET FUNDS
[Added 22 January 2010]
Question
Can investments in shares or units of money market funds1 that are redeemable at
any time be classified as cash equivalents?

Answer
It depends. IAS 7.7 specifies that equity investments (such as shares in investment
funds) are excluded from cash equivalents unless they are, in substance, cash
equivalents (e.g. preferred shares acquired within a short period of their maturity
and with a specified redemption date).
IAS 7.7 states that “[c]ash equivalents are held for the purpose of meeting
short-term cash commitments”. In this context, the critical criteria in the definition of
cash equivalents set out in IAS 7.6 are the requirements that cash equivalents be
“readily convertible to known amounts of cash” and “subject to insignificant risk of
changes in value”.
The first criterion means that the investment must be readily convertible to cash
(e.g. through redemption with the fund). The amount of cash that will be received
must be known at the time of the initial investment (e.g. on the basis of a constant
CU1.00 net asset value per unit); the units of money market funds cannot be
considered cash equivalents simply because they can be converted to cash at any
time at the then prevailing market price in an active market.
The second criterion means that an entity needs to assess the risk of future changes
in value at the time of initial investment, and must be satisfied that the risk is
insignificant. This can be determined through consideration of the fund's investment
rules or by establishing the nature of the underlying investments.
Note: IFRIC agenda decision published in the July 2009 IFRIC Update.
1 Money market funds are open-ended mutual funds that invest in short-term debt
instruments such as treasury bills, certificates of deposits and commercial paper. As the
main purpose of the investment is the preservation of principal, with modest dividends, the
net asset value of such an investment remains fairly constant.
Q&A IAS 7: 8-1 — INCLUSION OF BANK OVERDRAFTS WITHIN CASH

EQUIVALENTS
Question
Should bank overdrafts always be classified as cash equivalents?

Answer
No. The definition of cash equivalents makes no reference to the inclusion of bank
borrowings. IAS 7.8 acknowledges, however, that bank overdrafts repayable on
demand may form an integral part of an entity's cash management, in which case
they should be included as a component of cash equivalents. A characteristic of such
banking arrangements is that the bank balance often fluctuates from being positive
to overdrawn.
IAS 7 does not therefore mandate the inclusion of bank overdrafts in cash
equivalents in all circumstances. But it does require their inclusion when the bank
overdraft forms an integral part of the entity's cash management. IAS 7.8 also
emphasises that bank borrowings are generally considered to be financing activities.
Therefore, the Standard does not allow for other short-term loans (e.g. short-term
bank loans, advances from factors or similar credit arrangements, credit import
loans, trust receipt loans) to be classified as cash equivalents because they are
financing in nature.
Q&A IAS 7: 9-1 — PRESENTATION OF MOVEMENTS BETWEEN

COMPONENTS OF CASH AND CASH EQUIVALENTS
Question
An entity uses cash to purchase a short-term investment meeting the definition of a
cash equivalent. Is that purchase shown in the statement of cash flows?
Answer
No. IAS 7.9 states that “[c]ash flows exclude movements between items that
constitute cash or cash equivalents because these components are part of the cash
management of an entity rather than part of its operating, investing and financing
activities. Cash management includes the investment of excess cash in cash
equivalents”.
Q&A IAS 7: 10-1 — HEADINGS FOR STATEMENTS OF CASH FLOWS

Background
IAS 7.10 and 7.11 require cash flows to be presented in the statement of cash flows
under three standard headings ('operating', 'investing' and 'financing') in the most
appropriate manner for the entity's business.
Question
Does this mean that the headings cannot be tailored to the entity's individual
circumstances?
Answer
Yes. Unlike IFRS requirements for other financial statements (e.g. statement of
financial position and statement of comprehensive income), the headings for the
statement of cash flows are standard and should not be altered to suit individual
circumstances (unless, very exceptionally, the use of the standard wording is likely
to mislead readers of the financial statements). There are no requirements, however,
that would prevent further sub-classifications or analyses appropriate for the entity's
business being shown within these three headings in the statement of cash flows.
Q&A IAS 7: 16-1 — SALE AND LEASEBACK TRANSACTIONS

Question
How should the sales proceeds from a sale and leaseback transaction be reported in
the statement of cash flows?
Answer
For some sale and leaseback arrangements, the substance of the arrangements is
that the asset is not 'sold' but that the lessor makes a loan to the lessee (i.e. a sale
and finance leaseback) with the asset as security. From an accounting perspective,
the entity has not disposed of the asset. In this case, the receipt from the 'sale' of
the asset should be included as a financing cash flow rather than an investing cash
flow. This treatment is consistent with that in the statement of comprehensive
income and the statement of financial position.
In contrast, when the substance of the transaction is that the asset is sold and then
an operating lease is put in place, the receipt from the disposal of the asset will be
included as an investing cash flow.
Q&A IAS 7: 17-1 — CASH FLOWS ARISING FROM SHARES ISSUED BY A

SUBSIDIARY
[Amended 16 July 2010]
Background
IAS 7.17(a) states that cash proceeds from issuing shares should be classified as
financing activities. IAS 7.39 states that cash flows arising as a result of a
transaction, event or change in circumstances when control of a subsidiary is lost
should be classified as investing activities.
Question
How should the cash flows arising from a rights issue by a partly-owned subsidiary
be reflected in the statement of cash flows in the following two situations:
i. shares of a subsidiary are issued on a pro-rata basis to its parent and

minority shareholders; and
ii. shares are issued only to minority shareholders?
Answer
i. In the subsidiary's own statement of cash flows, the entire proceeds from the
rights issue should be shown under financing activities because they clearly
represent a cash inflow from issuing shares. In the consolidated statementof cash
flows, when shares are issued to the parent and minority shareholders on a pro-rata
basis such that the percentage interest held by the group is not changed, the cash
received from issuing shares to the parent will be eliminated on consolidation,
leaving the receipt from the minority shareholders as a cash inflow to the group.
Because there is no change in the group's interest in the subsidiary, this cash flow is
also financing in nature, and should be classified as such in the consolidated
statement of cash flows.
ii. The treatment in the subsidiary's own statement of cash flows is the same as that
described under (i) above. From the group perspective, although the minority
shareholders have injected new funds into the subsidiary, the issue of shares outside
the group gives rise to a reduction in the group's interest in the subsidiary. The
presentation in the consolidated statement of cash flows will depend on whether
control has been lost as a result of that reduction. When the transaction has resulted
in a loss of control, the cash flows will be classified as investing activities in
accordance with IAS 7.39. When control remains with the parent, following the
adoption of IAS 27(2008) Consolidated and Separate Financial Statements the
transaction is considered an equity transaction and the cash flows are classified as
financing in accordance with IAS 7.42A. Previously, in the absence of guidance within
IAS 7, entities may have classified such cash flows as investing, in which case that
treatment will need to be amended upon adoption of IAS 27(2008).

Q&A IAS 7: 17-EX-1 — CLASSIFICATION OF FINANCE LEASE PAYMENTS
— EXAMPLE
Example
An entity makes a payment of CU100,000 under a finance lease. In its financial
statements, it allocates CU20,000 to interest and CU80,000 as a repayment of loan
capital.
In its statement of cash flows, CU80,000 will be classified as a financing cash flow
and CU20,000 will be classified according to the entity's general classification for
interest.
Q&A IAS 7: 18-1 — INDIRECT METHOD — PRESENTATION OF

ADJUSTMENTS TO PROFIT OR LOSS
[Amended 30 June 2006]
Background
The indirect method starts with the profit or loss and adjusts it for:
• any non-cash items included in its calculation (such as depreciation or

movements in provisions);
• any cash flows in the period that were reported in the profit or loss of any
earlier period or will be reported in profit or loss of a future period (e.g.
operating accruals and prepayments, settlement of a liability for
restructuring costs accrued in the prior period); and
• any items of income and expense that are related to investing or financing
cash flows.
Question
Should these adjustments be presented in the statement of cash flows or in a
supporting note?
Answer

IAS 7 is not explicit as to whether these adjustments should be presented in the
statement of cash flows or in a supporting note. The illustrative example in Appendix
A to IAS 7 shows them in the statement of cash flows and, therefore, this is the
preferred presentation. It is the most common presentation used by entities applying
IAS 7, and is also the presentation used in the IFRS illustrative financial statements
published by the IASB. However, presentation of the adjustments in the notes is
generally acceptable.
Q&As IAS 7: 18-EX-1 and 18-EX-2 — PRESENTATION OF ADJUSTMENTS

FROM PROFIT TO OPERATING CASH FLOWS — EXAMPLE
IAS 7: 18-EX-1
Example
This approach starts with the 'profit for the year' presented in the statement of
comprehensive income (see Q&A IAS 7: 18-1).
IAS 7: 18-EX-2
Example
This approach aggregates the operating profit presented in the statement of
comprehensive income and the operating profit from discontinued operations (see
Q&A IAS 7: 18-1).
Q&A IAS 7: 18-2 — APPROPRIATE STARTING POINT FOR STATEMENT

OF CASH FLOWS — INDIRECT METHOD
[Added 30 June 2006]
Question
When using the indirect method of presentation for operating cash flows, IAS
7.18(b) requires that “profit or loss” be adjusted for (1) the effects of transactions of
a non-cash nature, (2) any deferrals or accruals of past or future operating cash
receipts or payments and (3) items of income or expense associated with investing
or financing cash flows. Which “profit or loss” is the appropriate starting point for the
presentation of these adjustments?
Answer
The illustrative example in Appendix A to IAS 7 starts with “profit before taxation”,
and, accordingly, this is the preferred presentation.
Entities that choose to present an operating result in the statement of

comprehensive income (or in a separate income statement, where applicable) may,
however, wish to use that operating result as the starting point for the presentation
of adjustments. Unless the entity has a discontinued operation (see below), the
items presented between operating result and profit/loss before taxation are
generally non-operating cash flows (share of results of associates, interest paid,
etc.). Where this is the case, rather than using profit/loss before taxation as the
starting point, and subsequently adjusting for all of the items between that amount
and the operating result, it is generally acceptable to use the operating result as the
starting point. SEC registrants should note, however, that this presentation is
unlikely to be acceptable to the SEC staff.
Where an entity has a discontinued operation, the results of which are presented
under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, the
“profit before tax” presented in the statement of comprehensive income (or separate
income statement) relates only to continuing operations. In these circumstances, we
believe that there is more than one way in which the requirements of IAS 7.18(b)
can be met.
The first approach, which is the preferred approach, is to start with the “profit for the
year” as presented in the statement of comprehensive income (or separate income
statement) under paragraph 82(f) of IAS 1 Presentation of Financial Statements.
This includes both continuing and discontinued operations. The amount can then be
adjusted for the items required under IAS 7.18(b). The advantage of this approach is
that it results in a very clear link between the amounts presented in the statement of
comprehensive income (or separate income statement), and the amounts presented
in the statement of cash flows. The disadvantage is that it can result in a long list of
adjustments being presented in the statement of cash flows.
Another solution, for entities presenting an operating result, would be to start with
an operating figure presented in the statement of comprehensive income (or
separate income statement) (i.e. the operating profit from continuing operations)
and to add to this the operating profit from discontinued operations, to arrive at an
operating profit for the reporting entity as a whole. As discussed above, this would
reduce the number of adjustments presented in the statement of cash flows. The
disadvantage is that it is not so easily linked to the amounts presented in the
statement of comprehensive income (or separate income statement).
Q&A IAS 7: 18-3 — CASH FLOWS TO BE CLASSIFIED AS 'OPERATING'

Question
Which cash flows should be classified as 'operating' in the statement of cash flows?
Answer
'Operating' is the residual category for the purpose of presenting cash flows. If a
cash flow does not fall within the scope of investing or financing activities, then it will

be classified as operating.
Examples of cash flows from operating activities are:
• cash received in the year from customers (in respect of sales of goods or
services rendered either in the year, or in an earlier year, or received in
advance in respect of the sale of goods or services to be rendered in a later
year);
• cash payments in the year to suppliers (for raw materials or goods for
resale whether supplied in the current year, or an earlier year, or to be
supplied in a later year);
• the payment of wages and salaries to employees;
• tax and other payments on behalf of employees;
• the payment of rent on property used in the business operations;
• royalties received in the year;
• cash receipts and cash payments of an insurance entity for premiums and
claims, annuities and other policy benefits;
• the payment of insurance premiums;
• cash payments or refunds of income taxes that cannot be specifically

identified with financing or investing activities;
• cash flows arising from futures contracts, forward contracts, option

contracts or swap contracts hedging a transaction that is itself classified as
operating; and
• cash flows arising from the purchase and sale of securities and loans held
for dealing or trading purposes.
Entities are permitted to choose how they present interest and dividends paid and
received, and they may choose to present them as operating in some circumstances
(see IAS 7.31–7.34).
Q&A IAS 7: 21-1 — FACTORING

Question
How should cash flows from the factoring of receivables be classified in the

statement of cash flows?
Answer
IAS 7 does not provide guidance on the treatment of factored receivables in a
statement of cash flows. When receivables are factored without recourse in
circumstances qualifying for derecognition of the receivables, no particular problems
arise. The receipt of the proceeds from the factor will simply be treated as an
operating cash flow, just as if it had been received directly from the customer. When
receivables are factored with recourse, however, and the advances from factors are
treated as financing creditors in the statement of financial position, the appropriate
treatment is less clear.
IAS 7 requires cash flows to be analysed under the standard headings according to
the substance of the underlying transactions. Where factoring is viewed as being, in
substance, a financing transaction, it might be argued that all of the cash flows
received from the factor should be viewed as financing cash inflows. This would be
consistent with the treatment of finance leases prescribed by IAS 7, where entering
into the lease is viewed as a non-cash transaction and so does not appear in the
statement of cash flows. The capital elements of the lease payments then appear as
a financing outflow. This could be argued as leading to an overstatement of financing
outflows, and an understatement of the investing outflows. But the treatment for
finance leases is specifically required by IAS 7 and is well established.
It could be argued that a similar principle should be applied to factored receivables.

The distortion would be more significant, however, and potentially the entity would
have no operating cash inflows at all if all of its receivables were factored. It appears
questionable whether showing all of an entity's sales revenue as cash flows from
financing could be said to give a true and fair view of its cash flows. Also,
importantly, the treatment of factored receivables is not addressed in IAS 7, whereas
the treatment of leases is addressed.
If it is concluded that the receipts from the factor should be viewed as operating
cash flows rather than financing cash flows (because they are, in substance, the
receipts from trade customers), there is a second question to be addressed. This is
whether all of the cash flows should be shown as operating or the movement on the
financing creditor should be treated as a financing cash flow. The preferred
treatment is to show the movement as a financing cash flow because this results in
operating cash flows including the cash flows from the customers as if the factoring
had not been entered into. It also results in financing cash flows as if the receivables
had been financed by a loan. Finally, it also reflects the IAS 7 definition of financing
activities as those “that result in changes in the size and composition
of…borrowings”.
Due to lack of clarity in IAS 7 as to the appropriate treatment of such transactions, it

is important that the policy adopted is clearly explained.

Q&A IAS 7: 25-1 — FOREIGN CURRENCY CASH FLOWS
Background
An entity, whose functional currency is £ Sterling, buys an item of equipment for

US$100,000. It recognises the purchase in its accounting records on the date of
delivery of the equipment. The rate of exchange on that date (US$2 to £1) results in
the equipment being recognised at £50,000. The invoice for the equipment is settled
by bank transfer 30 days later, at which date £55,000 is needed to settle the
liability. The exchange difference of £5,000 is recognised in profit or loss.
Question
How should this transaction be presented in the statement of cash flows?
Answer
The purchase of the equipment should be presented in the statement of cash flows
as an investing cash outflow of £55,000. Therefore, if the operating cash flows are
shown using the indirect method, one of the adjustments to net profit will be to
adjust for the exchange difference of £5,000.
If the item purchased had been goods for resale, then the cash flow for the purchase
should have been reported in operating (not investing) cash flows. Under the
requirements of IAS 7, a cash outflow of £55,000 would have been included in the
operating cash flows section of the statement of cash flows in respect of the
purchase. In the statement of comprehensive income, the cost of the goods
recognised at £50,000, would have been included in purchases and the exchange
difference of £5,000 would have been recognised in arriving at profit for the year.
Therefore, the full £55,000 would have been recognised in the statement of
comprehensive income in arriving at the net profit for the year. Consequently, if the
operating cash flows are shown using the indirect method, there will be no need to
adjust for the exchange difference of £5,000.
Q&A IAS 7: 32-1 — RESERVED

[Reserved 25 July 2008]
Reserved

Q&A IAS 7: 33-1 — INVESTMENTS IN DEBT SECURITIES ACQUIRED AT
A DISCOUNT OR A PREMIUM
Question
If an entity invests in debt securities at a discount or a premium (e.g. zero-coupon
bonds), how should the cash flows arising from such securities be classified?
Answer
At acquisition, the cash paid is classified as an investing cash flow. The excess of the
amounts received (during the life of the instrument and on maturity) over the
amount of the original investment should be reported as a cash inflow, classified in
the same way as interest received.
Q&A IAS 7: 33-2 — DEBT SECURITIES ISSUED AT A DISCOUNT OR A

PREMIUM
Question
If an entity issues debt securities at a discount or a premium (e.g. zero-coupon debt
securities), how should the cash flows from such securities by classified?
Answer
The proceeds received from issuing the debt securities should be classified as a
financing cash inflow. The excess of the amounts paid out (during the life of the
instrument and at maturity) over the amount received when the debt securities were
issued should be reported as a cash outflow, classified in the same way as interest
paid.
For complex instruments, such as zero-coupon debt securities, it is important not to

confuse principal amounts of finance with the nominal amounts of the instruments
concerned. The principal amount of a financing arrangement is the amount borrowed
at the beginning of the arrangement. It is not necessarily the same as any amount
shown as the nominal amount of the financial instrument. This distinction is
necessary to ensure that cash flows relating to finance costs are appropriately

classified.
See Q&A IAS 7: 33-EX-1 for an illustration of the approach described above.
Q&A IAS 7: 33-3 — SHARES CLASSIFIED AS LIABILITIES

Question
When instruments that are legally shares (e.g. certain preference shares) are
classified as financial liabilities under IAS 32 Financial Instruments: Presentation,
how should the cash flows relating to the dividends paid on those instruments be
classified in the statement of cash flows?
Answer
IAS 7.33–34 set out considerations for the classification of interest and dividends
and allow entities a number of alternatives. The only absolute requirements are that
interest and dividends received and paid should each be disclosed separately, and
that each should be classified in a consistent manner from period to period as either
operating, investing or financing activities.
When instruments that are legally shares are classified as financial liabilities under
IAS 32, the dividends paid on those shares will be presented as part of the interest
expense in the statement of comprehensive income. It follows that, in the statement
of cash flows, the dividends paid on such shares should similarly be presented as
interest paid and not as dividends and, therefore, should be classified consistently
with other interest payable.
Q&A IAS 7: 33-4 — TREASURY SHARES

Question
How should the cash flows relating to the acquisition of treasury shares be classified
in the statement of cash flows?
Answer
In accordance with paragraph 33 of IAS 32 Financial Instruments: Presentation, the
acquisition by an entity of its own equity instruments represents a transaction with
owners (who have given up their equity interest) rather than a gain or loss to the
entity and, accordingly, any consideration paid is recognised as a deduction in
equity. When consideration paid is in the form as cash, the associated cash flows
should be classified as cash flows from financing activities.
Q&A IAS 7: 33-EX-1 — ZERO-COUPON BOND ISSUED AT A DISCOUNT —

EXAMPLE
Example
An entity receives CU100,000 on 1 January 20X1, when it issues a zero-coupon
bond. On 31 December 20X5, it redeems the bond by paying cash of CU140,255 to
the bondholder. In its statements of comprehensive income for the five years ended
31 December 20X5, the entity classifies the CU40,255 as interest expense.
In its statement of cash flows for the year ended 31 December 20X5, CU100,000 is
classified as a financing cash flow and CU40,255 is classified according to the entity's
general classification for interest.
Q&A IAS 7: 35-1 — CLASSIFICATION OF TAX CASH FLOW RELATING TO

SHARE-BASED PAYMENT ARRANGEMENTS
Background
Entity A has an equity-settled share-based payment arrangement. The tax deduction

available under local tax laws in respect of the arrangement is greater than the
cumulative expense recognised under IFRS 2 Share-based Payment.
Paragraph 68C of IAS 12 Income Taxes states that “[i]f the amount of the tax
deduction (or estimated future tax deduction) [relating to remuneration paid in
shares, share options, or other equity instruments of the entity] exceeds the amount
of the related cumulative remuneration expense, this indicates that the tax deduction
relates not only to remuneration expense but also to an equity item. In this
situation, the excess of the associated current or deferred tax should be recognised
directly in equity”.
Question
In these circumstances, should the tax cash flow representing the 'excess tax
deduction' recognised in equity be classified as an operating or a financing cash flow?
Answer
IAS 7.35 requires that, unless they can be specifically identified with financing or
investing activities, cash flows arising from taxes on income should be classified as
operating cash flows.
Clearly, transactions of all types may have tax consequences. Identifying whether
each amount of income or expense included in the tax computation derives from
operating, investing or financing activities is a relatively simple task. Identifying the
cash flows, however, is not always so easy. For example, in the circumstances
described, when tax cash flows are paid net, there will generally not be a separate
cash inflow relating to the tax deduction for the share-based payment arrangement;
rather, the deduction will be reflected in a reduced cash outflow for taxes payable.
IAS 7.36 points out that, because it is often impracticable to identify tax cash flows
in respect of investing and financing activities, and because such cash flows often
arise in a different period from the cash flows of the underlying transaction, taxes
paid should generally be classified as cash flows from operating activities.
In the majority of cases, there will not be a specific cash flow identified with the tax
deduction for the share-based payment arrangement and, therefore, the taxes paid
will be classified as cash flows from operating activities. In the rare circumstances
when a specific cash flow can be identified, following the logic in IAS 12.68C, the
cash flow relating to the 'excess' tax deduction may be considered to relate to the
issue of equity (i.e. it may be classified as a financing cash flow), or it may be
considered to relate to employee services (i.e. it may be classified as an operating
cash flow). An entity should determine the appropriate classification as a matter of
accounting policy and apply the policy consistently.

Deleted
Q&A IAS 7: 39-1 — LOSS OF CONTROL AS A RESULT OF SHARES

ISSUED BY A SUBSIDIARY

Background
Company P enters into a joint venture agreement with Company Q, under which
Company Q acquires a 50 per cent interest in Company R, formerly a wholly-owned
subsidiary of Company P. Company R, which issues new shares to Company Q for
cash, has a bank overdraft of CU250,000 at the date that it ceases to be a subsidiary
of Company P.
Question
How should the change in status from a subsidiary to a jointly controlled entity be
reflected in the consolidated statement of cash flows, assuming that Company R is
accounted for using the equity method of accounting?
Answer
Although Company P retains a 50 per cent interest, Company R is no longer part of
the group, and its cash flows will no longer be consolidated. Under IAS 7.39, when a
transaction results in the loss of control of a subsidiary, the amount to be shown
under investing activities comprises cash and cash equivalents received as
consideration plus or minus any cash or cash equivalents transferred. In this case,
because the shares were issued directly to Company Q by Company R, Company P
receives no disposal proceeds. Therefore, the only amount to be presented in the
consolidated statement of cash flows is an investing cash inflow of CU250,000,
representing the balance on the subsidiary's overdraft at the date it ceases to be a
subsidiary.
Q&A IAS 7: 39-2 — CASH FLOWS ARISING SUBSEQUENT TO AN

ACQUISITION
Background
Cash flows relating to an acquisition may arise subsequent to the acquisition.

Examples of cash outflows include the payment of deferred and contingent
consideration. Examples of cash inflows include the receipt of proceeds of a warranty
claim or in respect of an indemnification asset.
Question
How should these cash flows be classified in the statement of cash flows?
Answer

IAS 7 provides no explicit guidance on the treatment of such items.
• Consideration payable shortly after the acquisition date
When consideration is payable shortly after the acquisition date, so that no

adjustment is necessary for the effects of discounting, the cash outflow will
be classified as investing. This is because there is no significant financing
element and the payment clearly represents the cost of making the
acquisition.
• Deferred consideration
In the case of deferred consideration, both the principal and any interest
element could be presented as financing cash flows on the basis that the
payments represent the servicing and settlement of a financing liability
recognised on the acquisition. This approach is consistent with IFRS
3(2008) Business Combinations, which requires the discounting of deferred
consideration. It is also consistent with the treatment of finance leases
under IAS 17 Leases, where the inception of the lease is treated as a
non-cash transaction so that the cash cost of acquiring the asset is
recognised in financing cash flows over the lease term.
• Contingent consideration
In the case of contingent consideration, under IFRS 3(2008) it is only the

acquisition-date fair value of contingent consideration that is recognised as
part of the consideration transferred in exchange for the acquiree (and,
consequently, affects goodwill). Changes in the fair value of contingent
consideration that do not relate to facts and circumstances that existed at
the acquisition date, but result from events after that date, do not adjust
goodwill. When contingent consideration is not equity, changes in its fair
value will be recognised in profit or loss, consistent with changes in
measurement for any financial liability or IAS 37 Provisions, Contingent
Liabilities and Contingent Assets liability. Since these changes are not
treated as a cost of the acquisition, and do not adjust goodwill, the
payment of contingent consideration could be presented as a financing
cash flow.
• Warranties
Warranties may be received from the seller regarding the value and
condition of the assets of the acquiree and its business, and are often short
term in nature. For example, the seller may warrant that, at the acquisition
date, there will be at least a specified level of working capital within the
business, with a warranty payment becoming due to the extent that the
actual level of working capital turns out to be lower. When a warranty
payment is determined based on the facts and circumstances that existed
at the acquisition date, any receipt by the acquirer is, in substance, an
adjustment to the consideration paid for the acquisition (and,
consequently, gives rise to a reduction in goodwill). Generally, such a
payment will be made shortly after the acquisition date and will not include
any significant financing element, in which case it should be shown as an
investing cash flow in the statement of cash flows. When such a payment
is deferred and includes a significant financing element, it should be
classified as a financing cash flow, following the logic outlined above in
respect of deferred consideration.
• Indemnification asset
When a seller provides an indemnity, giving rise to an indemnification

asset, it is agreeing to reimburse the buyer for specific outflows it may
incur. Because receipts under indemnities are a direct reimbursement of an
outflow incurred, the receipt should be classified in accordance with the
nature of the cash outflow. This matching of inflows and outflows is
consistent with the treatment of reimbursement assets under IAS 37.
Q&A IAS 7: 41-1 — CHANGES IN OWNERSHIP INTEREST INVOLVING A

CHANGE IN CONTROL
Background
When an entity has obtained or lost control of subsidiaries or other businesses during
the reporting period, the aggregate cash flows arising should be presented
separately and classified as investing activities in accordance with IAS 7.39. The
single-line entry in the statement of cash flows comprises the amount of cash paid or
received as consideration for obtaining or losing control, net of the cash and cash
equivalents in the subsidiaries or businesses at the date of the transaction, event or
change in circumstance. IAS 7.41 further requires that the cash flow effects of losing
control are not to be deducted from those of obtaining control. Rather, each is to be
shown separately.
Question
Do these requirements apply only to transactions where the parent is receiving or
paying cash?
Answer
No. The requirements of IAS 7.39–42 apply to all transactions, events or other
circumstances that result in a parent obtaining or losing control of a subsidiary. This
can occur without the parent receiving or paying out cash (e.g. in the circumstances
of a rights issue by the subsidiary) and also when there is a change in circumstances
but no change in absolute or relative ownership interests. The focus of the
requirements is on whether or not control has been obtained or lost; if so, associated
cash flows will always be classified as investing.

When the parent obtains or loses control without receiving or paying out cash,
investing cash flows will still arise if there were cash balances in the subsidiary at the
time of acquisition or disposal (see Q&A IAS 7: 39-1). This is because the entry in
the statement of cash flows for consideration is reported net of cash and cash
equivalents in the subsidiary.
Q&A IAS 7: 41-EX-1 — CASH FLOWS ARISING ON SALE OF A

SUBSIDIARY
Example
On 30 June 20X1, an entity sells its 100 per cent holding in a subsidiary for
CU900,000. At that date, the net assets of the subsidiary included in the
consolidated statement of financial position were as follows.
The consideration was received during the year ended 31 December 20X1 and
comprised cash of CU300,000 and equity shares of CU600,000.
In the investing activities section of the statement of cash flows for the year ended
31 December 20X1, the entry in respect of the sale of the subsidiary will be an inflow
of CU120,000 (being CU300,000 cash received less cash and cash equivalents of
CU180,000 in the subsidiary at the date of sale). The cash and cash equivalents of
CU180,000 in the subsidiary at the date of sale are deducted from the cash received
because the cash and cash equivalents of the group are reduced by this amount as a
result of the sale of the subsidiary.

Had the cash consideration of CU300,000 been received over two years with
CU150,000 being received in 20X1 and CU150,000 being received in 20X2, the
investing section of the statement of cash flows would present an outflow in 20X1 of
CU30,000 (being CU150,000 less the cash and cash equivalents of CU180,000) and
an inflow in 20X2 of CU150,000.
The group's property, plant and equipment is reduced by CU500,000 as a result of

the sale. However, this is not presented in the statement of cash flows as a sale of
property, plant and equipment for cash.
When the indirect method is used to present the operating activities section of the
statement of cash flows, the increase or decrease in inventories and accounts
receivable and payable will need to be adjusted for the sale of the subsidiary. Taking
inventories as an example, on 31 December 20X1 the inventories in the consolidated
statement of financial position totalled CU950,000 and at 31 December 20X0 totalled
CU1,000,000. In the adjustments from profit before taxation to the operating cash
flow, the movement in inventories will be an increase of CU100,000 (being the
decrease in the year of CU50,000 offset by the subsidiary's inventories in the
consolidated statement of financial position at the date of sale of CU150,000).
Q&A IAS 7: 43-1 — NON-CASH TRANSACTIONS

Background
Investing and financing activities that do not require the use of cash or cash
equivalents are excluded from the statement of cash flows (IAS 7.43).
Question
What types of transactions does this exclusion cover?
Answer
Examples of investing and financing transactions that do not result in cash flows and,
consequently, are excluded from the statement of cash flows, include:
• the acquisition of assets by way of finance lease (but the payments of

lease rentals are cash flows);
• the acquisition or disposal of assets (other than cash) in return for equity
securities;
• exchanges of non-monetary assets such as property, plant and equipment,

and inventories;
• the issue of bonus shares to holders of the entity's equity;
• the receipt of bonus shares from another entity in which the reporting
entity holds an investment; and
• the conversion of debt securities into equity securities.
The inception of a finance lease contract is one of the most commonly encountered
non-cash transactions. Such a transaction, although reflected in the statement of
financial position by recognising an asset and a matching liability, should not be
reflected in the statement of cash flows because the reporting entity neither pays nor
receives cash. It is not appropriate to show a cash outflow in respect of an asset
purchase and the drawdown of a loan. A sale and leaseback arrangement, however,
will generate cash flows and therefore should be included in the statement of cash
flows (see Q&A IAS 7: 16-1).
When transactions of a non-cash nature occur, they are required to be “disclosed

elsewhere in the financial statements in a way that provides all the relevant
information about these investing and financing activities” [IAS 7.43]. This disclosure
is normally made in narrative form in the notes.
Q&A IAS 7: 47-1 — CHANGE IN POLICY FOR COMPONENTS OF CASH

EQUIVALENTS
Background
IAS 7.47 states that “[t]he effect of any change in the policy for determining
components of cash and cash equivalents, for example, a change in the classification
of financial instruments previously considered to be part of an entity's investment
portfolio, is reported in accordance with IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors”.
Entity A has, for the first time in the current period, used its surplus cash on hand to
invest in a 90-day notice account which meets the definition of a cash equivalent.
Question
Is Entity A required to make disclosure under IAS 7.47 in respect of this new
component of cash equivalents?
Answer

It depends. If the 90-day account is included in cash equivalents for the first time
because the account was only opened during the current year, then this does not
represent a change in accounting policy. If the entity held equivalent balances in the
prior year, but classified them as investing, and during the current period decided
that they were more appropriately classified as cash equivalents, even though its
reasons for holding them have not changed, then this is a change in accounting
policy (provided that there has been no change of substance in the accounts and the
level of funds kept in them) and the requirements of IAS 8 are triggered.
Because IAS 7 focuses on the reason for holding a particular balance, the same
types of investments may be classified differently from year to year, without this
constituting a change in accounting policy. For example, in a particular year, an
entity may hold short-term bonds for the purpose of generating investment returns,
and they are therefore not classified as cash equivalents. In the following year,
perhaps because of a change in the cash flow profile of the entity, the same type of
investments may be held, but this time for the purpose of meeting short-term cash
commitments, and they are therefore classified as cash equivalents. In such
circumstances, the bonds will be classified in a different manner in the two years,
but this will not constitute a change in accounting policy.
Q&A IAS 7: 48-1 — BALANCES NOT AVAILABLE FOR USE BY THE

GROUP
Question
If one of the entities in a group, (e.g. a subsidiary) operates in a country where
exchange controls or other legal restrictions apply and the cash and cash equivalents
in the subsidiary are not available for use by other members of the group, how
should such cash and cash equivalent balances be presented in the consolidated
statement of cash flows presented by the group?
Answer
Restrictions on the use of cash or cash equivalents do not alter the classification of
the restricted amounts in the statement of financial position or statement of cash
flows. For example, when there are restrictions on the transfer of amounts from a
foreign subsidiary, the amounts are treated as part of group cash and cash
equivalents in the consolidated statement of cash flows presented by the group if
they meet the definition of cash and cash equivalents in the foreign subsidiary;
disclosure is made in accordance with IAS 7.48.

Q&A IAS 7: 50-1 — PRESENTATION OF SALES TAXES IN THE
STATEMENT OF CASH FLOWS
[Added 12 May 2006]
Question
Should cash flows reported under IAS 7 be presented inclusive or exclusive of sales
taxes?
Answer
IAS 7 does not explicitly address this issue.
The IFRS Interpretations Committee was asked to consider this issue in 2005,
specifically in connection with Value Added Tax (VAT). Different practices were
expected to emerge, the difference being most marked for entities that adopt the
direct method of reporting operating cash flows. The Interpretations Committee did
not add the project to its agenda, but recommended that the treatment of VAT
should be considered by the IASB as part of the project on performance reporting
(now titled Financial Statement Presentation).
In advance of the publication of any explicit guidance, the issue should be considered
in the context of IAS 7.50, which encourages disclosure of additional information
when it may be relevant to users in understanding the financial information and
liquidity of an entity. Therefore, an entity should disclose whether gross cash flows
are presented inclusive or exclusive of sales taxes.
In addition, such disclosure would be considered necessary to comply with IAS 1

Presentation of Financial Statements. In particular, IAS 1(2007).112(c) requires that
the notes provide additional information that is not presented in the statement of
financial position, statement of comprehensive income, statement of changes in
equity or statement of cash flows, but is relevant to an understanding of any of
them.

Q&A IAS 8: 4-1 — TAX EFFECTS OF CORRECTIONS OF PRIOR PERIOD
ERRORS AND OF RETROSPECTIVE APPLICATION OF CHANGES IN
ACCOUNTING POLICIES
Question
How should the tax effects of corrections of prior period errors and of retrospective
application of changes in accounting policies be accounted for and disclosed?
Answer
IAS 8.4 states that “[t]he tax effects of corrections of prior period errors and of
retrospective adjustments made to apply changes in accounting policies are
accounted for and disclosed in accordance with IAS 12 Income Taxes”.
IAS 12.57 states that the “[a]ccounting for the current and deferred tax effects of a
transaction or other event [should be] consistent with the accounting for the
transaction or event itself”. The Guidance on Implementing IAS 8 provides an
example of a retrospective restatement, which clearly demonstrates that the income
tax effect is part of the retrospective adjustment.
Therefore, if an adjustment is recognised against opening retained earnings, the tax

effect should also be recognised against opening retained earnings.
Subsequent movements in the deferred tax balance follow the item to which the
deferred tax balance relates. For the purpose of subsequent movements (reversals
or remeasurements), a deferred tax balance that was recognised through a
retrospective adjustment against retained earnings is, nonetheless, considered to
have been established in profit or loss if the retrospective adjustment was made in
respect of a transaction that affected profit or loss. For example, an item of property,
plant and equipment that is recognised at fair value as its deemed cost at the date of
transition to IFRSs in accordance with IFRS 1 First-time Adoption of International
Financial Reporting Standards may give rise to a deferred tax liability. Although the
additional deferred tax liability arising on transition to IFRSs is recognised in opening
retained earnings, the reversal of that deferred tax balance relates to depreciation of
the item of property, plant and equipment. Consequently, it should be recognised in
profit or loss, consistent with the recognition of the depreciation expense.
Q&A IAS 8: 8-1 — APPLICATION OF IFRSs TO IMMATERIAL ITEMS


Question
Should an entity consider applying the requirements of IFRSs even when the effect is
not material?
Answer
IAS 8.8 states that the accounting policies required under IFRSs “need not be
applied when the effect of applying them is immaterial”. However, the Standard also
clarifies that this does not mean that immaterial departures from IFRSs can be
made, or left uncorrected, in order to achieve a particular presentation of an entity's
financial positions, performance or cash flows.
In practice, an entity will sometimes wish to consider applying the requirements of

IFRSs even when the effect is immaterial. This is in part because materiality is
subject to judgement based on both quantitative and qualitative factors, but also
because items that are not material in the current period may become material in a
subsequent period.
Q&A IAS 8: 9-1 — STATUS OF GUIDANCE ACCOMPANYING IFRSs

Background
IAS 8.9 states that “IFRSs are accompanied by guidance to assist entities in applying
their requirements. All such guidance states whether it is an integral part of IFRSs.
Guidance that is an integral part of IFRSs is mandatory. Guidance that is not an
integral part of IFRSs does not contain requirements for financial statements”.
Question
Is it acceptable to depart from guidance that is not an integral part of IFRSs?
Answer
IAS 8.9 reflects the amendments in May 2008 as a result of Improvements to IFRSs.
The purpose of the amendment (and related amendments to IAS 8.7 and IAS 8.11)
was to clarify that implementation guidance published with an IFRS does not form
part of that IFRS and therefore is not mandatory.
However, although such guidance does not contain mandatory requirements, it is

nevertheless indicative of the way in which the IASB believes the IFRS should be
implemented. Departures from such guidance should therefore be made only after
careful consideration and when they can be demonstrated to be fully justified.
Q&A IAS 8: 10-1 — SELECTION OF ACCOUNTING POLICY FOR

COMBINATIONS OF ENTITIES UNDER COMMON CONTROL —
REQUIREMENT TO RESTATE COMPARATIVE INFORMATION
[Added 19 February 2010]
Background
Entities S1 and S2 are two subsidiaries of holding company H. Following a decision

by H to reorganise the legal structure of the group, S1 acquires S2 (i.e. H now holds
an indirect interest in S2 in place of the direct interest it held before the
reorganisation). The acquisition of S2 by S1 is considered a combination of entities
under common control and, under paragraph 2(c) of IFRS 3(2008) Business
Combinations, is excluded from the scope of that Standard.
This is the first time that S1 has entered into a transaction of this nature and,
therefore, it is required to develop a new accounting policy. In the absence of
specific IFRS literature on the topic, S1 has applied the requirements of IAS 8.10–12
and has chosen to account for the transaction at S2's carrying amounts at the date
of the transaction (i.e. as a pooling of interests).
Question
Is S1 obliged to restate the comparative periods in its consolidated financial
statements as if S1 had acquired S2 at the beginning of the earliest period
presented?
Answer
No. Even if S1 has developed its accounting policy by reference to a pronouncement
of another standard-setting body that requires restatement of comparatives when
the pooling-of-interests method is applied, S1 is not bound to apply all of the
requirements of that pronouncement.
However, the decision-usefulness of the restated comparative information should be

considered by management when developing its accounting policy and, if the failure
to restate comparative information would be detrimental to the users of the financial
statements, restatement should be considered. In addition, S1 should consider local
regulatory requirements that may require (or prohibit) restatement of comparative
periods for such transactions.

Q&A IAS 8: 11-1 — STATUS OF AGENDA DECISIONS OF IFRS
INTERPRETATIONS COMMITTEE
Question
Do agenda decisions issued by the IFRS Interpretations Committee form part of
IFRSs?
Answer
No. Agenda decisions issued by the IFRS Interpretations Committee form an
important source of guidance although they do not form part of IFRSs. Relevant
agenda decisions should be carefully considered as indicative (but not definitive)
guidance when selecting a suitable accounting policy for a transaction not specifically
addressed by a Standard or Interpretation.
Q&A IAS 8: 14-1 — EARLY ADOPTION OF A NEW IFRS

[Issued 7 May 2004]
[Amended 27 January 2006]
Background
Company M's reporting period ended on 31 December 20X1 and it has applied IFRSs
for several years. On 15 January 20X2, a new Standard was issued by the IASB,
which is effective for annual periods beginning on or after 1 January 20X3, with
earlier adoption permitted. Company M will not issue its 20X1 financial statements
until 1 March 20X2.
Question
Is Company M permitted to apply the new Standard issued after the reporting
period, but prior to the issue of financial statements, in its 20X1 financial
statements?
Answer
Yes.
Because the new Standard allows for early adoption, Company M has the option to

adopt the new Standard for periods in respect of which financial statements have not
yet been issued. If the new Standard did not allow for early adoption, early
application would not be permitted.
Company M may not adopt exposure drafts or other guidance that has not been
issued in its final form by the date of issue of its financial statements where this
would conflict with the requirements of IFRSs in effect at the reporting date.
IAS 8.20 specifically states that “early application of an IFRS is not a voluntary
change in accounting policy”. Therefore, any specific transitional provisions in the
new Standard should be applied for Company M's 20X1 financial year. If the new
Standard does not include any specific transitional provisions relating to the change
in accounting policy, the change should be applied retrospectively (IAS 8.19).
If the entity decides not to adopt the Standard in advance of its effective date, the
requirements of IAS 8.30 apply (see Q&A IAS 8: 30-1).
Q&A IAS 8: 14-2 — VOLUNTARY CHANGE IN ACCOUNTING POLICY FOR

JOINTLY CONTROLLED ENTITIES
[Issued 7 May 2004]
Background
Entity R has applied IFRSs for a number of years. Prior to its 20X3 reporting period,
Entity R's policy was to account for its interests in jointly controlled entities using
proportionate consolidation, the recommended treatment under IAS 31 Interests in
Joint Ventures. Most of the other participants in Entity R's business sector apply the
alternative method permitted under IAS 31 (i.e. the equity method). In 20X3,
because of this prevalence, Entity R decides to change its accounting policy for
jointly controlled entities to the equity method on the basis that this method will
provide reliable and more relevant information for the users of its financial
statements.
Question
In its 20X3 financial statements, how should Entity R account for its change in
accounting policy for jointly controlled entities?
Answer
Because this is a voluntary change in accounting policy rather than first-time
adoption of the Standard, the transitional provisions in IAS 31.58–58B do not apply.
Consequently, the new accounting policy should be applied retrospectively for all
jointly controlled entities (except to the extent that retrospective application is
impracticable (see IAS 8.23–25)).
Q&A IAS 8: 14-3 — CHANGE IN USE OF PROPERTY

Background
Entity N owns an office building that in previous reporting periods has been classified
as property, plant and equipment and accounted for under IAS 16 Property, Plant
and Equipment using the cost model. During the current reporting period, Entity N
has vacated the property and it has been leased to a third party. Entity N's
accounting policy for investment property under IAS 40 Investment Property is to
use the fair value model.
Question
Is the change in the accounting treatment for the office building from the cost model
under IAS 16 to the fair value model under IAS 40 a change in accounting policy?
Answer
No. The change in accounting treatment has arisen because of a change in
circumstances rather than a change in accounting policy. Entity N's policies for each
type of property remain unchanged but the office building in question is accounted
for as an investment property from the date of change of use. No retrospective
restatement is required in these circumstances.

[Issued 7 May 2004]
[Deleted 21 May 2010]
Deleted
Q&A IAS 8: 30-1 — DISCLOSURE OF THE IMPACT OF IFRSs ISSUED

AFTER THE REPORTING PERIOD
[Issued 7 May 2004]

Question
IAS 8.30 specifies disclosure requirements “[w]hen an entity has not applied a new
IFRS that has been issued but is not yet effective”. Is the application of this
paragraph limited to IFRSs issued before the end of the reporting period, or are the
disclosures also required in respect of IFRSs issued between the end of the reporting
period and the date when the financial statements are authorised for issue?
Answer
The disclosures required by IAS 8.30 should be made in respect of all IFRSs issued
before the date of issue of the financial statements that are not yet effective.
It will be helpful if the relevant note to the financial statements either specifies the
date at which the details are given or refers explicitly to them being as at the date of
authorisation of the financial statements.
Q&A IAS 8: 31-1 — DISCLOSURE OF THE IMPACT OF IFRSs NOT YET

EFFECTIVE
Background
In complying with the general requirements of IAS 8.30 to disclose information about
the possible impact of new IFRSs not yet effective, IAS 8.31 states that an entity
considers disclosing the following:
• the title of the new IFRS;
• the nature of the impending change or changes in accounting policy;
• the date by which application of the IFRS is required;
• the date as at which it plans to apply the IFRS initially; and
• either:
• a discussion of the impact that initial application of the IFRS is

expected to have on the entity's financial statements; or
• if that impact is not known or reasonably estimable, a statement to

that effect.
Question
Is all of this detail required for each new or amended IFRS in issue but not yet
effective?
Answer
No. It is clear from IAS 8.BC31 that the matters listed in IAS 8.31 are not intended
to be mandatory disclosure requirements; they are instead matters that an entity
“should consider” in applying IAS 8.30.
The question arises as to whether it is necessary for the financial statements to list
every new or amended IFRS that has been issued but is not yet effective, even if it is
expected to have no material effect on the entity's financial statements. The best
approach is to provide a complete list because this clearly meets the requirements of
the Standard and reduces the risk that some new pronouncements might be
overlooked.
However, a briefer disclosure may be acceptable in some circumstances; for

example, it may be acceptable to not mention a pronouncement that plainly does not
affect the entity because of its scope. Another factor to consider is that when a new
pronouncement has no material effect, it may be acceptable to adopt it in advance of
its effective date (which would have no material effect) and so exclude it from the
scope of IAS 8.30.
When a complete list is not provided, it may be wise to include a statement to the
effect that the impact of all other IFRSs not yet adopted is not expected to be
material.
Q&A IAS 8: 36-1 — CHANGE IN ESTIMATE OF A PROVISION FOR A

LAWSUIT
[Issued 7 May 2004]
Question
Should a change in the estimate of the outcome of a pending lawsuit be recognised
in profit or loss in the year of the change?
Answer
Yes. Even though the original estimate of the outcome may have been made several
years previously, and the case may continue for a number of years, a change in the
estimate of the outcome should be recognised in profit or loss in the period (year) of
the change.

Q&A IAS 8: 36-2 — PRESENTATION OF EFFECT OF A CHANGE IN
ACCOUNTING ESTIMATE
Question
How should a change in accounting estimate be presented in profit or loss?
Answer
When a change in an accounting estimate is recognised in profit or loss, the change
should be recognised in the same line item as the underlying item. For example, if
the best estimate of a provision for a legal claim is reduced downwards, the credit in
profit or loss should be included within the same expense heading where the original
expense was recognised. This ensures that the cumulative expense recognised under
that heading is correct.
The disclosure requirements of IAS 8.39 and IAS 8.40 should be complied with. In
addition, if the change in accounting estimate causes a material distortion in a
particular expense heading, additional disclosure may be required in accordance with
paragraph 98 of IAS 1 Presentation of Financial Statements.
Q&A IAS 8: 50-1 — IS 'UNDUE COST OR EFFORT' AN APPROPRIATE

BASIS FOR CONCLUDING THAT RETROSPECTIVE APPLICATION OR
RETROSPECTIVE RESTATEMENT IS IMPRACTICABLE?
Question
Is it appropriate to conclude that retrospective application of an accounting policy or
retrospective restatement for a prior period error is impracticable on the basis that it
would involve undue cost or effort?
Answer
No. It is not appropriate to conclude that restatement is impracticable merely
because of the cost or effort involved. When revising IAS 8 in 2003, the IASB
considered replacing the exemption from retrospective application of restatement on
the basis of 'impracticability' with one based on 'undue cost or effort'. However,
based on comments received on the exposure draft, the IASB decided that an
exemption based on management's assessment of undue cost or effort was too
subjective to be applied consistently by different entities. The IASB decided that
balancing costs and benefits was a task for the Board when it sets accounting
requirements rather than for entities when they apply those requirements.
Therefore, although the Standard does not explicitly say that undue cost or effort
does not alone render restatement impracticable, this is the clear intention of the
Board and is consistent with the definition of 'impracticable' in the Standard. [IAS
8.BC24]
Q&A IAS 10: 8-EX-1 — DECLINE IN VALUE OF SHARE PORTFOLIO

AFTER THE END OF THE REPORTING PERIOD — EXAMPLE
Example
An entity has a portfolio of shares. After the end of the reporting period, there has
been a substantial fall in the value of the stock market. The entity's accounting
policy is to measure the shares at fair value. The entity is not permitted to adjust the
fair value of the shares for the decline in value subsequent to the end of the
reporting period (i.e. the event is a non-adjusting event after the reporting period).
If the impact is significant, however, the entity may be required to disclose the
decline in fair value between the end of the reporting period and the date when the
financial statements are authorised for issue (see IAS 10.21).
Q&A IAS 10: 8-EX-2 — SIGNIFICANT MOVEMENTS IN EXCHANGE

RATES AFTER THE REPORTING PERIOD — EXAMPLE
Example
An entity translates foreign currency items at spot rate at the end of each reporting
period. In 20X1, due to significant economic upheaval in Country A, that country's
currency was devalued after the end of the reporting period. Nevertheless, for the
purposes of the year-end financial statements, items should be translated using the
closing rate at the end of the reporting period. If the effect of the exchange rate
movements after the reporting period is significant, disclosure may be required (see
IAS 10.21).
Q&A IAS 10: 8-EX-3 — DEFAULT BY CUSTOMER AFTER THE

REPORTING PERIOD — EXAMPLE
Example
An entity sells goods on credit to a third party. At the end of the reporting period,
there was no doubt about the customer's ability to pay. In the process of the
finalisation of the financial statements, the entity is informed that the customer is
going into liquidation as a result of events that occurred after the reporting period.
No impairment of the trade receivable should be recognised in the financial
statements, because the statement of financial position appropriately reflects the
circumstances as at the end of the reporting period. If the impact is significant,
however, the entity may be required to disclose the impact of the customer's default
after the reporting period (see IAS 10.21).
Q&A IAS 10: 12-1 — RESCINDING OF ILLEGAL DIVIDENDS PAID

BEFORE THE END OF THE REPORTING PERIOD
Background
Company A distributes dividends to its shareholders at the end of each quarterly

interim reporting period. Therefore, at the end of the annual reporting period,
Company A has paid out all of the dividends allocated for the period. After the end of
the annual reporting period, but before the financial statements are authorised for
issue, Company A discovers an error in its final interim financial report relating to
conditions that existed at the end of the reporting period. The financial statements
are adjusted accordingly, in accordance with IAS 10. The adjustment reduces profits
available for dividend distribution below the level at which dividends were paid (i.e. a
portion of the dividends distributed during the period should not have been paid
out). In the jurisdiction in which Company A operates, there is a legally binding
requirement that dividends distributed in excess of available profits be repaid.
Therefore, Company A issues demands to its shareholders for return of the
appropriate portion of the dividend.
Question

Is the rescinding of the dividend an adjusting event?
Answer
Yes. The need to rescind the dividend arises as a result of the discovery of an error
that has been accounted for as an adjusting event. Moreover, the rescinding of the
dividends itself meets the definition of an adjusting event because it provides
evidence of conditions that existed at the end of the reporting period (i.e. at the end
of the reporting period, the dividends were illegal).
Therefore, a receivable should be recognised in the statement of financial position for

the dividend to the extent that it is repayable.
Q&A IAS 10: 12-2 — RESCINDING OF DIVIDENDS PAID BEFORE THE

END OF THE REPORTING PERIOD DUE TO CASH FLOW SHORTAGE
Background
At the end of the annual reporting period, Company A has paid out all of the
dividends allocated for the period. After the end of the reporting period, Company A
has a cash-flow shortage and requests shareholders to return a portion of the
dividends paid during the reporting period.
Question
Is the request for the dividends to be returned an adjusting event?
Answer
No. The request for the dividends to be returned arises as a result of circumstances
that arose after the end of the reporting period. If the dividends are returned, they
should be accounted for as a capital contribution in the subsequent period, not a
reduction of the dividends paid.
Q&A IAS 10: 13-1 — LEGAL RIGHT TO RESCIND INTERIM DIVIDEND

DECLARED BUT NOT PAID

Background
An entity declares an interim dividend during the reporting period; it remains unpaid
at the end of the reporting period. Under local law, the directors have the right
subsequently to vary or rescind this dividend.
Question
Should the dividend be recognised as an obligation in the financial statements?
Answer
No. IAS 10.13 confirms that dividends should not be recognised unless an obligation
to pay exists at the end of the reporting period. Such an obligation does not arise
until the dividends are no longer at the discretion of the entity.
Q&A IAS 10: 14-1 — VOLUNTARY LIQUIDATION AFTER THE

REPORTING PERIOD
Background
An owner-managed entity's reporting date is 31 December 20X1. At the reporting

date, the entity is trading profitably and the owner-managers expect that it will
continue to do so. They have no intention to liquidate the entity or to cease trading.
But in March 20X2, before the financial statements are authorised for issue, the
owner-managers experience an unexpected change in personal circumstances and
decide to put the entity into voluntary liquidation.
Question
On what basis should the financial statements at the end of the reporting period for
20X1 be prepared?
Answer
The entity's financial statements should be prepared on a basis other than that of a
going concern in accordance with paragraph 25 of IAS 1 Presentation of Financial
Statements.
Q&A IAS 10: 17-1 — LOCATION FOR DISCLOSURES REGARDING

AUTHORISATION OF FINANCIAL STATEMENTS
Background
IAS 10.17 requires entities to disclose the date when the financial statements are
authorised for issue and who gave that authorisation.
Question
Where should these disclosures be located in the financial statements?
Answer
IAS 10 does not specify the location of these disclosures. Subject to local legal and
regulatory requirements, they might, for example, be made on the face of the
statement of financial position or another primary statement, or in the notes. They
might also be included in a statement of directors' responsibilities but only if that
statement forms part of the financial statements. Inclusion of these disclosures in a
separate statement outside of the financial statements, but which refers to the
financial statements, would not be acceptable.
Q&A IAS 11: 1-1 — APPLICATION TO CONTRACTS WITH A DURATION

OF LESS THAN ONE YEAR
Question
Should IAS 11 be applied to construction contracts with a duration of less than one
year?
Answer
IAS 11 applies to construction contracts accounted for in the financial statements
of contractors.
The term 'contractors' is not defined in IAS 11, and therefore, can be taken to refer
to reporting entities engaged in contracting activity.

Construction contracts are defined in IAS 11.3 as contracts "specifically negotiated
for the construction of an asset or a combination of assets that are closely
interrelated or interdependent in terms of their design, technology and function or
their ultimate purpose or use".
IAS 11 does not provide for a minimum duration for the construction period (such as
one year) for construction contracts falling within its scope. Nor does it refer to
'long-term contracts'. The principles of IAS 11 will need to be applied for all
construction contracts under which the contract activity starts in one reporting
period and ends in another, thus creating an allocation problem for contract income
and expenses.
Q&A IAS 11: 1-2 — APPLICATION TO INDIVIDUAL ORDERS FOR

SPECIFIC ITEMS
[Amended 29 October 2010]
Question
When an entity is engaged in the construction of large machines that are individually
built to customer order and unique specifications, does such activity fall within the
scope of IAS 11?
Answer
Yes. IAS 11 applies to construction contracts accounted for in the financial
statements of contractors. The term 'contractors' is not defined in IAS 11, and
therefore, can be taken to refer to reporting entities engaged in contracting activity.
Construction contracts are defined in IAS 11.3 as contracts "specifically negotiated

for the construction of an asset or a combination of assets that are closely
interrelated or interdependent in terms of their design, technology and function or
their ultimate purpose or use".
IAS 11.4 cites as examples of construction contracts “the construction of single

assets such as a bridge, building, dam, pipeline, road, ship or tunnel”. However, this
is not a complete list — and the manufacture of machines built to customer order
with a negotiated price will fall within the definition of a construction contract.
Q&A IAS 11: 1-3 — APPLICATION TO SERVICE TRANSACTIONS

Question
Does IAS 11 apply to service transactions?
Answer
IAS 11.5 clarifies that construction contracts will include contracts for the rendering
of services that are directly related to the construction of an asset (e.g. those for the
services of project managers and architects). Other examples include design,
engineering, procurement and construction management that are essential to the
construction of the asset.
The general criteria for revenue recognition for service transactions are established
in paragraph 20 of IAS 18 Revenue. The general principle established in IAS 18.20 is
that revenue should be recognised by reference to the stage of completion of a
service transaction at the end of the reporting period, which is consistent with IAS
11.
Therefore, although service contracts do not fall generally within the scope of IAS
11, they will be dealt with under IAS 18 using principles consistent with those
established in IAS 11, and IAS 11 provides useful guidance in this regard.
In some circumstances, careful judgement may be required to determine whether a

contract should be regarded as being for the supply of construction services or
simply for the supply of goods. In particular, merely because a contract requires
items to be supplied that have not yet been constructed, it does not necessarily
follow that the contract is for construction services.
In July 2008, IFRIC 15 Agreements for the Construction of Real Estate was issued. It
addresses whether an agreement is within the scope of IAS 11 or IAS 18, and when
revenue from the construction of real estate should be recognised.
Q&A IAS 11: 1-4 — IAS 11 AND SOFTWARE DEVELOPMENT CONTRACTS

[Added 23 May 2008]
Question
Are software development contracts within the scope of IAS 11?

Answer
Yes, if they meet the definition of a construction contract in IAS 11.
IAS 11 defines a construction contract as "a contract specifically negotiated for the
construction of an asset". Whether the asset under construction is tangible or
intangible is not relevant to this definition; therefore, it is possible for contracts for
the construction of intangible assets, such as software, to be within the scope of IAS
11. An entity should carefully assess each software development contract to
determine whether it meets this definition.
Software development contracts for fully bespoke products meet the definition of a
construction contract in IAS 11 and should be accounted for in accordance with IAS
11, including all of the disclosure requirements. Contracts for the supply of software
products already developed in-house or with minimal customisation fall into the
scope of IAS 18 Revenue as the supply of goods.
Q&A IAS 11: 8-1 — EFFECTS OF COMBINING AND SEGMENTING

CONTRACTS
Question
A Limited has five construction contracts in progress at the end of 200X, as set out
in the table below. How would the accounting for these contracts differ if they were
(a) treated as separate contracts, and (b) combined and treated as one contract?
Assume that the outcome of each contract can be estimated reliably.

Answer
If all of the contracts are combined and treated as one contract, A Limited recognises
60 per cent of the total expected profit of $210 (i.e. a profit of $126).
If each contract is treated separately, A Limited recognises the following profits and
losses in 200X:
Q&A IAS 11: 8-2 — SEGMENTING A CONTRACT COVERING THE

CONSTRUCTION OF MORE THAN ONE ASSET
Background
A contractor submits two separate bids for the construction of a 10 mile section of
motorway and a bridge included in the 10 mile stretch. The government has
structured the tender process such that the contract for the motorway construction
will be awarded separately from the contract for the bridge construction. The
contractor wins both bids, and a single contract covering both projects is signed with
the government, without modifying the costs and revenues attributable to each part
of the contract.
Question
Should the construction be accounted for as separate contracts, or as a combined
contract?
Answer
IAS 11.8 states:
When a contract covers a number of assets, the construction of each asset

shall be treated as a separate construction contract when:
1. separate proposals have been submitted for each asset;
2. each asset has been subject to separate negotiation and the contractor and
customer have been able to accept or reject that part of the contract
relating to each asset; and
3. the costs and revenues of each asset can be identified.
In this example, separate proposals were submitted for the motorway and the bridge
constructions. Even if one contractor wins the work on both projects and the terms
agreed to with the government for both projects are included in one legal contract,
each project (the bridge and the motorway) will be accounted for separately under
IAS 11.
The key determinant is whether the customer is able to accept one proposal and
reject the other. Segmenting contracts is not a matter of choice, but is required
when the criteria in IAS 11.8 are met.
In order to segment a contract, the contractor will need to have a cost system in
place to identify the costs and revenues attributable to each part of the contract.
Q&A IAS 11: 9-1 — COMBINING CONTRACTS TO BE ACCOUNTED FOR AS

A SINGLE CONTRACT
Background
A contractor submits one bid for the construction of a 10 mile section of motorway
and a bridge which is at one end of the 10 mile stretch. The bridge is in a different
jurisdiction from the motorway and, therefore, although only one bid is submitted
because the two local authorities have agreed to work together on the construction
of the road, separate contracts exist for the bridge and the motorway because the
counterparties (the two local authorities) are different.
Question

Should the construction be accounted for as separate contracts, or as a combined
contract?
Answer
IAS 11.9 states:
A group of contracts, whether with a single customer or with several

customers, shall be treated as a single construction contract when:
1. the group of contracts is negotiated as a single package;
2. the contracts are so closely interrelated that they are, in effect, part of a
single project with an overall profit margin; and
3. the contracts are performed concurrently or in a continuous sequence.
In this example, because one proposal was submitted for the motorway and the
bridge, even if two separate legal contracts are eventually signed, the contracts have
been negotiated as a single package. The bid was submitted on the basis that one
component would not have been awarded without the other, and so the contractor
must have worked out the expected gross margin on both components together.
Therefore, the two contracts should be accounted for as one contract under IAS 11.
For combination to be required, the group of contracts must be performed

concurrently or in a continuous sequence. If performance is separated by a period of
time long enough to result in differing economic environments in the periods of
performance, then separate accounting should be applied.
Combining contracts is not a matter of choice, but is required when the criteria in
IAS 11.9 are met.
Q&A IAS 11: 10-1 — CONSTRUCTION OF AN ADDITIONAL ASSET TO BE

TREATED AS A SEPARATE CONTRACT?
Background
A contractor is nearing completion of a 10 mile stretch of motorway under a contract

with the government. Under the contract, the contractor is paid CU10 million per
mile. A supplementary contract is signed between the government and the
contractor to cover an additional three miles of motorway at the same rate of CU10
million per mile.

Question
Should the supplementary contract be treated as a separate contract under IAS 11?
Answer
IAS 11.10 states:
A contract may provide for the construction of an additional asset at the

option of the customer or may be amended to include the construction of
an additional asset. The construction of the additional asset shall be
treated as a separate construction contract when:
1. the asset differs significantly in design, technology or function from the
asset or assets covered by the original contract; or
2. the price of the asset is negotiated without regard to the original contract
price.
In the example cited, the supplementary contract should be accounted for as part of
the original contract under IAS 11 because the pricing is the same as originally
negotiated, and the asset (motorway) does not differ significantly from the asset
(motorway) covered by the original contract.
Q&A IAS 11: 11-1 — BASIS OF RECOGNITION OF VARIATIONS, CLAIMS

AND INCENTIVE PAYMENTS
Question
A contractor is nearing the completion of a major contract and is in the process of
negotiation with the customer in respect of settlements to be received for variations,
claims and incentive payments. What are the criteria for determining whether such
supplementary amounts can be included in contract revenue?
Answer
Contract revenue comprises the initial amount of agreed revenue included in the
construction contract. It also includes variations, claims and incentive payments to
the extent that it is probable they will result in revenue and are capable of being
measured reliably (IAS 11.11(b)).
The revenue recognition criteria for variations, claims and incentive payments are
the same as for other types of revenue. The additional criteria discussed in the
following paragraphs are included in the guidance paragraphs of the Standard and
are intended to illustrate how the general revenue recognition criteria should be
applied to variations, claims and incentive payments.
A variation is defined in IAS 11.13 as "an instruction by the customer for a change
in the scope of the work to be performed under the contract". Depending on the
circumstances, variations may lead to increases or decreases in contract revenue.
For example, once a project has been negotiated, a customer may finalise the design
of the item to be constructed, and the changes in design may have implications for
the amount of work required by the contractor.
In practice, problems arise when assessing the likelihood of recovery of variations

and, thus, whether they should be included in contract revenue. IAS 11.13 states, in
part:
A variation is included in contract revenue when:

a. it is probable that the customer will approve the variation and the amount
of revenue arising from the variation; and
b. the amount of revenue can be reliably measured.
In many cases, it is a matter of judgement as to whether a variation will be

approved by the customer and, due to the fact that the amount recovered is often
the result of a negotiation process, the amount included in contract revenue related
to variations is usually an estimate.
A claim is defined in IAS 11.14 as "an amount that the contractor seeks to collect
from the customer or another party as reimbursement for costs not included in the
contract price". A claim in this context does not usually imply that a legal claim has
been filed in a court of law. Claims may arise from customer-caused delays, errors in
specifications or design, or disputed variations in contract work. Since claims are
initiated by the contractor, their recoverability may be even more uncertain than that
of variations. The amount included in contract revenue with respect to claims is
therefore an estimate based on management's judgement. As for variations, claims
are often settled at the end of the contract as a result of a negotiation. IAS 11.14
states, in part, that claims should only be included in contract revenue when:
a. negotiations have reached an advanced stage such that it is probable that

the customer will accept the claim; and
b. the amount that it is probable will be accepted by the customer can be

measured reliably.
Incentive payments are additional amounts paid to the contractor if specified

performance standards are met or exceeded. Commonly, such incentive payments
relate to completion dates and, thus, the earlier the work is completed, the more
contract revenue will be receivable. IAS 11.15 states, in part:

Incentive payments are included in contract revenue when:
a. the contract is sufficiently advanced that it is probable that the specified
performance standards will be met or exceeded; and
b. the amount of the incentive payments can be measured reliably.
IAS 11 requires that contractors should recognise revenue from variations, claims
and incentive payments once the conditions set out in IAS 11.13, 14 and 15
respectively have been met. An accounting policy of not recognising these items until
they are realised or until they are formally accepted by the customer would not be
acceptable under IAS 11.
Q&A IAS 11: 11-2 — CONTRACT REVENUE DENOMINATED IN A

FOREIGN CURRENCY
Question
How should contract revenue be recognised when it is denominated in a foreign
currency?
Answer
When a construction contract is entered into that is denominated in a functional
currency different from that of the reporting entity, the revenue recognised
incrementally over the course of the contract will be the incremental foreign currency
revenue translated at the spot rate. This treatment reflects the general requirement
of IAS 21 The Effects of Changes in Foreign Exchange Rates that foreign currency
transactions should be recognised by applying to the foreign currency amount the
spot exchange rate between the functional currency and the foreign currency at the
date of the transaction. In practice, if incremental revenue accrues fairly steadily
over a period, it may be acceptable to translate it at an average rate for that period
unless exchange rates for the period fluctuate significantly.
Q&A IAS 11: 12(a)-1 — RESERVED

[Reserved 17 September 2010]
Reserved

Q&A IAS 11: 16-1 — WASTAGE
Background
In many construction contracts, some level of wastage is unavoidable as part of the

construction process, and will be forecast within the entity's budgets and estimates
and included in contract costs.
Question
How should 'abnormal' wastage be accounted for?
Answer
When, as a result of the entity's inefficiency or error, abnormal or excessive costs
occur that could otherwise have been avoided, these are likely to relate to a
particular period and should, therefore, be recognised as an expense in that period,
i.e. they are excluded from contract costs.
If costs incurred to date are used to determine the stage of completion on a

contract, care should be taken to ensure that revenue attributed to work carried out
is not increased to offset additional costs incurred when abnormal or excessive costs
arise through inefficiency or error rather than as a result of further progress on the
contract.
Q&A IAS 11: 18-1 — TREATMENT OF INTEREST INCOME EARNED ON

THE TEMPORARY INVESTMENT OF FUNDS
Background
An entity has borrowed funds specifically for the financing of a construction contract
and capitalised the borrowing costs in accordance with IAS 23 Borrowing Costs.
Question
When the funds are temporarily invested and interest income is earned, should that
interest income be offset against contract costs?

Answer
Yes. IAS 23.12 requires that the amount of borrowing costs capitalised should be
reduced by any investment income arising on the temporary investment of funds
borrowed specifically for the assets concerned.
Therefore, for example, when a contract is funded by advances from the customer,
and no interest is charged on those advances, any interest income earned on the
temporary investment of those advances is treated as a negative contract cost.
Q&A IAS 11: 21-1 — PRE-CONTRACT COSTS

Background
Company Z is a software design company that develops software specifically suited

for a particular entity. In order to secure a contract with a particular entity, Company
Z incurs costs as part of its bid on a project. Such costs may include labour costs,
general administration costs, research and development costs, etc. Many of these
costs are incurred prior to securing the contract (and are referred to below as
'pre-contract costs').
Question
How should Company Z account for pre-contract costs?
Answer
Paragraph 89 of the Framework for the Preparation and Presentation of Financial
Statements states that 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".
General administration costs for which reimbursement is not specified in the contract
are identified in IAS 11.20, among others, as examples of costs that should be
excluded from contract costs because they cannot be attributed to contract activity
or allocated to a contract. Therefore, any overhead costs incurred in the
'pre-contract' period should be expensed when incurred (unless the contract specifies
that they are to be reimbursed).
IAS 11.21 specifies that other pre-contract costs should be included as part of
contract costs if:

• they relate directly to the contract;
• they were incurred in securing the contract;
• they can be separately identified;
• they can be measured reliably; and
• it is probable that the contract will be obtained.
A great deal of care should be taken when determining whether pre-contract costs
should be capitalised.
If pre-contract costs have been capitalised, and it subsequently transpires that it is

no longer considered probable that the contract will be obtained, the costs should be
recognised in profit or loss immediately.
Q&A IAS 11: 21-EX-1 — CONSIDERATION OF EXPENSED

PRE-CONTRACT COSTS — EXAMPLE
[Renumbered from IAS 11: 30-EX-1 on 29 October 2010]
Example
An entity incurred CU3 million of pre-contract costs during December 20X1, which
were directly attributable to the anticipated contract and which the entity believed
would be recoverable under that contract. However, due to the uncertainty of the
outcome, the costs were expensed when they were incurred in 20X1. The contract
was ultimately signed in 20X2 for a price of CU18 million. The entity's remaining
estimated costs to complete the contract were CU6 million.
Because the pre-contract costs were already recognised as expenses in the 20X1
financial year, they should be excluded from contract costs. The entity should
account for this contract prospectively, recognising CU18 million of contract revenue
and CU6 million of contract costs as work on the contract is performed.
Q&A IAS 11: 30-1 — PRE-CONTRACT COSTS ALREADY EXPENSED TO BE

EXCLUDED FROM CONSIDERATION OF PERCENTAGE OF
COMPLETION

Question
Is it appropriate to include pre-contract costs that have previously been expensed in
contract costs for the purposes of determining the stage of completion of a contract,
when the stage of completion is determined on a proportionate-cost basis?
Answer
No. Under IAS 11.21, when costs incurred in securing a contract are recognised as
an expense in the period in which they are incurred, they are not included in contract
costs when the contract is obtained in a subsequent period.
Therefore, for the purposes of determining the stage of completion of the contract,
pre-contract costs that have been expensed prior to obtaining a contract are
excluded both from the measure of contract costs incurred to date and the estimate
of total contract costs.
Q&A IAS 11: 30-EX-1 — RENUMBERED

[Renumbered to IAS 11: 21-EX-1 on 29 October 2010]
Renumbered
Q&A IAS 11: 30-2 — TREATMENT OF PREPAID COSTS IN ESTIMATING

THE PERCENTAGE OF COMPLETION
Background
A contractor undertakes a three-year contract. At the end of Year 1, management

estimates that the total revenue on the contract will be CU1,000 and that total costs
will be CU900, of which CU300 has been incurred to date.
During Year 1, the contractor purchased materials for CU50 to be used in Year 2.
Question
How should the percentage of completion of the contract be calculated (assuming
that the percentage of completion is calculated based on the proportion that costs
incurred to date bear to total contract costs)?
Answer
When calculating the percentage of completion of this contract, based on the
proportion of costs incurred to date to total costs of the contract, an adjustment is
required in respect of the purchased materials not yet used.
Therefore, in Year 1, contract revenue of CU280 and contract costs of CU250 are
recognised in profit or loss.
Generally, costs to be excluded from the measurement of "costs incurred for work
performed to date" will consist of: (1) materials not specifically produced or
fabricated for the project that have been purchased or accumulated at the job site,
but not physically installed; and (2) payments made to sub-contractors in advance of
their performance under the sub-contract.
Q&A IAS 11: 32-EX-1 — OUTCOME OF A CONTRACT CANNOT BE

ESTIMATED RELIABLY — EXAMPLE
Example
estimates that the total revenue on the contract will be CU1,000 but is unable to
estimate reliably the costs that will be incurred to complete the contract.
Costs of CU300 have been incurred to date, of which CU50 relates to purchased

materials that will be used in Year 2.
When the outcome of a contract cannot be estimated reliably, IAS 11.32 specifies
that:
• revenue should “be recognised only to the extent of contract costs incurred
that it is probable will be recoverable"; and
• contract costs should “be recognised as an expense in the period in which

they are incurred”.
As described in Q&A IAS 11: 30-2, contract cost of CU250 should be recognised in
Year 1.
Revenue is only recognised to the extent of costs incurred; therefore, in Year 1,

CU250 of revenue is recognised and CU250 of expenses is recognised, resulting in no
gross profit being recognised in the period.
Q&A IAS 11: 35-1 — DISCLOSURE IN THE PERIOD IN WHICH THE

OUTCOME OF A CONTRACT BECOMES CAPABLE OF RELIABLE
ESTIMATION
Background
When the uncertainties that prevented reliable estimation of the outcome of a

construction contract no longer exist, IAS 11.35 requires that contract revenue and
expenses should be recognised using the percentage of completion method.
Question
What, if any, disclosures are required in the period in which the outcome of a
contract becomes capable of reliable estimation?
Answer
IAS 11 does not address the question of disclosure in the period in which the
outcome of a contract becomes capable of reliable estimation. In the first period in
which the percentage of completion method is applied, the profit on the contract that
has not been recognised in previous periods will be recognised. When the entity
begins to use this method, profit will be measured on a different basis than in past
periods. This change could affect the comparability of the amounts reported and may
be required to be disclosed. For example, when material, disclosure may be required

under paragraph 97 of IAS 1(2007) Presentation of Financial Statements.
Q&A IAS 11: 36-EX-1 — RECOGNITION OF CONTRACT LOSSES —

EXAMPLE
Example
will be CU900, of which CU300 has been incurred to date. During Year 1, however,
the contractor purchased materials for CU50 to be used in Year 2.
Revenue and costs to be recognised in Year 1 are considered in Q&A IAS 11: 30-2.
In Year 2, additional costs of CU300 are incurred. Management estimates that the
costs to complete the contract in Year 3 are CU500.
Under IAS 11.36, when an entity estimates that the outcome of a contract will be a
loss, the expected loss is recognised as an expense immediately.
The following calculations are performed for Year 2.
Because management now estimates a loss on the contract, the CU100 loss is
recognised immediately as an expense in Year 2 when the estimate is made. In
addition, any profit recognised in Year 1 is reversed in Year 2, with the result that
the total loss reported in Year 2 is CU130.
Accordingly, in Year 2, contract revenue of CU265 (i.e. CU1,000 × 54.5% – CU280)

is recognised in profit or loss. The loss relating to work already performed is CU55
(cumulative revenue of CU545 less cumulative costs of CU600, or 54.5 per cent of
total losses of CU100), so a provision is required for future losses of CU45.
Therefore, in Year 2, total contract costs (including the provision for future losses) of
CU395 (CU600 – CU250 + CU45) are recognised in profit or loss.
Q&A IAS 11: 38-EX-1 — CHANGES IN ESTIMATES — EXAMPLE

Example
will be CU900, of which CU300 has been incurred to date. During Year 1, however,
the contractor purchased materials for CU50 to be used in Year 2.
Revenue and costs to be recognised in Year 1 are considered in Q&A IAS 11: 30-2.
In Year 2, additional costs of CU300 are incurred. Management estimates that costs
of CU350 will be incurred in Year 3.
Under IAS 11.38, at a minimum, at the end of each reporting period, an entity
reviews its estimates relating to the outcome of a contract and makes revisions as
appropriate. Because the percentage of completion method is applied to each
contract on a cumulative basis, revisions are treated as changes in estimates and are
used in estimating the percentage of completion and the outcome of the contract in
the period of change and in future periods. As such, prior periods are not adjusted.
In practice, most contractors review progress and expected outcomes much more
frequently than at the end of each reporting period in order to maintain control over
the project.
The following calculations are performed for Year 2.

No adjustment is made to the revenue or expenses recognised in Year 1 due to the
change in estimate in Year 2.
Therefore, in Year 2, contract revenue of CU350 (i.e. CU1,000 × 63% – revenue

already recognised in Year 1 of CU280) and contract costs of CU350 (i.e. CU600 –
CU250) are recognised in profit or loss.
Q&A IAS 11: 42-1 — PRESENTATION OF AMOUNTS IN THE STATEMENT

OF FINANCIAL POSITION
Question
Should invoiced amounts receivable from customers be included in the "gross
amount due from customers for contract work" required to be presented in the
statement of financial position under IAS 11.42(a)?
Answer
No. The wording of IAS 11.42 is a bit misleading in that actual trade amounts
receivable from customers (i.e. amounts already billed) are not part of this figure.
These are recognised as separate assets and liabilities in the statement of financial
position.

The following example illustrates the point.
A contractor enters into a three-year contract. At the beginning of the contract,

estimated revenue is CU10,000 and estimated total costs are CU8,000.
During Year 2, management revises its estimate of total costs to be incurred and,
thus, the outcome of the contract. As a result, during Year 2, a loss for the year is
recognised on the contract, even though the contract will still be profitable overall.
Progress billings of CU4,000, CU4,000 and CU1,000 are made on the last day of each
year and are received in the first month of the following year.
The asset or liability at the end of each year is as follows.

In addition, at the end of each reporting period, the entity recognises a trade
receivable for the progress payments outstanding at the end of the year of CU4,000,
CU4,000 and CU1,000.
Q&A IAS 11: 42-2 — CLASSIFICATION OF GROSS AMOUNTS DUE TO

CUSTOMERS AND DUE FROM CUSTOMERS AS MONETARY OR
NON-MONETARY ITEMS
[Added 18 August 2006]
Question
Are the "gross amount due from customers" and the "gross amount due to
customers" for contract work monetary items?
Answer
Gross amounts due from customers will generally be considered monetary items.
Monetary items are defined in paragraph 8 of IAS 21 The Effects of Changes in
Foreign Interest Rates, as "units of currency held and assets and liabilities to be
received or paid in a fixed or determinable number of units of currency". IAS 11.43
and .44 provide guidance on how the gross amounts due from and due to customers
are determined. Depending on the level of progress billings, the amount may change
from a liability to an asset, and that amount would then be settled or recovered by
additional work performed subsequently, profits or losses recognised, or any
additional work performed in completing the contract.
In the absence of any other factors, the amount due from customers is a recognised
asset that is probable of being recovered from the customer in cash (provided those
are the terms of the arrangement) once the amount has been billed. While the right
to cash may not have been established contractually through the billing, the nature
of the asset is monetary nonetheless.
However, gross amounts due to customers will generally be considered

non-monetary items if the contractor is expected to fulfil its obligations through work
performed. Amounts due to customers may arise due to high progress billings in the
early parts of the construction project that are in excess of the costs incurred plus
recognised profits and less recognised losses. Such an obligation is generally offset
by work performed at a later stage of the project, not through settlement by units of
currency. It may occur, depending on the circumstances, that an amount due to a
customer becomes payable in units of currency. In that case, those amounts should
be classified as monetary items.
Q&A IAS 12: 2-1 — FACTORS IN DETERMINING AN INCOME TAX

[Issued 15 August 2003]
Background
IAS 12 defines 'income taxes' as "all domestic and foreign taxes which are based on
taxable profits. Income taxes also include taxes, such as withholding taxes, which
are payable by a subsidiary, associate or joint venture on distributions to the
reporting entity".
Question
What factors should be considered in determining whether a tax is an 'income tax'?
Answer
The determination of whether a tax is an income tax for the purposes of IAS 12 is a
matter of careful judgment, based on the specific facts and circumstances. Factors to
consider in making this determination include, but are not limited to, whether:
• the 'starting point' for determining the taxable amount is based on taxable
profits rather than another metric (e.g. units of production);
• the tax is based on a 'taxable profit' notion, implying a net rather than a
gross amount;

• it is based on actual income and expenses or on a notional amount e.g. on
a tonnage capacity;
• the legal description or characteristic of the tax implies that the tax is
calculated based on taxable profits; and
• there is any withholding related to the tax.
Note: IFRIC agenda rejection published in the May 2009 IFRIC Update.
Q&A IAS 12: 2-2 — HYBRID TAXES

Question
An entity is subject to a tax that is comprised of two discrete components, a
production-based component and a profit-based component. The production-based
component is a fixed minimum amount per ton of product sold. The total tax,
however, may exceed the fixed minimum per ton depending on the entity's
profitability. Is this 'hybrid' tax an income tax under IAS 12?
Answer
The production-based component of the tax would not be considered an income tax
as defined in IAS 12 and, therefore, would be outside the scope of IAS 12. However,
any amounts due as a result of the profit-based component would be considered an
income tax and subject to IAS 12.
Regarding the presentation of the production-based component, such amounts may

be reported as either part of 'cost of goods sold' or 'operating expenses'.
Classification as part of cost of goods sold is preferable; however, classification as an
operating expense would be acceptable. In either case, the presentation must be
logical, reflect the substance of the entity's operations, and be consistently applied.
Q&A IAS 12: 2-3 — CLASSIFICATION OF PETROLEUM REVENUE TAX

[Added 8 September 2006]
Question
This Q&A considers the specific facts and circumstances of one type of petroleum
revenue tax (PRT) and describes the appropriate accounting treatment under IFRS
for that tax. For each "tax" or "duty" charged by a government, it is necessary to
consider the individual facts and circumstances of that charge to determine whether
it is an income tax to be accounted for under IFRS.
In the UK, as in a number of other countries, a PRT is charged on companies

involved in the extraction of oil and natural gases.
PRT is determined on the basis of revenue from extraction activities, less certain
deductions of "allowable expenditure". (Allowable expenditures refer mainly to items
directly related to the extraction activities, but can also include certain other
amounts, including administration allowances and allowable deductions based on
assets held in the industry.)
In arriving at corporate taxable income, any PRT paid is considered a deduction for
purposes of the corporate income tax regime.
Is PRT an "income tax" to be accounted for in accordance with IAS 12?
Answer
Tax calculated under a PRT scheme is an income tax to be accounted for under IAS
12. The charge is a tax based on "taxable profit" — the fact that this "taxable profit"
differs from that under the regular income tax regime (e.g. it may relate to only part
of the operations) is not considered relevant because the amount is charged by the
government in respect of an entity's profit, as determined for this particular tax.
Furthermore, the use of the phrase "income taxes include all domestic" in IAS 12
indicates that a country may possess more than one tax regime that satisfies the
definition of an income tax and should therefore be accounted for in accordance with
IAS 12. Accordingly, the fact that the PRT is treated as a deduction in arriving at
corporate taxable income does not preclude PRT from being considered an income
tax to be accounted for under IAS 12.
For further general factors to consider in determining whether a tax is an income

tax, refer to Q&A IAS 12: 2-1, Factors in Determining an Income Tax.

[Deleted 20 February 2004]

Deleted
Q&A IAS 12: 4-EX-1 — DELETED

Deleted
Q&A IAS 12: 5-1 — UNCERTAIN TAX POSITIONS — RECOGNITION AND

MEASUREMENT
Question
Entities are required to calculate and pay income taxes based on applicable tax law.
However, no tax system can anticipate every possible complex transaction.
Accordingly, the application of the tax rules to complex transactions is sometimes
open to interpretation, both by the financial statement preparers and by the taxation
authorities. The tax authorities may challenge positions taken by an entity in
determining its current income tax expense and require further payment. The
interpretations made by preparers when the tax provisions are unclear are generally
referred to as uncertain tax positions.
How should the effect of uncertain tax positions be recognised and measured under
IFRS?
Answer
Uncertain tax positions affect the amount recognised for current tax and are within
the scope of IAS 12. Under IAS 12.46, "[c]urrent tax liabilities (assets) for the
current and prior periods shall be measured at the amount expected to be paid to
(recovered from) the taxation authorities". [Emphasis added] Presumably, any
uncertain tax positions taken by an entity in determining its current tax liabilities
(assets) will be examined by the appropriate tax authority, which is assumed to have
full knowledge of all relevant information.
IAS 12 does not include explicit guidance regarding the recognition and
measurement of uncertain tax positions. However, IAS 37.10 Provisions, Contingent
Liabilities and Contingent Assets is relevant in this case because an uncertain tax
position may give rise to "a liability of uncertain timing or amount". It would be
inappropriate to present the resulting liabilities with other provisions recognised
under IAS 37, since IAS 37.5(b) specifically excludes provisions that are addressed
in IAS 12. However, preparers may use the recognition and measurement criteria of
IAS 37 when determining the appropriate accounting for uncertain tax positions.
Accordingly, an entity should follow a two-step process in accounting for its

uncertain tax positions:
Recognition
Having already presumed 100 per cent detection risk by the appropriate tax
authority, the entity may determine whether, under IAS 37.14(b), it is probable
that an outflow of economic resources will occur, i.e. that upon examination of the
uncertain tax position by the appropriate tax authority, the entity will sacrifice all or
part of the tax benefit obtained from the uncertain tax position. Note that under IAS
37, an outflow of economic resources is probable if it is more likely than not to occur.
Measurement
If the probability threshold in the first step of the process ("Recognition") is met, the
entity will need to measure the potential impact of the appropriate tax authority's
examination of the uncertain tax position, in other words, the entity's best estimate
of the amount of the tax benefit that will be lost. (See IAS 37.36.) That amount may
be determined in accordance with the guidance set out in IAS 37.39–.40.
As stated in IAS 37.38, the best estimate of the amount to be provided is

"determined by the judgement of the management of the entity, supplemented by
experience of similar transactions and, in some cases, reports from independent
experts". For purposes of evaluating the financial consequences of an examination of
an uncertain tax position by the appropriate tax authority, the assistance of tax
experts experienced in the tax jurisdiction concerned is recommended.
Should the probability threshold in the first step of the process ("Recognition") not
be met, i.e., it is not considered probable that the entity will sacrifice part or all of
the tax benefits to be obtained from the uncertain tax position when an entity
applies IAS 37 by analogy, no amount is provided for against such tax benefits
already recognised as part of the accounting for income taxes under IAS 12. The
entity may, nevertheless, be required to disclose information in accordance with IAS
12.88 regarding contingent tax liabilities.
Refer to Q&A IAS 12: 46-1 for the appropriate presentation and disclosure of
uncertain tax positions.
Refer to Q&A IAS 12: 6-1 for the appropriate presentation and disclosure of interest
and penalties related to income taxes.

Q&A IAS 12: 6-1 — CLASSIFICATION OF INTEREST AND PENALTIES ON
INCOME TAX DEFICIENCIES
[Reserved 12 January 2007]
[Reissued 26 January 2007]
Question
How should interest and penalties on income tax deficiencies be presented?
Answer
Interest and penalties assessed on income tax deficiencies should be presented
based on their nature (i.e. either as a finance cost (interest) or operating expense
(penalties)) because those items do not meet the definition of current or deferred
income tax expense as defined in IAS 12.5.
Q&A IAS 12: 7-1 — ACCOUNTING FOR ADDITIONAL TAX DEDUCTIONS

Question
Entity A (A) may receive a tax allowance in the form of an investment tax credit
(ITC) if it invests in more than 25 per cent of an investee abroad and meets the
conditions below. The ITC is given to encourage investment in foreign companies.
Activities in the financial and insurance sector do not qualify for the ITC. In addition,
A must:
• Acquire a minimum of 25 per cent of the shares in the investee.
• Hold shares in the investee for a minimum of five years.
If all conditions are met, the ITC is 25 per cent of the cost of the investment. Entity
A may use the ITC immediately or defer it; however, the ITC expires after five years.
How should the ITC be accounted for?
Answer
IAS 12.7 defines tax base as "the amount that will be deductible for tax purposes
against any taxable economic benefits that will flow to an entity when it recovers the
carrying amount of the asset". In the ITC described above, A has the flexibility to
either use the ITC immediately or defer it for up to five years. Hence, the tax credit
is received independently of the recovery of the asset either through its use or sale,
and the ITC is therefore not part of the tax base of the asset.
The ITC is an incentive that is not directly linked to any underlying asset (i.e., the
investment in the net assets of the subsidiary). It represents an unused tax credit,
and, in accordance with IAS 12.34, a deferred tax asset should be recognised to the
extent that it is probable that future taxable profit will be available against which the
unused tax credit can be used.
Note that IAS 12.4 includes a scope exemption for ITCs. However, ITCs are not
defined anywhere in the IFRS literature, and use of the term "investment tax credit"
in local tax legislation is not necessarily consistent with the term's use in IAS 12. The
answer above applies irrespective of whether the tax allowance is within the scope of
IAS 12.
Q&A IAS 12: 9-1 — DEFERRED TAX ON GOODWILL WRITTEN OFF TO

EQUITY
Question
Under "local" GAAP, a company eliminated goodwill of €10 million arising on a
business combination directly to reserves. On adoption of IFRS, the business
combination giving rise to the goodwill is not restated under IFRS 3 Business
Combinations. IFRS 1.B2(i) First-time Adoption of International Financial Reporting
Standards states that such goodwill should not be recognised in the opening balance
sheet and furthermore should not be transferred to the income statement on
disposal or impairment of the related investment.
Under local tax law, however, the €10 million of goodwill was recognised as an asset,
and annual tax deductions can be claimed over a specified period for the "cost" of
the goodwill.
Is there a temporary difference arising with respect to the tax deductions for
goodwill that should be recognised under IAS 12 at the date of transition?
Answer
Yes, a temporary difference will arise. IAS 12.9 clarifies that temporary differences
may arise where an asset is not recognised on the balance sheet but is taken into
account for income tax purposes. Whilst there is no asset on the balance sheet, the
goodwill can be considered to have been "written off" or expensed directly to
reserves. Although IAS 12.9 refers to items expensed through the income statement,
it should also be applied to those items "written off" to equity.
In addition, IAS 12.15 prohibits recognition of deferred tax on goodwill, which gives
rise to a taxable temporary difference on initial recognition; however, IAS 12.24
does not make reference to goodwill in the context of deductible temporary
differences.
In this case, a deductible temporary difference arises on transition since the goodwill
has a carrying amount of nil in the balance sheet. However, it has an initial tax base
of €10 million and, accordingly, a deferred tax asset should be recognised for the
remaining deductible temporary difference at the date of transition to IFRS with a
corresponding credit to retained earnings as a transition adjustment, subject to the
recognition criteria in IAS 12.44.
Q&A IAS 12: 9-2 — DEFERRED TAX ON ASSETS NOT RECOGNISED ON

THE BALANCE SHEET
Question
Company X (X) is a first-time IFRS adopter in 2005 for the group it heads. Under
local GAAP, deferred taxes were provided based on timing differences.
In 2002, by means of an internal group reorganisation that had no effect for local
GAAP financial reporting purposes, X created, in the books of a subsidiary, an
intangible asset that, for tax purposes, will be deductible in the tax return over three
years. Since the asset is not recognised for financial reporting purposes in X's
consolidated financial statements and does not meet any asset recognition criteria
under IFRS, it will not be recognised on first-time adoption of IFRS.
In its first IFRS consolidated financial statements, should X recognise a deferred tax
asset for the net carrying amount of the tax asset that arose at the date of transition
to IFRS?
Answer
The tax deduction arising should be treated similarly to the treatment discussed in
IAS 12.65 for an asset revalued for tax purposes, but not revalued for accounting
purposes. There is no substantive difference between having an asset for book
purposes and recognising a revaluation for tax purposes, and obtaining a new tax
base for which no specific asset or liability is being recognised for financial reporting
purposes.
IAS 12.9 and IAS 12.17 provide examples of "timing differences", i.e. one type of
temporary difference when no asset or liability exists in the balance sheet. However,
IAS 12.9 is not limited to timing differences. If a tax base of an asset exists for tax
purposes and no asset exists for accounting purposes, the book value of that asset
or liability is deemed to be zero.
The initial recognition exemption does not apply because the transaction was not one
in which the entity initially recognised an asset; rather, it was a reshuffling of the
accounting for existing assets.
Accordingly, a temporary difference is created at the time of the group's

reorganisation. This results in the recognition of a deferred tax asset at the date of
transition, subject to the recognition criteria in IAS 12.44.
Q&A IAS 12: 15-1 — TAX SAVINGS ASSOCIATED WITH THE COSTS OF A
BUSINESS COMBINATION
Question
In accordance with IFRS 3.29 Business Combinations, the cost of a business
combination includes any costs directly attributable to the combination.
For tax purposes, those costs are usually tax deductible in the separate financial
statements of the acquirer. They may or may not be deducted for tax purposes in
the year the combination occurs (so may or may not give rise to a temporary
difference).
When the costs are tax deductible in the period in which they are incurred, should
the tax savings be accounted for in the income statement or as an adjustment to the
cost of acquisition?
Answer
The only scenario in which IAS 12 permits an entity not to recognise current tax as
an income or expense in the income statement of the period is when the underlying
transaction that gives rise to the tax is recognised directly in equity (and therefore
the corresponding tax is also recognised directly in equity).
IAS 12.58 provides an exemption for current and deferred tax arising on a business
combination that is further detailed in IAS 12.66–68. However, none of the
circumstances indicated in those paragraphs apply in the case mentioned above, i.e.
the tax savings do not create, or consist of:
1. Deferred taxes associated with the acquiree's assets and liabilities

recognised at the date of the business combination;
2. Deferred tax assets that could not be recognised by the acquirer before the
business combination; and
3. The subsequent realisation of potential benefit of the acquiree's income tax

loss carryforwards or other deferred tax assets that did not satisfy the
criteria in IFRS 3 for separate recognition at the date of the business
combination.
Accordingly, there is no exemption from recognising the tax saving as income in the
income statement. The tax savings will be recognised in profit when the tax
deduction occurs.

[Reserved 4 February 2005]
Reserved

[Reserved 15 October 2004]
Reserved

[Deleted 11 March 2005]
Deleted

Q&A IAS 12: 24-1 — USE OF THE TERM "PROBABLE"
Question
Deferred tax assets are recognised to the extent that it is "probable" that taxable
profit will be available. How should the term "probable" be applied to recognition of
deferred tax assets?
Answer
The notion of probability should be applied positively. That is, a deferred tax asset
should be recognised if presumption over realisability is probable. As a result, this
approach places the burden of proof on the preparer to provide evidence to support
recognition.
IAS 12 is silent with regard to the probability threshold. IAS 37.23 Provisions,
Contingent Liabilities and Contingent Assets defines the term "probable" as "more
likely than not". Footnote 3 of IAS 37.23 acknowledges that this definition is not
necessarily applicable to other International Accounting Standards. However, the
term "probable" should be applied as "more likely than not".
Q&A IAS 12: 24-2 — ASSESSING REALISATION OF TAX BENEFITS FROM

AN UNREALISED LOSS ON AVAILABLE-FOR-SALE SECURITIES
Question
What is the manner of assessing the realisation of the tax benefits from unrealised
losses from securities classified as available-for-sale?
Answer
For most entities, the assessment concerning the realisation of tax benefits from
unrealised losses on an available-for-sale debt securities portfolio, often will depend
on the inherent assumptions used for financial reporting purposes concerning the
ultimate recovery of the carrying amount of the portfolio.
IAS 12.16 concludes that it is inherent in the recognition of an asset that its carrying
amount will be recovered in the form of economic benefits that flow to the entity in
future periods. Thus, ordinarily, an entity shall assume recovery of the carrying
amount of its available-for-sale debt securities portfolio to be its fair value at each
balance-sheet date. Generally, whenever an unrealised holding loss exists, recovery
at fair value would result in a capital loss deduction.
In certain jurisdictions the tax law may require utilisation of capital losses only
through offset of capital gains, an entity would need to assess whether realisation of
the loss is probable based on available evidence. For example, evidence considered
might include (1) available capital loss carryback recovery of taxes paid in prior
years, and (2) tax-planning strategies to sell appreciated capital assets that would
generate capital gain income. In these situations, available evidence should be
evaluated to determine if it is probable that the entity would have sufficient capital
gain income during the carryback and carryforward periods prescribed under tax law.
Q&A IAS 12: 29-1 — REALISATION OF DEFERRED TAX ASSETS

Question
What are some examples of evidence that should be considered in determining
whether or not a deferred tax asset is recognised?
Answer
In evaluating whether or not it is probable that taxable profit will be available, the
nature and timing of such profit should be considered.
The following are some examples of factors that may support the assertion that it is
probable that taxable profit will be available:
Contracts or firm sales backlog that will produce more than enough taxable
income to realise the deferred tax asset based on existing sales prices and cost
structures
• An entity enters into a long-term contract that will generate sufficient
future taxable income to enable it to utilise all existing operating loss
carryforwards.
• During the current year, an entity acquired another entity that operates in
a different industry that is characterized by stable profit margins. The
acquiree's existing contracts will produce sufficient taxable income to
enable utilisation of the loss carryforwards.
An excess of appreciated asset value over the tax basis of an entity's net assets in

an amount sufficient to realise the deferred tax asset
• An entity has invested in land that has appreciated in value. If the land
were sold at its current market value, the sale would generate sufficient
taxable income to utilise all tax loss carryforwards. The entity would sell
the land and realise the gain if the operating loss carryforward would
otherwise expire unused. After consideration of the tax-planning strategy,
the fair value of the entity's remaining net assets exceeds their tax and
financial reporting basis.
A strong earnings history exclusive of the loss that created the future deductible
amount coupled with evidence indicating that the loss is not a continuing
condition
• An entity incurs operating losses that result in a carryforward for tax
purposes. The loss resulted from the disposal of a subsidiary whose
operations are not critical to the continuing entity and the company's
historical earnings, exclusive of the subsidiary losses, have been strong.
The following are some examples of factors that may rebut the assertion that it is
probable that taxable profit will be available:
History of losses in recent years

• An entity has incurred operating losses for financial reporting and tax
purposes during recent years. The losses for financial reporting purposes
exceed operating income for financial reporting purposes as measured on a
cumulative basis from the most recent preceding years.
• A currently profitable entity has a majority ownership interest in a newly

formed subsidiary that has incurred operating and tax losses since its
inception. The subsidiary is consolidated for financial reporting purposes.
The tax jurisdiction in which the subsidiary operates prohibits it from filing
a consolidated tax return with its parent.
A history of operating loss or tax credit carryforwards expiring unused
• An entity has generated tax credit carryforwards during the current year.
During the last several years, tax credits, which originated in prior years,
expired unused. There are no available tax-planning strategies that would
enable the entity to utilise the tax benefit of the carryforwards.
Unsettled circumstances that if unfavorably resolved would adversely affect profit
levels on a continuing basis
• During the last several years, an entity has manufactured and sold devices
to the general public. The company has discovered, through its own
product testing, that the devices may malfunction under certain conditions.
No malfunctions have been reported. However, if malfunctions do occur,
the company will face significant legal liability.
• In prior years, the entity manufactured certain products that required the
use of industrial chemicals. The company contracted with a third party,
Company X, to dispose of the by-products. Company X is now out of
business, and the entity has learned that the by-products were not
disposed of in accordance with environmental regulations. A governmental
agency may propose that the entity pay for clean-up costs.
Q&A IAS 12: 34-1 — CARRYFORWARD OF UNUSED TAX LOSSES AND

TAX CREDITS
[Added 12 May 2006]
Question
When assessing the recoverability of deferred tax assets arising from the
carryforward of unused tax losses and unused tax credits, should a deferred tax
asset be recognised where the amount of probable future taxable profit available is
sufficient only for a portion, rather than the total, of the unused tax losses or unused
tax credits?
Answer
Yes. IAS 12.34 states the following:
A deferred tax asset shall be recognised for the carryforward of unused tax
losses and unused tax credits to the extent that it is probable that future
taxable profit will be available against which the unused tax losses and
unused tax credits can be utilised.
As unused tax losses and tax credits normally expire after a certain period, an
assessment of the recoverability of a deferred tax asset will have to take into
account the period during which the unused tax losses or unused tax credits can be
utilised before they expire.
When assessing the probability that taxable profit will be available against which
unused tax losses or unused tax credits can be utilised, an entity assesses whether it
is probable that it will have taxable profits before the unused tax losses or unused
tax credits expire. The entity assesses whether any portion of the total available
unused tax losses and unused tax credits is likely to be utilised before they expire.
Since entities incur tax losses and earn tax credits at different points in time, this
would affect the probability of utilisation at any given reporting date.
Note: IFRIC agenda rejection published in the June 2005 IFRIC Update.
Q&A IAS 12: 34-2 — ACQUISITION OF TAX LOSSES AT LESS THAN FAIR
VALUE
[Added 14 May 2010]
Background
Company A acquires Company B, which is a shell entity with valuable unused tax
losses. Company B does not meet the definition of a business under IFRS 3(2008)
Business Combinations and, therefore, the transaction is not a business combination
for the purposes of that Standard.
Company A acquires Company B (and, therefore, the tax losses) for CU100,000. This
is significantly lower than the tax asset that would be recognised in respect of the
tax losses under IAS 12 (CU1 million). Company A expects to be able to utilise all of
the available losses.
Question
How should the transaction be accounted for in the consolidated financial statements
of Company A?
Answer
On the date of acquisition, Company A should recognise the deferred tax asset
acquired at the amount paid (i.e. at CU100,000).
Subsequently, the unused tax losses in Company B are available for use against
Company A's taxable profits. Accordingly, the deferred tax asset recognised at the
date of acquisition should be assessed and measured in accordance with IAS 12. IAS
12.34 requires that “[a] deferred tax asset shall be recognised for the carryforward
of unused tax losses and unused tax credits to the extent that it is probable that
future taxable profit will be available against which the unused tax losses and tax
credits can be utilised”.
Therefore, Company A should determine the extent to which it is probable that

future taxable profits will be available against which the unused tax losses can be
utilised and the deferred tax asset should be remeasured to reflect this amount. Any
remeasurement should be recognised in profit or loss for the period.
In the above example, if it is probable that Company A will be able to utilise all of
the tax losses, the deferred tax asset should be remeasured to CU1 million with the
resulting gain of CU900,000 recognised in profit or loss.
The assessment as to whether it is probable that the tax losses will be utilised should
be based on the guidance provided in IAS 12.35 and IAS 12.36. (See also related

Q&As IAS 12: 35-1, IAS 12: 35-2 and IAS 12: 36-1.)
Q&A IAS 12: 35-1 — HISTORY OF RECENT LOSSES

Question
How should an entity's history of recent losses be assessed in determining whether
or not sufficient taxable profit will be available in order to realise a deferred tax
asset?
Answer
The assessment of whether or not an entity will have sufficient taxable profits in the
future to realise a deferred tax asset is a matter of careful judgment based on the
facts and circumstances available. Generally, entities that have losses for a
three-year period — the current year and the immediate two preceding years, are
not able to assert that sufficient taxable profit in the future will be available, absent
convincing evidence to the contrary.
An entity's use of a history of recent loss determination period, other than the
current and two most preceding years, is acceptable provided such period has a
basis for support. For example, a four-year period or two-year period is acceptable if
the entity can demonstrate that it operates in a cyclical business and the business
cycles correspond to those respective periods. The period an entity chooses to
determine if a recent loss is present should be applied consistently on a yearly basis.
A history of recent losses is evidence that is among the most objectively verifiable
and, as a result, carries more weight than other evidence that embodies some
degree of subjectivity. For this reason, whenever an entity has suffered cumulative
losses in recent years, realisation of a deferred tax asset is difficult to support if
those assertions are based on forecasts of future profitable results without a
demonstrated turnaround to operating profitability. In other words, an entity that
has cumulative losses generally is prohibited from using an estimate of future
earnings to support a conclusion that realisation of an existing deferred tax asset is
probable, if such forecast is not based on objectively verifiable information that need
to be disclosed in accordance with IAS 12.82. Examples of these would include
significant new contracts, increase in backlog, disposal of an unprofitable segment,
etc.
Q&A IAS 12: 35-2 — CONSIDERATIONS WHEN RECOGNISING UNUSED

TAX LOSSES AND UNUSED TAX CREDITS AS OFFSETS AGAINST
TAXABLE TEMPORARY DIFFERENCES
Question
Company A (A) is required to offset deferred tax assets and deferred tax liabilities
because it meets the conditions in IAS 12.74. Does the fact that A is offsetting the
deferred tax asset against the deferred tax liability mean that it can automatically
offset the corresponding credit and debit, respectively, and present the net debit or
credit in the income statement, or must the corresponding credit and debit be
recognised in profit and loss/equity/goodwill depending on its origin?
Answer
The corresponding entry to the deferred tax assets and deferred tax liabilities must
be recognised in the income statement, in equity or against goodwill, depending on
how the temporary difference arose. It is possible that the offsetting tax charges and
benefits may not be recognised in the same place. This may occur, for example,
when:
• The deferred tax liability arises on the revaluation of an item of property,

plant, or equipment when the revaluation is recognised in a revaluation
reserve in equity.
• The deferred tax asset or deferred tax liability arises from a hedging
instrument designated in a qualifying cash flow hedge relationship for
which gains/losses on the hedging instrument are recognised directly in
equity to the extent that the hedging relationship is effective.
• The deferred tax liability arises from the recognition of a compound

financial instrument for which a portion of the instrument is initially
recognised directly in equity.
Example
During the year, A revalues an item of property, plant and equipment by $1,000 to
$21,000, recognising the increase directly in the revaluation reserve within equity.
The tax base of the property, plant, and equipment is $20,000. At the same time,
the company incurs an operating tax loss of $800 during the period, which, under
the relevant tax legislation, can be carried forward indefinitely. The requirements for
recognition of the deferred tax asset arising from the tax loss carried forward are
satisfied. In addition, the requirements for offsetting deferred tax assets and
liabilities in IAS 12.74 are met. The tax rate is 30 per cent.
Company A recognises a deferred tax liability of $300 ($1,000 temporary difference

× 30%) and a deferred tax asset of $240 ($800 loss × 30%). The two amounts are
set off in the balance sheet so that a net deferred tax liability of $60 ($300 – $240)
is recognised. However, the deferred tax arising on the revaluation is recognised
directly in the revaluation reserve and the effect of the current year's loss is
recognised in the income statement.
The deferred tax entry recognised is as follows:
Q&A IAS 12: 36-1 — CONSIDERATION OF NON-RECURRING ITEMS ON

FUTURE PROFIT
Question
How should non-recurring items be assessed in determining whether or not sufficient
taxable profit will be available in order to realise a deferred tax asset?
Answer
Non-recurring items generally are not indicative of an entity's ability to generate
taxable income in future years.
Examples of non-recurring items that should be excluded in determining future profit

or loss include, but are not limited, to the following:
• One-time restructuring charges that permanently remove fixed costs from

future cash flows;
• Large litigation settlements or awards that are not expected to recur in

future years;
• Historical interest expense on debt that has been restructured or

refinanced as of the date financial statements are issued;
• Historical fixed costs that have been reduced or eliminated as of the date
the financial statements are issued;
• Large permanent differences that are included in pretax accounting income

or loss but are not a component of taxable income; and
• Severance payments relating to management changes.
Examples of items that should be included in the determination of future profit or

loss include, but are not limited to, the following:
• Unusual loss allowances (e.g. large loan loss or bad debt loss provisions);
• Poor operating results caused by an economic downturn, government

intervention, or changes in regulation;
• Operating losses attributable to a change in the focus or directives of a

subsidiary or business unit; and
• The onerous effects on historical operations attributable to prior

management decisions when a new management team is engaged
(excluding any direct employment cost reductions relating to the
replacement of the old management team).
Q&A IAS 12: 39-1 — DEFERRED TAX LIABILITY FOR A PORTION OF

UNDISTRIBUTED EARNINGS OF A SUBSIDIARY
Question
A deferred tax liability is not required for an excess of the amount for financial
reporting over the tax basis of an investment in a subsidiary, branch, associate or
interest in a joint venture when the investor is able to control the timing of the
reversal of the temporary difference, and it is probable that the temporary difference
will not reverse in the foreseeable future.
In the circumstance where such an exception relates to undistributed profits and an

entity requires its subsidiary to remit only a portion of undistributed earnings, would
the entity be required to recognise a deferred tax liability only for a portion of the
undistributed earnings to be remitted in the future?
Answer
Yes. IAS 12.39 is not an "all-or-nothing" requirement. If circumstances change and it
becomes probable that some or all of the undistributed earnings of a subsidiary will
be remitted in the foreseeable future but income taxes have not been recognised,
the investor should accrue as an expense of the current period, income taxes
attributable to that remittance.

Q&A IAS 12: 39-2 — CHANGE IN INVESTMENT FROM A SUBSIDIARY TO
AN ASSOCIATE
[Amended 6 November 2009]
Question
If a parent ceases to have control over a subsidiary, but it retains an investment that
is classified as an associate and is accounted for using the equity method under IAS
28 Investments in Associates, should the investor recognise deferred taxes relating
to its share of the undistributed profits of the investee?
Answer
Yes. A parent that did not previously recognise deferred income taxes relating to its
interest in the undistributed profits of a subsidiary (because it was probable that the
temporary difference would not reverse in the foreseeable future) should recognise
the deferred taxes relating to its remaining share of those undistributed profits when
the investment becomes an associate, because the investor is no longer able to
control the reversal of the temporary difference. Therefore, for example, if the
parent's interest is reduced to 40 per cent, it should recognise a deferred tax liability
for the temporary difference resulting from its 40 per cent share of the undistributed
profits of the associate.
If the parent did previously recognise deferred taxes relating to its interest in the
undistributed profits of the subsidiary, the deferred taxes attributable to
undistributed profits of the subsidiary will be derecognised as part of the accounting
for the disposal or other transaction that reduces the parent's interest in the
subsidiary. In the example above, the original deferred tax liability relating to 60 per
cent of the undistributed profits will be derecognised.
Q&A IAS 12: 39-EX-1 — CHANGE IN INVESTMENT FROM A SUBSIDIARY

TO AN ASSOCIATE
[Reserved 27 February 2009]
[Amended and reissued 6 November 2009]
Example
Entity X owns 100 per cent of the shares in its subsidiary, FI, which has
undistributed profits of CU1,000. Entity X has recognised no deferred tax liability for
the resulting taxable temporary difference because recovery of the undistributed
profits of the subsidiary is within its control, and it is probable that the temporary
difference will not reverse in the foreseeable future.
On 1 January 20X1, FI issues shares to an unrelated third-party investor such that

Entity X ceases to control FI. FI becomes an associate of Entity X, accounted for
using the equity method.
For the year ended 31 December 20X1, Entity X's share of FI's profits is CU2,000
and no dividends are paid or payable during the year. At the beginning of 20X2, FI
declares a dividend of 20 per cent of undistributed profits.
In its 20X1 financial statements, Entity X should recognise an income tax expense
for the tax effect of establishing (1) a deferred tax liability for the tax consequences
of CU2,000 of taxable income attributable to its share of FI's profit for 20X1, and (2)
a deferred tax liability for the temporary difference resulting from its share of FI's
accumulated retained earnings for the period prior to 1 January 20X1.
In this case, while the payment of the dividend by FI will result in the reversal of
only 20 per cent of the temporary difference related to Entity X's share of the
accumulated retained earnings of FI as at 1 January 20X1, Entity X should recognise
a deferred tax liability for its entire share of those accumulated retained earnings
because it is no longer able to control the timing of the reversal of the temporary
difference.
Q&A IAS 12: 39-3 — DEFINITION OF "FORESEEABLE FUTURE"

Question
Deferred tax liabilities for all taxable temporary differences associated with
investments in subsidiaries, branches and associates, and interests in joint ventures
are recognised unless it is probable that the temporary difference will not reverse in
the foreseeable future. How should the phrase "foreseeable future" be applied?
Answer
In applying the phrase "foreseeable future" it is reasonable to analogize to the
guidance in IAS 1 regarding the going concern assumption. IAS 1.24 Presentation of
Financial Statements states that the "…foreseeable future should be at least, but not
limited to, twelve months from the balance sheet date".
Therefore, for purposes of applying IAS 12, the "foreseeable future" would be at
least twelve months from the balance sheet date. However, depending on the facts
and circumstances, it may be a longer period.
Q&A IAS 12: 39-4 — DEFERRED TAX ON LOANS TO FOREIGN

SUBSIDIARIES
[Added 7 July 2006]
Question
Company B (B) has a wholly owned subsidiary, Company D (D). Company B has a
U.S. dollar functional currency, and D has a Botswana pula functional currency.
Company B made a loan denominated in Botswana pula to D. The loan does not have
fixed repayment terms and settlement of the loan is neither planned nor likely to
occur in the foreseeable future. According to IAS 21.15 The Effects of Changes in
Foreign Exchange Rates this loan, in substance, forms part of B's net investment in
D.
At year end, B translates the loan to U.S. dollars in its separate financial statements
using the closing exchange rate at year-end. The exchange differences on the
translation of the loan are recognised in profit or loss in the separate financial
statements of B (IAS 21.32). The exchange differences arising from this loan will
only incur tax when the loan is repaid.
Should B recognise deferred tax in respect of the exchange differences arising on

this loan in its separate financial statements?
Answer
IAS 12.39 provides guidance on when an entity should recognise a deferred tax
liability associated with investments in subsidiaries. Since the loan forms part of B's
net investment in D, IAS 12.39 should be applied to the recognition of deferred tax
on the loan.
Company B is able to determine when the loan will be repaid as it exercises control
over D. Therefore, B is able to control when tax will be incurred on the exchange
differences, and is able to control the timing of the reversal of the temporary
difference. As settlement of this loan is neither planned nor likely to occur in the
foreseeable future, it is probable that the temporary difference will not reverse in the
foreseeable future.
Company B should not recognise deferred tax in respect of the exchange differences
arising on the loan to D. In addition, B should comply with the disclosure
requirements of IAS 12.81(f).
Q&A IAS 12: 39-5 — DEFERRED TAX ON OVERSEAS INCOME THAT IS

ONLY TAXED ON REPATRIATION
Question
Company A (A) has a subsidiary Company C (C), which operates in a foreign tax
jurisdiction. During the year, A made an interest earning deposit of $100,000 in C
that is not considered to be permanent as equity. The interest income is not taxable
while held in the foreign tax jurisdiction and is only taxed on repatriation. Company
A has no current intention to repatriate the interest income.
At the end of the current financial year, the total interest earned was $10,000 and
the carrying amount of the deposit was $110,000. The tax base of the interest
earned was nil.
Should A recognise a deferred tax liability for the interest earned on the deposit?
Answer
Yes. Company A is required to recognise a tax liability on the temporary difference,
which is the difference between the carrying amount of $10,000 and the tax base of
nil.
The exception in IAS 12.38–45 relates to differences between the carrying amount
and the tax base of investments in subsidiaries, branches, associates, and interests
in joint ventures. The exception does not apply to temporary differences that exist
between the carrying amount and the tax base of the individual assets and liabilities
within the subsidiary, branch, associate, or joint venture.
For situations where the loan is considered to be permanent as equity, refer to Q&A
IAS 12: 39-4, Deferred Tax on Loans to Foreign Subsidiaries.
Note: IFRIC agenda rejection published in the February 2003 IFRIC Update.
Q&A IAS 12: 41-1 — FOREIGN OPERATIONS


Question
The tax law for a particular foreign jurisdiction may permit or require the taxpayer to
adjust the tax basis of an asset or liability to take into account the effects of
inflation. The inflation adjusted tax basis of an asset or liability would be used to
determine the future taxable or deductible amounts. If a foreign subsidiary of an
entity prepares domestic financial statements in accordance with IFRS, does the
exception in IAS 12.39 apply to assets and liabilities indexed for inflation for tax
purposes?
Answer
No. Because such temporary differences relate to the foreign operation's own assets
and liabilities, rather than to the reporting entity's investment in that foreign
operation, the foreign entity recognises the resulting deferred tax liability or asset
subject to realisation analysis in its domestic financial statements. The resulting
deferred tax is charged or credited to the income statement. Such amounts would
not be recognised in cases where the exceptions in IAS 12.15 and IAS 12.24 are
met.
Q&A IAS 12: 41-EX-1 — FOREIGN OPERATIONS

Example
Assume that X, an entity reporting under IFRS in €s, has operations in a foreign
country where the inflation rate is not considered highly-inflationary under IAS 29
Financial Reporting in Hyperinflationary Economies and that the foreign currency
(FC) is the functional currency.
At the beginning of 20X2, the foreign jurisdiction enacted tax legislation that
increased the tax basis of depreciable assets by 10 per cent. That increase will
permit Entity X to deduct additional depreciation in current and future years. Also,
assume that the basis of X's depreciable assets is FC1,000 for tax and financial
reporting purposes; the foreign tax rate is 50 per cent, and the current exchange
rate between FC and the Euro is €1 equals FC2.
X would establish a deferred tax asset for the deductible temporary difference
resulting from the difference between the €/FC equivalent of the foreign depreciable
asset and the indexed tax basis. Thus, at the beginning of 20X2, X would record a
deferred tax asset of FC50 ([FC1,000 × 10%] × 50%) in the foreign currency books
of record. Deferred tax asset would be remeasured into €25 (FC50 × .5) based on

the current exchange rate.
Q&A IAS 12: 41-2 — CONSOLIDATED FINANCIAL STATEMENTS —

DEFERRED TAX ARISING ON TEMPORARY DIFFERENCES WHERE
THE TAX BASES OF A SUBSIDIARY ARE DENOMINATED IN A
CURRENCY OTHER THAN ITS FUNCTIONAL CURRENCY
Background
A New Zealand Group that prepares consolidated accounts in NZD, includes a

subsidiary with a functional currency of USD. However, that subsidiary is obligated to
pay taxes that are calculated and denominated in NZD. Accordingly, the tax bases of
the assets and liabilities in the subsidiary's accounts are denominated in NZD;
therefore, changes in exchange rates give rise to temporary differences. The
resulting deferred tax is charged or credited to profit or loss in accordance with IAS
12.41.
Question
Should the deferred tax charge that has been recognised in the profit or loss of the
subsidiary as a result of the foreign currency exchange differences, be reclassified to
the foreign currency translation reserve (FCTR) in the consolidated financial
statements?
Answer
The deferred tax expense (income) arising from the foreign currency exchange
differences should not be reclassified. It forms part of the recognised tax expense
(income) on consolidation. The amount is a profit and loss item that takes account of
the genuine foreign currency exposure between the functional currency of the
subsidiary and the tax cash flows of that subsidiary. Neither the translation
requirements of IAS 21 The Effects of Changes in Foreign Exchange Rates nor the
consolidation requirements of IAS 27 Consolidated and Separate Financial
Statements suggest that a consolidation adjustment to reclassify the deferred tax
amount is appropriate.
Q&A IAS 12: 44-1 — RECOGNITION OF A DEFERRED TAX ASSET

RELATED TO A SUBSIDIARY CLASSIFIED AS A DISCONTINUING
OPERATION

Question
Should a deferred tax asset for the excess of the tax basis over the financial
reporting basis of an investment in a subsidiary that meets the requirements of a
"discontinuing operation" under IAS 35 Discontinuing Operations be recognised?
Answer
IAS 12.44 states that a deferred tax asset should be recognised for all deductible
temporary differences arising from investment in subsidiaries, branches, and
associates, and interests in joint ventures if it is probable that the temporary
difference will reverse in the foreseeable future and taxable profit will be available
against which temporary difference can be utilised.
The fact that a subsidiary is a discontinuing operation does not modify the way any
deductible temporary difference that may exist is recognised. As such, a deferred tax
asset should be recognised to the extent that is probable that the temporary
difference will reverse in the foreseeable future, and taxable profit will be available
against which the temporary difference can be utilised.
Q&A IAS 12: 46-1 — UNCERTAIN TAX POSITIONS — PRESENTATION IN

THE FINANCIAL STATEMENTS
Question
Entities must calculate and pay their income taxes on the basis of the requirements
of the tax law applicable in their jurisdiction(s). However, no tax system can foresee
and make provisions for every complex transaction in which an entity may engage.
Accordingly, application of the tax rules to complicated transactions is sometimes
open to interpretation by financial statement preparers and tax authorities. The tax
authorities may challenge positions that an entity takes in determining its current
income tax expense and may require further payment. The interpretations made by
preparers under these circumstances are generally referred to as "uncertain tax
positions".
How should the effect of uncertain tax positions be presented and disclosed under
IFRSs?
Answer
Under IAS 12.46, current tax liabilities (assets) for the current and prior periods are
measured at the amount expected to be paid to (recovered from) the tax authorities.
Therefore, uncertain tax positions may affect the amount recognised and presented
for current tax liabilities or assets under IAS 12.
Although uncertain tax positions may give rise to provisions as defined in IAS 37
Provisions, Contingent Liabilities and Contingent Assets (a liability of uncertain
timing and amount — see IAS 37.10), it would be inappropriate to present the
resulting liabilities as in accordance with IAS 37 since they are outside its scope (see
IAS 37.5(b)).
The balance sheet impact of an uncertain tax position should be subsumed in the
amount for current tax liabilities presented as current or non-current, depending on
when payment is expected to be made to the tax authority. The income statement or
equity impact (depending on the nature of the uncertain tax position) should be
included in the same line item as tax expense (income).
When the uncertain tax position gives rise to a contingent liability — for example,
because it is not probable that a payment will be made to the tax authority — an
entity must still follow the disclosure requirements under IAS 12.88, which states,
"An entity discloses any tax-related contingent liabilities and contingent assets in
accordance with IAS 37 . . . . Contingent liabilities and contingent assets may arise,
for example, from unresolved disputes with the taxation authorities".
Finally, the disclosure of information for uncertain tax positions is governed by the
requirements in IAS 12 for current taxes (in particular IAS 12.80(b)), as well as IAS
1.116 Presentation of Financial Statements relating to key sources of estimation
uncertainty when there is a significant risk of a material adjustment in carrying
amounts of assets and liabilities within the next financial year.
This Q&A deals only with the presentation and disclosure of the tax benefits resulting
from uncertain tax positions. The presentation and disclosure of interest and
penalties are discussed in Q&A IAS 12: 6-1.
Q&A IAS 12: 46-2 — DISCOUNTING CURRENT TAXES PAYABLE

Question
An entity has reached an agreement with the taxing authorities that gives the entity
more than 12 months to pay its tax liability. Would it be appropriate to discount the
tax payable?

Answer
Yes. Although IAS 12 does not specifically address discounting of current taxes
payable, IAS 37.45 Provisions, Contingent Liabilities and Contingent Assets requires
that liabilities be discounted "where the effect of the time value of money is
material". Therefore, the current tax payable should be discounted if the time value
of money is material.
IAS 12.53 states, "Deferred tax assets and liabilities shall not be discounted". A clear
distinction between current and deferred tax is necessary because the most
significant argument against discounting deferred taxes is the difficulty of forecasting
the timing of the reversal of temporary differences. The timing of the reversal is not
an issue in this case because the temporary differences have reversed.
Q&A IAS 12: 47-1 — THE CONCEPT OF "SUBSTANTIVE ENACTMENT"

UNDER IAS 12
Question
Deferred income tax assets and liabilities should be measured based on tax rates
(and tax laws) that have been enacted or substantively enacted by the balance sheet
date. How should the term "substantive enactment" be applied?
Answer
The determination of whether or not new tax rates are considered "substantively
enacted" is a matter of careful judgment, based on the specific facts and
circumstances. Factors to consider in assessing that determination include, but are
not limited to, the following.
• The legal system and related procedures or processes necessary for

enactment of the tax law change;
• The nature and extent of the remaining procedures or processes;
• The extent to which the remaining procedures or processes are

perfunctory; and
• The timing of the remaining procedures or processes.

Q&A IAS 12: 47-2 — TAX HOLIDAYS
Question
When a tax jurisdiction grants an exemption from a tax on income that otherwise
would give rise to an income tax obligation, the event is sometimes referred to as a
"tax holiday". For example, the jurisdiction may, for economic reasons, forgive
income taxes for a given period if an entity constructs a manufacturing facility
located within the jurisdiction. To what extent does a tax holiday impact an entity's
deferred taxes?
Answer
IAS 12 does not specifically address recognition of tax holidays. A tax holiday period
would not result in a temporary difference as the tax base of an asset or liability
would equal its carrying amount. As such, no deferred tax assets or liabilities would
be recognised.
Q&A IAS 12: 47-3 — RECOGNITION OF DEFERRED TAXES ON TAX

HOLIDAY PERIOD
Question
An entity is granted a 100 per cent exemption from taxation for 15 years,
commencing from the time the entity begins to generate taxable income. The entity
currently expects that it will incur losses for the next eight years, and therefore,
should only tax-effect temporary difference that reverse after a 23-year period. The
entity has taxable temporary differences related to its pension plan. Should
temporary differences that reverse during the holiday period be viewed as "exempt"
temporary differences, and if so, what is the applicable exemption period?
Answer
Temporary differences that are scheduled to reverse during a holiday period should
not be recognised assuming the conditions of the tax holiday are met. Those
differences that reverse in periods after the tax holiday has expired should be tax
effected. In the fact pattern above, however, the entity should be the holiday period
as 15 years (and not 23 years). To do otherwise would be equivalent to anticipating
future tax losses, an action that is not allowed under IAS. In this case, the applicable
tax holiday period at each balance sheet date would continue to remain fifteen years
as long as the entity is incurring losses.
Q&A IAS 12: 47-4 — PHASED-IN TAX RATES

Question
A phased-in change in tax rates occurs when an enacted law specifies that in future
periods the tax rate applied to taxable income will change (e.g. an enacted tax law
provides that the corporate tax rate would be 43 per cent in 20X1, 38 per cent in
20X2, and 35 per cent for 20X3, and thereafter). How should deferred tax assets and
liabilities that are expected to be realised or settled in future years through the
carryback of a future loss to the current year, or a prior year be measured, when
phased-in tax rates exist?
Answer
The tax rate used to measure deferred tax liabilities and deferred tax assets should
be the enacted, or substantively enacted tax rate expected to apply to taxable
income in the years that the liability is expected to be settled, or the asset
recovered. Consequently, enacted or substantively enacted changes in tax laws or
rates that become effective for a particular future year(s) must be considered when
determining the tax rate to apply to measure the tax consequences of temporary
differences that are expected to reverse in those years. This may require knowledge
about the elections that are expected in the future, and the amounts of expected
income or loss in the future years when those temporary differences are expected to
reverse.
Q&A IAS 12: 47-5 — CHANGE IN TAX STATUS OF AN ENTITY

Question
When should the effect of a voluntary change in the tax status of an entity be
recognised?
Answer
The effect of an election for a voluntary change in tax status should be recognised on
the approval, or on the filing date if no approval is necessary (e.g. if the approval
change is perfunctory). A change in tax status that results from a change in tax law
will be recognised on the enactment date or the substantially enacted date if
applicable.
Q&A IAS 12: 49-1 — GRADUATED TAX RATES

Question
For entities that expect graduated tax rates to be a significant factor, how should the
applicable tax rate be determined to measure deferred tax assets and liabilities?
Answer
The applicable tax rate used to measure deferred tax assets and liabilities is the
average tax rate that is expected to apply to the taxable profit (tax loss) for the
periods in which the temporary differences are expected to reverse. The
determination of the applicable tax rate may require an estimate of future taxable
income for the year(s) in which existing temporary differences or carryforwards will
enter into the determination of income tax. That estimate of future income includes
(1) income or loss exclusive of reversing temporary differences, and (2) reversal of
existing taxable and deductible temporary differences. The following illustrates the
measurement of deferred income tax assets and liabilities when graduated tax rates
are a significant factor.
Q&A IAS 12: 49-EX-1 — GRADUATED TAX RATES

Example
Assume the following:
• At the end of 20X1, Entity X, which operates in a single tax jurisdiction,

has €30,000 of deductible temporary differences, which are expected to
result in tax deductions of approximately €10,000 for each of the next
three years — 20X2 through 20X4.
• Historically, the graduated tax rate structure in the applicable tax

jurisdiction has had an impact on the determination of X's income tax
liability.

• The graduated tax rates in that tax jurisdiction are as follows:
X's estimate of pretax income for the three years 20X2 through 20X4 is €410,000,
€110,000, and €60,000, respectively, exclusive of reversing temporary differences.
The estimated taxable income and income taxes payable for those years is computed
as follows:

X's average applicable tax rate is 23.8 per cent [(€3,400 + €2,230 + €1,500) ÷
€30,000]. Therefore, it recognises a deferred tax asset at the end of 20X1 of €7,130
(€30,000 × 23.8%). Recognition of all or a portion of the deferred tax asset is
contingent to meeting the probable realisation criterion established under IAS 12.
If X's estimate of taxable income for 20X2 through 20X4 exceeded €335,000 per
year, the amount of income tax liability would not be affected by the graduated rate
structure, and therefore, the requirement to estimate amounts and periods over
which existing temporary differences will reverse may be eliminated. In this
situation, measurement of the deferred tax asset would be at the average rate (34
per cent in the example), which is the applicable rate expected to apply.
Q&A IAS 12: 51-1 — REVERSALS OF TEMPORARY DIFFERENCES

Question
How should an entity schedule the reversal patterns of temporary differences?
Answer
IAS 12 does not specifically address the scheduling of reversal patterns. Because of
cost benefit considerations, there may be more than one approach to scheduling
reversal patterns. However, it is apparent from the discussion in IAS 12.35 and
12.36 that two concepts underlie the determination of the reversal patterns for
existing temporary differences:
• The year(s) in which temporary differences result in taxable or deductible

amounts generally are determined by the timing of the recovery of the
related asset or the settlement of the related liability.
• The tax law determines whether future reversals of temporary differences

will result in taxable and deductible amounts that offset each other in
future years.
The same method of reversal should be assumed when measuring the deferred tax
consequences for a particular category of temporary difference for a particular tax
jurisdiction. For example, if the loan amortisation method and the present value
method are both systematic and logical reversal patterns for temporary differences
that originate as a result of assets and liabilities that are measured at present value,
an entity engaged in leasing activities consistently should use either of those
methods for all its temporary differences related to leases that are recorded as lessor
receivables, because those temporary differences relate to a particular category of
items. If that same entity has temporary differences from loans receivable, a
different method of reversal might be assumed because those differences relate to
another category of temporary difference.
If the same temporary difference exists in two or more tax jurisdictions, the same
method should be used for that temporary difference in those jurisdictions. In
addition, the same method for a particular category within a particular tax
jurisdiction should be used consistently from year to year and any change in that
method of assumed reversal is a change in estimate that should be reported
consistent with IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors.

Q&A IAS 12: 51-EX-1 — REVERSALS OF TEMPORARY DIFFERENCES
Example
The following illustrations provide a description of several types of temporary
differences and general guidance for determining the pattern of their reversal. The
guidance is provided for illustrative purposes only and is not intended to prescribe
the extent to which scheduling reversals is necessary or to suggest that a specific
method should be used among alternative methods.
Deferred Description Suggested Reversal Pattern

Tax Item
State, Income taxes that are paid to These temporary differences

Provincial a state, provincial or local should reverse based on
and Local jurisdiction may be deductible estimates of when the taxes
Taxes for purposes of computing an that are expected to become
enterprise's corporate income deductible for corporate tax
tax liability. In such cases, a purposes.
deductible temporary
difference is created.
Obsolete For financial reporting The temporary difference should

Inventory purposes, inventory may be reverse in the period the
written-down to net realizable inventory deductions are
value (e.g. when expected to be claimed.
obsolescence occurs). For tax
purposes, generally, the
benefit of such a write-down
cannot be realized through
deductions until disposition of
the inventory. This event
generates a deductible
temporary difference

temporary difference.
Land The financial reporting of the Regardless of the reason for the
value assigned to land may temporary difference, the
differ from the tax basis. For enterprise should assume the
example, (1) it was acquired temporary difference will
in a nontaxable purchase reverse in the year in which the
business combination; (2) as land is expected to be sold to an
a result of differences in unrelated third party; otherwise,
capitalized costs, (3) the the timing of the reversal would
property was recorded at be indefinite.
predecessor cost, or (4) it
If, however, the sale is assumed
was revalued in accordance
to be at an indefinite future
with IAS 16.29.
date, the enterprise cannot
avoid recognition of the deferred
tax consequences of temporary
difference on land in accordance
with IAS 12.20.
Deferred In certain tax jurisdictions, Temporary differences from

Income and certain revenue or income revenues or gains deferred for
Gains might be taxed upon receipt financial reporting purposes, but
of cash (e.g. rental income, not for tax purposes, should be
loan or maintenance fees assumed to result in deductible
received in advance), but for amounts when the revenue or
financial reporting purposes gain is expected to be earned or
such income is deferred and generated (i.e. when the
recognized in the period the financial statement liability or
fee or income is earned. The deferred credit is expected to be
amounts deferred in an settled).
enterprise's balance sheet will
result in a deductible
temporary difference.
Allowances Certain tax jurisdictions An allowance for loan losses is

for Doubtful require that taxpayers use a considered to result in
Accounts “specific charge-off method” deductible amounts in the future
to compute bad debt year(s) that the particular loans,
deductions for tax purposes. or portions thereof, for which
For financial reporting there is an allowance for losses
purposes, enterprises at the current financial
recognize loan losses in the statement date, are expected to
period the loss is estimated to be deemed wholly or partially
occur, which creates a worthless for tax purposes, or
deductible temporary are planned to be disposed of, if
difference they are held for sale

difference. they are held for sale.
Property, There are two primary In each case, it is necessary to

Plant and reasons that an enterprise estimate the amounts and
Equipment might determine it is timing of taxable income or loss
necessary to schedule the expected in future years. For
reversals of temporary some assets and liabilities,
differences related to temporary differences may
depreciable assets: (1) to accumulate over several years
determine if taxable income and then reverse over the next
of the appropriate character several years, which is a
within the carryback or common pattern for depreciable
carryforward period available assets.
under the tax law is sufficient
to reach a conclusion that
realization of a deferred tax
asset is probable, and (2) to
determine the applicable tax
rate used to measure
deferred tax assets and
liabilities through a process
that determines the enacted,
or substantially enacted tax
rates expected to apply to
taxable income in the periods
in which the deferred tax
liabilities, or assets are
expected to be settled, or
realized.
Office For tax purposes, office The reversal of the temporary

Buildings buildings and other real difference between the indexed
Adjusted for estate may not be adjusted tax basis and the net
Inflation depreciated. Additionally, the book value of the property for
tax basis of such property financial reporting purposes
routinely may be increased should be assumed to occur
for the approximate loss in during the year in which the
purchasing power caused by building is expected to be sold.
inflation.
Assets The carrying amount for The difference between the

Under financial reporting purposes amount reported for
Construction of an asset under construction in progress for
construction for an financial reporting and its
enterprise's own use may related tax basis should be
differ from its tax basis as a scheduled to reverse over the
result of differences in expected depreciable life of the
capitalized costs (e.g. interest asset, which should not
capitalized). commence prior to the date the
property is expected to be
placed into service
placed into service.
Loss Under IAS 37 Provision, The deductible temporary

Contingencies Contingent Liabilities and differences are scheduled to
Contingent Assets, a reverse during the periods that
provision accrued for financial the losses are expected to be
reporting purposes may not deductible for tax purposes.
be deductible for tax
purposes until paid.
Warranty In most tax jurisdictions, tax The temporary differences

Reserves deductions for accrued attributable to warranty accruals
warranty costs are not for financial reporting should be
permitted until the obligation scheduled to reverse during the
is settled. years in which the tax
deductions are expected to be
claimed.
Organization Under certain tax If reported as an expense in the

Costs jurisdictions, organizational period incurred, any deductible
(Start-Up costs generally are deferred temporary differences should be
Costs) and amortized to income over scheduled to reverse based on
a fixed number of years using the future amortization of the
the straight-line method. tax basis of the asset.
Unless an enterprise can
demonstrate clearly that such
costs have a future economic
benefit, they are recognized
as an expense for financial
reporting purposes in the
period they are incurred

period they are incurred.
Construction Certain tax jurisdictions may For those enterprises that use
Contracts require use of the completed the completed contract method
contract method for tax for tax purposes, a temporary
purposes, which creates a difference will result in future
temporary difference for taxable income in the amount of
enterprises using the gross profit recognized for
percentage-of-completion financial reporting purposes.
method for financial reporting The reversal of these differences
purposes. would be assumed to occur
based on the period in which the
contract is expected to be
completed.
If the percentage-of-completion
method is used for both tax and
financial reporting purposes,
temporary differences may
nevertheless result because the
gross profit for tax purposes
may be computed differently
than it is for financial purposes.
Scheduling the reversals of
these temporary differences
generally would require
estimates of the amount and
timing of gross profit for tax and
financial reporting purposes.
Assets and Certain assets and liabilities Two common methods, the “loan
Liabilities are measured at present amortization method” and the
Measured at values (e.g. loans receivable, “present value method”, are
Present capital lease obligations of used for scheduling the
Values lessee, deferred reversals of temporary
compensation arrangements, differences relating to assets
pension and and liabilities measured at
post-employment obligations, present value.
loans receivable and payable
Loan Amortization Method —
that are acquired in a
The temporary difference
purchase business
may be scheduled to reverse
combination).
based on the future
reductions in the principal
balance of the asset or
liability.
Present Value Method — The
temporary difference may be
scheduled to reverse based
on the present value of
f h fl
future cash flows.
Employee In many instances, application The following two approaches
Benefits of IAS 19 Employee Benefits may be used to schedule the
will result in temporary reversals of temporary
differences because under differences related to pension
many tax laws generally there assets and liabilities:
is no tax basis for those
Reduction in Future
assets and liabilities reported
Contributions Approach —
in an enterprise's statement
the pattern of taxable
of financial position.
amounts in future years that
will result from the
temporary difference related
to a prepaid pension cost,
should be considered the
same as the pattern of
estimated net periodic
pension cost for financial
reporting for the following
year and succeeding years, if
necessary, until such excess
on a cumulative basis equals
the amount of the temporary
difference.
Refund From the Plan
Approach — the pattern of
deductible amounts in future
years that will result from
the temporary difference
related to a liability for
accrued pension cost, should
be considered the same as
the pattern by which
estimated tax deductions are
expected to exceed interest
attributable to that liability
for accrued pension cost for
the following year, and
succeeding years, if
necessary, until such excess,
on a cumulative basis, equals
the amount of the temporary
difference.
If the information necessary to
apply either of the above
approaches is not available, the
enterprise might use the
following approach, which
reflects certain aspects of the
methodology for recognition and
appropriate period.
Undistributed In cases where an enterprise For purposes of assessing the

Earnings is unable to control the timing amounts and timing of future
of reversal of the temporary income from these sources, the
difference regarding expected remittances should be
investments in affiliates or it based on the expected timing of
is not probable that the the cash flows or distribution of
temporary difference will not dividends in kind (i.e. assets
reverse in the foreseeable other than cash).
future, a temporary difference
may arise in connection with
unremitted earnings.
Q&A IAS 12: 51-2 — CONSIDERATION OF FUTURE EVENTS

IAS 12: 51-2
Question
To what extent should future events be considered when assessing the realisability
of deferred tax assets?
Answer
In general, entities should consider all currently available information about the
future. However, certain future events should not be anticipated or considered in
determining the realisability of deferred tax assets. These items include, but are not
limited to, the following:
• Changes in tax laws or rates (except substantially enacted),
• Changes in tax status,
• Expected business combinations,
• Anticipating future income from events beyond the entity's control and that
are non-recurring or unusual in nature (e.g. forgiveness of indebtedness
for purposes of avoiding derecognition of a deferred tax asset), and
• Events dependent on future market conditions or otherwise not within the

entities control.
Q&A IAS 12: 51-3 — CONVERTIBLE INSTRUMENTS WITH DIFFERENT

TAX TREATMENTS ON REDEMPTION AND CONVERSION
Background
Under IAS 32 Financial Instruments: Presentation, the requirement to separate the

equity and financial liability components of a compound instrument is consistent with
the principle that a financial instrument must be classified in accordance with its
substance, rather than its legal form. The expected manner of recovery is not taken
into account in establishing this classification.
In some jurisdictions, the tax treatment for a convertible instrument may differ
depending on whether the instrument is settled in cash or by the delivery of shares.
Question
Should the measurement of the deferred tax liability or asset recognised in relation
to a convertible instrument with different tax treatments on redemption and
conversion reflect the expected manner of settlement of the instrument?
Answer
Yes. Unlike IAS 32, IAS 12.51 and 52 require that the tax base and the tax rate used
to determine deferred tax assets and liabilities reflect the manner in which the entity
expects to settle the instrument.
However, when settlement is outside the control of the issuer, the presumed
settlement should be aligned with the IAS 32 classification (i.e. cash settlement
should be presumed) unless there is strong evidence that the instrument will be
settled by the delivery of shares.
Q&A IAS 12: 52-1 — DEFERRAL OF TAXABLE INCOME IN EQUITY —

REALISED GAINS
Background
Under Greek tax law, a company may elect not to be taxed on realised gains from
the sale of securities; instead, such gains may be transferred to a special reserve
account for tax purposes. Realised losses from the sale of securities must be
transferred to the special reserve account and therefore such losses are not tax
deductible. If the reserve is insufficient to cover the losses, a debit special reserve is
created. In the event that the company makes a distribution from that reserve,
which is at the sole discretion of the shareholders, the tax becomes payable. In
addition, liquidation, capitalisation and relief of the accumulated losses would trigger
an immediate payable/receivable.
Company B has utilised this election and therefore any realised gains or losses on its
marketable securities (either classified as available for sale or held for trading) have
not been included in the tax payable calculation. It appears that such arrangements
are being accounted for as follows by at least some companies in Greece:
• No current or deferred tax liability is recorded until such time as a dividend

is declared (and recognised in the financial statements) out of the special
reserve account. This is in accordance with IAS 12.52A–52B.
• A deferred tax asset is recorded in respect of realised losses from the sale
of securities to the extent that the loss exceeds the net cumulative gain
available in the special reserve. The reason for recognising the asset is that
when a loss is available to be carried forward, the company will not elect to
transfer future gains to the special reserve, thereby triggering a tax liability
that is then reduced by the amount of the losses.
Question
Should Company B record a deferred tax liability (asset) for the realised gains in the
special reserve account?
Answer
The company must make a positive decision to transfer realised gains to the special
reserve (rather than the transfer being automatic). This is a matter of legal form
rather than substance, as any company acting rationally will choose to defer its tax
liability.
Both the tax liabilities and the tax assets result from the consequences of paying a
dividend and should be accounted for in accordance with IAS 12.52A–52B. When a
distribution is paid from the special reserve, the related income tax shall be recorded
at the appropriate rate.
Alternatively, it may be argued that the realised gains are not taxable and hence
that there is no temporary difference in respect of the realised gains.
See Q&A IAS 12: 52-2 for discussion of the accounting for unrealised gains deferred
in an equity account.
Q&A IAS 12: 52-2 — DEFERRAL OF TAXABLE INCOME IN EQUITY —

UNREALISED GAINS
Background
Under Greek tax law, a company may elect not to be taxed on realised gains from
the sale of securities; instead, such gains may be transferred to a special reserve
account for tax purposes. Realised losses from the sale of securities must be
transferred to the special reserve account and therefore such losses are not tax
deductible. If the reserve is insufficient to cover the losses, a debit special reserve is
created. In the event that the company makes a distribution from that reserve,
which is at the sole discretion of the shareholders, the tax becomes payable. In
addition, liquidation, capitalisation and relief of the accumulated losses would trigger
an immediate payable/receivable.
Company B has utilised this election and therefore any realised gains or losses on its
marketable securities (either classified as available for sale or held for trading) have
not been included in the tax payable calculation. It appears that such arrangements
are being accounted for as follows by at least some companies in Greece:
• No current or deferred tax liability is recorded until such time as a dividend

is declared (and recognised in the financial statements) out of the special
reserve account. This is in accordance with IAS 12.52A–52B.
• A deferred tax asset is recorded in respect of realised losses from the sale
of securities to the extent that the loss exceeds the net cumulative gain
available in the special reserve. The reason for recognising the asset is that
when a loss is available to be carried forward, the company will not elect to
transfer future gains to the special reserve, thereby triggering a tax liability
that is then reduced by the amount of the losses.
Question
Should Company B record a deferred tax liability (asset) for the unrealised gains
recorded in either the income statement or equity?
Answer
For the same reasons as those set out in Q&A IAS 12: 52-1, that is, that the
undistributed rate should be used to measure the deferred taxation, no deferred tax
should be recognised in the income statement or in equity.
Alternatively, as in Q&A IAS 12: 52-1, no temporary difference exists.
Q&A IAS 12: 52-3 — APPLICABLE TAX RATE FOR INDEFINITE-LIFE

INTANGIBLE ASSETS
Question
Company A (A) operates in a tax regime where different tax rates apply depending
on whether the gain arises from capital events or operations. Company A has an
indefinite-life intangible asset. Should A apply the use rate or the sale rate in
determining the associated deferred tax liability?
Answer
IAS 12 notes that the manner in which an entity recovers the carrying amount of the
asset may affect the tax base and/or the tax rate applicable when the entity recovers
that carrying amount.
SIC-21 Income Taxes — Recovery of Revalued Non-Depreciable Assets deals with

assets that are not consumed through use and therefore do not have a useful life.
For example, land may have an unlimited life. In contrast, an indefinite-life asset is
one for which there is no foreseeable limit to the period over which the asset is
expected to generate net cash inflows for the entity. Therefore, SIC-21 does not
apply to indefinite-life intangible assets. Furthermore, IFRIC noted in a rejection
notice that SIC-21 has a limited scope that does not address this particular issue.
An entity must make an assessment as to the expected manner of recovery of the

intangible asset, and apply the appropriate tax rate (e.g. use rate or sale rate) based
on that expectation, in order to determine the deferred tax liability.
Q&A IAS 12: 52-4 — APPROPRIATE TAX RATE FOR INVESTMENT

PROPERTIES
Question
Company A (A) has an investment property, which is measured at fair value in
accordance with IAS 40 Investment Property. Company A was acquired in a business
combination, so the initial recognition exemption did not apply. There is no intention
to sell the property in the short term. Different tax rates apply for the use and sale
of the asset. The taxation authority does not allow an on-going tax deduction for
depreciation with respect to any aspect of the property; therefore, on a use basis the
tax base of the investment property is generally zero or small. However, on a sale

basis the tax base is the cost of the property.
Should the deferred tax liability of the investment property be recognised at the sale
rate or the use rate?
Answer
SIC-21.4 Income Taxes — Recovery of Revalued Non-Depreciable Assets includes
within its scope, investment properties carried at revalued amounts that are
accounted for under IAS 40 only if they would be considered non-depreciable if IAS
16 Property, Plant and Equipment were to be applied.
Thus, the deferred tax consequences in respect of revalued investment properties

would depend on whether they are depreciable or non-depreciable assets.
Although investment properties are not generally depreciated, they are "depreciable"
because they have a limited useful life. SIC-21 is clear that only investment
properties that "would be considered non-depreciable if IAS 16 were to be applied"
fall within its scope. This effectively restricts its scope to freehold land.
Thus, if a company holds investment property that comprises land and buildings, and
these are accounted for in accordance with the fair value model in IAS 40, then,
generally, the deferred tax consequences of the land and building elements would
need to be considered separately for purposes of IAS 12.
The land element has an unlimited economic life and is therefore a non-depreciable
asset as defined by IAS 16. Consequently, any deferred tax asset or liability arising
on the land element should reflect the tax consequences of selling the asset.
However, in some cases, for example, due to re-zoning or other circumstances, land
held under a finance lease could have a limited life and be a depreciable asset.
The building element has a finite life, so it is assessed as depreciable. Thus, any
deferred tax asset or liability should reflect the tax consequences that would follow
from the manner in which the company expects, at the balance sheet date, to
recover the asset. This would be used in situations for which there is generally no
tax base (or a small tax base based on tax allowances claimed on a component of
the investment property designated as plant for tax purposes), generally followed by
eventual sale for the asset's estimated residual value (for which there is a tax base
based on capital disposal). In practice, to the extent that the building's estimated
residual value reflects its current fair value, the entire investment property is
ultimately recovered through sale; hence, the tax base applicable to a sale is
appropriate. However, to the extent that the building's estimated residual value is
lower than its current fair value, a tax base based on the use and consumption of
that element of the building should be used.

Q&As IAS 12: 52-5 and 52-6 — APPROPRIATE RATE FOR INVESTMENTS
IN ASSOCIATES
Background
Company A (A) has a 20 per cent interest in Company B (B). The investment in B is
treated as an equity-accounted investment in the consolidated financial statements
of A. Dividends received from B are not taxable; however, any capital gain on
disposal of the investment in B is taxable at a rate of 15 per cent.
IAS 12: 52-5
[Added 1 December 2006]
Question
Should deferred tax be measured at the use rate or the sale rate?
Answer
IAS 12 requires deferred tax to be determined based on the manner in which the
entity expects to recover the asset, which will often involve a degree of judgement.
Factors to consider in making this judgement include, but are not limited to:
• Whether A intends to sell its interest in B.
• The dividend yield on the investment.
• The market price for the investment.
• The reason for acquiring and holding the investment.
The lack of evidence of intent to sell, even though such intent may be a possibility at
some future point, may lead to an assumption of recovery through use.
IAS 12: 52-6
Question
If A accounted for its investment in B as a financial asset carried at fair value rather
than an associate, would the answer in Q&A IAS 12: 52-5 be different?
Answer
No. Irrespective of how the investment is accounted for, A must still assess the
manner in which it expects to recover the asset.
Q&A IAS 12: 52-7 — ACCOUNTING FOR ROLLOVER RELIEF

Question
In some jurisdictions, a company may be entitled to "rollover relief" when it disposes
of a capital (fixed) asset for a profit and replaces it with an equivalent asset. In such
circumstances, the gain on disposal may not be assessed for tax purposes until the
replacement asset is disposed of, when it is taken into account via the "capital" (or
sale) tax base of the replacement asset. When it disposes of the replacement asset,
the company is required to pay the tax on the gain on disposal of the replacement
asset together with the tax on the gain on disposal of the original asset.
Should a deferred tax liability with respect to the gain on the original asset be
recognised by the entity at the time of disposing of that asset?
Answer
In many cases, the "rollover" of the gain on disposal of the original asset into the tax
base of the replacement asset merely postpones, rather than eliminates, the
payment of tax, and IAS 12.20(b) requires that a deferred tax liability is recognised.
If the replacement asset is recovered entirely through use, it may be the case that
the tax for which "rollover relief" was given is not merely postponed, but
permanently relieved. Thus, in determining the tax base of a replacement asset, a
company should, on the basis of the expected manner of recovery, give careful
consideration to the effect of rollover relief on the tax payments flowing from its
recovery.
Q&A IAS 12: 52-8 — RECOVERY THROUGH SALE AND USE SUBJECT TO
DIFFERENT INCOME TAXES
[Added 7 May 2010]
Background
Company D acquires machinery in a business combination. The machinery is initially

recognised in the consolidated financial statements at its fair value of CU150. Entity
D is not entitled to claim any tax deductions if the machinery is used in its operations
and, therefore, the machinery's tax base for recovery through use is nil.
Company D expects to use the machinery for a number of years and then sell it for
its currently estimated residual value of CU50. The income on sale of the machinery
is subject to a different type of income tax and, when the machinery is sold, a tax
deduction of CU100 will be available. Therefore, the machinery's tax base for
recovery through sale is CU100.
The tax rates expected to apply when the temporary differences reverse are 10 per
cent in respect of use and 30 per cent in respect of sale. In the tax jurisdiction in
which Company D operates, losses on disposal of this type of asset can only be
recovered against gains on disposal of similar assets and not against general
operating profits.
Question
What deferred tax asset or liability should be recognised in respect of the machinery?
Answer
In the circumstances described, the recovery of the machinery through use is subject
to one type of income tax and recovery through sale is subject to another type of
income tax at a different rate. There is no equalisation mechanism under which the
total tax deductions obtained for the two types of income tax together equal the cost
for tax purposes; the tax regime is such that there are effectively two distinct tax
systems applicable to the recovery of the asset. In such circumstances, it is often
necessary to consider separately the tax bases and temporary differences arising
from recovery through use and recovery through sale. Any deductible temporary
differences need to be assessed for recognition in accordance with the usual
requirements, separately from any taxable temporary differences arising.
Company D should therefore recognise deferred tax as follows.

Q&A IAS 12: 58-1 — RECYCLING OF TAX EFFECTS ON GAINS AND
LOSSES ON FINANCIAL INSTRUMENTS THAT ARE DIRECTLY
RECOGNISED IN EQUITY
Question
Company A (A) (£ functional) undertakes the following two forms of hedge
accounting:
• cash flow hedges its £ denominated floating rate debt with a receive £
float, pay £ fixed interest rate swap; and
• net investment hedges its US$ foreign operations with a £ receive float,
US$ pay float cross-currency swap.
Company A also has investments in listed equity securities that are classified as
available for sale.
Company A, therefore, has fair value gains and losses recognised in equity on the
interest rate swap, the cross-currency swap, and the available-for-sale securities.
These fair value gains and losses will be recycled to the income statement
respectively when:
1. floating interest is paid on the debt (IAS 39.100 Financial Instruments:

Recognition and Measurement);
2. the foreign operation is sold (IAS 39.102); and
3. the available-for-sale securities are sold (IAS 39.55(b)).
All three of these financial instruments are taxed at 30 per cent on the unrealised
gains and losses that are recognised in the period. The unrealised gains and losses
on these financial instruments should be recognised directly in equity, in accordance
with IAS 39. As a result, the current tax on such gains or losses also should be
recognised directly in equity, in accordance with IAS 12.
When the gains and losses on the financial instruments recognised in equity are
subsequently recycled into the income statement, should the tax effects previously
recognised in equity also be recycled into the income statement?
Answer
The question as to whether the tax effects previously recognised in equity should be
recycled into the income statement, is a matter of accounting policy choice.
The preferred treatment is that these tax amounts are recycled into the income
statement. Even though IAS 12 makes no reference to recycling of tax effects on
amounts recognised directly in equity, it is clear that the tax effects follow the gains
or losses to which they relate. This principle is applied when the gains or losses are
initially recognised in equity, and equally can be applied when they are subsequently
recycled to the income statement. If the tax is not recycled, the income statement
will be misrepresented, as the change in fair value of the financial instruments will be
recognised in the income statement, but the tax effects will not.
The alternative treatment is that these amounts are not recycled. Instead, when the
amounts relating to the financial instruments are recycled into the income
statement, a reserves transfer should be processed to move the tax amounts into
retained earnings. The rationale for this is that the tax, when it arises, is reported in
equity following the transaction to which it relates. The subsequent recycling of the
gains and losses on the financial instruments has no tax impact, so there is no tax
transaction to record.
Q&A IAS 12: 61-1 — AVAILABLE-FOR-SALE INVESTMENTS

Question
Assume that an entity has a portfolio of available-for-sale investments and that
during 20X1 their fair value has declined such that unrealised holding losses are
incurred and reported directly in shareholders equity. Available evidence supports a
conclusion that the full deferred tax asset should not be recognised as of the end of
the year. In 20X2, the entity's estimate of future income, exclusive of temporary
differences and carryforwards, changes. Accordingly, these circumstances have
caused a change in judgment about the realisability of the related deferred tax asset
in future years, and an unrecognised deferred tax asset is no longer necessary at the
close of 20X2. Recognition of a deferred tax asset is reported directly in equity in
20X2 in accordance with paragraph 61. Also, assume that in 20X3, the fair value of
the securities increases such that the unrealised loss previously reported directly in
shareholders equity, is eliminated and the securities are sold at no gain or loss.
Shareholders' equity is increased for the market value increase net of any related tax
consequences. When should the deferred tax consequences related to AFS
investments that remain in equity be eliminated?
Answer
The answer depends on whether the entity is using the individual
security-by-security approach or the portfolio approach. The tax consequences under
each method may sometimes be reported differently.
Security-by-Security Approach. Under the individual security approach, the tax

consequences of unrealised gains and losses that are reported directly in
shareholders' equity are tracked on an individual security-by-security approach.
Because there is zero cumulative pretax unrealised gain or loss on the
available-for-sale portfolio at the end of 20X3, and because there was no tax effect
originally recorded directly in shareholders' equity, the credit to eliminate the gross
deferred tax effect remaining in equity at the close of 20X3 is charged to income tax
expense from continuing operations during 20X3.
Portfolio Approach. Under the portfolio approach, the entity should follow a strict
period-by-period cumulative incremental allocation of income taxes to the change in
unrealised gains and losses reflected in equity. Under this approach, the net
cumulative tax effect is ignored. The net change in unrealised gains or losses
recorded in shareholders' equity under this approach would be eliminated only at the
date the entire inventory of available-for-sale investments are sold or otherwise
disposed.
Q&A IAS 12: 61-2 — HOLDING GAINS AND LOSSES ON

AVAILABLE-FOR-SALE INVESTMENTS RECOGNISED FOR BOTH
FINANCIAL REPORTING AND TAX PURPOSES
Question
When an unrealised loss on available-for-sale (AFS) investments is incurred and the
loss deductions are included in the determination of taxable income or loss in the
entity's corporate tax return, how should the tax consequences for financial reporting
purposes be measured and recorded?
Answer
When an unrealised loss on available-for-sale investments is incurred and the loss
deductions are included in the determination of taxable income or loss in the tax
return, the tax consequences for financial reporting purposes should be measured
and recorded (1) in the year the unrealised loss is incurred, and (2) in the year the
investments are sold. Q&A IAS 12: 61-EX-1 illustrates this concept.
Q&A IAS 12: 61-EX-1 — HOLDING GAINS AND LOSSES ON

AVAILABLE-FOR-SALE INVESTMENTS RECOGNISED FOR BOTH

FINANCIAL REPORTING AND TAX PURPOSES
Example
This illustration is based on the following assumptions:
• For financial reporting purposes, unrealised gains and losses on

available-for-sale investments are recorded directly in shareholder's equity
net of any tax consequences.
• The tax law permits an election whereby unrealised gains and losses on
investment portfolios are included in the determination of taxable income
or loss. The Company has chosen to elect this provision of the law.
• At the end of 20X1, the unrealised loss on available-for-sale investments is

€5 million, all of which occurred during the current year.
• The tax rate for 20X1 and 20X2 is 30 per cent.
• The market value of the portfolio, determined at the close of 20X1 (i.e. an
unrealised loss of €5 million), does not change through the end of 20X2.
• A pretax loss on the sale of the portfolio of €5 million is recorded in income

on the last day of 20X2 and taxable income is zero for 20X2.
The journal entries for Year 1 would be as follows:

The journal entries for Year 2 would be as follows:
Q&A IAS 12: 61-3 — CAPITAL GAINS TAX ON A SHARE BUY BACK
Question
A subsidiary company held 10 per cent of the ordinary shares of the holding
company. These shares were classified as treasury shares by the group. The holding
company subsequently bought back the shares from the subsidiary company. After
the buy back the shares were cancelled, and therefore the treasury shares were
derecognised in the group accounts.

In accordance with the law in the tax jurisdiction in which the group operates, a
company is liable for capital gains tax (CGT) if it sells an asset for more than its base
cost. In this case, the subsidiary company sold the shares for more than the base
cost. The group, therefore, incurred CGT on the sale.
Should the group record the CGT incurred in either the income statement or equity?
Answer
IAS 12 requires that current and deferred tax be charged directly to equity if the tax
relates to items that are credited or charged to equity. In this case, a transfer from
one reserve in equity (the treasury share reserve) to another reserve in equity
(share capital) is recorded to reflect the cancellation of shares by the group. The CGT
represents a transaction cost of the cancellation and should therefore be accounted
for as a deduction from equity without being shown in the statement of recognized
income and expense (SORIE).
Q&A IAS 12: 62-1 — HEDGE OF A NET INVESTMENT IN A FOREIGN

SUBSIDIARY
Question
Entities sometimes enter into transactions to hedge their net investment in a foreign
subsidiary (for example, through the use of a forward contract). Under the provisions
IAS 39.150 Financial Instruments: Recognition and Measurement, such a transaction
would be designated as a hedge of the foreign currency exposure of a net
investment in a foreign operation. Gains and losses on the effective portion of such
hedging transactions are recognised directly in equity.
If such a hedging transaction creates a temporary difference, but the parent does
not provide for deferred taxes related to translation adjustments, should deferred
taxes be recognised for the temporary difference created by the hedging
transaction?
Answer
Yes. A deferred tax liability or asset will result from hedging gains and losses
regardless of whether a parent entity's investment in a foreign subsidiary or foreign
corporate joint venture will not reverse in the foreseeable future. The tax
consequences of establishing a deferred tax asset or liability for hedging transactions
are reported as a component of equity in accordance with the guidance contained in

IAS 12.61.
Q&A IAS 12: 65A-1 — TAX BENEFITS AND "WITHHOLDING TAXES" FOR
DIVIDENDS PAID TO SHAREHOLDERS
Question
A tax jurisdiction may assess an entity with a "withholding tax" to be paid for the
benefit of the recipients when the entity makes a dividend distribution. In certain
instances, an entity will receive a future tax benefit for withholding the tax from the
recipient's distributions. For example, a reduction in future income taxes in an
amount equivalent to the "withholding tax". What income tax consequences result
from the "withholding tax" under IAS 12?
Answer
If an entity receives a future tax benefit related to a "withholding tax", the entity
should recognise a deferred tax asset for the future tax benefit. The offsetting credit
should be recognised as a component of profit and loss. Otherwise, if the entity does
not receive a tax benefit, there is no current or deferred tax consequence because
the recognition of a withholding tax is an event that is recognised directly in equity in
accordance with IAS 12.65A.
A tax that is assessed on an entity based on dividends distributed is, in effect, a

withholding tax for the benefit of recipients of the dividend and should be recorded in
equity as part of the dividend distribution in that entity's separate financial
statements if both of the following conditions are met:
• The tax is payable by the entity if and only if a dividend is distributed to

shareholders. The tax does not reduce future income taxes the corporation
would otherwise pay; and
• Shareholders receiving the dividend are entitled to a tax credit at least

equal to the tax paid by the entity, and that credit is realisable either as a
refund, or as a reduction of taxes otherwise due, regardless of the tax
status of the shareholders.
Therefore, if an entity obtains a benefit from withholding a tax, the initial payment to
the tax authorities is not a "withholding tax" as stated in IAS 12.65A, and therefore,
should be recognised as an increase in income tax expense (as opposed to equity
being part of the dividend distribution), with the future tax benefit likewise
recognised as a component of profit or loss.

Q&A IAS 12: 65A-EX-1 — TAX BENEFITS AND "WITHHOLDING TAXES"
FOR DIVIDENDS PAID TO SHAREHOLDERS
Example
Entity X decides to pay a dividend of $100 to its shareholders. The local tax law
requires X to withhold 35 per cent of the dividend paid to the tax authorities. X
obtains a future tax credit equal to the amount paid to the tax authorities in
connection with the dividend that would be applied to future tax payment over the
next three years.
Upon payment of the dividend, X would record the following journal entries:
As with any other deferred tax asset the recognition of the deferred tax is contingent
on meeting the recognition criteria stated in IAS 12.44. In the event that those
criteria are not met the company would not recognise the deferred tax asset upon
payment of the tax, but when the criteria are met.
Q&A IAS 12: 66-1 — TAX SAVINGS ASSOCIATED WITH THE COSTS OF A
BUSINESS COMBINATION
Question
In accordance with IFRS 3.29 Business Combinations, the cost of the business
combination includes any costs directly attributable to the combination.
Consequently, those costs form part of the goodwill recognised.
Where the costs are tax deductible in the period in which they are incurred (and
therefore there is no temporary difference), should the current tax savings be
accounted for in the income statement or as an adjustment to the cost of
acquisition?
Answer
The only scenario in which IAS 12 permits an entity not to recognise current tax as
an income or expense in the income statement of the period is when the underlying
transaction that gives rise to the tax is recognised directly in equity, in which case
the corresponding tax is also recognised directly in equity. This exemption does not
apply in respect of business combinations.
IAS 12.66–68 provide specific exemption for deferred tax arising on a business
combination, but not in respect of current tax.
Accordingly, there is no exemption from recognising the tax saving as income in the
income statement. The tax savings will be recognised in profit when the tax
deduction occurs.
Q&A IAS 12: 68-1 — RECOGNITION OF DEFERRED TAX ASSETS AFTER

INITIAL ACCOUNTING IS COMPLETE WHERE CORRESPONDING
ENTRY WAS PROCESSED TO EQUITY
Question
Entity A acquired Entity B on 1 March 2005. The initial accounting was completed by
year end 31 December 2005. During the 2006 financial year, Entity A realised the
benefit of some of the acquiree's income tax loss carryforwards that did not satisfy
the recognition criteria of IFRS 3.37 Business Combinations at the date of
acquisition. The entity's income tax loss carryforwards arose from share-based
payment transactions that had occurred in the past for which no IFRS 2 Share-based
Payment expense was recognised.
In accordance with IFRS 3.65, should the income tax benefit be recognised in the
income tax expense line or directly in equity?
Answer
IFRS 3.65 requires the income tax benefit to be recognised as income in accordance
with IAS 12. IAS 12.68C requires that a tax deduction relating to remuneration in
shares should be recognised in equity to the extent it exceeds the related cumulative
remuneration expense. In this case no expense has been recognised. Accordingly,
the amount will be recognised directly in equity, even though this results in an
accounting mismatch whereby the goodwill write-off required by IAS 12.68 and IFRS
3.65 will be recognised in the income statement, but the income is recognised
directly in equity.
Q&A IAS 12: 68A-1 — SHARE-BASED PAYMENTS AND FIRST-TIME

ADOPTION OF IFRSs — SUBSEQUENT DEFERRED TAX ACCOUNTING
Background
Entity A granted share options to employees on 1 January 2001 (i.e. before the
mandatory application of IFRS 2 Share-based Payment on 7 November 2002). The
arrangement involved a five-year vesting period, following which employees have
the right to exercise the options for 10 years. Entity A adopted IFRSs in 2008, with a
transition date of 1 January 2007.
Entity A recognised a remuneration expense for this arrangement under its previous
GAAP and, as permitted by IFRS 1(2008).D2, did not apply IFRS 2 retrospectively at
the date of transition to IFRSs.
When the options are exercised, Entity A will receive a tax deduction based on the
intrinsic value of the options at the date of exercise. IAS 12.68A–68C require that a
deferred tax asset should be recognised on all deductible temporary differences
relating to share options. On the date of transition to IFRSs, Entity A recognised a
deferred tax asset based on the difference between the fair value of the underlying
shares and the exercise price of the options. The amount was adjusted against

equity.
Question
What is the appropriate accounting treatment for subsequent changes in the amount
recognised for the deferred tax asset relating to vested share options not yet
exercised?
Answer
Subsequent changes in the amount of the deferred tax asset (based on the
difference between the fair value of the underlying shares on the evaluation date and
the exercise price of the options) should be recognised in profit or loss or in equity,
depending on the expense actually recognised for the awards.
Entity A should determine the “cumulative remuneration expense” related to the

estimated future tax deduction, as referred to in IAS 12.68C, by reference to the
original remuneration expense recognised under previous GAAP. If the amount of the
estimated future tax deduction on a subsequent reporting date is higher than the
amount associated with the remuneration expense recognised under previous GAAP,
this implies that the tax deduction relates not only to the remuneration expense but
also to an equity item. In such circumstances, the change in the deferred tax asset
should be recognised partially in profit or loss, with the residual recognised in equity.
If the previous GAAP expense had been reversed on transition to IFRSs, the expense
under IFRSs would be considered to be nil and all subsequent changes in the
deferred tax asset would be recognised in equity.
See Q&A IAS 12: 68A-EX-1 for an illustration.
Q&A IAS 12: 68A-EX-1 — SHARE-BASED PAYMENTS AND FIRST-TIME

ADOPTION OF IFRSs — SUBSEQUENT DEFERRED TAX ACCOUNTING —
EXAMPLE
Example
Entity A granted 100 share options with an exercise price of CU1 per share option to
employees on 1 January 2001 (i.e. before the mandatory application of IFRS 2
Share-based Payment on 7 November 2002). The arrangement involved a five-year
vesting period, following which employees have the right to exercise the options for
10 years. Entity A adopted IFRSs in 2008, with a transition date of 1 January 2007.

Entity A recognised a remuneration expense of CU400 for this arrangement under its
previous GAAP and, as permitted by IFRS 1(2008).D2, did not apply IFRS 2
retrospectively at the date of transition to IFRSs.
On 1 January 2007, all of these share options are vested and remain outstanding. On
that date, the fair value of Entity A's shares is CU3 per share. Accordingly, the share
options have an intrinsic value of CU2 per share (i.e. fair value of CU3 – exercise
price of CU1). Assuming a tax rate of 30 per cent, on transition to IFRSs Entity A
recognises a deferred tax asset of CU60 (CU2 × 100 share options × 30%). On 31
December 2007, Entity A's share price has increased to CU8 per share such that the
share options have an intrinsic value of CU7 per share option. The deferred tax asset
relating to the share-based payment arrangement is now calculated as CU210 (i.e.
CU7 × 100 share options × 30%), resulting in a deferred tax income for the period
of CU150 (i.e. deferred tax asset of CU210 at the end of the period less CU60 at the
beginning of the period). The deferred tax income for the period is recognised partly
in profit or loss and partly in equity as follows:
Q&A IAS 12: 68A-2 — INCOME TAX EFFECTS OF REPLACEMENT

AWARDS ISSUED IN A BUSINESS COMBINATION
[Added 14 May 2010]
Background
Company A acquires Company B in a business combination. As part of the

transaction, Company A issues equity-settled share-based payment awards to
replace share options held by the employees of Company B. A portion of the
market-based measure of the replacement awards is attributed to pre-combination
services and, therefore, forms part of the consideration transferred in the business
combination.
The replacement awards are tax deductible, with the amount of the tax deduction
based on the intrinsic value (i.e. fair value of the shares less exercise price) of the
award at exercise date. Accordingly, a deferred tax asset is recognised at the
acquisition date. Subsequent to the acquisition date, Company A's share price
changes and the deferred tax asset is remeasured to reflect the anticipated tax
deduction.
Question
How should the subsequent remeasurement of the deferred tax asset related to
pre-combination services be recognised?
Answer
Either of the following treatments is acceptable. The entity should select one of these
treatments as an accounting policy choice to be applied consistently to all similar
transactions.
Alternative 1: Apply the principle established in IAS 12.68A–68C
IAS 12.68C states that, in the context of share-based payments, “[i]f the amount of
the tax deduction (or estimated future tax deduction) exceeds the amount of the
related cumulative remuneration expense, this indicates that the tax deduction
relates not only to remuneration expense but also to an equity item. In this
situation, the excess of the associated current or deferred tax should be recognised
directly in equity”.
In the context of replacement awards granted as part of a business combination, the

cumulative remuneration expense is comprised of the amount attributed to
pre-combination services at the acquisition date (as determined in accordance with
paragraph B58 of IFRS 3(2008) Business Combinations) and the amount of
compensation expense recognised for the replacement awards since the date of the
business combination, if any. Therefore, the tax deduction related to the excess over
the acquisition-date market-based value would be recognised in equity under the
principle in IAS 12.68C.
Alternative 2: All changes in the deferred tax assets related to

pre-combination services are recognised in profit or loss
This alternative is based on the fact that Example 6 of IAS 12 does not appear to
apply the principle in IAS 12.68C to distinguish whether a portion of the increase in
the deferred tax asset should be recognised in equity rather than in profit or loss.
The example indicates that subsequent to the business combination the intrinsic
value of the options has increased above the market-based value of the replacement
awards measured on the acquisition date. In the example, the entire change in the
deferred tax asset appears to be recognised as “deferred tax income”. Accordingly,
based on Example 6 of IAS 12, it appears acceptable to recognise all movements in

deferred tax assets related to pre-combination services in profit or loss.
Q&A IAS 12: 68A-EX-2 — INCOME TAX EFFECTS OF REPLACEMENT

AWARDS ISSUED IN A BUSINESS COMBINATION – EXAMPLE
[Added 14 May 2010]
Example
On 1 January 20X1, Company A acquires Company B in a business combination. On
the acquisition date, the employees of Company B hold fully vested share options
with a market-based value of CU120. As part of the business combination, the share
options held by employees of Company B are replaced by fully vested share options
of Company A with a market-based value of CU120. In accordance with paragraphs
B56–B62 of IFRS 3(2008) Business Combinations, the market-based value of the
replacement awards is determined to relate to pre-combination services and forms
part of the consideration transferred to acquire Company B.
A tax deduction is available when the share options are exercised, based on the
intrinsic value of the awards on the date of exercise. The tax rate applicable to
Company A is 40 per cent. On the acquisition date, the intrinsic value of the awards
is CU100 and accordingly a deferred tax asset of CU40 is recognised on that date.
On 31 December 20X1, the intrinsic value of the replacement awards has increased
to CU150 such that the deferred tax asset related to the replacement awards is
CU60.
The increase in deferred tax asset is recognised under either of the following two
alternatives.
Alternative 1: Apply the principle established in IAS 12.68A–68C
The estimated future tax deduction of CU150 exceeds the amount of the cumulative
remuneration expense of CU120 (the cumulative remuneration expense being equal
to the acquisition-date market-based value because no compensation expense in
respect of the replacement awards relates to the post-combination period).
Accordingly, the deferred tax asset related to the excess of CU30 is recognised in
equity. Therefore, the increase in deferred tax asset of CU20 is recognised as
follows:

Alternative 2: All changes in the deferred tax assets related to
pre-combination services are recognised in profit or loss
Under this alternative, the increase in the deferred tax asset of CU20 for the year is
Either of the above treatments is acceptable as an accounting policy choice to be

applied consistently to all similar transactions.
Q&A IAS 12: 68C-1 — DEFERRED TAX ON SHARE OPTIONS GRANTED

PRIOR TO 7 NOVEMBER 2002
Question
Company A granted share options to employees prior to 7 November 2002 (i.e.
before the mandatory application of IFRS 2 Share-based Payment). The options vest
in 2006 subject to non-market vesting conditions. Company A did not recognise the
transaction prior to 7 November 2002, and did not make a retrospective adjustment
for the transaction on first-time adoption of IFRS. On transition to IFRS in 2005,
there is consequently no expense recorded in the income statement in respect of
these options (the company has not applied IFRS 2 to these options under the
requirements of IFRS 2.54). However, on vesting, Company A will receive a tax
deduction based on the intrinsic value at the date of exercise.
Does a temporary difference exist at the date of transition where there has been no
accounting recognition of the share-option grant (i.e. no recognition of an asset or
liability and no expense)?
Answer
Yes, there is a temporary difference. The principle of IAS 12.68A–68C is to require
deferred tax to be recognised on all temporary differences related to share options.
Therefore, where there is no remuneration expense recognised in the accounts but
there is a future tax deduction, deferred tax on the whole temporary difference,
equal to the expected tax deduction, is required to be recognised in equity at the
date of transition.
Q&A IAS 12: 68C-2 — CURRENT AND DEFERRED TAX ARISING FROM
CASH-SETTLED SHARE-BASED PAYMENTS
Question
Company A (A) grants its employees cash-settled share appreciation rights (SARs)
that vest after three years of service. The relevant taxation authority of the country
in which A is established allows a tax deduction not equal to the cash paid, but based
on a different formula. To calculate the corresponding deferred tax under IAS
12.68B, A must estimate the amount of the tax deduction to be received in future
periods by using information available at the end of the reporting period. Sometimes
the amount of the estimated tax deduction measured in accordance with IAS 12.68B
or ultimately received may exceed the cumulative remuneration expense recognised
under IFRS 2 Share-based Payment.
IAS 12.68C states, "If the amount of the tax deduction (or estimated future tax
deduction) exceeds the amount of the related cumulative remuneration expense, this
indicates that the tax deduction relates not only to remuneration expense but also to
an equity item. In this situation, the excess of the associated current or deferred tax
should be recognised directly in equity".
In a cash-settled scheme such as the one described above, would recognition of the
amount of the tax deduction in excess of the cumulative remuneration expense
result in recognition, directly in equity, of the current or deferred tax arising from
this excess in accordance with IAS 12.68C?
Answer
No. IAS 12.68C applies to equity-settled share-based payment transactions only.
Therefore, any amount of the associated current or deferred tax relating to
cash-settled schemes that is in excess of the cumulative remuneration expense
should be recognised directly in profit or loss and not in equity.
Q&A IAS 12: OTHER-1 — INTERCORPORATE TAX ALLOCATION AMONG

MEMBERS OF A CONSOLIDATED GROUP

Question
How should income tax be allocated among members of a consolidating group under
IAS 12?
Answer
There are two approaches that could be used.
Parent Company Down Approach. Under this approach, the consolidated amount
of current and deferred tax expense for a period is allocated to the individual group
members using a systematic, rational, and consistent approach. For example, the
allocation method for financial reporting purposes might allocate consolidated tax
expense to subsidiary group members based on each group member's percentage of
the total consolidated income tax expense or benefit for the period. Allocation
methods not based on each group member's pretax income or loss are also
acceptable for financial reporting. For example, an allocation policy that is based on
the parent's effective tax rate may be considered systematic, rational, and consistent
with the broad principles established under IAS 12, if the method conforms to the
tax law.
If the tax-sharing agreement provides that the individual group members will pay
(receive) income taxes based on a pro rata allocation of the consolidated group's tax
liability (refund) for a period, the determination of the need for not recognizing a
deferred tax asset in the stand-alone financial statements of a group member should
be consistent with the available evidence at the consolidated group level. In other
words, if a deferred tax asset is not recognised at the parent company also, it should
not be recognised in the financial statements of the stand-alone group member.
Separate Return Approach. When the separate return method of allocation is

used, current and deferred tax expense or benefit for the period is determined for
each member of a consolidated group by applying the requirements of IAS 12 as if
that group member were filing a separate tax return. Under the separate return
method, the sum of the amounts allocated to the individual group members
sometimes may not equal the total current and deferred income tax expense, or
benefit of the consolidated group. Any difference is considered as a consolidation
entry.
If the legal tax-sharing agreement between the parent company and the group
member is based on the amount of cash to be paid, or received, as if the group
member had filed a separate tax return, realisation of the deferred tax asset shall be
based on available evidence as it relates only to that group member. Thus, if that
group member has negative evidence (e.g. cumulative losses in recent years), it
would be difficult to support a conclusion that recognition of the defined tax asset is
appropriate, irrespective of the available evidence (e.g. a history of profitable
operations at the consolidated group level).

Q&A IAS 12: OTHER-EX-1 — INTERCORPORATE TAX ALLOCATION —
PARENT COMPANY DOWN APPROACH
Example
The following illustrates the application of the parent company down approach where
allocation is based on each group member's percentage of pretax income as a
percentage of the total consolidated pretax income for the period.
Assume a parent company, Entity P, a holding company operating in a tax

jurisdiction with a 40 per cent tax rate, has current and deferred tax expense for
20X1 of €1,000 based on €2,500 of pretax accounting income. Also, assume that P
has two operating subsidiaries that are members of the consolidated group,
Subsidiaries S1 and S2. During 20X1, S1 and S2 had pretax accounting income of
€500 and €2,000, respectively. Because, S1's and S2's pretax income as a
percentage of P's total 20X1 pretax income of €2,500 is 20 per cent and 80 per cent,
respectively, S1 would record a current and deferred tax expense for 20X1 of €200
(€1,000 × 20%), and S2 would record a current and deferred tax expense for 20X1
of €800 (€1,000 × 80%).
Under this approach, the sum of the current and deferred tax expense or benefit for
the period as determined at the consolidated parent company level should equal the
sum of the total current and deferred income tax expense or benefit allocated to all
group members for the period. The only exception to this procedure occurs when the
consolidated amount of income tax expense or benefit is adjusted for eliminating
entries such as would be required for the tax consequences of intercompany sales
between group members that occur in the same tax jurisdiction.
Q&A IAS 12: OTHER-EX-2 — INTERCORPORATE TAX ALLOCATION —

SEPARATE RETURN APPROACH
Example
Assume a parent company, Entity P, a holding company operating in a tax
jurisdiction with a graduated rate structure, has current and deferred tax expense for
20X1 of €1,000 based on €2,500 of pretax accounting income. The graduated tax
rates are as follows:

Also, assume that P has two operating subsidiaries that are members of the
consolidated group — Subsidiaries S1 and S2. During 20X1, S1 and S2 had pretax
income of €500 and €2,000, respectively. Because the allocation method is based on
a stand-alone method, S1 would recognise a current and deferred tax expense of
€150 (€500 × 30%) for 20X1; S2 would recognise a current and deferred tax
expense of €775 [€150 + €175 + (€999 × 45%)] Note that, in this instance, as a
consequence of the graduated tax rate structure, the sum of the tax expense
allocable to individual group members of €925 (€150 + €775) does not equal the
total income tax expense of the consolidated group of €1,000.
Q&A IAS 12: Appendix A, B11-1 — INTERCOMPANY TRANSACTIONS

BETWEEN DIFFERENT TAX JURISDICTIONS
Question
After an intercompany sale of inventory or other assets occurs at a profit between
affiliated entities that are included in consolidated financial statements but not in a
consolidated tax return, the acquiring entity's tax basis of that asset exceeds the
reported amount in the consolidated financial statements. This occurs because, for
financial reporting purposes, the effects of gains or losses on transactions between
entities included in the consolidated financial statements are eliminated in
consolidation. How should affiliated entities account for the tax consequences of
intercompany sales between different tax jurisdictions?
Answer
Unrealised profits resulting from intragroup transactions that are eliminated from the
carrying amount of assets on consolidation (e.g. inventory, property, plant or
equipment) and no equivalent adjustment made for tax purposes, generally, give
rise to a temporary difference for which deferred taxes must be recognised on
consolidation.

A deductible temporary difference arises, representing the difference between the
carrying amount and the tax base. A deferred tax asset is calculated by multiplying
the temporary difference by the tax rate applicable in the purchaser's tax
jurisdiction, as the deduction is available at that rate when the unrealised profit is
realised from the sale to an unrelated third party. In situations involving the transfer
of assets intended for internal use, the deferred taxes should be amortised over the
assets expected life or, alternatively, under another systematic and rational manner
(e.g. based on the ratio of actual sales as a percentage of total projected sales
related to the asset), consistent with the depreciation method applied under IAS 16
Property, Plant and Equipment.
Where entities operate in different tax jurisdiction and/or are subject to different tax
rates, the rate used is that at which the temporary difference is expected to reverse,
which generally is that of the purchaser's tax jurisdiction. Under this approach, the
deferred tax recognised may not entirely offset the tax currently payable from the
sale.
Q&A IAS 12: Appendix A, B11-EX-1 — INTERCOMPANY TRANSACTIONS

BETWEEN DIFFERENT TAX JURISDICTIONS
Example
• Parent entity, P, operates in jurisdiction A, which has a 40 per cent tax

rate. P's wholly owned subsidiary, S, operates in jurisdiction B that has a
50 per cent tax rate.
• P sells inventory to S at a €100 profit and the inventory is on hand at

year-end. Assume P purchased the inventory for €200. Therefore, S's cost
basis in jurisdiction B is €300.
• Available evidence supports a conclusion that realisation of the deferred

tax asset representing the tax benefit of S's deductible temporary
differences is probable.
• P prepares consolidated financial statements and, for financial reporting

purposes, gains and losses on intercompany transactions are eliminated in
consolidation.
The impact of this intercompany transaction on P's consolidated financial statements

is shown below in the following journal entries:

Assume in a subsequent period that S sold the inventory that it acquired from P to
an unrelated third party for the exact amount it previously paid P — €300. The
journal entry to reflect the sales and related tax consequences to be reflected in the
consolidated financial statements of P:
Q&A IAS 16: 2-1 — UTILITY FEES PAID TO A GOVERNMENT

Background
In some jurisdictions, developers of factories, offices, apartment buildings and

shopping malls must pay a 'capacity fee' to the government for the privilege of being
able to purchase, on an ongoing basis, defined quantities of electricity and other
utilities beyond certain minimum quantities that can be purchased without paying
the fee. The fee is paid on a one-off basis and covers supply, either on an indefinite
basis or at least for a substantial number of years. The building owner still pays the
going rate to purchase the electricity and other utilities. The capacity fee attaches to
the entity that owns the building, and it can be transferred to another building if the
capacity allowed by the fee is not fully utilised.
Question
How should capacity fees be accounted for?
Answer
Because the capacity fees are transferable between buildings, they are not part of
the cost of the building but should be capitalised as a purchased intangible asset in
their own right. As such, they would be subject to the requirements of IAS 38
Intangible Assets relating to amortisation and impairment.
If instead the fees were attached to the building and were not transferable, they
would be recognised as part of the cost of the building and depreciated.
Q&A IAS 16: 3(d)-1 — CLASSIFICATION OF MINERAL RIGHTS

[Added 7 July 2006]
Question
Should mineral rights be classified as intangible assets or as property, plant and
equipment?
Answer
The term 'mineral rights' is not defined in IFRSs. In practice, it is often used to refer
to both an 'intangible' right to explore or mine and the 'tangible' underlying mineral
reserve.
The Illustrative Examples accompanying IFRS 3 Business Combinations list 'use

rights' such as drilling and mineral rights as an example of a contract-based
intangible asset that should be recognised separately from goodwill in a business
combination.
However, it is not always possible to distinguish the intangible right from the tangible
element. In accordance with paragraph 4 of IAS 38 Intangible Assets, an entity
should assess which element is more significant when an asset incorporates both
intangible and tangible elements. For that reason, the entity should assess whether
the underlying reserve or the right to mine is more significant. If the tangible
resource/reserve is the more significant element, the combined mineral rights should
be classified as tangible.

Factors to consider in this assessment include whether the rights:
• are granted for extraction of the mineral resource,
• include ownership of the land on which the mineral resources are located,
or
• are granted for exploration only.
Q&A IAS 16: 6-1 — CLASSIFICATION OF A HOTEL AS PROPERTY, PLANT

AND EQUIPMENT VERSUS INVESTMENT PROPERTY
Question
Should hotel properties be classified as property, plant and equipment within the
scope of IAS 16 or as investment properties within the scope of IAS 40 Investment
Property?
Answer
The key determinant is whether the owner acts primarily as the hotel operator or as
a landlord.
• If the property owner's primary source of income from the property

depends on day-to-day or week-by-week occupancy of hotel rooms and
usage of restaurants and other facilities, and the property owner is
providing services directly to hotel guests and diners, the hotel is likely to
be property held by the entity for use in the production of services, in
which case IAS 16 applies.
• On the other hand, if the owner's primary source of income from the
property comes from longer-term leases (months and years rather than
days or weeks), the hotel is likely to be an investment property, in which
case IAS 40 applies. That is the case even if the property owner provides a
relatively insignificant amount of ancillary services such as cleaning.
Management must make that determination based on facts and circumstances. It is

not a matter of accounting policy choice.
IAS 40 acknowledges that it may be difficult to determine when ancillary services are
so significant that a property does not qualify as an investment property. For
example, the owner of the hotel may transfer certain responsibilities to a third party
under a management contract. The terms of such management contracts vary
widely. At one end of the spectrum, the owner's position may, in substance, be that
of a passive investor. At the other end of the spectrum, the owner simply may have
outsourced certain day-to-day functions, while retaining significant exposure to
variations in the cash flows generated by the operations of the hotel. In the latter
case, classification as an investment property is not appropriate.
Classification as an investment property also may be acceptable if the direct

involvement of the reporting entity in the operation of the property is short-term. For
example, following the acquisition of a hotel, when the reporting entity continues to
operate it while seeking a suitable third-party manager, the operation of the hotel
can be seen to be incidental to the underlying objective of investment return.
Q&A IAS 16: 6-2 — BASE STOCK OF ASSETS

Background
A restaurant maintains a base stock inventory of silverware and dishes in an

unchanging amount. Additions to the stock are recognised in profit or loss. On
average, the turnover of the items is likely to exceed one year.
Question
Is it appropriate to classify the dishes and silverware as property, plant and
equipment?
Answer
Yes. These items are tangible assets held for use in the supply of goods and services
and are expected to be used for more than one period. They are therefore
appropriately classified as property, plant and equipment and should not be included
in current assets.
Q&A IAS 16: 6-3 — PROPERTY, PLANT AND EQUIPMENT USED IN

RESEARCH ACTIVITIES
Background
Paragraph 54 of IAS 38 Intangible Assets states that "[e]xpenditure on research (or

on the research phase of an internal project) shall be recognised as an expense

when it is incurred".
Question
Does that mean that all property, plant and equipment used in research activities
should be recognised as an expense in profit or loss when acquired?
Answer
No. Property, plant and equipment used in research activities should be accounted
for in the same way as other property, plant and equipment under IAS 16. However,
the depreciation of property, plant and equipment used in research activities
constitutes a research expense to which IAS 38 applies.

[Deleted 23 July 2010]
Deleted
Q&A IAS 16: 6-5 — GOLD BULLION HELD BY A CENTRAL BANK —

CLASSIFICATION
[Renumbered from IAS 2: 6-3 on 9 July 2010]
Background
Central banks commonly hold significant gold reserves to support the national
currency. Such reserves are not traded and the levels frequently do not change from
one year to the next.
Question
How should the gold bullion be classified for accounting purposes under IFRSs?
Answer
The gold bullion should be classified as property, plant and equipment, and
accounted for under IAS 16 Property, Plant and Equipment, using either the cost
model or the revaluation model. Gold bullion meets the definition of property, plant
and equipment in that it is a tangible item, held for use in the supply of services
(stabilisation of the exchange rates for the benefit of entities operating in the
jurisdiction) and can be expected to be used during more than one period.
IGB.1 “Definition of a Financial Instrument: Gold Bullion” of IAS 39 Financial

Instruments: Recognition and Measurement states that gold bullion “is a commodity.
Although bullion is highly liquid, there is no contractual right to receive cash or
another financial asset inherent in bullion”. Accordingly, gold bullion is not a financial
instrument and is outside the scope of IAS 39.
The gold bullion is not (1) held for sale, (2) in the process of production for sale, nor
(3) to be consumed in a production process or the rendering of services. Therefore,
it does not meet the definition of inventories in paragraph 6 of IAS 2 Inventories.
Q&A IAS 16: 7-1 — SUBSTANTIAL MODIFICATION COSTS

Background
A retail outlet needs to be redecorated each year. Because the expenditure is

incurred on a regular basis and is not particularly large, the retailer treats the
redecoration as part of the day-to-day servicing of the store and recognises an
expense as it is incurred. This year, the entity has requested the supplier carrying
out the redecoration work to install new partitioning, which is intended to make the
outlet more profitable and result in additional future economic benefits.
Question
How should these costs be accounted for?
Answer
IAS 16 does not distinguish between subsequent expenditure that maintains the
existing service potential of an asset ('repairs and maintenance') and subsequent
expenditure that enhances that service potential ('improvements'). Instead, all major
subsequent expenditure should be capitalised, providing it is probable that future
economic benefits will flow to the entity, and any part of the existing asset that has
been replaced should be derecognised, irrespective of whether it has been
depreciated separately. However, the costs of the day-to-day servicing of property,
plant and equipment are not capitalised, even though they are arguably incurred in
the pursuit of future economic benefits, because they “are not sufficiently certain to
be recognised in the carrying amount of an asset under the general recognition
principle”. [IAS 16.BC5–BC12]
When an entity incurs both maintenance costs and substantial modification costs in
relation to a specific item of property, plant and equipment, the expenditure should
be analysed according to its nature. Any costs of day-to-day servicing should be
accounted for in profit or loss, but substantial modification costs should be
capitalised as part of the cost of the asset to the extent that (1) they can be
measured reliably and (2) it is probable that future economic benefits associated
with the modification will flow to the entity.
Accordingly, in the circumstances described, the redecoration costs will be

recognised in profit or loss as an expense under IAS 16.12, while the incremental
partitioning costs will be capitalised if they satisfy the recognition criteria set out in
IAS 16.7 (i.e. the cost incurred to install new partitioning can be measured reliably
and it is probable that future economic benefits associated with the partitioning will
flow to the entity). To the extent that the new partitioning replaces existing
partitioning, the partitioning that is being replaced should be derecognised.
Q&A IAS 16: 8-1 — STAND-BY EQUIPMENT

Background
An entity has installed two turbines. One will produce energy for the plant, and the
other will be used as a backup in case the first turbine fails or is otherwise rendered
out of service. The probability that the spare turbine will be used is very low. The
spare turbine is necessary, however, to ensure the continuity of the production
process if the first turbine fails. The useful life of the stand-by turbine will equal the
life of the plant, which is the same as the useful life of the primary turbine.
Question
How should this stand-by equipment be accounted for?
Answer
IAS 16.8 states that stand-by equipment qualifies as property, plant and equipment
when the entity expects to use it during more than one period; it does not state that
such use should be regular. Therefore, the spare turbine is classified as property,
plant and equipment and depreciated from the date it becomes available for use (i.e.
when it is in the location and condition necessary for it to be capable of operating in
the manner intended by the management).
The useful life of stand-by equipment will be determined by the useful life of the
equipment for which it serves as back-up; in this example, the turbine will be
depreciated over the shorter of the life of the turbine and the life of the plant of

which the turbine is part.
The accounting for stand-by equipment is different from the accounting for spare
parts considered to be property, plant and equipment that are 'not available for use'.
Refer to Q&A IAS 16: 8-2 regarding the accounting for spare parts.
Q&A IAS 16: 8-2 — SPARE PARTS CLASSIFIED AS PROPERTY, PLANT

AND EQUIPMENT
Background
An entity buys five new machines for use in its production facility. Simultaneously, it
purchases a spare motor to be used as a replacement if a motor on one of the five
machines breaks.
Question
Should the spare motor be classified as property, plant and equipment and, if so,
when should depreciation commence?
Answer
Spare parts and servicing equipment are usually carried as inventories and
recognised as an expense as they are consumed. Major spare parts and stand-by
equipment will, however, qualify for recognition as property, plant and equipment
when the entity expects to use them during more than one period. “Similarly, if the
spare parts and servicing equipment can be used only in connection with a particular
item of property, plant and equipment, they are accounted for as property, plant and
equipment”. [IAS 16.8]
In the circumstances described, the motor will be used in the production of goods
and, once brought into service, will be operated during more than one period. It is
therefore classified as property, plant and equipment.
The motor does not qualify as stand-by equipment (see Q&A IAS 16: 8-1) because it
will not be ready for use until it is installed. Therefore, the useful life of the motor
commences when it is available for use within the machine rather than when it is
acquired. It should be depreciated over the period starting when it is brought into
service and continuing over the lesser of its useful life and the remaining expected
useful life of the asset to which it relates. If the asset to which it relates will be
replaced at the end of its useful life and the motor is expected to be used or usable
for the replacement asset, a longer depreciation period may be appropriate. During
the period before the motor is available for service, any reduction in value should be
reflected as an impairment loss under IAS 36 Impairment of Assets at the time
impairment is indicated.
Q&A IAS 16: 9-1 — COMPONENTISATION OF ASSETS

Question
Is componentisation of assets required?
Answer
IAS 16 does not prescribe what constitutes a separate item of property, plant and
equipment and allows a degree of judgement according to the entity's
circumstances. It does, however, suggest that, for individually insignificant items
(such as moulds, tools and dies), it may be appropriate to aggregate the items and
to apply the recognition criteria to the aggregate value. [IAS 16.9]
However, IAS 16.43 requires that each part of an item of property, plant and
equipment with a cost that is significant in relation to the cost of the item should be
depreciated separately. Componentisation is therefore implicitly required under IAS
16.43 for all significant components of property, plant and equipment.
The determination as to whether an item is significant requires a careful assessment

of the facts and circumstances. This assessment would include at a minimum:
• comparison of the cost allocated to the item to the total cost of the
aggregated property, plant and equipment; and
• consideration of potential impact of componentisation on the depreciation

expense.
Q&A IAS 16: 13-1 — REPLACEMENT COSTS

Background
A hotel operator refurbishes its hotels every 10 years, on average.

Question
Is it appropriate to capitalise the refurbishment costs as part of the cost of property,
plant and equipment?
Answer
The cost of refurbishment should be capitalised if the recognition criteria in IAS 16.7
are met. (It is probable that future economic benefits associated with the
expenditure will flow to the hotel operator and the expenditure can be measured
reliably.)
IAS 16.13 requires that if the cost of a replacement part is recognised in the carrying
amount of an asset, then the carrying amount of what was replaced is derecognised
(regardless of whether it had been identified as a component and depreciated
separately), so that the replacement and the replaced item are not both carried as
assets. Therefore, in the circumstances described, if the refurbishment expenditure
is capitalised, this indicates that previously recognised assets may now be required
to be derecognised, typically giving rise to a loss to the extent that they have not
already been depreciated.
When it is not practicable to determine the carrying amount of the replaced part, the
cost of the replacement may be used as an indication of what the cost of the
replaced part was at the time it was acquired or constructed. [IAS 16.70]
Q&A IAS 16: 16-1 — BROKER'S COMMISSION REBATE TO PURCHASER

OF PROPERTY
Background
During negotiations to purchase a real estate property, the purchaser was unwilling
to accept the seller's best offer. To induce the purchaser to agree on the sale, the
broker agreed to rebate a portion of the seller-paid commission to the purchaser.
Question
How should the purchaser account for the rebated commission?
Answer
For the purchaser, there is only one transaction — the purchase of property.
Accordingly, the net amount paid by the purchaser is the cost of the property. The

commission rebate is not immediate income to the purchaser.
If the purchaser had been required to pay a brokerage commission, that commission
would have been part of the cost of the property as a cost necessarily incurred to
obtain the asset. In the circumstances described, the commission rebate is similarly
a component of the cost of the property.
Q&A IAS 16: 16-2 — LAND CLEARING COSTS

Background
A ski slope operator has developed a piece of land into a ski resort. To do that, the
operator has cut the trees, cleared and graded the land and hills, and constructed ski
lifts.
Question
Should the tree cutting and land clearing and grading costs be capitalised as part of
the cost of land or as part of the cost of the ski lifts?
Answer
These costs are expenditures directly attributable to bringing the land to working
condition for its intended use and, therefore, are part of the cost of the land, not the
ski lifts.
As required under IAS 16.59, when the cost of site dismantlement, removal and
restoration is included in the cost of land, that portion of the land asset is
depreciated over the period of benefits obtained by incurring those costs.
Q&A IAS 16: 16-3 — REIMBURSEMENT OF PART OF THE COST OF AN

ASSET
[Amended and Reissued 1 October 2010]
Background
Company A enters into a contract with Company B to produce and sell a specific
product. Company A needs to transform a major part of its plant to be able to
produce that product, and commissions that transformation work from another
party, Company C, unconnected with Company A and Company B. The
transformation costs are significant and exclusively for the purpose of this sales
contract. As a result, Company A and Company B enter into an agreement under
which Company B will reimburse Company A for a portion of the transformation
costs. The cash received from Company B can only be used to offset the costs of the
transformation for Company A.
Question
Should the reimbursement be deducted from the cost of the transformation?
Answer
From the perspective of Company A, two transactions are occurring: the purchase of
services (transformation costs) from Company C, and the supply of products to
Company B. Accordingly, Company A must determine whether the amount receivable
from Company B relates to the former or to the latter.
The arrangement between Company A and Company B is within the scope of IFRIC
18 Transfers of Assets From Customers. IFRIC 18.6 states that the Interpretation
“also applies to agreements in which an entity receives cash from a customer when
that amount of cash must be used only to construct or acquire an item of property,
plant and equipment and the entity must then use the item of property, plant and
equipment either to connect the customer to a network or to provide the customer
with ongoing access to a supply of goods or services, or to do both”. In this case, the
cash from Company B must be used to acquire transformation services from
Company C that will create assets to be used exclusively to provide Company B with
the supply of a specific product.
Accordingly, Company A applies IFRIC 18 as described below.
• Company A has received cash from Company B, so it has received an asset

and must recognise it.
• The cost of the transformation will be recognised as property, plant and

equipment, without any offset of the amount received from Company B.
• Instead, the amount received from Company B is deferred, to be

recognised as revenue when the conditions in IAS 18 Revenue are met.
• No separate service is being provided to Company B other than the supply

of the specified product, so the amount received from Company B should
be regarded as revenue relating to the supply of that specified product.
Therefore, the amount received as a reimbursement from Company B should be

treated as revenue in accordance with IAS 18, and not as a reduction in the cost of
the transformation. Because the payment is an integral part of the contract to
produce and sell the product, the two transactions should be accounted for together
in accordance with IAS 18.13. The total revenue (i.e. the price per the sales contract
plus the reimbursement) should be recognised when the conditions for revenue
recognition set out in IAS 18 are met.

[Renumbered to IAS 40: 20-5 on 24 September 2010]
Renumbered
Q&A IAS 16: 16-5 — CAPITALISATION OF THE CARRYING AMOUNT OF

A DEMOLISHED BUILDING TO THE COST OF CONSTRUCTING A NEW
BUILDING
[Added 2 May 2008]
Background
In 20X1, Company E purchased land for CU40 million and a building for CU60
million. The building is used by Company E in its business. It is classified as
property, plant and equipment and is depreciated over its estimated useful life. In
20X3, Company E demolishes the building and constructs a new building for its own
use on the same piece of land. The carrying amount of the old building before
demolition is CU55 million.
Question
Should the CU55 million be written off to profit or loss or be capitalised as part of the
cost of the new building?
Answer
The carrying amount of CU55 million should be written off to profit or loss. Under
IAS 16, Company E is required to depreciate the building to its residual value over its
useful life. The useful life of Company E's building is equivalent to the period from
when Company E decided to demolish the building to the demolition date in 20X3.
The residual value of the building is zero because the building will be demolished.
Therefore, after management's decision to demolish the building, Company E should
revise both the useful life and the residual value of the building and should adjust
the depreciation expense accordingly, resulting in a write-down of the building to
zero before demolition.

Q&A IAS 16: 16-6 — CAPITALISATION OF COSTS INCURRED BETWEEN
THE COMPLETION OF A BUILDING AND THE DATE OF APPROVAL FOR
OCCUPATION
[Added 13 November 2009]
Background
On 20 September 20X0, Company A completed the construction of a building

intended for use as its administrative headquarters.
By law, the local health and safety authority must approve the offices for occupation
before any activity can commence. This approval can be requested only when the
building is physically complete, and it takes on average three months to obtain the
approval.
The health and safety authority issued the approval for occupation on 20 December
20X0. In the three months from 20 September 20X0, Company A incurred CU10 of
building management costs (e.g. utility and security expenses) and interest
expenses. (The building is identified as a qualifying asset under IAS 23 Borrowing
Costs.)
Question
Should the costs incurred by Company A between 20 September 20X0 (when the
building was physically completed) and 20 December 20X0 (when the approval for
occupation was issued) be included in the initial cost of the building?
Answer
Yes. The management costs incurred are considered "directly attributable to bringing
the asset to the location and condition necessary for it to be capable of operating in
the manner intended by management" (IAS 16.16(b)). In addition, obtaining the
approval for occupation is considered to be an activity "necessary to prepare the
qualifying asset for its intended use or sale" (IAS 23.25); therefore, Company A
should continue to capitalise borrowing costs until the approval is obtained.
However, any abnormal amounts of wasted resources incurred in obtaining that

approval should not be capitalised (IAS 16.22). For example, if the approval for
occupation had taken longer than the customary three-month period from the
completion of construction, due to avoidable delays caused by Company A failing to
provide the required information to the health and safety authority, Company A
could include in the original cost of the building only costs incurred during the time
usually required to obtain the approval for occupation (in the circumstances under

consideration, three months).
If the delays were due to a slow response from the health and safety authority
(without cause by Company A), the capitalisation period would be extended.
Q&A IAS 16: 16-7 — REHABILITATION LIABILITY — CHANGE IN

LEGISLATION
[Added 28 May 2010]
Background
Company X acquired a building in 20X1. Asbestos was used in the construction of the
building. During 20X5, legislation was enacted which requires Company X to either
remove the asbestos or vacate the building.
Company X obtains a reliable estimate of the costs of removing the asbestos. In

accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets,
Company X recognises a provision for the cost of removing the asbestos.
Question
Should Company X capitalise the estimated cost of removing the asbestos from the
building?
Answer
IAS 16.16 states that the cost of an item of property, plant and equipment should
include "the initial estimate of the costs of dismantling and removing the item and
restoring the site on which it is located, the obligation for which the entity incurred
either when the item is acquired or as a consequence of having used the item during
a particular period for purposes other than to produce inventories during that
period". IAS 16.BC14 confirms that IAS 16.16 does not specifically address how an
entity should account for the "cost of obligations an entity did not face when it
acquired the item, such as an obligation triggered by a law change enacted after the
asset was acquired".
Company X should therefore assess whether the costs of removing the asbestos
meet the general recognition criteria in IAS 16.7. In this scenario:
• the cost of removing the asbestos can be reliably measured; and
• it is probable that economic benefits associated with the asbestos removal

will flow to Company X (because the building would otherwise be vacated).

Therefore, Company X should capitalise the estimated cost of removing the asbestos.
The change in legislation is also an indicator of impairment; consequently, when the

legislation is enacted, Company X should estimate the recoverable amount of the
building.
Q&A IAS 16: 16-8 — COSTS INCURRED IN DEMOLISHING

PRE-EXISTING STRUCTURES
Question
Should the costs incurred to demolish pre-existing structures in order to build on a
site be capitalised in the costs of the new asset?
Answer
It depends. The costs that may be included in the carrying amount of an asset are
limited to those that arise directly from the construction or acquisition of the asset.
When, for example, costs are incurred to demolish existing structures in order to
build on a site, the cost of demolition may be incremental to the construction cost or
it may be associated with derecognition of a previously held asset. It depends on
whether the existing structures were previously used in the entity's business, or
were acquired as part of the site with the specific intention of demolishing them. In
the latter case, the demolition costs are clearly incremental and should be included
in the cost of the new asset. In the former case, the cost of the old asset should be
written off to profit or loss through accelerated depreciation once the decision to
demolish is made (see Q&A IAS 16: 16-5); the demolition costs incurred relate to
the derecognition of the old asset and should also be expensed when incurred.
Q&A IAS 16: 20-1 — TRAINING COST AS A COMPONENT OF THE COST

OF AN ASSET
Background
An entity acquires equipment of a type that its employees have never operated
before. During the installation period, the employees receive extensive training on
the equipment. The cost to the entity includes the incremental cost of hiring experts
to conduct the training, and the directly attributable cost of wages to the employees
during the training period. The equipment could not be used by the entity unless its
employees received the training.
Question
Do these training costs qualify as a component of the cost of the equipment?
Answer
No. The training costs do not fall within the scope of costs directly attributable to
bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by the management. This piece of equipment
would be capable of operating in the manner intended by the management without
the entity incurring the training cost — even though the employees would not know
how to operate the equipment.
Q&A IAS 16: 20-2 — CESSATION OF CAPITALISATION

Question
When should an entity cease to capitalise costs in the carrying amount of asset?
Answer
IAS 16.20 states that “[r]ecognition of costs in the carrying amount of an item of
property, plant and equipment ceases when the item is in the location and condition
necessary for it to be capable of operating in the manner intended by management.
Therefore, costs incurred in using or redeploying an item are not included in the
carrying amount of that item”.
In the case of a self-constructed asset, or the installation of a major asset, a policy

decision should be made and applied consistently as to what event or activity
characterises the point at which an asset's physical construction/installation is
complete (i.e. when the item is in the location and condition necessary for it to be
capable of operating in the manner intended by management), so that all costs
incurred after that point are identified and expensed. When a commissioning period
is involved, it will similarly be essential to determine in principle the point that
characterises reaching the capability of operating at normal levels, and then to
ensure that costs incurred after reaching that point are identified and expensed.
When there is delay in achieving final physical completion, costs arising during the
period of delay are likely to fall into the category of abnormal costs and so be
expensed as incurred. Borrowing costs incurred during such a period of delay will not
qualify for capitalisation under IAS 23 Borrowing Costs, which requires that
capitalisation should cease when active development is suspended.
Regulatory consents (e.g. health and safety clearance) are sometimes required
before an asset may be used legally. Cost capitalisation will not necessarily continue
until such consents are in place. Management will normally seek to ensure that such
consents are in place very close to the time frame for physical completion and
testing, and that they do not delay the commencement of operations. Avoidable
delays in obtaining consents which prevent the start of operations should be seen as
abnormal and similar in effect to an industrial dispute, creating a hiatus during which
capitalisation should cease (see Q&A IAS 16: 16-6).
The words 'capable of operating in the manner intended by management' in IAS 16

cannot be used to justify ongoing capitalisation of costs (and postponement of
depreciation) once the asset has actually been brought into use just because the
asset does not live up to management's original intentions. This may, however,
constitute an impairment trigger under IAS 36 Impairment of Assets.
Q&A IAS 16: 22-1 — COST OF ABNORMAL AMOUNTS OF WASTE IN

PRODUCING A SELF-CONSTRUCTED ASSET
Background
A power company, Company P, signed a contract with a contractor to construct a

power plant. Company P believed that the quality of the construction work was poor
and terminated the construction contract. The contractor then successfully sued
Company P for breach of contract. Company P paid a lump sum to the contractor as
compensation for the breach of contract, and the construction work was resumed
thereafter.
Question
Should the lump sum compensation paid to the contractor be recognised
immediately as an expense or added to the construction cost of the power plant?
Answer
The amount does not fall within the scope of costs that are directly attributable to
bringing the asset to the location and condition necessary for it to be capable of
operating in the manner intended by management. This cost is similar in nature to
the cost of abnormal amounts of wasted material, labour or other resources
described in IAS 16.22 and, therefore, should be expensed.

Q&A IAS 16: 22-2 — ACCOUNTING FOR SELF-CONSTRUCTED ASSETS
Question
When accounting for a self-constructed asset under IAS 16, how should the concept
of 'directly attributable' costs be applied?
Answer
IAS 16.22 states that “[i]f an entity makes similar assets for sale in the normal
course of business, the cost of the asset is usually the same as the cost of
constructing an asset for sale”, in accordance with the principles of IAS 2
Inventories. For example, if the entity were a car manufacturer, the costs used to
determine the cost of a car for sale under IAS 2 could also be used in determining
the cost of a car that will be held as property, plant and equipment.
However, if the entity does not construct similar assets for sale, only those elements
of costs described in IAS 16.16 can be incorporated in the cost of a self-constructed
asset. Accordingly, costs which can be included are:
• direct materials;
• direct labour costs; and
• unavoidable costs that are directly attributable to the construction activity

(i.e. costs that would have been avoided if the asset had not been
constructed).
This concept of 'directly attributable' costs is different from the concepts applied in
the measurement of costs of conversion in IAS 2. The latter includes a systematic
allocation of fixed and variable production overheads that are incurred in converting
materials into finished goods. Such systematic allocation of fixed overheads is not
appropriate under IAS 16, because IAS 16 looks to capitalise only directly
attributable costs.
The Standard gives no further guidance on how to determine which costs should be
viewed as 'directly attributable'. Costs that are directly incremental as a result of the
construction of a specific asset would generally be eligible if they relate to bringing
the asset to working condition. When an entity regularly constructs assets, however,
it is possible that some element of apparently 'fixed' costs may also be directly
attributable. In such circumstances, an entity should consider which costs would
have been avoided if none of those assets had been constructed. For example, a
construction company may employ builders who are normally engaged on the
construction of properties for sale. If those builders are engaged for part of the year
on the construction of a new head office for the entity, their direct employment costs
should be capitalised as part of the cost of the new head office.
It is, therefore, likely that some variable production overheads may be able to be
incorporated into the cost of the asset (depending on whether they could have been
avoided absent the self-construction of the asset) but that no fixed production
overheads can be incorporated.
Q&A IAS 16: 23-1 — PAYMENT FOR AN ASSET DEFERRED BEYOND

'NORMAL CREDIT TERMS'
Background
The commercial property market in a particular city is very slow. As an inducement

to potential purchasers, a seller of commercial property in that city advertises a
property for sale at "no interest for the first three years after purchase, market rate
of interest thereafter". Other property sellers in the city are making similar offers. A
buyer purchases a property on those terms. IAS 16.23 requires imputation of
interest if payment for an item of property is "deferred beyond normal credit terms".
Question
In the circumstances described, is the three-year interest-free period 'normal credit
terms'?
Answer
No. The intent of IAS 16.23 is to ensure that the asset is recognised at its current
cash sale price. The reference to 'normal credit terms' is intended to recognise that
settlement of cash purchases often take a few days, weeks, or even months
(depending on the industry and national laws), and imputation of interest is not
required in those circumstances. However, particularly for a large item such as
property, the cash sale price would be significantly lower for cash payment made
up-front rather than deferred for three years. If the deferral period is greater than
what can be considered normal credit terms, the imputed interest element should be
recognised as an expense (unless such interest is capitalised in accordance with IAS
23 Borrowing Costs).
Q&A IAS 16: 23-2 — TIME VALUE OF MONEY ON DEPOSIT PAID FOR
THE ACQUISITION OF AN ASSET

Background
Company A places an order with a supplier for the purchase of an asset. Company A
has two choices regarding payment for the asset:
• it can pay the list price of CU10,000 when the asset is delivered in 2
years' time; or
• it can pay CU5,000 as an up-front, non-refundable deposit, and make a

final payment of CU3,500 when the asset is delivered.
Question
If Company A chooses to pay the up-front deposit, how should the time value of
money associated with the deposit be accounted for?
Answer
Because such a substantial deposit is paid up-front, the total amount that Company
A is required to pay is reduced; that is, the time value of money associated with the
up-front payment is reflected in the total amount payable.
The deposit is non-refundable and, therefore, it is not a financial asset. Nevertheless,

the deposit represents not only a payment on account for the asset but also, in
effect, provides financing to the supplier. Therefore, it will be appropriate to
recognise the implicit financing as part of the cost of the asset by unwinding the time
value of money over time, using the discount rate implicit in the original transaction
(14 per cent in the above example), as follows.
Including the time value of money as part of the cost of the asset is consistent with
IAS 16.23, which states that "[t]he cost of an item of property, plant and equipment
is the cash price equivalent at the recognition date".

Q&A IAS 16: 23-EX-1 — DEFERRED PAYMENT TERMS — EXAMPLE
Example
When payment for an item of property, plant and equipment is "deferred beyond
normal credit terms, the difference between the cash price equivalent and the total
payments is recognised as [an interest expense] over the period of credit", unless it
is capitalised in accordance with the requirements of IAS 23 Borrowing Costs. [IAS
16.23]
On 1 January 20X1, an item of property is offered for sale at CU10 million, with
payment terms being three equal instalments of CU3,333,333 over a two year period
(payments are made on 1 January 20X1, 31 December 20X1 and 31 December
20X2). The property developer is offering a discount of 5 per cent (i.e. CU500,000) if
payment is made in full at the time of completion of the sale and purchase
agreement (which corresponds to an implicit interest rate of 5.36 per cent per
annum).
The purchaser will recognise the acquisition of the asset as follows.
The following entry will be required at the end of 20X1.

The following entry will be required at the end of 20X2.
Q&A IAS 16: 24-EX-1 — EXCHANGES OF ASSETS — EXAMPLE

Example
Under IAS 16.24, when an item of property, plant and equipment is “acquired in
exchange for a non-monetary asset or assets, or a combination of monetary and
non-monetary assets”, the cost of that item is measured at fair value (even if the
entity cannot immediately derecognise the asset given up) unless:
• "the exchange transaction lacks commercial substance"; or
• "the fair value of neither the asset received nor the asset given up is
reliably measurable".
A ship charterer owns land and buildings which are carried in its statement of
financial position at an aggregate carrying amount of CU10 million, but which have a
market value of CU15 million. It exchanges the land and buildings for a ship, which
has a market value of CU18 million, and pays an additional CU3 million cash.
Provided that the transaction has commercial substance, the entity will recognise the
ship at a cost of CU18 million (its fair value) and will recognise a profit on disposal of
the land and buildings of CU5 million, calculated as follows.

The required journal entry is therefore as follows.

Deleted
Q&A IAS 16: 31-1 — ASSETS FOR WHICH FAIR VALUE CANNOT BE
RELIABLY DETERMINED
Question
When should an entity conclude that the fair value of an item cannot be reliably

determined?
Answer
IAS 16 provides no guidance as to the circumstances in which it is appropriate to
conclude that the fair value of an item of property, plant and equipment cannot be
measured reliably, nor does it address the appropriate accounting for those assets
whose fair value cannot be measured reliably.
However, IAS 40 Investment Property contains useful guidance on the

circumstances in which it is appropriate to conclude that the fair value of an item of
property, plant and equipment cannot be measured reliably. Under that Standard,
the exception is allowed when, and only when, comparable market transactions are
infrequent and alternative reliable estimates of fair value (e.g. based on discounted
cash flow projections) are not available. IAS 40 is very restrictive, and allows this
exception to be invoked only when an entity first acquires an investment property.
IAS 16 is not so explicit, and seems to permit a greater degree of flexibility. It
seems, however, that the intention of the IASB is that, when the entity has selected
the revaluation model as its accounting policy for a particular class of assets, there
should be a rebuttable presumption that all of the assets within that class will be
carried at revalued amounts. The 'not reliably measurable' exception should be
invoked only in exceptional circumstances. When the entity holds particular types of
assets for which it will frequently be difficult to establish fair values (e.g. specialised
plant and machinery), then it is preferable to adopt the cost basis for that entire
class of assets, so as to avoid the reporting of amounts in the financial statements
that are a mixture of costs and valuations at different dates.
When fair value cannot be reliably measured, the only reasonable approach is to
account for those assets using IAS 16's cost model. This is consistent with the
treatment required by IAS 40 for those investment properties whose fair value is not
reliably measurable. To assist users of the financial statements, additional
disclosures should be provided in respect of those assets carried at cost less
accumulated depreciation and accumulated impairment losses. Again, useful
guidance can be found in IAS 40, which requires that such assets be disclosed
separately. In addition, entities are required by IAS 40 to disclose:
• a description of the property;
• an explanation of why fair value cannot be determined reliably;
• if possible, the range of estimates within which fair value is highly likely to
lie; and
• on disposal of the property:
• the fact that the entity has disposed of property not carried at fair
value;
• the carrying amount of the property at the time of sale; and

• the amount of gain or loss recognised.
Although IAS 16 does not require equivalent disclosures, they should be seen as best
practice. In addition, some of these disclosures may on occasions be necessary in
order to comply with paragraph 97 of IAS 1 Presentation of Financial Statements,
which requires that when items of income and expense are material, their nature
and amount should be separately disclosed.
Q&A IAS 16: 33-1 — DETERMINING FAIR VALUE

Background
According to IAS 16.33, if there is no market-based evidence of fair value because of

the specialised nature of an item of property, plant and equipment, and the item is
rarely sold except as part of a continuing business, the entity may need to estimate
fair value using an income or a depreciated replacement cost approach.
Question
How should the depreciated replacement costs be determined?
Answer
The depreciated replacement cost valuation method is defined by International
Valuation Guidance Note No. 8, paragraph 3.1 as “[t]he current cost of reproduction
or replacement of an asset less deductions for physical deterioration and all relevant
forms of obsolescence and optimisation”. It involves determining the cost of
rebuilding the property, plant and equipment item and deducting an allowance for
depreciation, based on age, physical obsolescence and market factors.
The depreciated replacement cost valuation method is used when an item of

property, plant and equipment is identified as a specialised asset. In particular,
specialised properties are defined in International Valuation Standards Note No. 8,
paragraph 3.2 as “[p]roperty that is rarely, if ever, sold in the market, except by
way of a sale of the business or entity of which it is a part, due to the uniqueness
arising from its specialised nature and design, its configuration, size, location, or
otherwise”. Examples of specialised assets may include a nuclear power station, a
chemical plant or a film studio.
Q&A IAS 16: 34-1 — FREQUENCY OF REVALUATIONS

Question
How often should an item of property be revalued when applying the revaluation
approach?
Answer
IAS 16.31 requires that revaluations should “be made with sufficient regularity
[such] that the carrying amount does not differ materially from that which would be
determined using fair value at the end of the reporting period”. The Standard
therefore does not insist on annual revaluations.
The frequency of revaluations will depend upon fluctuations in the fair values of the
items of property, plant and equipment under consideration. Some items of
property, plant and equipment (e.g. properties situated in countries with high capital
asset inflation rates) may experience significant and volatile movements in fair
value, thus necessitating annual revaluations. Such frequent revaluations would be
unnecessary for items of property, plant and equipment with only insignificant
movements in fair value (e.g. machinery situated in countries with relatively low
capital asset inflation rates).
Q&A IAS 16: 35-EX-1 — ELIMINATION OF ACCUMULATED

DEPRECIATION AT THE DATE OF REVALUATION — EXAMPLE
Example
IAS 16.35 allows that any depreciation accumulated on an asset at the date of
revaluation can be dealt with in one of two ways, i.e. either:
• "restated proportionately with the change in the gross carrying amount of

the asset so that the carrying amount of the asset after revaluation equals
its revalued amount" (Method A). The carrying amount is increased to the
revalued amount by restating the cost and depreciation proportionately.
This method is often used when an asset is revalued to its depreciated
replacement cost by means of an index; or
• "eliminated against the gross carrying amount of the asset and the
[resulting] net amount restated to the revalued amount of the asset"
(Method B). The accumulated depreciation is eliminated, and any
remaining surplus is used to increase cost. This method is often used for
buildings. It is the most commonly used method in practice.
A property has a carrying amount of CU10 million, represented by cost of CU12

million and accumulated depreciation of CU2 million. It is revalued to its fair value of
CU13 million.
Q&A IAS 16: 37-1 — DEFINITION OF A 'CLASS' OF ASSETS

Background
A class of property, plant and equipment is defined in IAS 16.37 as "a grouping of
assets of a similar nature and use in an entity's operations". The following examples
are cited as separate classes:
• land;
• land and buildings;
• machinery;
• ships;

• aircraft;
• motor vehicles;
• furniture and fixtures; and
• office equipment.
Question
Are the classes of assets cited as examples in IAS 16.37 required to be presented?
Answer
No. The examples cited as separate classes are not intended to be prescriptive or
comprehensive. In practice, it is not uncommon for some of these classes to be
combined. For example, in situations when motor vehicles are not significant to an
entity, motor vehicles and machinery may be combined in a plant and machinery
class. For similar reasons, office equipment may be included in the furniture and
fixtures class.
IAS 16.73 requires detailed disclosures for each class of property, plant and
equipment. This should be borne in mind when distinguishing classes, because
multiple classes could lead to voluminous disclosures.
Q&A IAS 16: 38-1 — REVALUATION ON A ROLLING BASIS

Background
The requirement to revalue entire classes of assets is a potentially onerous

requirement because for some reporting entities, a class of assets could comprise a
large number of items. For this reason, IAS 16.38 allows a class of assets to be
revalued on a rolling basis, provided that the revaluation of the class of assets is
completed within a short period of time and that the revaluations are kept up to
date.
Question
How should a 'short period' be interpreted?
Answer
“If an item of property, plant and equipment is revalued, the entire class of property,
plant and equipment to which that asset belongs shall be revalued”. [IAS 16.36]
“[I]tems within a class of property, plant and equipment are revalued simultaneously
to avoid selective revaluation of assets and the reporting of amounts in the financial
statements that are a mixture of costs and valuations at different dates”. [IAS
16.38] This is intended to prevent the distortions caused by the selective use of
revaluation, also referred to as 'cherry-picking', so as to take credit for gains without
acknowledging falls in the value of similar assets.
No further guidance is provided in IAS 16 as to how a 'short period' should be

interpreted for the purposes of IAS 16.38 although, given the drafting of the
Standard, it is presumably less than a financial year. The general approach of IAS
16.38 is, however, to require simultaneous valuations so as to avoid amounts being
reported that are a mixture of costs and values as at different dates. Accordingly, it
would seem appropriate:
• for all such valuations to take place in the same accounting period (and in
the same interim period when an entity produces interim financial
statements); and
• for the acceptable length of the period to take into account how stable fair
values are, so that assets that are subject to greater volatility are revalued
over a shorter period.
Q&A IAS 16: 39-EX-1 — REVALUATION SURPLUS — EXAMPLE

Example
[In the examples below, for simplicity, the deferred tax impact in each period has
been ignored.]
IAS 16.39 requires that when an asset's carrying amount is increased as a result of a
revaluation, the increase (being the difference between the fair value at the date of
revaluation and the carrying amount at that date) should generally be recognised in
other comprehensive income and accumulated in equity, under the heading of
revaluation surplus.
A revaluation increase should be recognised in profit or loss, however, to the extent

that it reverses a revaluation decrease of the same asset previously recognised as an
expense.
Revaluation surplus
An entity purchased a parcel of land on 1 July 20X1 for CU125 million. At 31

December 20X1, the land is valued at CU150 million.
The revaluation surplus of CU25 million is recognised in other comprehensive income

and credited to a property revaluation reserve within equity.
Revaluation surplus reversing previous deficit

December 20X1, the land is valued at CU125 million. At 31 December 20X2, the fair
value of the land has increased to CU150 million.
20X1: Revaluation deficit of CU15 million is recognised in profit or loss.
20X2: Revaluation surplus is treated as follows:
• CU15 million is credited to profit or loss (i.e. reversal of the previous

deficit).
• CU10 million is recognised in other comprehensive income and credited to

the property revaluation reserve within equity.
Q&A IAS 16: 40-EX-1 — REVALUATION DEFICIT — EXAMPLE

Example
[In the example below, for simplicity, the deferred tax impact in each period has
been ignored.]
IAS 16.40 requires that when an asset's carrying amount is decreased as a result of
a revaluation, the decrease should generally be recognised in profit or loss. A
revaluation decrease should be recognised in other comprehensive income, however,
"to the extent of any credit balance existing in the revaluation surplus in respect of
that same asset". The decrease reduces the amount of the revaluation surplus
accumulated in equity.
Revaluation deficit reversing previous surplus

December 20X1, the land is valued at CU70 million. At 31 December 20X2, the fair
value of the land has decreased to CU55 million.

20X1: Revaluation surplus of CU10 million is recognised in other comprehensive
income and credited to the property revaluation reserve within equity.
20X2: Revaluation deficit is treated as follows:
• CU10 million is recognised in other comprehensive income and debited to

the property revaluation reserve within equity (i.e. reversal of the previous
surplus).
• CU5 million is recognised in profit or loss (i.e. excess of deficit over

available surplus attributable to the same parcel of land).
Q&A IAS 16: 40-EX-2 — REVALUATION SURPLUS REVERSING

PREVIOUS DEFICIT: EFFECT OF DEPRECIATION — EXAMPLE
Example
[For simplicity, the deferred tax impact has been ignored.]
The cost of a property with a useful life of 20 years is CU10 million. Depreciation
each year is CU0.5 million.
At the end of Year 5, the property has a carrying amount of CU7.5 million and a fair
value of CU6 million. At that date, the directors move to the revaluation basis of
accounting. The deficit on revaluation of CU1.5 million is recognised in profit or loss.
At the end of Years 6 through 9, the directors determine that there is no material
difference between the carrying amount of the property and its fair value and,
therefore, no valuation adjustments are required. Depreciation of CU2 million (i.e. 5
× CU0.4 million) is recognised in the periods up to the end of Year 10, at which time
the property has a carrying amount of CU4 million. During Year 10, however, the
value of the property increases sharply to a closing fair value of CU7 million.
Applying the basic principle as stated in IAS 16.39, the portion of the revaluation
surplus that is to be credited to profit or loss at the end of Year 10 might appear to
be CU1.5 million (i.e. the amount of the deficit previously recognised in profit or
loss). In effect, however, part of this revaluation decrease has already been reversed
through the recognition of a lower depreciation expense for Years 6 to 10.
Accordingly, the amount of the revaluation surplus that is credited to profit or loss
should be reduced by the cumulative reduction in depreciation in Years 6 to 10 as a
result of recognising the revaluation deficit (i.e. (CU0.5 million less CU0.4 million) ×
5 years). Therefore the amount of the revaluation surplus credited to profit or loss is
CU1 million. The remaining CU2 million of the revaluation surplus is recognised in
other comprehensive income and credited to the revaluation reserve within equity.
The end result is that the balance on the revaluation reserve (CU2 million) is the
excess of the carrying amount (CU7 million) over what it would have been had the
property never been revalued (CU5 million).
This treatment is consistent with the treatment prescribed for the reversal of an
impairment loss.
Q&A IAS 16: 41-EX-1 — TRANSFER FROM REVALUATION RESERVE TO

RETAINED EARNINGS — EXAMPLE
Example
[For simplicity, the deferred tax impact has been ignored.]
The cost of a property with a useful life of 20 years is CU10 million. Depreciation
each year is CU0.5 million. At the end of Year 5, the property has a carrying amount
of CU7.5 million and a fair value of CU12 million. The surplus on revaluation of CU4.5
million is credited to the revaluation reserve and the property will be depreciated
over its remaining 15-year useful life at the rate of CU0.8 million per annum.
Assume that for the remainder of its useful life the depreciated carrying amount of
the property is not materially different from its fair value. Therefore, no further
revaluation adjustments are required.
In Years 6 through 20, depreciation has been increased by CU0.3 million per annum
as a result of the revaluation. Therefore, at the end of each of those years, it is
acceptable to make a transfer from the revaluation reserve to retained earnings of
an amount of CU0.3 million, to reflect the realisation of the revaluation reserve. If
such periodic transfers are made, then the revaluation reserve will have been
reduced to zero at the point that the property is fully depreciated.
Alternatively, if no annual transfers are made, the reserve may be transferred in its
entirety on the retirement or disposal of the asset.
The reserve transfers referred to in IAS 16.41 are implied to be at the option of the
reporting entity, rather than being mandated by the Standard. There would,
therefore, appear to be another alternative — to make no reserve transfer. That
option would, however, result in the permanent retention of the portion of the
revaluation reserve relating to assets that have been fully depreciated or disposed

of.
Any transfer between the revaluation reserve and retained earnings, which should be
made on a net of tax basis, will reduce the amount that is available for offset against
future revaluation deficits in respect of individual assets.
Q&A IAS 16: 44-1 — COMPONENT ACCOUNTING FOR IN-PLACE LEASES

Background
Entity A acquires a building with a number of operating leases for tenants already in
place. Entity A applies the cost model for investment property under IAS 40
Investment Property (i.e. Entity A measures the property in accordance with IAS
16's cost model).
Question
Should Entity A depreciate separately the different amounts reflected in the cost of
the building attributable to the in-place leases (above and below market rentals,
direct costs associated with obtaining new tenants etc.)?
Answer
IAS 16.44 states that, in the circumstances described, “it may be appropriate to
depreciate separately amounts reflected in the cost [of the property] that are
attributable to favourable or unfavourable lease terms relative to market terms”. If
Entity A determines, through the exercise of judgement, that the components of cost
attributable to favourable or unfavourable lease terms are significant, those
components should be depreciated separately.
However, IAS 16 is silent with respect to other amounts related to the value of
in-place leases that may be reflected in the cost of the property. Therefore, whether
Entity A recognises such amounts as separate components for depreciation purposes
is an accounting policy choice to be applied consistently for all similar transactions.
Q&A IAS 16: 44-2 — SEPARATE DEPRECIATION OF 'INTANGIBLE'

COMPONENTS

Background
When an item of property, plant and equipment is first recognised, IAS 16 requires
that the entity should allocate the amount initially recognised between the item's
significant parts (i.e. those separately identifiable components of the item with a cost
that is significant to the total cost of the item). Each significant part is required to be
depreciated separately. [IAS 16.44]
Question
Are the components of an item of property, plant and equipment to be depreciated
separately always separately identifiable physical components?
Answer
No. IAS 16's approach of depreciating separate parts of a single item of property,
plant and equipment is most easily understood in relation to the physical
components of a single item. A common example of the allocation of the cost of an
item of property, plant and equipment is that of an aircraft, as mentioned in IAS
16.44. The airframe, engines and cabin interior of a single plane are likely to have
significantly different useful lives. Under IAS 16, these parts are separately identified
at the time that the aircraft is acquired, and each is depreciated separately over an
appropriate useful life.
There will, however, also be 'parts' that are less tangible. An entity may purchase an
item of property, plant and equipment that is required to undergo major inspections
or overhauls at regular intervals over its useful life. For example, an entity might
acquire a ship that requires a major overhaul once every five years. Part of the cost
of the ship may be allocable to a separate component representing the service
potential required to be restored by the periodic overhauls. That separate component
is isolated when the asset is acquired, and depreciated over the period to the next
overhaul.
The identification of this inherent component at the time of acquisition may not be
simple, because it will generally not have been separately invoiced. Therefore, an
estimate of the cost will be required. This will generally be based on the current cost
of the expected overhaul or inspection (i.e. the estimated cost of those activities if
they were performed at the time of the purchase).
Expenditure incurred subsequently on the major inspection or overhaul is capitalised

provided that the recognition criteria set out in IAS 16.7 are met. To the extent that
the separate component representing the estimated cost of the inspection or
overhaul has not been fully depreciated by the time that the inspection or overhaul
expenditure is incurred, it is derecognised and will therefore give rise to a loss.
See Q&A IAS 16: 44-EX-1 for illustration of the accounting treatment for major

inspection or overhaul costs which qualify for separate recognition.
Q&A IAS 16: 44-EX-1 — SEPARATE DEPRECIATION OF COST OF MAJOR

OVERHAUL — EXAMPLE
Example
An entity purchases a ship for CU40 million. This ship will be required to undergo a
dry dock overhaul every five years to restore its service potential. At the time of
purchase, the service potential that will be required to be restored by the overhaul
can be measured based on the cost of the dry docking if it had been performed at
the time of the purchase of the ship, e.g. CU4 million.
The following shows the calculation of the depreciation of the ship for Years 1 to 5,
using the straight-line method.
By the end of Year 5, the service potential would be fully depreciated. When a dry
docking is carried out in Year 6, the expenditure is capitalised to reflect the
restoration of service potential, which is then depreciated over the period to the next
overhaul in Years 6 to 10.
The process in Years 6 to 10 repeats every five years from Year 11 onwards until
Year 30, when both ship and the cost of dry docking are fully depreciated and a new
ship is acquired.
Note that the entity is required to use its best efforts to identify separately
components such as the service potential component when the asset is first acquired
or constructed. That separate identification, and the subsequent separate
depreciation of the service potential component, is not, however, a necessary
condition for the capitalisation of the subsequent expenditure on the overhaul as part
of the cost of the asset.
If, in the example above, the entity had failed to identify the service potential
component at the date of acquisition because it was not considered significant, and
had not depreciated that component separately during Years 1 to 5, the expenditure
on the overhaul in Year 6 would still be capitalised as part of the cost of the asset,
provided that the general recognition criteria were met. In this circumstance, the
entity would be required to estimate the remaining carrying amount of the service
potential component at the date of the first overhaul (which would be approximately
CU3.33 million, i.e. CU4 million depreciated for 5 years out of 30), and to
derecognise that carrying amount at the same time as the expenditure on the
overhaul is capitalised.
Q&A IAS 16: 51-EX-1 — CHANGE IN ESTIMATED USEFUL LIFE —

EXAMPLE
Example
An entity purchased an item of plant at a cost of CU1.2 million with an estimated
useful life of 10 years.
At the end of Year 3, the asset has a carrying amount of CU840,000. On the basis of
experience of similar assets, the item of plant is now estimated to have a remaining
useful life of 4 years. The asset is determined not to be impaired. Consequently, the
carrying amount of CU840,000 is depreciated over the remaining 4 years at
CU210,000 per annum.
Depreciation charges for Years 1 through 7 will be as follows.

When there is a significant reduction in estimated useful life, an entity will always
need to consider whether this is an indicator of impairment (see Q&A IAS 16: 51-1).
Q&A IAS 16: 51-1 — CHANGE IN ESTIMATED USEFUL LIFE

Background
IAS 16.51 requires that the estimate of the useful life of an item of property, plant
and equipment should be reviewed at least at each financial year-end. If
expectations differ from previous estimates, the change is accounted for as a change
in accounting estimate in accordance with IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
Question
What circumstances might lead to a change in the estimated useful life of an asset
and what accounting implications follow such a change?
Answer
Estimates of useful lives require adjustment occasionally in light of changes in
experience and knowledge. These changes may reflect the extension of estimated
useful lives due to exceptional maintenance expenditure, curtailment of estimated
useful lives due to excessive use, or obsolescence not included in the original
estimates. When the original estimate of the useful life of an asset is revised, the
undepreciated cost (or valuation) should be recognised in profit or loss over the
revised remaining useful life, except to the extent that the depreciation expense

qualifies for capitalisation into the cost of other assets, such as inventories.
A significant reduction in the estimated useful life of an asset may indicate that the
asset has been impaired because the amount that the entity expects to generate
from the use of the asset may have been reduced below its carrying amount (see
paragraph 12(f) of IAS 36 Impairment of Assets). In such circumstances, a detailed
impairment text should be performed and, if necessary, an impairment loss
recognised to reduce the carrying amount of the asset to its recoverable amount.
The recoverable amount is then depreciated over the revised estimate of the useful
life of the asset.
See Q&A IAS 16: 51-EX-1 for an illustration of the effect of a change in estimated
useful life.
Q&A IAS 16: 56-1 — DEPRECIATION OF LEASEHOLD IMPROVEMENTS

Background
IAS 16.56(d) states that the expiry dates of related leases should be taken into
account in determining the useful life of a depreciable asset.
Question
Should the renewal option in a lease contract be considered in estimating the useful
life of leasehold improvements?
Answer
The renewal period(s) should be taken into account if, at the inception of the lease, it
is 'reasonably certain' that the lessee will exercise the renewal option. For property
acquired by a lessee under a finance lease, paragraph 27 of IAS 17 Leases states
that "if there is no reasonable certainty that the lessee will obtain ownership by the
end of the lease term, the asset shall be fully depreciated over the shorter of the
lease term and its useful life". IAS 17.4 defines lease term to include "any further
terms for which the lessee has the option to continue to lease the asset, with or
without further payment, when at the inception of the lease it is reasonably certain
that the lessee will exercise the option". This 'reasonable certainty' of renewal test
should be applied at the commencement of the lease both in accounting for the lease
itself and in assessing the depreciable life of leasehold improvements relating to both
finance and operating leases. In particular, therefore, the assumption regarding the
lease term should be applied consistently for the lease and for any leasehold
improvements.

Q&A IAS 16: 58-1 — DEPRECIATION OF HISTORIC BUILDINGS
Background
Buildings have limited useful economic lives and are no different from other
depreciable assets. Although their estimated useful lives are usually significantly
longer than other items of property, plant and equipment, they should nevertheless
be depreciated in a similar manner, generally using the straight-line method. IAS
16.58 emphasises that an increase in the value of the land on which a building
stands does not affect the determination of the useful life of the building. An
exception to the general requirement to depreciate buildings is allowed for those
properties that qualify as investment properties under IAS 40 Investment Property
and that are accounted for using the fair value model.
Question
Does IAS 16 allow any exemption from depreciation for historic buildings?
Answer
No. The fact that they may have been built centuries earlier, and may be expected to
last for centuries more, does not exempt them from depreciation. It is possible that
the useful life of such a building may be very long. Also, when an entity intends to
sell such a building in due course, rather than use it for the remainder of its physical
life, it is possible that the residual value may be relatively high. Both of these factors
may lead to the depreciation recognised being relatively small. Care should be taken
to identify any components (e.g. roofs) that may require replacement at periodic
intervals, which will need to be depreciated over a shorter period.
Note: An exception to the general requirement to depreciate buildings is allowed for

those properties that qualify as investment properties.
Q&A IAS 16: 60-1 — INCREASING CHARGE DEPRECIATION

Background
Entities will often construct items of property, plant and equipment that are expected
to generate benefits over many years. Customer demand to use the assets may,
however, be expected to start slowly and take a number of years to reach an
expected 'normal' level. In such cases, an entity may wish the depreciation charge
for the asset to increase gradually to reflect customers' expected phased-in demand.
Question
Would such a depreciation method be appropriate in the circumstances described?
Answer
It depends on how the asset's benefits are being consumed. IAS 16.60 requires that
depreciation reflect the pattern in which the asset's economic benefits are consumed
by the entity. Those benefits should be viewed in terms of physical capacity or
physical output (using up physical capability, wear and tear, technical obsolescence)
and legal limits on the physical use of the asset (such as by a lease).
While an 'increasing charge' or 'sinking fund' method of calculating depreciation is

not appropriate under IAS 16, a unit-of-production method of calculating
depreciation will be appropriate if it reflects the pattern of benefit consumption. This
method is more likely to be justified for a physical asset, reflecting the wear and
tear, than for an intangible asset.
More generally, alternative methods of depreciation (e.g. decreasing charge

depreciation and the sum-of-digits method, or 'rule of 78') are acceptable under
IFRSs only if they reflect the pattern in which the asset's economic benefits are
expected to be consumed. As a consequence, a method based on tax allowances
granted (e.g. the double declining balance method) will not be permitted unless it
also reflects the expected consumption pattern of the asset.
The depreciation method adopted should be based on the economic depreciation of

the asset, rather than the return from the asset (e.g. the annuity method).
Therefore, consideration of the time value of money in determining the depreciation
method is not appropriate.
Q&A IAS 16: 61-EX-1 — CHANGE IN DEPRECIATION METHOD —

EXAMPLE
Example
IAS 16.61 states that a change from one method of recognising depreciation to
another does not constitute a change in accounting policy but is accounted for as a
change in estimate in accordance with IAS 8 Accounting Policies, Changes in

Accounting Estimates and Errors. The carrying amount of the asset is written off
using the new method over the remaining useful life, commencing with the period in
which the change takes place. Separate disclosure of the impact of the change will
be required if the change has a material effect in the current period or is expected to
have a material effect in subsequent periods.
An entity acquired an asset 3 years ago at a cost of CU5 million. The depreciation
method adopted for the asset was 10 per cent reducing balance.
At the end of Year 3 the carrying amount of the asset is CU3,645,000. The entity
estimates that the remaining useful life of the asset is 8 years and determines to
adopt straight-line depreciation from that date so as to better reflect the revised
estimated pattern of recovery of economic benefits.
Depreciation charges for Years 1 through 11 will be as follows.
Q&A IAS 16: 67-1 — DISPOSAL OF PROPERTY, PLANT AND EQUIPMENT

Background
An entity enters into a transaction whereby it sells an item of property, plant and
equipment to a third party. It concurrently enters into a contract with the third party
to buy all of the actual output of the asset over its remaining useful life at a fixed
per-unit price, but in total not less than a minimum payment equal to the value of 90
per cent of the expected output. The minimum payment must be made even if the
actual output is below expectation.
Question
Should the entity recognise the sale of the asset by removing it from its statement of
financial position?
Answer
In this situation, the entity should also consider the requirements of IFRIC 4
Determining Whether an Arrangement Contains a Lease. If it is concluded that the
supply arrangement involves a finance lease, the requirements of IAS 17 Leases
regarding sale and leaseback transactions apply.
Q&A IAS 16: 68A-1 — APPLICATION OF IFRS 5 TO 'IN-PERIOD'

DISPOSALS OF ASSETS
Background
Entity R prepares its financial statements to 31 December and it does not prepare
interim financial reports. At 31 December 20X1, Entity R carried a property asset in
its statement of financial position at its revalued amount of CU2 million in accordance
with IAS 16. Depreciation is CU60,000 per year. In April 20X2, management decides
to sell the property and it is advertised for sale. By 30 April 20X2, the sale is
considered to be highly probable. At that date, the asset's fair value is CU2.6 million
and its value in use is CU2.8 million. Costs to sell the asset are estimated at
CU100,000. On 15 June 20X2, the property is sold for CU2.75 million.
Question
Is Entity R required to apply the requirements of IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations to the disposal of the property?
Answer
Yes. When the effect is material, the requirements of IFRS 5 should be applied not
only for items meeting the criteria for classification as held for sale at the end of the
reporting period, but also for all 'in-period' disposals, including assets sold during the
reporting period that were not classified as held for sale at the previous reporting

date.
In the circumstances described, the following steps are required.
• Entity R should determine the date at which the IFRS 5 criteria for
classification as held for sale are met (assume the date is determined to be
30 April 20X2 in this case).
• Entity R should depreciate the property until the date of the reclassification
as held for sale. Accordingly, the depreciation expense is CU60,000 × 4/12
= CU20,000.
• The property should be revalued to its fair value at that date of CU2.6
million if the difference between the property's carrying amount at that
date and its fair value is material (see Q&A IFRS 5: 18-1). The revaluation
increase should be recognised in other comprehensive income in
accordance with IAS 16.
• Entity R should consider whether the property is impaired by comparing its

carrying amount (fair value) with its recoverable amount (higher of value
in use and fair value less costs to sell). In the above example, no
impairment loss is recognised because value in use of CU2.8 million is
higher than fair value less costs to sell of CU2.5 million. If any impairment
loss were identified at this point, it would be accounted for as a revaluation
decrease under IAS 16.
• The property should be reclassified as held for sale and remeasured to fair
value less costs to sell (CU2.5 million). Because, in this example, the
property is already carried at fair value, the requirement to deduct costs to
sell results in the immediate recognition of a loss of CU100,000. In
accordance with IFRS 5, this write-down to fair value less costs to sell
should be recognised in profit or loss.
• When the property is disposed of on 15 June 20X2, a profit on disposal of

CU150,000 is recognised (net proceeds of CU2.65 million less carrying
amount of CU2.5 million). Any remaining revaluation reserve relating to
the property is not recognised in profit or loss, but it may be transferred to
retained earnings in accordance with IAS 16.
The application of IFRS 5 in the above example affects the amounts reported in profit
or loss, because the valuation movement prior to the date of reclassification
(CU620,000) is recognised in other comprehensive income and is not subsequently
reclassified to profit or loss. In addition to the depreciation expense of CU20,000,
there will be a net gain recognised in profit or loss of CU50,000, which is comprised
of the fair value movement after reclassification (CU150,000) less costs to sell
(CU100,000). If IFRS 5 had not been applied, in addition to the depreciation expense
of CU27,500 (CU60,000 × 5.5/12), the net gain recognised in profit or loss would
have been CU677,500 (net proceeds of CU2.65 million less the carrying amount at
15 June 20X2 of CU1,972,000).

For assets measured under IAS 16's cost model, the application will not affect the
net amount reported in profit or loss for the period. However, it will affect the
amounts disclosed under IFRS 5.41(c) and, when disclosed separately, amounts
reported for gains or losses arising on the disposal of property, plant and equipment.
Q&A IAS 16: 79-1 — DISCLOSURE OF IDLE ASSETS AND

CONSTRUCTION IN PROGRESS
Question
To what extent are disclosures required for property, plant and equipment that is
temporarily idle and assets under construction when additional construction has been
postponed?
Answer
IAS 16.74(b) requires an entity to disclose the amount of expenditures recognised in
the carrying amount of an item of property, plant and equipment in the course of its
construction. IAS 16.79(a) encourages an entity to disclose the amount of property,
plant and equipment that is temporarily idle.
Paragraph 112(c) of IAS 1(2007) Presentation of Financial Statements requires an

entity to provide in the notes to the financial statements information that is not
presented elsewhere in the financial statements but is relevant to an understanding
of any of the financial statements.
In combination, the requirements of IAS 16 and IAS 1 lead to an expectation that,

when the amount of idle assets or postponed construction projects becomes
significant, such amounts will be separately disclosed.
Reference: IFRIC agenda rejection published in the May 2009 IFRIC Update.
Q&A IAS 16: 79(d)-1 — VOLUNTARY DISCLOSURE OF REVALUED

AMOUNTS
Question

Does IAS 16 specify any particular requirements when an entity applying the cost
model for property, plant and equipment voluntarily discloses the fair value of its
property, plant and equipment?
Answer
Entities that adopt the cost model of accounting for their property, plant and
equipment may wish to disclose the fair value of their property, plant and equipment
in a note to the financial statements when the fair value is materially different from
the carrying amount. Such disclosures are encouraged by IAS 16.79(d). In disclosing
such fair values, entities are not strictly bound by IAS 16's revaluation rules.
However, when the amounts disclosed do not represent current fair values, they
could mislead users of the financial statements. Therefore, the entity should either
disclose the current fair values of the assets concerned, or not disclose revalued
amounts at all.
Similar considerations apply when an entity engages in 'cherry-picking', by disclosing

current values only for those assets whose fair values are significantly above
carrying amounts and ignoring those assets whose fair values are significantly below
their carrying amounts. Accordingly, when fair values are disclosed voluntarily under
IAS 16.79(d), they should normally be disclosed for an entire class of assets.
Q&A IAS 17: 2-1 — LEASES OF INTANGIBLE ASSETS

[Issued 7 May 2004]
Question
Are all leases of intangible assets excluded from the scope of IAS 17?
Answer
Intangible assets are within the scope of IAS 17 if they establish rights for the
exclusive use of the intangible asset. Rights under licensing agreements for items
such as motion picture films, video recordings, plays, manuscripts, patents and
copyrights are excluded from the scope of IAS 17.
Brands and trademarks often are licensed exclusively, and therefore, are examples
of leases of intangible assets that are included in the scope of IAS 17.

After initial recognition, a lessee deals with an intangible asset held under a finance
lease under IAS 38 Intangible Assets.
Q&A IAS 17: 4-1 — LEASE OF PART OF AN ASSET

[Issued 7 May 2004]
Question
Is it possible to lease part of an asset? How should an entity account for a lease of a
portion of a larger asset?
Answer
IAS 17 would apply to such an agreement, as long as the agreement has fully
conveyed the right to use that portion of the asset.
In some instances this "right to use" may only pertain to a portion of a larger asset
(e.g., transponder on a satellite, part of a building). IAS 40.10 Investment Property,
specifically conceives that a portion of a property could be sold separately or leased
out separately under a finance lease.
Q&A IAS 17: 4-2 — ESTIMATING UNGUARANTEED RESIDUAL VALUE

WHEN CALCULATING A LEASE'S IMPLICIT INTEREST RATE
[Issued 7 May 2004]
[Reserved 7 April 2006]
[Amended and Reissued 30 March 2007]
Question
How should an unguaranteed residual value be factored into the calculation of
interest rate implicit in a finance lease?
Answer
IAS 17 does not define "residual value". Unguaranteed residual value in the lease is
determined in accordance with the definition in IAS 16.6 Property, Plant and
Equipment, as "the estimated amount that an entity would currently obtain from
disposal of the asset, after deducting the estimated costs of disposal, if the asset

were already of the age and in the condition expected at the end of its useful life".
(Q&A IAS 17: 4-3 addresses inflation and unguaranteed residual value.)
IAS 17.4 defines the interest rate implicit in the lease as the rate that discounts the
present value of "(a) the minimum lease payments and (b) the unguaranteed
residual value to be equal to the sum of (i) the fair value of the leased asset and (ii)
any initial direct costs of the lessor". However, the estimate of the unguaranteed
residual value is already a current value, in accordance with IAS 16, not an
estimated cash flow to be received for the unguaranteed residual value at the end of
the lease, which would require assumptions about inflation, price changes, etc. It
would, therefore, be inappropriate to discount the value obtained under IAS 16. To
obtain the implicit interest rate, an entity would consider the rate necessary to
discount the minimum lease payments. The combination of (a) the present value of
minimum lease payments, and (b) the current value of the unguaranteed residual
value estimated under IAS 16, would equal the amount of the fair value of the leased
asset, including initial direct costs.
Q&A IAS 17: 4-3 — INFLATION AND UNGUARANTEED RESIDUAL

VALUES
[Issued 7 May 2004]
Question
In the initial assessment of a lease should the impact of inflation be considered in
determining the unguaranteed residual value of a leased asset?
Answer
The unguaranteed residual value should be determined at the inception of the lease
in accordance with the definition of residual value in IAS 16 Property, Plant and
Equipment (i.e. at current value).
The possible effects of future inflation in estimating unguaranteed residual values

should not be considered because anticipated increases in residual values, as a result
of inflation, represent a contingency that should be recognised only as it is realised
(e.g. as a portion of sales proceeds when the asset is sold at the end of the lease).
Q&A IAS 17: 4-4 — IMPACT OF VARIABLE RENTALS ON MINIMUM

LEASE PAYMENTS — INFLATION (CONSUMER PRICE INDEX)
[Issued 7 May 2004]
[Reserved 10 December 2004]
[Amended and Reissued 7 July 2006]
Question
How should the minimum lease payments be measured where the lease payments
are linked to a change in an inflation index, such as the consumer price index?
Answer
The definition of contingent rent refers to a payment "that is not fixed in amount but
is based on the future amount of a factor that changes other than with the
passage of time (e.g. percentage of future sales, amount of future use, future
price indices, future market rates of interest)". Those words, highlighted in bold,
were added by the December 2003 revision to IAS 17.
Where an agreement specifies that at the beginning of the lease the annual
payments will be set at a fixed amount, but in future years will be increased by a
rate of inflation (i.e. a percentage increase), that future increase will not form part of
the minimum lease payments but will be contingent rent.
Commonly, the link to inflation is expressed in terms of a change in an index, such

as the consumer price index. For example, at the beginning of the lease the index is
1.21, while at the end of Year 1 it is 1.24. The lease agreement specifies that the
amount of the annual lease payments will be equal to CU100 multiplied by the
change in the inflation index. The minimum lease payments would be assumed to be
CU100 for every year of the lease since that is considered to be the base rent for the
whole contract. In Year 2, an increase in the rent of CU3 (CU100 × (1.24 – 1.21)) is
contingent rent.
In addition, careful consideration of the terms of the lease may be required where an
inflation adjustment is leveraged. This might represent an embedded derivative.
Q&A IAS 17: 4-5 — MINIMUM LEASE PAYMENT COMPONENTS —

MAINTENANCE
[Issued 7 May 2004]
Question
Lease installments include payments related to maintenance incurred by the lessor
on behalf of the lessee. Should minimum lease payments include the portion of lease
payments related to maintenance?

Answer
If the substance of the lease payments is for maintenance, it should be excluded
from the calculation of minimum lease payments as it represents a cost for services
to be paid by and reimbursed to the lessor.
Q&A IAS 17: 4-6 — MINIMUM LEASE PAYMENT COMPONENTS —

ADMINISTRATION COSTS
[Issued 7 May 2004]
Question
Lease installments include payments related to administration incurred by the lessor
on behalf of the lessee. Should the administration portion of rental payments be
included in minimum lease payments?
Answer
No. Administration costs represent executory costs that are excluded from the
calculation of minimum lease payments.
Q&A IAS 17: 4-7 — DETERMINING THE FAIR VALUE OF LEASED

EQUIPMENT
[Issued 7 May 2004]
Question
How is the fair value of leased equipment determined under IAS 17, for lease
classification purposes?
Answer
Fair value is defined in IAS 17.4 as "the amount for which an asset could be
exchanged, or a liability settled, between knowledgeable, willing parties in an arm's
length transaction". No further guidance is provided. This definition of fair value is
not specific to IAS 17.
In general, the fair value of any asset should normally be determined by

market-based evidence of the amount for which the asset could be exchanged,
taking account of prevailing market conditions and reflecting any volume or trade
discounts that would ordinarily be available to market participants.
When considering leased assets, there may be particular sources of evidence

available. For example, when the lessor is a manufacturer or dealer, the lessor's
normal selling price for the equipment may be an appropriate starting point for
the determination of fair value, reflecting any volume or trade discounts that may be
applicable.
When the lessor is not a manufacturer or dealer and there has been a significant
lapse of time between the acquisition of the property by the lessor and the inception
of the lease, the determination of fair value should consider market conditions
prevailing at the inception of the lease, which may indicate that the fair value of the
property is greater or less than its cost or carrying amount, if different.
When the leased asset is a second hand or specialised asset, and a market price is
not available, the fair value could be based on a depreciated replacement cost of a
comparable new asset.
Q&A IAS 17: 4-8 — COMPONENTS OF MINIMUM LEASE PAYMENTS —

TERMINATION PENALTIES
[Issued 7 May 2004]
Question
In some leases the terms include a termination penalty if the lessee terminates the
contract prior to the end of the agreed lease term, which may, or may not be
explicitly expressed as a termination penalty. Should the minimum lease payments
include a termination penalty?
Answer
The inclusion or exclusion of the termination penalties in the
minimum-lease-payments calculation should be consistent with the determination of
the lease term under the arrangement.
The standard defines the lease term as the "non-cancellable period", together with
further periods for which the lessee has the option to extend the lease, thus, at
inception, it is reasonably certain the lessee will exercise.
Likewise, the lease can be expressed as a "longer" period with an option that is
either explicit or implied by the inclusion of termination penalty clauses to cancel the
lease at an earlier date. The amount of termination payment will be one of the
factors considered in determining whether it is reasonably certain that the lease will
continue to full term. If it is not reasonably certain to continue to full term, the lease
term is the shorter non-cancellable period. In such cases termination penalties would
form part of the minimum lease payments.
Where it is assessed that the lease term is the full length of the arrangement, the
termination penalties should be excluded from the minimum lease payments.
Q&A IAS 17: 4-9 — RENEWAL OPTIONS — LEASE TERM

[Issued 7 May 2004]
Question
Under what circumstances would it be considered that an option to renew a lease is
reasonably certain to be exercised?
Answer
The determination of when an option to renew a lease is "reasonably certain" is a
matter of careful judgement. Situations that normally would result in a renewal
option being "reasonably certain" of exercise include, but are not limited to, the
following:
• The lessee has the right to prescribe the lease terms on renewal of the
lease,
• The lease rentals on renewal are expected to be lower than market rates,
and
• The lessee is economically compelled to renew based on the nature of the

assets being leased or the existence of penalties.
The renewal period should be included in the lease term where it is reasonably
certain that the option will be exercised.
Q&A IAS 17: 4-10 — LESSEE'S INCREMENTAL BORROWING RATE —

FOREIGN CURRENCY
[Issued 7 May 2004]
Question
Which incremental borrowing rate should be used where the lease is denominated in
a foreign currency?
Answer
The lessee's incremental borrowing rate should be the rate at which the lessee could
obtain funding for the asset in the foreign currency.
Q&A IAS 17: 4-11 — SELECTION OF INCREMENTAL BORROWING RATE

[Issued 7 May 2004]
Question
In order to verify if, at inception of the lease, the present value of the minimum
lease payments amounts to at least substantially all of the fair value of the leased
asset, Company A (lessee) used its incremental borrowing rate as it was
impracticable to determine the interest rate implicit in the lease.
When Company A asked its bank what rate it would incur to borrow the funds, over a
similar term, necessary to purchase the asset, the bank offered two options:
1. Rate for an unsecured loan; and
2. Rate for a secured loan.
What rate should be used as the lessee's incremental borrowing rate? One for an
unsecured loan, one for a secured loan, or does Company A have the choice between
both?
Answer
The determination of the rate should be based on the facts and circumstances of the
leasing practices in the specific jurisdictions. Generally, most lease arrangements are
secured, and therefore, the secured loan rate would be appropriate. However, there
might be situations in which the lease arrangement would be unsecured and
consequently the unsecured loan rate would be appropriate (as the lessor would
have appropriately considered the unsecured leasing arrangement in its pricing).
Q&A IAS 17: 4-12 — SECURITY DEPOSITS — MINIMUM LEASE

PAYMENTS
[Issued 7 May 2004]

Question
Should refundable security deposits be included in the calculation of the present
value of minimum lease payments?
Answer
Yes. If the lessee is required to make a security deposit at the inception of the lease
that is refundable at the end of the lease term, the payment and subsequent refund
of the deposit should be considered in the calculation of the present value of the
minimum lease payments. The effect of the deposit and subsequent refund is to
accelerate the cash outflows of the lessee in the early years of the lease.
Q&A IAS 17: 4-13 — ACCOUNTING FOR MAINTENANCE COSTS

ASSOCIATED WITH LEASED ASSETS
Question
An entity leases some equipment under a lease contract that is classified as an
operating lease. The terms of the contract stipulate that the equipment must be
returned to the lessor in the same condition it was in when originally leased.
Should a provision be made for the requirement to return the equipment in its
original condition, and, if so, when should the provision be recognised?
Answer
The answer depends on the particular lease clause. For example, the equipment may
suffer general wear and tear that is merely a result of being used. In such
circumstances, it may be necessary to gradually build up a provision to repair or
maintain the equipment over the lease term, so that it can be returned to the lessor
in its original condition. Generally, in these circumstances, it would be inappropriate
to set up the full provision at the outset of the lease.
Conversely, other contracts may require specific work to be performed. For example,
the contract may stipulate that the equipment must be painted at the end of the
lease, before being returned to the lessor. In such circumstances, it may be
appropriate to recognise a provision (and corresponding expense) at the outset of
the lease, as by signing the contract the entity has committed itself to painting the
asset, irrespective of any wear and tear suffered.

Note that industry practice may have developed for leases of certain assets, such as
aircraft.
Q&A IAS 17: 4-14 — IMPACT OF VARIABLE RENTALS ON MINIMUM

LEASE PAYMENTS — PRIME INTEREST RATE
[Added 7 July 2006]
Question
How should the minimum lease payments be measured where the lease payments
are linked to a prime interest rate, for example, LIBOR?
Answer
At the inception of the lease, the future minimum lease payments should be
determined on the basis of the prime interest rate (e.g. LIBOR) at that date.
It is considered that the link of lease payments to an interest rate (e.g. LIBOR) is an
adjustment to the lease payments for the time value of money. Contingent rentals
are those linked to the future amount of a factor that changes "other than with the
passage of time". Contingent rents, therefore, are considered to be those arising
from future changes in the rate of the prime interest rate, not those arising from
applying LIBOR at the date-of-inception of the lease to the determination of lease
payments.
For example, if the lease specifies that lease payments will increase by LIBOR each
year, the minimum lease payments calculation will assume that LIBOR remains at
the rate at the date-of-inception for the remainder of the lease. Any future changes
in the level of lease payments, caused by future changes to the existing LIBOR rate,
represent contingent rental, which will be recognised as incurred.
Careful consideration of the terms of the lease is required to determine whether a

prime interest rate adjustment included is leveraged, in which case it might
represent an embedded derivative.
Q&A IAS 17: 4-15 — FINANCE LEASES: EVALUATION OF MINIMUM

LEASE PAYMENTS — LEASE INCENTIVES GIVEN BY A LESSOR
[Added 7 July 2006]

Question
How does a lessor treat incentives it provides when determining the minimum lease
payments?
Answer
SIC-15 Operating Leases — Incentives, provides guidance for incentives in operating
leases. All incentives for the agreement of a new or renewed operating lease should
be recognised as an integral part of the net consideration agreed for the use of the
leased asset, irrespective of the incentive's nature or form, or the timing of
payments.
Likewise, if incentive payments are given in respect of finance leases, the incentives
should be included as a reduction of the minimum lease payments to be received by
the lessor.
Where there are tenant incentives paid at the start of a lease, even when they are
not part of the actual lease documentation, they should be included in the minimum
lease payments calculation.
Q&A IAS 17: 4-16 — EVALUATION OF MINIMUM LEASE PAYMENTS —

RENT REVIEWS
Question
A lease allows for rent reviews every five years. When determining the minimum
lease payments, how should one treat rent reviews?
Answer
The definition of minimum lease payments specifically excludes contingent rents.
Rent reviews, whether to market rates or upward-only, give rise to contingent rent.
Therefore, at the inception of the lease the minimum lease payments throughout the
lease term will be equal to the initial payments before any rent reviews have
occurred.
Whether a lease specifies a rent of CU 100 annually plus market increases, or CU

100 annually resetting up or down to market every five years, the minimum lease
payments are CU 100 annually. Any increase or decrease as a result of the review

will be contingent rent.
The basis of any rent review under the lease should be evaluated carefully to
determine whether the rent review resets the lease payments to market at the date
of the review or whether, in substance, the amount of change in the lease payments
at the date of the review was fixed at inception.
Q&A IAS 17: 4-17 — IDENTIFICATION OF A SPECIFIC ASSET UNDER

IFRIC 4
Background
Company A (A) enters into a three-year agreement to provide Internet access to

Company B (B). The agreement requires B to make monthly payments and specifies
the amount of bandwidth B needs. In order to provide B with the necessary
bandwidth, A installs a router on B's premises. The router is not explicitly specified in
the agreement, but is necessary to provide the required service and bandwidth to B.
Company A has 24-hour access to the router to undertake any necessary
maintenance or service. The useful life of the router is estimated to be three years.
Company A can replace the router at any time during the contract period provided
that the replacement can provide the same service. Generally, A would only replace
the router if it is damaged or needs to be upgraded. Company A has an excess
inventory of these routers and does not have a history of replacing or exchanging
the routers before the end of the contracts.
Question
Is the router an asset that is implicitly identified in the agreement?
Answer
IFRIC 4.6 states:
Determining whether an arrangement is, or contains, a lease shall be

based on the substance of the arrangement and requires an assessment of
whether:
(a) fulfilment of the arrangement is dependent on the use of a specific
asset or assets (the asset); and
(b) the arrangement conveys a right to use the asset.
Assessment of whether the arrangement is dependent on the use of a

specific asset
IFRIC 4.7 states:
Although a specific asset may be explicitly identified in an arrangement, it

is not the subject of a lease if fulfilment of the arrangement is not
dependent on the use of the specified asset. For example, if the supplier is
obliged to deliver a specified quantity of goods or services and has the
right and ability to provide those goods or services using other assets not
specified in the arrangement, then fulfilment of the arrangement is not
dependent on the specified asset and the arrangement does not contain a
lease. A warranty obligation that permits or requires the substitution of the
same or similar assets when the specified asset is not operating properly
does not preclude lease treatment. In addition, a contractual provision
(contingent or otherwise) permitting or requiring the supplier to substitute
other assets for any reason on or after a specified date does not preclude
lease treatment before the date of substitution.
In addition, IFRIC 4.8 states:
An asset has been implicitly specified if, for example, the supplier owns or
leases only one asset with which to fulfil the obligation and it is not
economically feasible or practicable for the supplier to perform its
obligation through the use of alternative assets.
Company A's 24-hour access to the router, immediate access to replacement
routers, and contractual permission to change the router at any time indicate that
the router installed on B's premises is not an implicit asset under IFRIC 4.8. In
effect, A can choose (1) which router to use in providing B with Internet access for
the three-year contract period and (2) whether to replace that router.
The determination of whether this conclusion applies to any given situation requires
careful assessment of all facts and circumstances.
When fulfilment of the agreement to provide Internet access does not depend on the
use of a specific asset (i.e. the criteria in IFRIC 4.6(a) are not met), the agreement
does not contain a lease. In such cases, the agreement is a contract for the provision
of services and should be accounted for in accordance with the relevant standards.
Q&A IAS 17: 7-1 — LEASE OF SEVERAL ASSETS

[Issued 7 May 2004]
Question

Should a lease agreement for more than one asset be assessed separately for each
asset?
Answer
The lease should be assessed separately for each significant asset which operates
independently; for example, where payments increase in response to different
factors, the lease runs for different periods, or the lease can be terminated and
renegotiated separately.
Q&A IAS 17: 7-EX-1 — RESERVED

[Issued 7 May 2004]
[Reserved 25 June 2010]
Reserved
Q&A IAS 17: 8-1 — ACCOUNTING FOR A TYPICAL SYNTHETIC LEASE

TRANSACTION
[Issued 7 May 2004]
Background
Company A desires to construct a new corporate headquarters. Company A has

identified the site and has prepared design plans for the new building, but has not
yet purchased the land. The estimated cost to acquire the land and construct the
building is $100 million. Company A wants to enter into a lease that will allow it to
take advantage of favourable short-term interest rates, participate in any
appreciation in the value of the property and retain operational flexibility.
The transaction is structured as follows:
A lessor (bank) is identified which will lease the property to Company A upon its
completion. The lessor appoints Company A to act as construction agent to oversee
the building's completion and funds construction of the leased asset through the
issuance of debt and equity. The following chart depicts the structure of the
synthetic lease.

Company A signs a five-year noncancelable bondable lease (triple net lease where
lessee is responsible for maintenance, taxes, and insurance) with the lessor to
commence upon completion of the building. Company A's lease payments to the
lessor are sufficient to cover the lessor's debt service obligation plus a yield to its
equity holders. If the lease terminates prior to the stated expiration date, but after
(1) the construction period or (2) during the construction period as a result of
Company A's gross negligence, willful misconduct, fraud, or bankruptcy, then the
lessee is required to reimburse the lessor for all costs incurred relating to the project
(the "Lease Balance"). The other terms of the lease are structured such that:
• The lease does not automatically transfer ownership of the property before
the end of the lease term.
• The lease does not have a bargain purchase price option.
• The lease term is less than 75 per cent of economic useful life of the
property.
• The present value of the minimum lease payments (irrespective of any

guarantees) is less than 90 per cent of the fair value of the leased property
at the inception of the lease.
The lease is structured such that upon lease expiration, Company A has the following
alternatives:
• Company A can renew the lease upon mutually acceptable terms at fair
market rentals, the Lessor must be able to renew corresponding credit
facility.
• Company A may elect to purchase the property from the lessor for an
amount equal to the outstanding note and certificate balances. Company A
has determined at lease inception that the fixed price purchase option is
not a "bargain purchase option".
• Company A can terminate the lease and re-market the property as agent
for the lessor.
If the proceeds from the re-marketing exceed the Lease Balance, the excess will be
returned to Company A in accordance with the terms of the lease. If, however, the
proceeds are less than the Lease Balance, the lessee is required to make a residual
value guarantee payment for all or a portion of the shortfall. The amount of the
residual value guarantee, equal to 85 per cent of the Lease Balance, is established in
the lease agreement. The present value of the lease payments is equal to less than
90 per cent of the expected fair value of the property upon completion of
construction. Assuming that Company A has strong credit, as a result of the residual
value guarantee, the lessor is economically at risk for only the decline in the fair
value of the property in excess of 85 per cent of the Lease Balance.
The chart below depicts which party to the lease incurs a loss or realises a gain
(excluding the impact of depreciation) upon the remarketing of a leased asset upon
expiration of a lease in which the lessee provides a residual value guarantee and
receives all appreciation in the leased asset over the asset's original cost. This
illustration is based on the following assumptions:
• The lease balance is $100.
• The lessee provides a residual value guarantee to the lessor for the first
$85 of losses.
• The lease provides that all appreciation in the value of the leased asset in
excess of its original cost will be paid to the lessee upon remarketing of the
leased asset.

Question
How should the lessee classify the above lease transaction?
Answer
IAS 17.8 requires a lease that transfers from the lessor to the lessee substantially all
the risks and rewards incidental to ownership to be classified as a finance lease.
Therefore, an analysis of both the risks and the rewards incidental to ownership is
required.
The above transaction transfers all of the rewards of ownership to the lessee through
the ability to obtain all of the proceeds received from re-marketing the property; that
is, Company A will receive all of the potential increase in value of the property.
Furthermore, IAS 17.11(b) states that this fact is an indicator, individually or in
combination with other indicators, which may lead to a lease being classified as a
finance lease.
IAS 17.10(d) states that a lease would be classified as a finance lease by the lessor
when, "at the inception of the lease the present value of the minimum lease
payments amounts to at least substantially all of the fair value of the leased asset".
The minimum lease payments (in accordance with the definition in IAS 17.4) include
all amounts guaranteed by the lessee or by a party related to the lessee. While these
payments would exclude the taxes and insurance to be paid by the lessee, it would
include the sum of the lease payment and the maximum amount that could, in any
event, become payable under the residual value guarantee.
IAS 17.9 supports the inclusion of the maximum amount of the guarantee by stating
that different classifications between the lessee and the lessor could exist, for
example, when there is a residual value guarantee by an unrelated party.
Therefore, based on the guidance noted above, the lease transaction would be
accounted for as a finance lease by the lessee.

Q&A IAS 17: 9-1 — DIFFERENT CLASSIFICATION OF LEASES BY LESSOR
AND LESSEE
[Issued 7 May 2004]
Question
Under which circumstances could a lease be classified differently by the lessor and
lessee?
Answer
The present value of the minimum lease payments may differ for the lessor and the
lessee — this could be the case where a residual value has been guaranteed to the
lessor by an independent third party capable of meeting the guarantee. Thus, the
present value of the minimum lease payments may be lower for the lessee than for
the lessor, resulting in classification as an operating lease by the lessee and as a
finance lease by the lessor.
The classification of leases is based on the extent to which risks and rewards incident
to ownership of a leased asset have been transferred by the lessor or received by the
lessee. When an independent third party is involved in the lease, it may result in the
lessor transferring the significant risks and rewards of ownership. However, the
lessee may not receive the significant risks and rewards of ownership, if some of the
risks and rewards are transferred to a third party.
Q&A IAS 17: 10-1 — CLASSIFICATION OF LEASES — OPTION BY

HOLDING COMPANY TO ACQUIRE ASSET
[Issued 7 May 2004]
Question
A company (the lessee) enters into a lease with a third party. The holding company
of the lessee has an option to acquire the leased asset at less than market value at
the end of the lease term. The holding company has no operations other than to act
as an investment holding company. How should the lease be classified?
Answer
It is reasonably certain that the holding company will exercise the option to acquire
the asset as the exercise price is less than the expected market value. As a result,
the lessor has transferred the risks and rewards associated with ownership of the
asset. The lessor should classify the lease as a finance lease.
The option to acquire the asset is not held by the lessee; but the substance is that
only the lessee will have use of the asset. As a result, the lessee should classify the
lease as a finance lease.
Q&A IAS 17: 10-2 — CLASSIFICATION OF LEASES — PUT AND CALL

OPTION
[Issued 7 May 2004]
Question
At the end of the lease term, the lessee has a call option to acquire the leased asset
at a fixed price. The lessor has a corresponding put option for the same value. What
is the impact of the put and call option on the lease classification?
Answer
The substance is that of a forward contract. At the end of the lease term, the lessee
will exercise the call option if the market value of the leased asset exceeds the
exercise price of the option. The lessor will exercise the put option if the market price
is less than the exercise price of the option. Therefore, either the put or the call
option will be exercised at the end of the lease term, and the lessee will acquire the
asset at the end of the lease term. Consequently, the lease should be classified as a
finance lease from the perspective of both the lessee and the lessor.
Q&A IAS 17: 10-3 — TRANSFER OF OWNERSHIP

[Issued 7 May 2004]
Question
Ownership of the leased asset transfers to the lessee at the end of the lease term. Is
it necessary for the transfer to be effected in terms of the lease agreement in
order for the lease to be classified as a finance lease?
Answer
No. Legal title may transfer either as a result of the lease agreement or within a
separate agreement which forms part of the overall leasing transaction (e.g. where

the lessor has concluded a separate forward sale agreement with the lessee).
Q&A IAS 17: 10-4 — CLASSIFICATION OF LEASES — USEFUL ECONOMIC

LIFE INDICATOR
[Amended 15 May 2009]
Question
IAS 17.10(c) states that an indicator that a lease is a finance lease is when "the
lease term is for the major part of the economic life of the asset even if title is not
transferred". What is considered to be the "major part" of an asset's economic life?
Answer
There is no further discussion in IAS 17 as to what the "major part" of an asset's
economic life is. IAS 17 requires that the classification of a lease should be
determined based on the substance of the agreement, according to whether the
agreement transfers substantially all of the risks and rewards of ownership.
Other GAAP may establish specific thresholds, but those should not be considered
definite guidelines in the application of IAS 17. IAS 17 requires careful consideration
of all the risks and rewards of ownership, including (but not limited to) the
possibilities of losses from idle capacity or technological obsolescence, variations in
return due to changing economic conditions, the expectation of profitable operation
over the asset's economic life, and gain or loss from movements in value or
realisation of a residual value.
Note that when renewal or purchase options exist, these should be assessed at the
inception of the lease to determine whether it is reasonably certain that the option
will be exercised. The lease term will include the further term when exercise of the
option is assessed as reasonably certain.
Q&A IAS 17: 10-5 — CLASSIFICATION OF LEASES — SUBSTANTIALLY

ALL OF THE FAIR VALUE
Question

IAS 17.10(d) states that an indicator that a lease is a finance lease is when "at the
inception of the lease the present value of the minimum lease payments amounts to
at least substantially all of the fair value of the leased asset". What is considered to
be "substantially all" of the fair value of a leased asset?
Answer
There is no further discussion in IAS 17 as to what constitutes "substantially all" of
the fair value of a leased asset. IAS 17 requires that the classification of a lease
should be determined based on the substance of the agreement, according to
whether the agreement transfers substantially all of the risks and rewards of
ownership.
Other GAAP may establish specific thresholds, but those should not be considered
definite guidelines in the application of IAS 17. IAS 17 requires careful consideration
of all the risks and rewards of ownership, including (but not limited to) the
possibilities of losses from idle capacity or technological obsolescence, variations in
return due to changing economic conditions, the expectation of profitable operation
over the asset's economic life, and gain or loss from movements in value or
realisation of a residual value.
Note that when renewal or purchase options exist, these should be assessed at the
inception of the lease to determine whether it is reasonably certain that the option
will be exercised. The lease term will include the further term when exercise of the
option is assessed as reasonably certain, and the minimum lease payments will
include payments due with respect to this further term.
Q&A IAS 17: 11-1 — BARGAIN RENEWAL OPTION — GENERAL

ASSESSMENT
[Issued 7 May 2004]
Question
How should one assess whether the secondary rent period represents a bargain
renewal option?
Answer
A bargain renewal option occurs when a lessee has the ability to continue the lease
for a secondary period at a rent which is substantially lower than market rent. The
rent for a secondary period would be considered substantially lower than market rent
if it would be economically rational for the lessee to continue the lease at that lower

rent.
Factors to consider in determining whether a renewal represents a bargain are:
• Nature of the leased asset,
• Possibility of technological obsolescence,
• Possibility of higher operating and maintenance costs over the secondary

rent period, and
• Costs to be incurred by the lessor to find a new lessee and to prepare the
asset for a new lessee.
Q&A IAS 17: 11-EX-1 — BARGAIN RENEWAL OPTION — GENERAL

ASSESSMENT
[Issued 7 May 2004]
Example
A lessee has a renewal option for a secondary rent period. The lease payments are
indexed to the Consumer Price Index (CPI) during any renewal periods, at 75 per
cent of the CPI existing at the time of the renewal.
A 25 per cent discount may, depending on circumstances, be regarded as a

significant saving that would lead to the renewal option being classified as a bargain.
Q&A IAS 17: 11-2 — BARGAIN RENEWAL OPTION — SPECIFIC

ASSESSMENT
[Issued 7 May 2004]
Question
How should one assess whether the secondary rent period represents a bargain
renewal option, if the rental payments in the renewal period are equal to a certain
percentage of the original monthly payments.
Answer
A suggested approach to assess whether this represents a bargain would be to

compare:
• The implicit interest rate determined by assuming that the lease is

terminated at the end of the original lease term, with
• The implicit interest rate determined by assuming that the lease is renewed
at the reduced rentals rates.
Appropriate estimates of the residual value of the asset at the end of the original
term and at the end of the renewal period should be included in the respective
computations.
If the implicit interest rate increases or remains substantially the same when the
renewal option is assumed to be exercised, it is appropriate to conclude that the
renewal option is not a bargain.
The assessment of whether the interest rate differential is a bargain or not will
depend on economic conditions prevailing in that jurisdiction taken together with the
circumstances of the parties to the lease agreement.
Q&A IAS 17: 11-3 — CANCELLATION CLAUSES

[Issued 7 May 2004]
Question
A five year lease has successive cancellation clauses that are exercisable by the
lessee in three-month intervals. What is the effect on lease classification?
Answer
An estimate should be made of the likelihood that the lessee will cancel the lease. To
the extent that it is probable that the lessee will exercise any cancellation clause,
this would impact the lease term, and consequently the classification of the lease.
Furthermore, in assessing the probability of cancellation, the intention of the parties

should be considered so that an assessment is made based on the substance of the
agreement.
Q&A IAS 17: 13-1 — ACCOUNTING FOR A CHANGE IN CLASSIFICATION

OF LEASES BY LESSEES
[Issued 7 May 2004]

Question
How should a lessee account for a change in classification of the lease, if the
provisions in the lease are changed significantly, suggesting that the lease would
have been classified differently at inception had the changed provisions been in
effect at that time?
Answer
In terms of IAS 17, the revised agreement is considered as a new agreement over its
term.
For lessees, if a lease previously classified as an operating lease now becomes a

finance lease, the lease should be capitalised by the lessee at the present value of
the remaining minimum lease payments, and accounted for as a finance lease from
that point forward. No prior year adjustments should be made. If a finance lease is
reclassified as an operating lease, the lessee should follow the guidance for sale and
leaseback transactions.
For lessors, if a lease previously classified as an operating lease now becomes a

finance lease, the lease receivable should be capitalised at the present value of the
remaining minimum lease payments, and the leased asset should be derecognised.
No prior year adjustments should be made. A profit or loss may arise on
derecognition of the asset and recognition of the finance lease receivable. If a
finance lease is reclassified as an operating lease, the lessor should remove the lease
receivable from the balance sheet, and recognise a leased asset for the same
amount.
Q&A IAS 17: 13-2 — ACCOUNTING FOR A CHANGE IN CLASSIFICATION

OF LEASES BY LESSORS
[Issued 7 May 2004]
Question
How should a lessor account for a change in classification of the lease, if the
provisions in the lease are changed to such an extent that the lease would have been
classified differently at inception had the changed provisions been in effect at that
time?
Answer
In terms of IAS 17, the revised agreement is considered as a new agreement over its
term.
Therefore, if a lease previously classified as an operating lease now becomes a

finance lease, the lease receivable should be capitalised at the present value of the
remaining minimum lease payments, and the leased asset should be derecognised.
No prior year adjustments should be made. A profit or loss may arise on the
derecognition of the asset.
If a finance lease is reclassified as an operating lease, the lessor should remove the
lease receivable from the balance sheet, and recognise a leased asset for the same
amount.
Q&A IAS 17: 13-3 — UPGRADE OF LEASED ASSETS

[Issued 7 May 2004]
Question
A lessee is entitled to upgrade leased computers prior to the end of the initial lease
term. A new lease agreement is concluded for each upgrade. What impact will the
upgrade have on the lease?
Answer
The upgraded computers are distinct from the original leased computers. The lease
provisions are renegotiated on upgrade of the computers. Therefore, the provisions
of the lease change on upgrade of the computers and the lease of the upgrades
should be assessed as a new lease over the renegotiated term.
Q&A IAS 17: 13-4 — EXERCISE OF A PURCHASE OPTION IN A LEASE

ARRANGEMENT
Background
Company A (A) leases a property from Company B (B) for ten years. The lease
includes an option under which A may purchase the asset from B at the market price
of the asset at the end of the lease. Company A may exercise the option no later
than two years before the lease expires. The commercial rationale for this is to allow
B to market the leased asset for sale or lease to a third party if A chooses not to
exercise the purchase option. At inception of the lease, A assesses that there is a
reasonable commercial possibility that it will not exercise the purchase option and
hence classifies the lease as an operating lease.
Towards the end of the eighth year of the lease, A serves notice that it will purchase
the property, thereby creating a binding purchase commitment. Company A will not
acquire legal title to the property until exercise of the option at the end of year ten.
Question
Does the notification that the purchase option will be exercised require reassessment
of the classification of the lease?
Answer
No. IAS 17.13 clarifies that lease classification is made at the inception of the lease
unless the lease terms are subsequently modified (other than by renewing) and that
modification would have resulted in a different classification if the modified terms
had been in effect at inception.
In this case, the purchase price for the asset will be determined at the end of the
original ten-year lease term, and paid for on exercise at the end of year ten. The
original operating lease terms have not been modified. Company A continues to
account for the operating lease until the purchase option is exercised at the end of
year ten when A will account for an acquisition of the property.
However, if at the date of notification, the option price is renegotiated to be the

market price for the asset at the date of notification and the original lease term is
shortened to eight years, this would be a termination of the original lease and
acquisition of the asset, and, therefore, would be accounted for as such.
Q&A IAS 17: 13-5 — EXERCISE OF A RENEWAL OPTION IN A LEASE

ARRANGEMENT
Background
Company A (A) leases a property from Company B (B) for ten years. The lease
includes a renewal option under which A may extend the lease contract with B at the
end of the lease. At inception of the lease, exercise of the renewal option is not
considered probable.
Company A must give notice if it intends to exercise the renewal option no later than
two years before the end of the lease term. The commercial rationale for this is to
allow B to market the leased asset for sale or lease to another party if Company A
chooses not to exercise the renewal option.
Towards the end of the eighth year of the lease, A serves notice that it will renew the
lease contract, thereby extending the lease.
Question
Does the notification that a renewal option will be exercised require reassessment of
the classification of the lease?
Answer
No. IAS 17.13 states:
Lease classification is made at the inception of the lease. If at any time the
lessee and the lessor agree to change the provisions of the lease, other
than by renewing the lease, in a manner that would have resulted in a
different classification of the lease under the criteria in paragraphs 7–12 if
the changed terms had been in effect at the inception of the lease, the
revised agreement is regarded as a new agreement over its term.
However, changes in estimates…, or changes in circumstances…, do not
give rise to a new classification of a lease for accounting purposes.
[Emphasis added.]
In the above scenario, the lease contains a renewal option, exercise, however, is not
considered probable at inception of the lease. Subsequent notification by A
represents a change in circumstance indicating the intention to renew, but does not
alter the existing lease agreement, therefore, reassessment of the lease is not
required. On actual renewal of the lease at the end of the lease term, A effectively
enters into a new lease which is classified according to IAS 17.8.
However, if the original lease did not include a renewal option and the lease is
renegotiated to include one, or the terms of an existing renewal option in a lease are
changed, this would be a modification in accordance with IAS 17.13, hence,
classification of the lease should be reassessed at the date of exercise, i.e. in year
eight.
Q&A IAS 17: 13-6 — CHANGE IN LESSOR DURING THE TERM OF AN

OPERATING LEASE
Background
Company A leases a building from Company B at the beginning of 20X1. The lease
term is for a period of eight years and there is an annual fixed increase in lease
payments of 11 per cent. The lease is classified as an operating lease and, therefore,
Company A recognises the lease payments as expenses on a straight-line basis over
the lease term. As a result of the increasing lease payments, Company A recognises
a lease accrual in the first few years of the lease because the straight-line lease
expense is greater than the amount paid to Company B.
At the end of 20X4, Company B sells the building to Company C and legal transfer
takes place prior to the end of the year. As part of the sale, the original lease is
cancelled and Company A simultaneously enters into a lease for the same building
with Company C. The new lease also expires in 20X8 and has an annual fixed
increase in lease payments of 11 per cent; the first lease payment due is equivalent
to the lease payment originally due at the end of 20X4 when the first lease was
cancelled.
Question
Does the introduction of a new lessor represent a new lease which needs to be
assessed under IAS 17 or, given that the substance of the lease is identical before
and after the sale, should there be no accounting impact?
Answer
IAS 17.13 states that if the provisions of a lease are changed in a manner that would
have resulted in a different classification of the lease if the changes had been in
place at the inception of the lease, the revised agreement is regarded as a new lease
over its term. IAS 17.13 also states that changes in estimates or circumstances do
not give rise to a new lease classification.
In this instance, the lease classification remains unchanged before and after the sale
of the building from Company B to Company C. Given that there is no change in the
provisions or substance of the lease, apart from a change in lessor, this should be
regarded as a change in circumstance which does not give rise to a new lease
classification. As a result, any accrual previously recognised by Company A is not
released to profit or loss when the new lease is entered into; Company A continues
to account for the lease as previously.
Q&A IAS 17: 14-1 — PAYMENTS TO ACQUIRE LEASEHOLD RIGHTS

[Issued 7 May 2004]
Question
It is common for a new lessee to pay the incumbent tenant a lump sum when
transferring the lease contract. How should this lump sum payment be accounted
for?
Answer
The lump sum payment should be accounted for as pre-paid lease payments, which
are amortised over the lease term in accordance with the pattern of benefits
provided, if the lease is an operating lease. If the lease is a finance lease, the lump
sum payment should be capitalised to the value of the asset to the extent that the
carrying amount of the asset does not exceed its fair value. Alternatively, such a
lump sum payment could be attributed to the purchase of other rights separate from
the leased asset.
Q&A IAS 17: 14-2 — LONG-TERM LAND LEASES THAT DO NOT

TRANSFER THE TITLE TO THE LESSEE
Question
Do long leases of land represent a situation when a lease of land would not
"normally" be classified as an operating lease?
Answer
No. IAS 17.14 states that, "a characteristic of land is that it normally has an
indefinite economic life and, if title is not expected to pass to the lessee by the end
of the lease term, the lessee normally does not receive substantially all of the risks
and rewards incidental to ownership, in which case the lease of land will be an
operating lease".
IAS 17.BC8 explains that the Board has confirmed that because land normally has an
indefinite economic life, and therefore there are significant risks and rewards
associated with the land at the end of lease terms that do not pass to the lessee,
land will normally be classified as an operating lease. Although in the case of a long
lease the time value of money would reduce the residual value of the land to a
negligible amount, this does not alter the conclusion that significant risks and
rewards associated with the land are not passed to the lessee.
The IFRIC, however, has noted that one example of a lease classification affected by
the introduction of the word "normally" was a lease of land in which the lessor had
agreed to pay the lessee the fair value of the property at the end of the lease period.
In such circumstances, significant risks and rewards associated with the land at the
end of the lease term would have been transferred to the lessee despite there being

no transfer of title.
Note: IFRIC agenda rejection published in the March 2006 IFRIC Update.
Q&A IAS 17: 16-1 — CLASSIFICATION — LEASE OF INVESTMENT

PROPERTY
[Added 26 May 2006]
Question
Company A (A) (as lessee) leases a property which meets the definition of an
investment property under IAS 40 Investment Property. Company A, however, is
unable to obtain a reliable allocation between the land element and the buildings
elements of the leased property; accordingly, the entire lease is classified as a
finance lease (assuming it is not clear that both elements are operating leases, in
which case the entire lease would be classified as an operating lease). Nevertheless,
the characteristics of the land element are that it has an indefinite economic life and
title is not expected to pass to the lessee by the end of the lease term. For this
reason, the unidentifiable land component of the property is in the nature of an
operating lease. Does IAS 40 require A to measure the property using the fair value
model?
Answer
No. The requirement in IAS 17.19 to adopt the fair value model applies when an
entity chooses to account for a property interest held under an operating lease as an
investment property. Since the entire property is classified as a finance lease, IAS 40
allows a choice between the cost model and the fair value model. This option is
available for finance leases (as determined by IAS 17) irrespective of whether there
may be an "operating lease" component for land which cannot be reliably
determined.
Q&A IAS 17: 27-1 — FINANCE LEASES — DEPRECIATION OF LEASED

ASSETS
[Issued 7 May 2004]
[Reserved 19 May 2006]
[Amended and Reissued 26 May 2006]
Question
An asset is leased under a finance lease where the lease term is shorter than the
useful life of the asset. Subsequent to initial recognition, it becomes certain that an
option to renew the lease will be exercised. At inception this option was not
reasonably certain. Should the depreciation period be revised to include the expected
renewal of the lease?
Answer
No. The depreciation period should not be revised to include the expected renewal of
the lease since IAS 17.27 requires that the asset should be depreciated over the
shorter of the lease term and its useful life. Consequently, the lessee will not obtain
ownership by the end of the lease term. With exercise of the renewal option, a new
lease agreement effectively will be created. In order to classify and account for the
new lease, the provisions of IAS 17 should be applied. See also Q&A IAS 17: 27-2,
Exercise of Renewal Option in a Lease Arrangement.
Q&A IAS 17: 27-2 — EXERCISE OF RENEWAL OPTION IN A LEASE

ARRANGEMENT
[Added 26 May 2006]
Question
An asset is leased under a finance lease where the lease term is shorter than the
useful life of the leased asset. Subsequent to initial recognition, an option to renew
the lease is now exercised. At inception of the lease, it was not reasonably certain
that the option would be exercised; therefore, the renewal option was not taken into
account in assessing the lease term. How should the renewal of the lease be
accounted for?
Answer
In substance, the renewal of the lease is a separate lease agreement; hence, the
existing lease should continue to be accounted for as a finance lease to the end of its
original term. Subsequently, the renewal of the lease needs to be classified. Where
the renewal of the lease is classified as a finance lease, IAS 17.20 applies for initial
measurement at commencement of the renewal lease term, and IAS 17.25 applies
for subsequent measurement. If the renewal of the lease is classified as an operating
lease, it should be accounted for as any other operating lease in accordance with IAS
17.33.
Q&A IAS 17: 33-1 — TIME PATTERN OF USER'S BENEFIT FROM AN

OPERATING LEASE
[Added 12 May 2006]

Question
If annual payments in an operating lease increase by a fixed annual percentage over
the life of the lease, would it be acceptable to recognise these increases in each
accounting period as they arise when they are intended to compensate for expected
annual inflation over the lease period?
Answer
No. To recognise income from annual fixed inflators as they arise would not be
consistent with the time pattern of the user's benefit.
IAS 17 does not incorporate adjustments to reflect the time value of money (e.g. by
deferring a portion of a level payment to a later period). Rather, under an operating
lease, IAS 17.33 requires lease payments to be recognised on a straight-line basis
over the lease term unless another systematic basis is more representative of the
time pattern of the user's benefit.
Note: IFRIC agenda rejection published in the November 2005 IFRIC Update.
Q&A IAS 17: 33-2 — RECOGNITION OF OPERATING LEASE INCENTIVES

UNDER SIC-15
[Added 12 May 2006]
Question
What is the appropriate period and method over which to recognise an incentive for
an operating lease when an incentive is provided to the lessee and the lease contains
a clause that requires lease payments to be repriced to market rates?
Answer
IAS 17.33 requires lease payments under an operating lease to be recognised as
follows:
As an expense on a straight-line basis over the lease term unless another

systematic basis is more representative of the time pattern of the user's
benefit.
SIC-15.5 states:
The lessee shall recognise the aggregate benefit of incentives as a

reduction of rental expense over the lease term, on a straight-line basis
unless another systematic basis is representative of the time pattern of the
lessee's benefit from the use of the leased asset.
Even if an operating lease is repriced to market rates during the lease term, it does
not mean that the lease expenses of a lessee should be comparable to the lease
expense of an entity entering into an operating lease at the same time at market
rates. Moreover, the repricing itself should not be considered representative of a
change in the time pattern of the lessee's benefit referred to in SIC-15.5.
Consequently, an incentive for an operating lease shall be recognised on a

straight-line basis over the full term of the operating lease, unless thorough
assessment shows that another systematic basis is more representative of the time
pattern of the lessee's benefit from use of the leased asset.
Q&A IAS 17: 33-3 — LEASE PAYMENTS ON UNUSED PROPERTY

[Added 26 May 2006]
Question
Company XYZ (XYZ) currently is performing a major expansion of its oil production
capacity; production will start in 20X6. In order to ensure shipping capacity, the
company will enter into operating lease transactions in 20X5 for rail cars that will be
stored on XYZ's premises. Expected use in 20X5 will be minimal. Company XYZ is
optimistic that they will be able to rent out the cars to other producers in 20X5 but
this activity will be minimal. The sole reason for the leases is to ensure that the rail
cars will be available to XYZ in 20X6.
When should XYZ commence recognising the lease payments in its financial
statements?
Answer
In accordance with IAS 17.4, assets, liabilities, income and expenses resulting from
a lease are recognised in the financial statements at the commencement of the lease
term. The commencement of the lease term is the date from which the lessee is
entitled to exercise its right to use the leased asset. In 20X5, XYZ has the right to
use the leased rail cars. Irrespective of whether XYZ chooses to exercise its right and
in accordance with IAS 17.33, it should commence recognising the lease expense in
20X5 on a straight-line basis over the lease term.

Q&As IAS 17: 33-4 and 33-5 — DISCOUNTING OF OPERATING LEASE
PAYMENTS
IAS 17: 33-4
[Added 26 May 2006]
Question
In determining the operating lease expense to be charged in each year (which, given
the exception of contingent rentals, is straight-lined over the lease period), are the
future payments discounted to their present value?
Answer
No. An entity should not discount the future payments in determining the total
operating lease expense to be recognised.
IAS 17 requires the use of straight-line recognition, unless there is an alternative

method that would represent the time pattern of the users' benefits. The users'
benefits in a standard operating lease do not vary from year to year, only as a result
of the passage of time; consequently, discounting is not appropriate. Alternative
methods are only appropriate where the benefit from the leased asset being gained
by the lessee is gained, based on some other pattern — for example, units of
production. However, even if alternative methods are used, it does not make sense
to discount the lease payments simply because of alternative cash flow patterns.
IAS 17: 33-5
[Added 26 May 2006]
Question
When payments increase with time, whereas, the rentals are recognised on a
straight-line basis, an accrual will be built up over the first half of the lease and run
back down again in its second half. Should this accrual be discounted to its present
value?
Answer
No. Consistent with the way the lease expense is calculated (by analysing
undiscounted payments), the liability should be recognised without taking into
account the effect of discounting.

Q&A IAS 17: 33-6 — INITIAL DIRECT COSTS INCURRED BY THE LESSEE
IN AN OPERATING LEASE
Background
Company A enters into an operating lease of a property and incurs a statutory levy
(e.g. stamp duty) at a fixed percentage of the fair value of the leased property. The
statutory levy is payable at the inception of the lease.
Question
How should Company A account for the cost of the statutory levy?
Answer
IAS 17 is silent on the subject of initial direct costs incurred by a lessee in an
operating lease. In the absence of a specific Standard applying to a transaction or
event, paragraph 11 of IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors states that the requirements and guidance in IFRSs dealing with similar
and related issues should be considered.
One way to account for the cost of the levy, in the absence of any specific guidance
allowing its deferral, would be to recognise an expense when it is incurred.
Alternatively, guidance on similar issues found elsewhere in IFRSs (as set out below)
recognises that costs incurred to obtain benefit over time should be expensed over
time. By analogy, such guidance would support recognition of the statutory levy as
an asset and amortisation over the lease term on a straight-line basis. In particular:
• IAS 17. 52 states that “[i]nitial direct costs incurred by a lessor in

negotiating and arranging an operating lease [are] added to the carrying
amount of the leased asset and recognised as an expense over the lease
term;
• IAS 17.20 and 24 state that initial direct costs incurred by a lessee on
entering into a finance lease are added to the amount recognised as an
asset;
• paragraph 16(b) of IAS 16 Property, Plant and Equipment requires directly

attributable costs in relation to an asset to be added to the carrying
amount of the asset and depreciated over the asset's useful life; and
• paragraph 43 of IAS 39 Financial Instruments: Recognition and

Measurement states that transaction costs incurred on entering into
financial instruments not classified as at fair value through profit or loss
are included in the initial measurement of the financial instrument.
Q&A IAS 17: 33-7 — OPERATING LEASE PAYMENTS — CONTINGENT

RENT
Question
IAS 17.33 requires lease payments under an operating lease to be recognised as an
expense on a straight-line basis over the lease term, unless another systematic basis
is more representative of the time pattern of the user's benefit. IAS 17.50 requires
equivalent treatment for lease income from operating leases i.e. that it be recognised
as income on a straight-line basis over the lease term, unless another systematic
basis is more representative of the time pattern in which use benefit derived from
the leased asset is diminished.
Should contingent rents in an operating lease be estimated at inception of the lease

and recognised on a straight-line basis over the lease term?
Answer
IAS 17.25 requires that, for finance leases, contingent rents should be recognised as
expenses when they are incurred. The treatment adopted for contingent rents under
operating leases should be consistent with this requirement.
Therefore, contingent rents under operating leases should not be estimated and
included in the total lease payments to be recognised on a straight-line basis over
the lease term; instead, they should be recognised as expenses in the period in
which they are incurred.
Note: In July 2006, the IFRIC noted that, although IAS 17 is unclear on this issue,
this has not, in general, led to contingent rentals being included in the amount to be
recognised on a straight-line basis over the lease term. The IFRIC recommended to
the Board that IAS 17 be amended to clarify the approach intended by the Standard.
A proposed amendment was issued in October 2007 as part of Improvements to
IFRSs (2008). The proposal was subsequently delayed pending the outcome of the
IASB's leases project.
Q&A IAS 17: 35-1 — DISCLOSURE OF OPERATING LEASE PAYMENTS

[Issued 7 May 2004]

Question
In disclosing the future minimum operating lease payments, should disclosure be
made of the cash payments expected in terms of the lease agreement, or of the
straight line expense recognised as a result of IAS 17.33, if different?
Answer
Disclosure should be made of the cash flows expected in terms of the lease
agreement.
Q&A IAS 17: 36-1 — TERMINATION OF LEASES

[Issued 7 May 2004]
Question
How should a finance lease be accounted for when it is terminated early?
Answer
Lessee — The lessee should remove both the leased asset (in accordance with IAS
16 Property, Plant and Equipment) and the lease liability from its balance sheet
where early termination does not create an obligation to purchase the asset, and
recognise any resulting difference in the income statement.
Lessor — The derecognition of a lease receivable by a lessor is included in the scope

of IAS 39 Financial Instruments: Recognition and Measurement. The derecognition
criteria of IAS 39 therefore should be applied.
Q&A IAS 17: 36-2 — FINANCE LEASE: RECOGNITION OF LEASE

INCENTIVES (RENT-FREE PERIOD) — BY LESSEE
[Added 7 July 2006]
Question
How does a lessee account for a rent-free period at the beginning of a finance lease?
Answer
At the commencement of the lease the lessee will recognise a leased asset and a
finance lease payable either at the amount of the fair value of the leased asset or, if
lower, at the amount of the present value of the minimum lease payments.
The lessee will also treat the finance lease payable as prescribed by IAS 17.25 (i.e.
with a constant periodic rate of interest on the remaining balance of the liability
during the lease term including the rent-free period). Although there will be no
payments made during the rent-free period (i.e. no reduction in the liability), finance
charges will be recognised (at the rate implicit in the lease) in the income statement
with corresponding increases in the liability.
For example, the lessee has recorded a lease liability of CU100 at the
commencement of the lease. The rent-free period is one year and the implicit
interest rate is 10 per cent. At the end of Year 1, the liability is increased by CU10,
because no payment is made. The balance will be reduced by payments in
subsequent years.
Q&A IAS 17: 36-3 — FINANCE LEASE: RECOGNITION OF LEASE

INCENTIVES (RENT-FREE PERIOD) — BY LESSOR
[Added 7 July 2006]
Question
How does a lessor account for a rent-free period at the beginning of a finance lease?
Answer
At the inception of the lease, calculation of the minimum lease payments and
determination of the interest rate, implicit in the lease by the lessor, will factor in nil
payments by the lessee during the rent-free period.
The lessor will recognise a finance lease receivable: initially, under IAS 17.36 at the
amount equal to the net investment in the lease; and, subsequently, finance income
is recognised at a constant rate on the net investment under IAS 17.39. During the
"rent-free" period this will result in the accrued finance income increasing the finance
lease receivable.
Q&A IAS 17: 36-EX-1 — FINANCE LEASE: INITIAL AND SUBSEQUENT

ACCOUNTING BY A LESSOR
[Added 7 July 2006]

Background
Company A (A) which is not a manufacturer-dealer, leases a machine to Company B

(B) for 25 years. The rents are CU10 million per year.
• At inception, the fair value of the machine is CU120 million.
• The carrying amount of the machine is CU95 million.
• Company A incurred CU5 million of initial direct costs relating to the

negotiating and arranging of the lease.
• The machine also has an unguaranteed residual value for A. The present
value of the unguaranteed residual value is CU10 million.
• The present value of minimum lease payments is CU115 million and the
present value of any unguaranteed residual value is CU10 million.
Question
How should A account for the lease in its financial statements under IAS 17 at
commencement of the lease, and subsequently? Can it recognise a gain up-front?
Answer
At the commencement of the lease, A, the lessor, will reclassify the machine from
equipment to finance lease receivables on its balance sheet. The net investment in
the lease will be the lease receivable, calculated as a total of the present value of the
minimum lease payments, including annual rents and the unguaranteed residual
value.
The present value of the minimum lease payments is calculated using the interest
rate implicit in the lease. IAS 17.4 defines this rate as "the discount rate that, at the
inception of the lease, causes the aggregate present value of (a) the minimum lease
payments and (b) unguaranteed residual value to be equal to the sum of (i) the fair
value of the leased asset [CU120 million] and (ii) any initial direct costs of the lessor
[CU5 million]". This sum is CU125 million.
Therefore, the lease receivable at the inception of the lease is CU125 million.
As A is not a manufacturer-dealer, the difference between the original carrying

amount of the machine and the net investment in the lease is recognised in the
income statement as a gain on disposal of the machine: a gain of CU25 million
(CU125 – CU95 – CU5 million).
The accounting entries (in millions) required at commencement of the lease are as
follows:

IAS 17.39 subsequently requires that finance income should be recognised on a
pattern that reflects a constant periodic rate-of-return on the lessor's net investment
in the finance lease, using the rate implicit in the lease. Company A will recognise
annual rental payments received (CU10 million) as partly being the repayment of the
finance lease receivable and partly as interest income.
The accounting entry for Year 1 (in millions) will be as follows (the constant periodic
rate of return is 7.2 per cent):
The accounting entry for Year 2 (in millions) will be as follows (the constant periodic
rate of return is 7.2 per cent):
In addition, A should review the unguaranteed residual value of CU10 million on a

regular basis.

Q&A IAS 17: 39-1 — FINANCE LEASE: SUBSEQUENT ACCOUNTING BY A
LESSOR — CHANGES IN UNGUARANTEED RESIDUAL VALUE
Question
Should a lessor reflect changes in the unguaranteed residual value of the leased
asset (i.e. residual interest in property) in the subsequent measurement of its
finance lease receivable?
Answer
Changes in the unguaranteed residual value of the leased asset will only impact the
finance lease receivable if the changes indicate impairment of the receivable and,
subsequently, reversal of impairment.
General
IAS 17.36 requires the lessor's net investment in the finance lease to be shown as a
finance lease receivable. The net investment in the finance lease is equal to the
unguaranteed residual value accruing to the lessor plus the minimum lease
payments, discounted at the interest rate implicit in the lease.
The subsequent measurement of the lease receivable is specified by IAS 17 and by

the derecognition and impairment requirements of IAS 39 Financial Instruments:
Recognition & Measurement.
The recognition of finance income is based on a constant rate of return on the net
investment. Finance income is recognised at the rate implicit in the lease (e.g. 5 per
cent) on the total net investment including the unguaranteed residual value.
Impairment
Over the term of the lease, IAS 17.41 requires the estimated unguaranteed residual
value to be reviewed regularly for any potential reductions in the estimated amount.
Hence, the portion of lease receivable representing the unguaranteed residual value
should be regularly compared with the current assessment of residual value. If the
current assessment of the residual value is below the carrying amount of this portion
of the finance lease receivable, an immediate loss should be recognised.
IAS 39.63 specifies that any impairment will be measured as the difference between
the carrying amount and the present value of the estimated future cash flows, i.e.
the minimum lease payments discounted at the originally assessed interest rate
implicit in the lease and current assessment of unguaranteed residual value.
Subsequent to an impairment loss, interest will be accrued using the rate implicit in
the lease on the basis of the revised carrying amount. The interest rate implicit in
the lease was determined at the inception of the lease and remains unchanged.
Reversal of Impairment
The guidance on reversal of an impairment loss for financial assets in IAS 39.65
applies. Any reversal of an impairment loss of the residual value, where permitted in
accordance with IAS 39, is limited to the amount of the residual value estimated at
the inception of the lease with accreted interest.
Q&A IAS 17: 53-1 — ANNUITY METHOD DEPRECIATION

[Issued 7 May 2004]
Question
Entity A leases an asset to Entity B under an operating lease. The asset is recognised
in the financial statements of the lessor and is depreciable. Entity A would like to use
the annuity method of depreciation. The entity believes that in including the time
value of money in the depreciation calculation, it would reflect the economics of the
transaction more faithfully. Therefore, lower depreciation in the early years is offset
by higher interest charges, and vice versa.
Does IAS 16 allow an operating lessor to depreciate the leased asset using the
annuity method?
Answer
No. IAS 17.53 states that the lessor should apply normal depreciation policy for
similar assets and the depreciation charge should be calculated on the basis set out
in IAS 16 Property, Plant and Equipment.
IAS 16.60 states that the depreciation method used shall reflect the pattern in which
the asset's economic future benefits are expected to be consumed. The method
should be based on the economic depreciation of the asset, not on the return from
the asset. Therefore, the consideration on the time value of money in the
depreciation calculation is not permitted.

Moreover, IAS 38.98 Intangible Assets, explicitly states, in part:
There is rarely, if ever, persuasive evidence to support an amortisation

method for intangible assets with finite useful lives that results in a lower
amount of accumulated amortisation than under the straight-line method.
Q&A IAS 17: 56-1 — DISCLOSURE BY LESSORS

[Issued 7 May 2004]
Question
Should the lessor disclose the cash flows from future minimum lease payments, or
the amounts expected to be recognised as income (if the cash flows are structured
differently to the economic use of the asset)?
Answer
The actual cash flows should be disclosed, and not the amounts recorded in income.
This disclosure is required in addition to the disclosure requirements of IAS 32
Financial Instruments: Presentation.
IAS 32 requires, amongst other things, the disclosure of the terms and conditions
that may affect the timing and certainty of future cash flows.
Q&A IAS 17: 59-1 — FINANCE LEASEBACKS

Background
Entity Y sells a vessel to a third party and at the same time enters into an agreement
with the third party to lease the vessel back for five years. The lease is a finance
lease.
The net present value of the lease payments and the fair value of the vessel is CU8
million and the carrying amount of the vessel before the sale is CU4 million. The
residual value of the vessel is CU2 million.
IAS 17.59 requires that the excess of the sales proceeds over the carrying amount
should not be immediately recognised as income by Entity Y, but should be deferred

and amortised over the lease term.
Question
How should the deferred credit be presented in Entity Y's statement of financial
position?
Answer
In practice, the most straightforward treatment is to continue to recognise the asset
at its previous carrying amount and to account for the asset as if the sale and
leaseback transaction had not occurred (sometimes referred to as a 'net'
presentation). The proceeds from the 'sale' transaction are credited to a liability
account representing the initial net obligation under the finance lease.
This presentation reflects the fact that the sale and leaseback transaction has not
resulted in a significant change to the seller's interest in the risks and rewards
incidental to ownership. Consequently, there is unlikely to be any change to the
asset's useful life or residual value so far as the seller is concerned.
If the net presentation were adopted in the circumstances described, the carrying
amount of the asset would be unchanged and the following entry would be recorded
to recognise the proceeds received.
In subsequent accounting periods, an annual depreciation expense of CU0.4 million

[(CU4 million – CU2 million)/5] would be recognised.
Alternatively, Entity Y could adopt a 'gross' presentation, under which the 'sale' of
the asset is recognised; the deferred credit is accounted for in the same way as any
other form of deferred income in that it is an income amount for which cash has
been received in advance but that cannot be recognised immediately. The
consequence is that the asset is recognised at its fair value at the date of the sale
and leaseback transaction, and this new carrying amount is the basis for subsequent
depreciation.
If the gross presentation were adopted in the circumstances described, the following
entries would be recorded.

In subsequent accounting periods, an annual depreciation expense of CU1.2 million
[(CU8 million – CU2 million)/5] would be recognised; the annual amortisation of the
deferred gain would be CU0.8 million [CU4 million/5], resulting in a net impact on
profit or loss of CU0.4 million.

Reserved
Q&A IAS 18: 7-2 — RECOGNITION OF INCOME WHEN WARRANTS

LAPSE
Question
Does an increase in equity always represent a gross inflow of economic benefits
requiring revenue recognition? For example, an entity has issued warrants (options
issued on the entity's own shares). These warrants were originally issued for cash,
with a credit to equity. The warrants lapse unexercised.
Answer
No. As a general matter, income does not include increases to equity relating to
contributions from equity participants. The fact that an equity participant no longer
has an equity claim on the assets of the entity does not convert the equity
contribution into income.
Q&A IAS 18: 7-3 — DERIVATIVES PRESENTATION IN THE INCOME

STATEMENT
[Added 11 May 2007]
Background
Entity A, a pound sterling functional currency company, has highly probable forecast
revenue streams in U.S. dollars. Entity A enters into derivative contracts (forward
contracts) to hedge the foreign currency cash flow exposure associated with the
highly probable future U.S. dollar revenue. Assume that the terms of the forward
contracts are aligned with the terms (amount and timing) of the highly probable
forecast U.S. dollar revenue; i.e. that the forward contracts provide a good economic
hedge of the forecast U.S. dollar revenue. Further assume two possible scenarios:
a. The forward contracts are not designated in qualifying hedge relationships

under IAS 39 Financial Instruments: Recognition and Measurement; thus,
all fair value movements on the derivatives are recognised in profit or loss
in accordance with IAS 39.9.
b. The derivatives are designated in qualifying cash flow hedge relationships;

however, the relationships give rise to some hedge ineffectiveness that, in
accordance with IAS 39.95(b), is reported in profit or loss.
Question
In either scenario, can the gains or losses on the derivatives (either total gains or
losses in scenario A or ineffectiveness in scenario B) be presented within the revenue
line?
Answer
Yes. IAS 39 requires that in both scenarios, gains or losses on the derivatives (all
gains or losses in scenario A and the ineffective portion of such gains or losses in
scenario B) are reported in profit or loss. However, the standard does not specify
where these amounts should be presented within profit or loss and would not
preclude presenting them within the revenue line elsewhere in operating profit or in
finance cost.
To the extent that any derivative gains or losses are included in the revenue line
(under either scenario A or B), together with other economic benefits that satisfy the
definition of revenue (such as amounts recognised for sale of goods), the derivative
gains or losses should be disclosed separately to satisfy the IAS 18.35(b)
requirement to disclose separately an amount for "each significant category of
revenue".
If the entity chooses to present derivative gains or losses in scenario A or B within

the revenue line, the same presentation should be applied to all similar items
consistently from period to period.
Q&A IAS 18: 8-1 — MEASURING REVENUE "GROSS" OR "NET"

[Amended and Reissued 20 April 2007]
Question
IAS 18.8 states that in an agency relationship, "gross" amounts collected by the
agent on behalf of the principal are not benefits that flow to the agent and,
therefore, are not revenue. The agent's revenue is the "net" amount of the
commission. However, IAS 18.8 does not provide guidance or indicators of when a
seller is an agent or a principal. What are appropriate indicators?
Answer
Determining whether a seller is an agent or principal requires judgement and will
depend on the particular facts and circumstances of each arrangement.
Examples indicating, individually or in combination, that the seller may be acting as

a principal, and that therefore gross revenue reporting is appropriate, include
situations in which the seller:
• Is the primary obligor in the arrangement. (This is often a strong

indicator.)
• Has general inventory risk (before the customer order is placed or on

customer return).
• Has latitude in establishing price.

• Changes the product or performs part of the service.
• Has discretion in supplier selection.
• Is involved in determining product or service specifications.
• Has physical loss inventory risk (after the customer order or during
shipping).
• Has credit risk.
• Is responsible for warranty or quality risk on the product(s) sold or

service(s) rendered.
Examples indicating individually or in combination that the seller may be acting as an

agent, and that therefore net revenue reporting is appropriate, include situations in
which:
• The supplier (and not the seller) is the primary obligor in the arrangement.
(This is often a strong indicator.)
• The seller earns a fixed or determinable amount.
• The supplier (and not the seller) has credit risk.
The lists above are not comprehensive. Circumstances may require that some factors
be weighted more heavily than others, and conclusions should not be based solely on
the number of factors present.
Note that while IFRS may not contain any guidance on the matter, other references
are available and may be consulted as long as the factors taken into account are
applied consistently and do not conflict with IFRS.
Q&A IAS 18: 8-2 — INCOME TAX WITHHELD IN A DIFFERENT

COUNTRY
Background
Company X performs consulting services for Company C, which is in a different

country from Company X. According to local law in Company C's country, Company C
withholds 20 per cent of Company X's fee as local income tax withholding and
transmits this amount to the local government on behalf of Company X. Company C
pays the remaining 80 per cent balance to Company X. The countries do not have a
tax treaty and Company X is not required to file a tax return in Company C's
country. However, Company X may at its option file a tax return in Company C's

country to recover taxes withheld in excess of its share of income. Company X was
fully aware that the 20 per cent income tax would be withheld in Company C's
country when it agreed to perform the consulting services for Company C.
Question
If Company X's fee was €100 and Company C remitted €80 to Company X and €20
to the local government, does Company X have revenue of €100 and tax expense of
€20 or net revenue of €80?
Answer
Revenue of €100 and income tax expense of €20. Under Company C's local law,
Company X is the primary obligor in the arrangement; however, the amount is paid
by Company C on behalf of Company X. Additionally, Company X has the latitude to
set the price from which the tax will be determined. Therefore, based on the criteria
noted in Q&A IAS 18: 8-1, Company X is not considered an agent.
Q&A IAS 18: 8-3 — VALUE ADDED TAX (VAT) REBATE

Background
In Country C, software developers must pay a 17 per cent VAT (this rate is
consistent with VAT on other similar items) to the government when software is sold
to distributors or end users, but 14 per cent is rebated by the government to the
developer almost immediately, resulting in an effective three per cent VAT rate. This
is well known by both the developer and the buyer, who factor it into the selling
price. Even though the seller effectively pays three per cent, the buyer gets credit for
17 per cent if the software is resold.
Assume software is sold for $103 inclusive of VAT. This was negotiated based on
selling price of $100 plus effective VAT of $3.
Question
How much revenue should the seller recognise?
Answer
IAS 20.3 Accounting for Government Grants and Disclosure of Government
Assistance, defines a government grant as "assistance by government in the form of
transfers of resources to an entity in return for past or future compliance with certain
conditions relating to the operating activities of the entity". The 14 per cent VAT
rebate is regarded as a government grant to encourage the software development
industry. Therefore, the seller will record revenue of $88 ($103 ÷ 1.17) and
government grant income of $12 [($103 – $88) × (14 ÷ 17)]. In accordance with
IAS 20.29, government grants related to income shall be presented outside of
revenue. The $3 is excluded from revenue under IAS 18.8.
Q&As IAS 18: 8-4 and 8-5 — SEVERANCE TAXES

IAS 18: 8-4
Question
What if the government levies tax only on products sold and such amounts are
reinvoiced to the purchaser?
Answer
In this case, the amount should be regarded as a sales tax that is excluded from
revenue under IAS 18.8. In effect, the company is acting as a collection agent for
the government. (See Q&A IAS 18: 8-1.)
Revenue from the extraction of mineral ores is excluded from the scope of IAS 18.
However, the severance tax issue is not excluded.
IAS 18: 8-5
Deleted

Reserved
Q&A IAS 18: 8-7 — ROYALTY PAYMENTS

Question
A company is required by contract to pay a royalty to the government or owner of
certain intangible assets. The royalty is specified as a percentage of gross proceeds
from sales less costs applicable to the royalty owner's share of production. The
company may pay the royalty in cash or in kind. Should the royalty be netted
against the operating company's revenue or recognised as an operating expense?
Answer
The company should record its revenue on a gross basis. The company that is the
primary obligor pays the royalty (in the case of cash payments) out of proceeds from
sales and has the ability to set the price from which the royalty is determined.
These royalty payments, however, must be differentiated from a distribution to

shareholders in the form of a royalty.
Q&A IAS 18: 10-1 — CASH DISCOUNTS

Question
A seller offers a cash discount for immediate or prompt payment (i.e. payment
earlier than required by the normal credit terms). A sale is made for €100 with the
balance due within 60 days. If the customer pays within 10 days, the customer will
receive a two per cent discount on the total invoice. How should the seller account
for this early payment term?
Answer
IAS 18.10 states that the amount of revenue arising on a transaction is the amount
agreed to by the buyer or seller. If the agreement between buyer and seller calls for
payment within a relatively short period such as 90 days, and the environment is not
hyperinflationary, a cash discount for prompt payment is not intended as a financing
transaction. It is simply a way of identifying the amount agreed to by the buyer and
seller. It also can be viewed as a mechanism to enhance collectibility of the agreed
amount. Therefore, the seller should recognise revenue net of the amount of cash
discount given. In the example above, revenue would be €100 if the discount is not
taken or €98 if the discount is taken.
This answer is consistent with the guidance in IAS 2.11 Inventories, which states
that trade discounts, rebates, and other similar items are deducted in determining
the costs of purchase.
Q&As IAS 18: 10-2 and 10-3 — SALES INCENTIVES — GROSS OR NET
Background
A vendor who sells its products and services through a retailer gives the retailer a
cash incentive payment when a related service is sold to end customers in
combination with the main product. For example, a retailer sells a warranty along
with the vendor's product. The vendor's tariff schedules an additional CU 10 to be
received on this package. The retailer may or may not be required to follow the
vendor's pricing policy. This warranty is serviced by the vendor, and therefore the
retailer's cost is zero. The retailer then remits CU 8 (regardless of the actual price
received from the end customer) to the vendor (or CU 10 with a subsequent
payment from the vendor to the retailer of CU 2).
IAS 18: 10-2
Question
Should the vendor account for the incentive payment of CU 2 as a reduction of
revenue or as a promotion expense?
Answer
The answer will depend on whether the retailer (intermediary) is acting as a principal
or as an agent (see Q&A IAS 18: 8-1).
If the retailer is acting as an agent, the incentive payment to the retailer of CU 2 is

similar in substance to a commission and, therefore, should be treated as an
expense by the vendor under IAS 18.8.
If, however, the retailer is acting as a principal, the incentive payment should be
treated as a volume rebate and, accordingly, as a reduction in revenue under IAS
18.10.

IAS 18: 10-3
[Deleted 26 January 2007]
Deleted

Reserved

Reserved
Q&A IAS 18: 12-2 — TRANSPORT SALES OF OIL

Background
Company A owns and operates a pipeline to transport crude oil. Company A does not
produce or distribute crude oil, but merely provides for use of its pipeline to the
buyer and the seller in a contract for a use fee. The seller and buyer will
independently determine the sales price, and either the buyer or seller will pay a fee
to Company A to transport the oil purchased/sold in its pipeline.
The pipeline needs to be full of product at all times to be operational. Therefore,

during initial construction of the pipeline, Company A purchases oil to fill the
pipeline. Company A charges a fixed fee for its transportation services and literally
swaps crude oil at one entry point for crude oil at another exit point. Company A
bears the risk of loss due to theft or line loss in excess of maximums allowed under
the contract. This loss is rare and normally arises in a pipeline spill that is covered by

insurance.
Question
How should Company A record revenue, gross of the oil sold or net equal to the fee
received?
Answer
While the entity initially purchases product for the pipeline, it effectively exchanges,
that product with equivalent product from customers when the crude oil is pushed in,
and then pushed out, of the pipeline. Therefore, this transaction is regarded as an
exchange of similar assets, and only the fee charged for use of the pipeline should be
recorded as revenue.
Q&A IAS 18: 12-3 — TRANSFER OF INVENTORY FOR AN ENTITY'S OWN

ORDINARY SHARES
Background
Company A has produced inventory at a cost of £80 that is sold to unrelated third
parties at a price of £100. Company A enters into a transaction to buy £100 of its
ordinary shares from a minority interest holder in return for £100 of its inventory
(priced at the retail rate).
Question
How should Company A account for this transaction?
Answer
Company A should record revenue for the sale of its inventory for £100 and treasury
shares for £100. The form of consideration should not have an impact on whether
revenue should be recorded. Company A would then record cost of sales and reduce
inventory by £80.
Q&A IAS 18: 13-1 — SALES ARRANGEMENTS IN WHICH THE SELLER

HAS PARTIALLY PERFORMED ITS OBLIGATIONS

Question
Does failure to deliver one item or to perform one service specified by a sales
arrangement preclude the immediate recognition of any revenue for that sales
arrangement?
Answer
No. IAS 18.13 notes that the revenue recognition criteria should be applied to the
separately identifiable components of a single transaction. If all other recognition
criteria are met, revenue may be recognised for a sales arrangement,
notwithstanding the seller's remaining obligation for additional performance or
delivery, in the following circumstances:
a. Revenue from the sales arrangement may be recognised in full if the

seller's remaining obligation is inconsequential or perfunctory. In this case,
costs expected to be incurred to fulfil the remaining obligation must be
reliably estimable and accrued when the revenue is recognised. A
remaining performance obligation is not inconsequential or perfunctory if:
• It is essential to the functionality of the delivered products or services

(for example, installation and/or training).
• Failure to complete the activities would result in the customer's

receiving a full or partial refund or the right to reject the products
delivered or services performed to date
Additionally, a remaining performance obligation may not be

inconsequential or perfunctory if:
• The seller does not have a demonstrated history of completing the

remaining tasks in a timely manner and reliably estimating their costs.
• The cost or time to perform the remaining obligations for similar

contracts historically has varied significantly from one instance to
another.
• The skills or equipment required to complete the remaining activity are

specialised or are not readily available in the marketplace.
• The cost of completing the obligation, or the fair value of the

obligation, is more than insignificant in relation to such items as the
total contract fee, gross profit, and operating income.
• The period before the remaining obligation will be extinguished is

lengthy.
• The timing of payment of a portion of the sales price is coincident with

completing performance of the remaining activity.
b. A portion of the revenue under the sales arrangement is recognised when

the seller has substantially fulfilled the terms of a separately identifiable
component of the arrangement.

Deleted

Reserved
Q&A IAS 18: 13-4 — UP-FRONT FEES

Question
In general, when can up-front fees be recognised as revenue?
Answer
Unless the up-front fee is in exchange for products delivered or services performed,
and therefore, substantial risks and rewards have been transferred to the buyer in a
separate transaction as described in IAS 18.13, the fee is not recognised as revenue
up front but rather as unearned revenue (even if it is non-refundable). An up-front
fee would not be regarded as relating to a separate transaction if, for example:
• The up-front fee is negotiated in conjunction with the pricing of other

elements.
• The customer would ascribe a lower value, or no value, to the up-front

activity in the absence of the performance of the other elements of the
arrangement.
• The vendor often does not sell the initial right or activities separately.

The up-front, non-refundable fees should be recognised as revenue over the life of
the agreement(s) the fee relates to.

Reserved
Q&A IAS 18: 13-6 — REVENUE RECOGNITION — PREPAID MINUTES

CARDS AND OTHER SIMILAR ARRANGEMENTS
Background
Many entities in the telecom industry offer customers 'prepaid minutes' cards under
which customers acquire prepaid cards entitling them to a fixed number of minutes.
The period of redemption may be fixed or may extend indefinitely.
Other entities offer 'rollover minutes' arrangements under which telecom operators
offer customers a fixed amount of minutes per month for a fixed fee. Unused
minutes in a specific month can be carried forward to the next month. The
arrangements either contemplate a maximum number of months over which the
minutes can be rolled forward or that carryforward can be indefinite.
Question
When should revenue related to prepaid minutes cards and rollover minutes be
recognised?
Answer
Under IAS 18.13, where a transaction consists of the delivery of separately
identifiable components, the proceeds of the transaction are allocated to each
component and recognised when the conditions for revenue recognition applicable to
the specific component are satisfied.
However, IAS 18 does not provide guidance on how to achieve this result.
Accordingly, an entity should establish a systematic methodology to allocate the
proceeds from the sale of prepaid minutes cards (or rollover arrangements) and
recognise revenue associated with each minute based on this allocation method. One
such allocation method is described in paragraph 7 of IFRIC 13 Customer Loyalty
Programmes, which states that the “amount of revenue recognised shall be based on
the number of award credits that have been redeemed . . ., relative to the total
number expected to be redeemed”.
Accordingly, following the hierarchy of guidance specified in paragraphs 10–12 of IAS

8 Accounting Policies, Changes in Accounting Estimates and Errors, to the extent
that a reliable estimate can be made of the expected number of minutes to be used,
a method reflecting expected utilisation, such as the one described in IFRIC 13.7, is
considered preferable when determining how to recognise revenue related to prepaid
minutes cards and rollover minutes.
Nonetheless, other methods (e.g. a method under which each minute is valued at
the same amount and only recognised upon use by the customer or on expiry) may
also be acceptable if they reflect the substance of the transaction (e.g. if the number
of minutes expected to be used cannot be reliably estimated).
Note that this conclusion does not apply to arrangements under which the customers
can request a cash settlement for the unused minutes (see Q&A IAS 39: 39-1).
Q&As IAS 18: 14-1 and 14-1.1 — SALE WITH A BUYBACK

AGREEMENT/OPTION
Background
Company A sells and delivers a non-financial product in one period and agrees to buy
it back in the next accounting period at a fixed price. The fixed price is the original
selling price plus an element to compensate the "buyer" for holding costs. Legal title
transfers at delivery, and the buyer is responsible for loss or damage to the product
while it holds the product.
IAS 18: 14-1
Question
Should Company A recognise revenue and cost of goods sold at the time of delivery?
Answer
No. Company A has not transferred to the buyer the significant risks and rewards of
ownership, as required by IAS 18.14(a). IAS 18.13 notes that the revenue
recognition criteria may have to be applied to two or more transactions together
"when they are linked in such a way that the commercial effect cannot be
understood without reference to the series of transactions as a whole". Further,
paragraph 5 of the Appendix suggests that this transaction is in the nature of a
financing arrangement, not one that gives rise to revenue.
IAS 18: 14-1.1
Question
What if Company A has an option (meaning the right but not an obligation) to buy
the goods back at a fixed price for a fixed period of time?
Answer
In this case, Company A has retained an important benefit of ownership, namely the
ability to profit from the difference between the strike price of the option and the fair
value of the goods at the time the option is exercised. The significance of this benefit
is to be determined at the date the transaction is being reviewed for the
determination of whether to recognise revenue. If the benefits retained are
significant, revenue should not be recognised until expiry of the repurchase period.
On the other hand, if A had the right to buy the goods back at market price at the
time of repurchase, and the goods are readily available in the market, then revenue
is recognised at the time of delivery. The determination of whether to recognise
revenue is a matter of judgment.
Q&A IAS 18: 14-2 — REVENUE RECOGNITION: "TRADE LOADING" AND

"CHANNEL STUFFING"
Background
Sometimes manufacturers or dealers try to enhance the apparent volume of their

sales, profits, and/or market share by inducing their wholesale customers to buy
more product than they can promptly resell. The result is accelerated, but not
increased, volume, because the wholesalers' inventories become bloated and their
future orders from the manufacturers are reduced. This practice is known as "trade
loading" or "channel stuffing".
Question
How is revenue recognised in the case of trade loading or channel stuffing?

Answer
Companies may induce wholesale customers to buy more product than they can
promptly resell for reasons other than enhancing the appearance of their financial
figures (e.g. to improve cash flows or to spread production more evenly throughout
the year when sales are seasonal). If the revenue recognition criteria in IAS 18.14
for sales of goods are met, the revenue should be recognised. However, in many
situations, products sold during "channel stuffing" programs are merely held by the
wholesaler to be returned in a future accounting period when it is determined the
products cannot be sold to the end user. Assuming the criteria in IAS 18.14 are met,
revenue is recorded net of the expected returns. Therefore, management must
estimate the amount of product to be returned. Historical return rates may not
capture appropriately the high level of returns usually related to "channel stuffing"
programs.
Q&As IAS 18: 14-3, 14-4 [DELETED], and 14-5 — INSTALMENT SALES
ACCOUNTING METHOD
Background
In some cases, because of the nature of the industry in which an entity operates,
goods are sold and delivered even though collection of the sales price is not
reasonably assured. Often in those cases, payment is required in periodic
instalments over an extended period of time. The seller generally will retain a lien on
the product sold until payment is completed. Paragraph 8 of the Appendix
(instalment sales, under which the consideration is receivable in instalments)
suggests that revenue is recognised at the time of delivery based on the discounted
presented value of the instalment payments.
IAS 18: 14-3
Question
For instalment sales, is the method of accounting described in paragraph 8 of the
Appendix appropriate if the collection of the sales price is not reasonably assured?
Answer
No. A fundamental condition for revenue recognition in IAS 18.14(d) is that it is
probable that the economic benefits associated with the transaction will flow to the
entity. If that is not the case, revenue recognition is deferred. Paragraph 8 of the
Appendix presumes that collectibility is not an issue.

IAS 18: 14-4
Deleted
IAS 18: 14-5
Question
If the instalment sales accounting method is used, how is revenue presented in the
income statement?
Answer
The following is one example of how these sales may be presented:
Q&A IAS 18: 14-6 — TRANSFER OF SIGNIFICANT RISKS AND REWARDS

OF OWNERSHIP OF THE GOODS

Question
A condition for revenue recognition in IAS 18.14(a) is that the seller has transferred
to the buyer "the significant risks and rewards of ownership of the goods". Does
national law affect the timing of such transfer, and therefore, can the timing of
revenue recognition differ between countries?
Answer
Yes. The transfer of the risks and rewards of ownership often coincides with the
transfer of legal title, which can differ from country to country. That does not mean
that different revenue recognition criteria are applied in different countries, but,
rather, the recognition criteria are met at different times in different countries. The
principle is that the significant risks and rewards of ownership have passed from the
seller to the buyer.
Examples of legal provisions that can affect the transfer of risks and rewards, and
therefore, the timing of revenue recognition, include:
• In some jurisdictions, title does not legally transfer until the buyer obtains
physical possession of the goods.
• A "cooling off" period in real estate sales (often residential real estate
sales), during which the buyer has an absolute legal right to rescind the
transaction is required in certain markets.
Q&A IAS 18: 14-7 — GOODS SHIPPED FOB SHIPPING POINT BUT
SELLER ARRANGES SHIPPING
Background
When goods are shipped "free on board" (FOB) shipping point, title passes to the
buyer when the goods are shipped, and the buyer is responsible for any loss in
transit. On the other hand, when goods are shipped FOB destination, title does not
pass to the buyer until delivery, and the seller is responsible for any loss in transit.
Company A sells goods FOB shipping point, and it is clear that title transfers to the
buyer at the time of shipment. Company A's business practice is to arrange for
shipping the goods to the buyer and to deal directly with the shipping company.
Company A bills the buyer for the shipping costs separately from the product.
Company A's business practice is also that if there is any damage or physical loss
during transit, Company A provides the buyer with replacement products at no
additional cost. If the loss or damage in transit is substantial, Company A's insurance
coverage would cover all or most of the loss.
Question
May Company A recognise revenue once its products have been shipped?
Answer
No. While title has passed, Company A has retained a significant risk of ownership
(i.e. responsibility for damage or loss in transit). The fact that Company A's
insurance would cover a substantial loss is evidence that it has managed its risk, but
Company A has still retained the risk. The criterion for recognising revenue set out in
IAS 18.14(a) has not been met.
Q&A IAS 18: 14-8 — GOODS SHIPPED FOB DESTINATION BUT

SHIPPING COMPANY ASSUMES RISK OF LOSS
Question
Company A sells goods "free on board" (FOB) destination, which means that title
does not pass to the buyer until delivery, and Company A is responsible for any loss
in transit. To protect itself from loss, Company A contracts with the shipping
company for the shipping company to assume total risk of loss while the goods are in
transit. May Company A recognise revenue when the goods are shipped?
Answer
No. While Company A has managed its risk, it has not transferred risk to the buyer.
Therefore, the criterion in IAS 18.14(a) has not been met until the goods have been
delivered.
Q&A IAS 18: 14-9 — SELLER ARRANGES FOR MANUFACTURER TO SHIP

DIRECTLY TO BUYER ("DROP SHIPMENT")
Question
When should revenue be recognised if the seller is a distributor who arranges to
have the manufacturer ship the products directly to the buyer (herein referred to as
a "drop shipment")?
Answer
The seller should recognise revenue as if it had shipped the product(s) itself.
Therefore, if those terms specify FOB shipping point (see Q&A IAS 18: 14-7), the
distributor recognises revenue when the manufacturer ships the goods. If those
terms specify FOB destination, the distributor recognises revenue when the buyer
receives the goods.
A distributor who arranges for direct shipping of products from a manufacturer to a

buyer must also consider whether it should report revenue on a gross or net basis.
This determination will depend on whether the distributor is acting as a principal or
an agent (see Deloitte Touche Tohmatsu guidance under IAS 18.8).
Q&A IAS 18: 14-10 — AGREEMENT DOES NOT SPECIFY SHIPPING

TERMS
Question
When should revenue be recognised if the sales agreement does not specify shipping
terms?
Answer
This is essentially a legal question as to what the seller's and buyer's rights are in
the circumstances. IAS 18.14 requires that the seller has transferred the significant
risks and rewards of ownership of the goods to the buyer (and that the other criteria
in IAS 18.14 are met). The judgement as to when ownership and all rewards and
risks of loss have been transferred is a legal determination that should consider the
laws of the jurisdiction in which the sale is made.
Q&A IAS 18: 14-11 — ABSENCE OF A WRITTEN SALES AGREEMENT

WHEN ONE IS NORMALLY OBTAINED

Question
A company's normal practice is to obtain written sales agreements signed by the
buyer. In certain circumstances, product is delivered without a signed agreement.
When should revenue be recognised?
Answer
the circumstances. IAS 18 does not require a written sales agreement as a condition
for revenue recognition. What is required is that the seller has transferred the
significant risks and rewards of ownership of the goods to the buyer (and the other
criteria in IAS 18.14 are met). This means that both the buyer and the seller should
have a clear understanding of all terms of the transaction, including pricing, payment
terms, return rights, shipping, installation, and warranty rights. The revenue
recognition criteria in IAS 18 should be evaluated based on the mutually understood
terms of the transaction. It may be useful to obtain the advice of legal counsel
regarding the rights and obligations of the parties.
Q&A IAS 18: 14-12 — WRITTEN SALES AGREEMENT HAS EXPIRED BUT
SHIPMENTS CONTINUE
Question
A company's normal practice is to obtain written sales agreements signed by the
buyer. The agreement has a fixed termination date and no provision for automatic
extension. The seller has continued to ship product to a customer after the written
agreement expires. Should revenue be recognised?
Answer
significant risks and rewards of ownership of the goods to the buyer (and the other
criteria in IAS 18.14 are met). This means that both the buyer and the seller should
have a clear understanding of all terms of the transaction, including pricing, payment
terms, return rights, shipping, installation, and warranty rights. The expiry of the
agreement may indicate that the "seller" has retained significant risks of ownership,
that the amount of revenue cannot be measured reliably, or that collectibility (flow of
benefits to the seller) is not probable. If any of those is the case, IAS 18.14 would
preclude revenue recognition.

Even if it is determined that revenue should be recognised in this case, a question
arises as to the measurement of the revenue. If the vendor has a history of
providing price or other concessions as an inducement to renewal of a sales
agreement, that must be taken into account in measuring the revenue from the
product shipped after the sales agreement has expired.
Q&A IAS 18: 14-13 — ORAL SALES ARRANGEMENTS

Question
A company's normal practice is to deliver products based on an oral arrangement
(either a telephone call from the customer or walk-in business). When should
revenue be recognised?
Answer
significant risks and rewards of ownership of the goods to the buyer. This means that
both the buyer and the seller should have a clear understanding of all terms of the
transaction, including pricing, payment terms, return rights, shipping, installation,
and warranty rights. Many companies routinely provide goods or services based on
an oral agreement. There is an expectation that the company would have clearly
articulated its policies and terms of sale to its customers through brochures, store
signage, notices on invoices, advertising, and similar written means. The revenue
recognition criteria in IAS 18 should be evaluated based on the mutually understood
terms of the transaction. It may be useful to obtain the advice of legal counsel
regarding the rights and obligations of the parties.
Q&As IAS 18: 14-14 and 14-15 — UNLIMITED RIGHT OF RETURN
Background
Company A distributes VCDs and DVDs. Its key customers are department stores. It
also sells to small shops. The sales agreement with key customers allows these
customers to return any slow-moving stock, but there is no definition of slow-moving
in the agreement. The returns could result in replacement of the returned goods with
other VCDs and DVDs or return of cash. For customers other than the key
customers, the sales agreement limits their returns of slow-moving stock to not
more than 10 per cent of purchases. In both cases, based on experience, Company A
is able to make a reliable estimate of the amount of returns.
IAS 18: 14-14
Question
How should Company A account for its revenues from (a) key customers (whose
right to return goods is unlimited) and (b) other customers (whose right of return is
limited)?
Answer
A condition for recognising revenue from the sale of goods in IAS 18.14(a) is that
"the entity has transferred to the buyer the significant risks and rewards of
ownership of the goods". In this case, both classes of customers have assumed all of
the significant rewards of ownership of the goods; they have an unrestricted right to
resell the goods. Furthermore, because a reliable estimate of the amount of returns
can be made for both classes of customers, the extent to which the buyer has
assumed the significant risks also can be measured for both classes of customers.
Therefore, revenue should be recognised on initial delivery of the goods in an
amount that reflects a reduction for the estimated amount to be returned.
IAS 18: 14-15
Question
Would the answer to Q&A IAS 18: 14-14 be different for the key customers if the
effect of their right to return all slow-moving stock cannot be measured?
Answer
Yes. In this case, Company A has retained an immeasurable risk of marketability and
obsolescence. The condition in IAS 18.14(a) is not met, and Company A should
recognise revenue on a consignment basis (i.e. when the key customers resell the
goods to third-party customers).


Deleted
Q&A IAS 18: 14-17 — UNLIMITED RIGHT OF REPLACEMENT OF

PRODUCT
Background
Pharmaceutical Company P manufacturers a drug that it sells directly to a distributor.

The distributor sells the drug to pharmacies that sell the drug to the end user. Drugs
sold have an expiration date. Company P allows returns of all drugs not sold to the
end user after they have expired in return for a new batch of the same drug. This is
done for customer service and safety reasons.
Question
How does the right of return affect the revenue recognition policies of Company P?
Answer
As noted in Q&A IAS 18: 14-18, before revenue can be recognised, it must be
measurable at the fair value of the consideration received or receivable. This requires
that the amount of returns from the pharmacies can be measured reliably. If returns
can be measured reliably, Company P recognises revenue on initial delivery of the
goods to the distributors in an amount that reflects a reduction for the estimated
returns.
Q&A IAS 18: 14-18 — BILL AND HOLD SALES

Background
Company A manufactures its product only after receiving non-cancellable purchase

orders. At the end of the financial reporting period, customers from whom
non-cancellable purchase orders have been received may not yet be ready to take
delivery of the products for various reasons, such as lack of storage space, having a
sufficient supply of the products in their distribution channel, or delays in customers'
production schedules. Accordingly, at the customers' request, Company A arranges
to store the products either segregated in its own warehouse or in a third-party
warehouse. Company A retains title to the product, and payment by the customer
depends on delivery to a customer-specified site.

Question
Is it appropriate for Company A to recognise revenue when the goods are
manufactured and stored, or should it wait until delivery to the customer's specified
site?
Answer
Since Company A retains title and the customer is not obligated to pay until the
goods are delivered to the customer's site, the significant risks of ownership have
not been transferred to the customer, even though the order is non-cancellable.
Paragraph 1 of the Appendix describes a bill-and-hold sale in which revenue would
be recognised on completion of manufacture if shipping is delayed at the buyer's
request. But the facts in that example are that the buyer has taken title and accepts
billing. Neither of those things has happened in the case of Company A.
Even if the buyer takes title in a bill-and-hold transaction, paragraph 1 of the

Appendix identifies the following additional revenue recognition criteria:
a. It is probable that delivery will be made.
b. The item is on hand, identified, and ready for delivery to the buyer at the
time the sale is recognised.
c. The buyer specifically acknowledges the deferred delivery instructions.
d. The usual payment terms apply.
In addition, of course, the amount must be due and billable at the point a sale is
recorded.
Consistent with criterion (a) above, revenue recognition at completion of

manufacture would not be appropriate if there is no fixed delivery schedule or if the
delivery schedule is significantly longer than those customary in the industry.
Consistent with criterion (c) above, revenue recognition at completion of

manufacture would not be appropriate if the seller, rather than the buyer, has
requested that the transaction be on a bill-and-hold basis. Also, the buyer must have
a substantial business purpose for ordering the goods on a bill-and-hold basis.
Q&A IAS 18: 14-19 — SALE OF PRODUCTS WITH A TIME RESTRICTION

ON RESALE OR USE

Background
Company A, a manufacturer of designer clothing, ships clothing for the "spring

season" to customers in December 20X0. While the customers (clothing retailers)
take title to the goods when they receive them, the terms of the sales prohibit the
customers from displaying or selling the clothing until 15 February 20X1. The terms
of the arrangement are such that payment generally is not due until the restriction is
lifted.
Question
When is revenue recognised — when the goods are delivered (20X0) or when the
restriction on resale expires (20X1)?
Answer
The limitation on when the product can be sold would not, in and of itself, preclude
revenue recognition. However, IAS 18.14(a) prohibits revenue recognition, when
goods are sold, until the seller has transferred to the buyer the significant risks and
rewards of ownership of the goods. In the above situation, the timing is short
compared to the life cycle of the inventory and the timing of the restriction does not
affect the value of the inventory to be sold. However, if the timing was longer (e.g.
until the summer season) a review of whether the significant rewards of ownership
has been transferred should be performed.

Reserved
Q&As IAS 18: 14-21 and 14-22 — PRE-COMPLETION CONTRACTS BY

PROPERTY DEVELOPERS
Background
A property development company is the legal owner of various plots of land; it has
obtained all the necessary planning permits and is marketing residential properties
for sale. Construction is either carried out by the Company or by sub-contractors
employed by the Company.
The construction of some of the properties is started before a buyer is identified.

Part-way through construction, when the buyer is identified, the development
company enters into a binding agreement with the buyer. In this case, the buyer has
very little flexibility regarding the design of the property.
For other properties, construction only commences after a buyer has been identified
and the developer has entered into a binding agreement with the buyer; in this case,
the property may be built to include specifications requested by the buyer. The sales
contract refers to the sale of property, for example, "a villa built on plot no. XX with
the specifications shown in appendix YY attached".
In either of the scenarios described above, a deposit is paid when the sales contract
is signed, and further payments are made before completion of the construction. In
most cases, the full sales consideration is paid to the developer by the time the
property is completed and delivered to the buyer. Payments may be linked to stage
of completion.
In the event that the buyer cancels or defaults on the contract, the developer is
entitled to sell the property and settle any pending liabilities. If the amount realised
is not adequate, the buyer is liable to discharge the remaining liability.
Legal title to the property is transferred to the name of the buyer after delivery of
the property and when the sales consideration is fully paid.
IAS 18: 14-21
Question
How should property developers recognise revenue arising from the pre-completion
contracts described above — under IAS 11 Construction Contracts, or IAS 18, as sale
of goods?
Answer
IAS 11.3 defines a construction contract as a contract specifically negotiated for the
construction of an asset. The standard does not provide any further guidance about
the meaning of "specifically negotiated". Where a contract does not meet this
definition, it will be accounted for under IAS 18.
In the first scenario outlined above (i.e. where the contracts relate to a building
already under construction prior to the identification of a buyer), the purchase will
not have been specifically negotiated for the construction of the property. Therefore,
such contracts clearly fall out of the scope of IAS 11.
Judgement might be required for conclusion in the situations when contracts are
signed before the construction commences and allow specifications by the buyer. If
the developer is building a property totally to the buyer's design, it would appear to
be a construction contract; in this case, it might be expected that the title to the
land would pass prior to construction. However, if the buyer has merely selected a
design proposed by the developer, but the developers would still have proceeded
with construction on that plot without this specific contract, the transaction would
not meet the definition of a construction contract. This is so even if the buyer is able
to specify some features of the construction — these generally will not result in the
generation of a construction contract as contemplated in IAS 11.
In the second scenario outlined above (i.e. where the contract is signed before
construction commences), it appears on the facts presented that the customer is
requesting certain specifications permitted by the developer rather than specifically
negotiating a contract for construction. Hence, IAS 18 is the appropriate Standard to
apply.
IAS 18: 14-22
Question
If IAS 18 applies, when is the sale recognised?
Answer
Paragraph 9 of the Appendix to IAS 18 addresses revenue recognition principles for
real estate sales. It states that for real estate sales, revenue normally is recognised
when legal title passes to the buyer.
A condition for revenue recognition in IAS 18.14(a) is that the seller has transferred
to the buyer "the significant risks and rewards of ownership of the goods". The
transfer of the risks and rewards of ownership frequently coincides with the transfer
of a legal title, which can differ from country to country. However, that does not
mean that different revenue recognition criteria are applied in different countries,
but, rather, the recognition criteria are met at different times in different countries.
The principle is that the significant risks and rewards of ownership have passed from
the seller to the buyer.
In the situation described, where the legal title is transferred after the final payment
by the buyer, the risks and rewards of ownership of the properties appear to be
transferred together with the legal title for the property, because up until that point
the risks and rewards of ownership, including the residual value risks and rewards,
are retained by the property developer.
All relevant facts and circumstances need to be assessed using the guidance in IAS
18.14–19. Additional information may lead to a different conclusion about the timing
of the revenue recognition for the sale of properties.
Q&A IAS 18: 14-23 — REVENUE RECOGNITION IN THE

PHARMACEUTICAL INDUSTRY
Background
The Pharmaceutical Price Regulation Scheme (PPRS) in Country A is a joint initiative

between the pharmaceutical industry and the Department of Health (DH). The PPRS
applies to all entities supplying branded, licensed medicines to the Public Health
Service (PHS). The objectives of the PPRS are to ensure that the PHS buys medicines
at reasonable prices while allowing pharmaceutical entities to earn a reasonable
profit so that they are able to continue to invest in research and development
activities.
PPRS operates by limiting the profits an entity can make from the supply of
medicines to the PHS.
The entity's return on capital employed is calculated based on the annual financial
return. All excess profits earned over the prescribed limits for the current period
should be refunded to the DH.
Question
Should payments made by pharmaceutical companies to the DH be treated as an
expense or as a deduction from revenue?
Answer
In this scenario, the pharmaceutical companies are effectively operating in a
regulated market in which the prices they can charge are governed by an agreement
with the DH. When the companies are required to pay a refund to the DH because
their profits have exceeded the allowed profits for the period, this is a reduction of
the revenue already recognised and should be accounted for as such.
However, note that the accounting for government schemes to regulate the prices of
pharmaceutical products should be based on the particular facts and circumstances
of the government scheme under which the entity operates. Different types of
regulations may exist in different jurisdictions, some being in the nature of rebates
or limits on profits, whereas others may be in the nature of an expense.

Q&A IAS 18: 14-24 — SALE AND REPURCHASE OF NON-FINANCIAL
ASSETS — OPERATING LEASE
Background
Company A, a manufacturer of construction equipment, sells and delivers a crane (a

non-financial asset) to a customer. Under the terms of the sale agreement, the
customer will be required to sell the asset back to Company A at a specified future
date (14 months later) at a fixed price (approximately 85 per cent of the initial sale
price).
The legal title to the crane transfers to the customer at delivery, but Company A is
still responsible for maintenance costs while the crane is held by the customer.
Question
How should this arrangement be accounted for by Company A?
Answer
IAS 18.13 states that a sale and repurchase agreement should be treated as a single
transaction when the terms are linked in such a way that the commercial effect
cannot be understood without considering the series of transactions as a whole.
An assessment is required to determine whether, taking into account the terms of

repurchase, the seller has transferred the significant risks and rewards of ownership
to the customer at the date of the initial sale. Depending on the facts and
circumstances, an entity may account for the transaction as an outright sale, a lease,
or another type of financing arrangement.
In the circumstances described, the assessment of the sale and repurchase in

combination leads to a conclusion that the substance of the series of transactions is
an operating lease in accordance with IAS 17 Leases; the customer has a right to
use the crane for 14 months. In addition, in this particular case (because of the
relative size of the repurchase price compared to original sale price) the substance is
that there is also a financing agreement in accordance with IAS 39 Financial
Instruments: Recognition and Measurement for an amount equal to the present
value of the fixed repurchase price, with a 14-month term.
Company A retains the risks and rewards attached to the ownership of the crane. As
a consequence, Company A should neither recognise a sale nor derecognise the
asset, but should instead recognise the cash received from the customer, together
with a liability for the repurchase price.
The difference between the initial sale price and the present value of the obligation
to repurchase the crane represents the operating lease revenue and it should be
recognised on a straight-line basis over the lease term of 14 months.
The financial liability for the repurchase price is within the scope of IAS 39. Interest
expense on this liability should be calculated using the effective interest method.
Consequently, interest expense will be charged at a constant rate on the carrying
amount of the liability over the time between the original sale and the future
repurchase date.
Refer also to Q&A 18: 14-1.
Q&A IAS 18: 15-1 — RETENTION OF TITLE

Question
IAS 18.15 states, in part:
...in most cases, the transfer of the risks and rewards of ownership
coincides with the transfer of the legal title or the passing of possession to
the buyer. This is the case for most retail sales.
In some countries, it is common for the seller to retain a form of title to goods
delivered to customers until the customer makes payment, so that the seller can
recover the goods in the event of customer default on payment (often described as a
"Retention of Title Clause"). Can the seller recognise revenue when the goods are
delivered in these circumstances?
Answer
The revenue recognition principle (IAS 18.14(a)) is that the risks and rewards of
ownership of the goods are transferred to the buyer. Transfer of title may be an
indicator that the risks and rewards of ownership have passed to the buyer, but it is
not a required condition. Presuming all other revenue recognition criteria have been
met, revenue can be recognised if the only rights that a seller retains with the title
are those enabling recovery of the goods in the event of customer default on
payment. IAS 18.17 elaborates that if a seller retains legal title "solely to protect the
collectibility of the amount due", revenue recognition is not precluded.

Q&A IAS 18: 16-1 — CUSTOMER ACCEPTANCE PROVISION
Question
If a sales contract gives the customer the unilateral right, for a certain period of time
after delivery, to accept or reject the goods, should revenue be recognised (a) when
the goods are shipped with a provision for estimated returns, or (b) after customer
acceptance?
Answer
It depends on the probability of customer acceptance. If the entity is uncertain about
the probability of acceptance, revenue recognition should not occur until the earlier
of customer acceptance and expiry of the acceptance period. A condition for revenue
recognition in IAS 18.14(a) is that the seller has transferred to the buyer "the
significant risks and rewards of ownership of the goods". If the probability of
customer acceptance is uncertain, those risks must be regarded as remaining with
the seller. Nor does the customer have an obligation to pay until acceptance or
expiry of the acceptance period.
Q&A IAS 18: 16-EX-1 — CUSTOMER ACCEPTANCE PROVISION

Example
Manufacturer A produces a ball bearing for use in the manufacture of automobiles.
The buyer of the ball bearing requires defects to be less than 1.0 parts per million
(ppm). These ball bearings are tested prior to shipment through sample analysis to
ensure their quality meets the requirements of the buyer. After the sample testing is
completed, it is determined that the error rate is 0.8 ppm. Therefore, on delivery,
Manufacturer A can be reasonably assured that the goods meet the specifications of
the buyer and can record revenue. If testing was not completed or showed a
probability of customer rejection, revenue would not be recognised until customer
acceptance is received.
Q&A IAS 18: 16-2 — VENDOR INSTALLATION — CUSTOMER

ACCEPTANCE
Background
Company A (A) sells a machine and is required to install it on the customer's

premises. The sales contract requires the customer to officially inspect and accept or
reject the installation. Based on A's experience, the probability of customer
acceptance of the equipment after installation is completed is very high.
Question
Should revenue be recognised (1) when the machine is delivered (if necessary, with
a provision for estimated additional installation costs) or (2) after customer
acceptance?
Answer
It depends on whether the transaction includes two separately identifiable
components of revenue: (1) delivery of the machine and (2) its installation. If the
installation cannot be unbundled, i.e., the installation cannot be accounted for
separately from the sale of the machine, then revenue should be recognised on
delivery of the machine only if, among other criteria:
• It is probable that the customer will accept the machine (if relevant — see
Q&A IAS 18: 16-1).
• The installation process is simple in nature, for example the installation of

a factory tested television receiver which only requires unpacking and
connection of power and antennae (see paragraph 2(a)(i) of the IAS 18
Appendix).
Q&A IAS 18: 16-3 — VENDOR INSTALLATION — SETTLEMENT TERMS

Question
A sales contract requires payment of 90 per cent on completion of the delivery and
installation of a machine, and the remaining 10 per cent at the earlier of customer
acceptance or 90 days. Assume installation is not separately accounted for. How
should revenue be recognised?

Answer
Since installation is not a component of revenue to be accounted for separately, 100
per cent of the revenue should be recognised when the significant risks and rewards
of ownership of the machine have been transferred to the buyer. (See Q&A IAS 18:
16-2 to determine whether this will be on delivery with an appropriate accrual for
any estimated additional installation costs to be incurred, or on completion of
installation.) The recognition of revenue is not affected by the settlement terms
unless there is uncertainty regarding the flow of the economic benefits related to the
transaction to the entity.

Reserved

Deleted
Q&A IAS 18: 17-1 — LAY AWAY SALES — CUSTOMER FORFEITS A

DEPOSIT
Question
If a customer forfeits its deposit under a lay away program, is the deposit recognised
as revenue?
Answer
There are two issues here. The first is what are the seller's rights under the law. If
such forfeited deposits do not remain the property of the seller but rather must be
remitted to the government under "escheat laws", then no revenue is recognised.
Normally, for lay away sales under paragraph 3 of the Appendix, the deposit is
recorded as a liability, not revenue. However, sometimes the seller may already have
recognised revenue when a "significant deposit is received". If that is the case, and
the deposit is forfeited and the seller is required to remit the deposit to the
government, the seller should establish an allowance for estimated forfeitures at the
time the revenue is recognised.
If, under the law, the seller keeps the deposit, a second issue is how to classify the
deposit in the seller's income statement. The deposit satisfies the definition of
revenue in IAS 18.7 (i.e. gross inflow of economic benefits in the course of the
ordinary activities of the entity). The fact that the seller has retained the deposit
without having delivered any goods is an event that is part of the ordinary course of
business of a lay away seller. If these forfeitures are significant, it may be
appropriate to disclose the amount separately.
Q&A IAS 18: 17-2 — LAY AWAY SALES

Background
Company Z is a retailer of high-cost home electronics equipment. Generally Z sells

much of its product up front. Historically, lay away sales account for approximately
10 per cent of Z's total sales.
Company Z's lay away policy requires that customers put down at least 25 per cent
of the sales price as an up-front, non-refundable deposit. Once a deposit is received,
Z identifies the product to be sold and segregates it in its warehouse. After this
occurs, the customer has one year to make the final payments or else the equipment
will be returned to inventory. No interest is charged to the customer.
Company Z's experience with lay away sales is that most sales are consummated
with an average six-month lay away period before the customer pays the entire sale
amount.
Customer A has decided to purchase on lay away a home theatre system with a
retail cost of $2,000. In November 2001, A puts down $1,200 as an up-front
payment. Company A will take delivery only when the entire retail amount is paid. In
April 2002, A pays the remaining balance of $800 and takes delivery of the home
theatre system.
Question
How should Company Z account for the deposit received?

Answer
In accordance with paragraph 3 of the Appendix, revenue from lay away sales is
recognized when a "significant" deposit is received. The determination of whether a
deposit is considered significant is a matter of careful judgment, based on all of the
relevant facts and circumstances. Factors to consider in making this determination
include, but are not limited to, the following:
• The entity's policy on lay away sales, including the amount of deposit
generally required;
• The nature and amount of the goods sold; and
• The history of lay away sales, including the extent to which sales are
consummated.
In any case, the final conclusion should be supported by sufficient objective

evidence.
In this case, the deposit is significant, and therefore, Company A would recognise
the sale for the home theatre for $2,000 in November 2001, with a receivable for
$800.

Reserved

Reserved


Reserved

Reserved
Q&A IAS 18: 18-5 — OUTSOURCING CONTRACTS — UP-FRONT

PAYMENTS
Question
In signing an outsourcing contract with a client, a service provider may make an
up-front payment to the client.
How should up-front payments made to clients by service providers in the context of
outsourcing contracts be treated?
Answer
The amount of the up-front payment and the price charged for the service provided
are generally part of a global pricing agreement for that service. To the extent that
the up-front payment does not correspond to an identifiable service received by the
service provider from the client, or to the reimbursement by the service provider of
costs necessary for the contract incurred by the client, the amount of the up-front
payment should be accounted for as a reduction of revenue.
As a result, the up-front payment would be accounted for as an asset (rebate paid in
advance) and amortised against revenue over the contract period.
Q&A IAS 18: 20-1 — CLAIMS PROCESSING AND BILLING SERVICES


Question
Company A (A) performs claims processing and medical billing services for health
care providers. It prepares and submits claims to government agencies and
insurance companies, tracks the outstanding billings, collects the amounts billed, and
remits payments to the health care provider. Company A's fee is 5 per cent of the
amount collected. Company A has reliable, historical evidence indicating that the
government agencies and insurance companies pay 85 per cent of the claims
submitted with no further effort on A's part.
Under IAS 18.20, revenue from rendering services should be recognised by reference
to the stage of completion of the transaction. How is that principle applied in this
case? Specifically, may A recognise as revenue its 5 per cent fee on 85 per cent of
the gross billings at the time it prepares and submits the billings, or must it wait
until collections occur?
Answer
The recognition of revenue in such a case will depend on whether the amount that
will be received by A is sufficiently predictable to be a reliable measurement. If A can
make a reliable estimate of collections, revenue related to at least 85 per cent of the
claims can be recognised. The entity shall determine the pattern of revenue
recognition that best reflects the stage of completion.
Similar arrangements should be analysed to ascertain whether a transaction contains

multiple elements to be accounted for separately. If so, revenue will be recognised
separately for the different activities performed by A.
Q&A IAS 18: 20-2 — PERFORMANCE-BASED FEE PARTWAY THROUGH

THE PERFORMANCE PERIOD
Background
Company A, an investment manager, will earn a bonus of £1 million if a managed

fund's performance exceeds the performance of the S&P 500 by 20 per cent for the
calendar year 20X1. Company A's financial year (fiscal year) ends 30 June 20X1. At
that time, the fund is outperforming the S&P 500 by 25 per cent.
Question
Should the investment manager recognise revenue (bonus) at 30 June 20X1 and, if
so, £500,000 (one-half year's worth) or £1 million (the expected total bonus)?

Answer
IAS 18.20 states that revenue can be recognised when the amount of revenue can
be measured reliably and it is probable that the economic benefits will flow to the
entity. The investment manager has not earned the bonus until the annual return
exceeds the performance of the S&P 500 by 20 per cent. As the markets are very
volatile, the annual performance of the S&P 500 can not be estimated reliably before
the end of the year. Consequently, no amount of the bonus can be determined
reliably before the bonus measurement date. Therefore, the fund manager should
not recognise any of the bonus at 30 June 20X1.
Q&A IAS 18: 20-3 — LIFETIME MEMBERSHIP FEES IN A PRIVATE CLUB

Background
Company A owns and operates a private club. New members have an option of
paying a single up-front, non-refundable lifetime membership fee rather than
monthly or annual payments. That fee entitles members to most, but not all, of the
club's services for the member's life. Lifetime members must pay separately for
those services not covered by the lifetime membership fee.
Question
How should revenue from the lifetime membership fee be recognised?
Answer
Revenue should be recognised ratably over the time the individual may be expected
to require the services of the club. IAS 18.20 requires that income from a service
transaction be recognised by reference to the stage of completion of the transaction.
The club member would not pay an up-front membership fee in the absence of
on-going usage of the club's services. Moreover, the pricing of the lifetime
membership fee and the monthly usage fee are interrelated.
Q&A IAS 18: 20-4 — PRIVATE CLUB INITIATION FEES

Background
Company A constructs and operates a private club. New members pay an initiation
fee at the time they join. For a newly constructed club, most of the initiation fees are
received around the time when the club is first opened. The fees are non-refundable.
In addition to the initiation fee, all members must pay an annual membership fee,
which more than covers annual operating costs.
Question
When should revenue from the initiation fee be recognised?
Answer
Paragraph 17 of the the Appendix indicates that if an initiation or entrance fee
permits only membership and all other services or products are paid for separately at
fair value, the initiation or entrance fee is recognised at the time the new member
joins, but not earlier than when the club is operating and collectibility is assured.
Therefore, the payment of the initiation fee and the payment for subsequent services
are considered distinct earning events.
Q&A IAS 18: 20-5 — MEMBERSHIP OR SERVICES: WHEN THE

CUSTOMER IS ENTITLED TO A FULL REFUND
[Issued 30 January 2004]
Question
Company A (A) sells one-year memberships in a facility it operates. The terms state
that if the customer is unhappy with the facility for any reason within 30 days of
joining the facility, the customer can request a full refund of the membership fee
paid upon sign up. After 30 days, the membership is non-refundable. Company A's
experience is that approximately 20 per cent of its customers do request a refund
during the 30-day period.
Should A begin recognising the membership fee from the date the membership
contract is signed (with appropriate provision for estimated refunds), or should
recognition be deferred until after the 30-day money-back period elapses?
Answer
Paragraph 17 of the IAS 18 Appendix states:
Initiation, entrance and membership fees.

Revenue recognition depends on the nature of the services provided. If
the fee permits only membership, and all other services or products are
paid for separately, or if there is a separate annual subscription, the fee is
recognised as revenue when no significant uncertainty as to its
collectability exists. If the fee entitles the member to services or
publications to be provided during the membership period, or to purchase
goods or services at prices lower than those charged to non members, it is
recognised on a basis that reflects the timing, nature and value of the
benefits provided.
Accordingly, revenue recognition begins when the contract is signed, less the
consideration relating to the 20 per cent of expected refunds, if such an adjustment
reflects a reliable estimate of the level of expected refunds.
Q&A IAS 18: 20-6 — STRUCTURING FEES AND DAY ONE PROFIT
[Added 8 June 2007]
Background
On behalf of a client, a bank performs structuring services that may result in the
origination of a structured product. If this origination occurs, the bank intends to
designate the asset as at fair value through profit or loss. The instrument is not
quoted in an active market; therefore, the bank will use a valuation technique in
determining fair value. In addition, not all inputs into the valuation technique are
observable market data.
Question
When an entity receives fee income associated with the origination of a structured
product, and the resulting assets are designated at fair value through profit or loss,
should the fee be recognised up front?
Answer
It depends. Paragraph 14 of the IAS 18 Appendix states that "[t]he recognition of
revenue for financial service fees depends on the purposes for which the fees are
assessed and the basis of accounting for any associated financial instrument. The
description of fees for financial services may not be indicative of the nature and
substance of the services provided. Therefore, it is necessary to distinguish between
fees that are an integral part of the effective interest rate of a financial instrument,
fees that are earned as services are provided, and fees that are earned on the
execution of a significant act".
IAS 39.AG76 Financial Instruments: Recognition and Measurement, states that

"[t]he best evidence of the fair value of a financial instrument at initial recognition is
the transaction price (i.e. the fair value of the consideration given or received) unless
the fair value of that instrument is evidenced by comparison with other observable
current market transactions in the same instrument (i.e. without modification or
repackaging) or based on a valuation technique whose variables include only data
from observable markets".
An entity must distinguish between fees that are either of the following:
• Earned for services (structuring services).
• An integral part of generating an involvement with the resulting financial

instrument.
If the fees are paid to the bank, even if an instrument is not originated and the
amount of these fees is equal to the fair value of the service, the fees are considered
structuring fees and would be recognised as revenue as the structuring services are
provided (as in the first fee option listed above).
If the fee compensates for a below-market return on the instrument or the

structuring fee will not be earned if the structured product is not originated, then this
"fee" forms part of the transaction price — i.e. "the fair value of the consideration …
received" (IAS 39.AG76) (as in the second fee option listed above). If the entity is
applying a valuation technique that values the instrument at an amount different
from the sum of the proceeds from the "fees" and the proceeds paid on the
origination of the instrument, then this day one profit cannot be immediately
recognised unless the valuation technique only uses observable market data. (In
effect, the "fees" will be partly or fully deferred as part of the deferred day one
profit.)

Deleted
Q&A IAS 18: 29-2 — RECOGNISING REVENUE ON A FILM LICENSING

AGREEMENT
Question
In December 20X0, Company A (A), a film production company, sells a broadcast
license to a television network allowing the network to broadcast a film four times
over a two-year period commencing 1 January 20X1. The film is physically delivered
to the network in December 20X0, collectability of the license fee from the network
is assured, and A has no further rights or obligations under the sales agreement.
Company A cannot control when (or whether) the network broadcasts the film.
How should A recognise revenue from the licensing agreement?
Answer
Company A should recognise revenue entirely upon delivery of the film to the
television network in December 20X0. Paragraph 20 of the IAS 18 Appendix states,
in part:
An assignment of rights for a fixed fee or non-refundable guarantee under

a non cancellable contract which permits the licensee to exploit those
rights freely and the licensor has no remaining obligations to perform is, in
substance, a sale.
The paragraph goes on specifically to cite the granting of rights to exhibit a motion
picture film in markets where the licensor has no control over the distributor and
expects to receive no further revenues from the box office receipts, and states:
In such cases, revenue is recognised at the time of sale.

In the current case, both the right to show the film, as well as the physical film itself,
are delivered in December 20X0, and A (licensor) has no remaining obligations to
perform. Accordingly, the sale is deemed to have occurred and revenue shall be
recognised upon delivery, i.e. December 20X0.

Deleted
Q&A IAS 18: 29-4 — DIVIDENDS IN THE FORM OF EQUITY

INSTRUMENTS OF THE INVESTEE (NO CASH ALTERNATIVE)

Background
I Limited holds an equity investment in Entity A. Entity A distributes a dividend in the

form of its own equity shares to all of its ordinary shareholders on a pro-rata basis.
No cash alternative is offered. After the distribution, the relative shareholdings of the
investors in Entity A remain unchanged.
Question
Should I Limited recognise dividend revenue for the fair value of the shares in Entity
A it receives?
Answer
No. When all ordinary shareholders are paid a share dividend on a pro-rata basis,
there is no change in the financial position or economic interest of any of the
investors. In such circumstances, in accordance with IAS 18.29(a), the dividend is
not recognised as revenue because it is not probable that there is an economic
benefit associated with the transaction that will flow to the investor.
Note: See IFRIC agenda rejection published in the January 2010 IFRIC Update
See Q&A IAS 18: 29-5 for a discussion of the accounting for share dividends when a
cash alternative is offered.
Q&A IAS 18: 29-5 — DIVIDENDS IN THE FORM OF EQUITY

INSTRUMENTS OF THE INVESTEE (WITH A CASH ALTERNATIVE)
Background
I Limited holds an equity investment in Entity A. Entity A offers all of its shareholders
the right to receive a dividend in cash or in shares. I Limited subsequently elects to
receive the dividend in shares.
Question
How should I Limited recognise the dividend received?
Answer
The substance of a share dividend with a cash alternative is that of a dividend in
cash with an immediate reinvestment in shares. Accordingly, at the date the

dividend is authorised (i.e. the date when the shareholders' right to receive the
dividend is established), I Limited should recognise the dividend as revenue,
measured at the higher of the value of the shares offered and the value of the cash
alternative. This reflects the fact that the investor would be expected to opt for the
most economically advantageous alternative.
From the date of authorisation of the dividend until the date on which I Limited
elects to receive cash or shares, the estimated revenue should be adjusted to reflect
changes in the fair value of the shares but it should never fall below the value of the
cash alternative.
On the date that I Limited makes its final election, the revenue amount becomes
fixed.
See Q&A IAS 18: 29-4 for a discussion of the accounting for share dividends when
no cash alternative is offered.
Q&A IAS 18: 30-1 — PAYMENTS RECEIVED UNDER ROYALTY

AGREEMENTS
Question
Royalty agreements vary, but essentially their purpose is to sell a right to use an
entity's assets, such as trademarks, patents, and software, for a certain period of
time.
Under royalty agreements, should revenue recognition be up front upon signing the
agreement or should it be deferred and spread over the duration of the agreement?
Answer
Paragraph 20 of Appendix A states that recognition of revenue under royalty
agreements should be recognised in accordance with the substance of the
arrangements.
Paragraph 20 further clarifies that the overriding factor in determining the

accounting treatment for such arrangements should be whether the licensor has any
remaining obligation to perform. The outcome of each arrangement depends on the
circumstances. Below are two typical examples.

License to use a trademark
The sale of the right to use a trademark often requires that the licensor (seller)
continue to ensure the "quality" of the trademark. When the requirement imposes a
genuine performance obligation (i.e. the licensee could realistically seek redress for
non-performance), revenue recognition shall be deferred and spread over the period
of performance (i.e. the license term) by the seller. If, however, the requirement is a
mere formality and the seller has no remaining obligation to perform, then revenue
shall be recognised immediately.
Software licensing arrangement
Software licensing arrangements allow the licensee (customer) to use intellectual

property. Upon delivery of the software license, in the absence of any requirement
that the licensor (seller) provide technical support, software upgrades, or
enhancements, a sale has occurred and revenue from the sale can be fully
recognised.
If the licensor sells technical support or software upgrades together with the license,
the arrangement should be analysed as to whether it is a multiple-element
arrangement, in which case revenue shall be recognised separately for each of the
identified components.
Q&A IAS 18: 35-1 — DISCLOSURE OF REVENUE RECOGNITION

ACCOUNTING POLICY
Question
IAS 18.35(a) requires disclosure of the accounting policies adopted for the
recognition of revenue. With respect to the sale of goods, what should be included in
such a disclosure?
Answer
The following examples should be considered, depending on circumstances, for
inclusion in the revenue recognition accounting policy disclosure:
• If an entity has different policies for different types of revenue

transactions, the policy for each material type of transaction should be
disclosed.
• If sales transactions have multiple elements, such as product and service,

the disclosure should include the accounting policy for each element as well
as how multiple elements are determined and valued.
• Changes in estimates that underlie revenue recognition, such as changes in

estimated returns, should be disclosed.
• Any specific revenue transactions that are unusual because of their nature,
size, or frequency of occurrence may require separate disclosure.
Q&A IAS 19: 4-1 — PROFIT-SHARING EMPLOYEE BENEFITS BASED ON

TAXA
[Added 5 June 2009]
Background
In certain jurisdictions, labour laws require entities to pay their employees a cash
benefit that is calculated based on the entities' taxable income as determined under
the local income tax law (before deduction for the workers' profit-sharing payments).
The liability for the amount paid to the employees under the profit-sharing benefit
plan is tax deductible for the entity when recognised.
The aggregate profit-sharing cost is often allocated to the employees based on their
relative salaries during the year and the amount of effective days employed by the
entity in the year. The profit-share is usually paid in the early part of the following
year. Generally, individuals that are no longer employed by the entity when the
payment is made are still entitled to receive a payment for the time they were
employed by the entity.
The features of such profit-sharing benefit plans may vary between jurisdictions.
Features may include the following.
• Local labour laws may limit the annual payment to individual employees.
Once this limit is reached, any excess is paid to the government to fund
public programmes (e.g. worker education, investments). The entity is not
entitled to keep any of the excess.
• Local tax laws may permit the carry forward of taxable losses to future
periods. If there is tax loss carried forward, the entity can apply it against
current taxable net income to reduce its profit-sharing obligation.
• If the tax authorities adjust an entity's taxable income, the entity may be
required to recalculate the profit-sharing amount for the period. If the
entity made an overpayment to the employees in the previous year(s), the
entity has a right to claim a refund from the employees (even if they are
no longer employed with the entity).
Question
Should profit-sharing benefit plans under which employees are entitled to receive a
share of the "taxable profits" of an entity be accounted for in accordance with IAS 12
Income Taxes, or IAS 19?
Answer
Profit-sharing benefit plans should be accounted for under IAS 19 (not IAS 12).
IAS 19 applies to employee benefits provided under legislative requirements,

including short-term benefits (e.g. profit sharing arrangements). While the amount
paid to the employees is based on taxable income, it is paid to the employees in
exchange for services rendered and, therefore, the payment should be classified as
employee compensation.
Even when the plans include additional features such as those described above
(remittance of excess payment to the government or adjustment of the
profit-sharing benefit amount for the effect of tax loss carry forwards and tax
reassessment), the substance of the arrangement remains that of a profit-sharing
employee benefit to which IAS 19 applies.
Q&A IAS 19: 7-1 — TREATMENT OF THE INTRODUCTION OF A NEW

STATE BENEFIT
Question
Subsequent to the establishment of a defined benefit plan by a company, the costs
for providing these employee benefits may increase or decrease as a result of the
introduction of a new, significant, and unpredictable state cost imposed on the plan.
There is no consequence for the employee benefits payable to the plan participants.
Indirect consequences may ultimately result if the company decides to amend the
plan.
Where a state introduces in an unpredictable manner a new significant state cost

(e.g. tax) for an existing employer's defined benefit obligation, with no consequence
on the ultimate benefit to be received by employees, should the change be treated

as a plan amendment or a change in actuarial assumptions?
Answer
This should be treated as a change in actuarial assumptions.
IAS 19.50(a), IAS 19.63, and IAS 19.73 clearly indicate that the entity should take
into account all elements that will influence the ultimate cost of providing the defined
benefit.
More specifically, IAS 19.73 states that actuarial assumptions are an entity's best
estimates of the variables that will determine the ultimate cost of providing
post-employment benefits.
IAS 19.96–101 and IAS 19.109–115 (curtailments and settlements) deal with the
impact of plan amendments. Those paragraphs refer to actions of the entity resulting
in past service costs, curtailments, and settlements. IAS 19, BC54 also indicates that
"[p]ast service cost results from a management decision, rather than inherent
measurement uncertainty".
On the basis of IAS 19.98 (a) and (b), past service cost cannot include the effect of
differences between actual and previously assumed elements that will ultimately
determine the cost of providing defined benefits, because actuarial assumptions
allow for projecting these elements. When an entity did not make an assumption
about such an element, it was making an assumption of zero value for that element.
In summary, the introduction of the new state cost should be treated as a change in
actuarial assumptions for the following reasons:
• Variables that will determine the ultimate cost of providing

post-employment benefits are reflected under the actuarial assumptions to
be made;
• Plan amendments can only arise as a result of actions initiated by the

entity providing post-employment defined benefits;
• If an entity did not take into account an element that will determine the
cost of providing post employments benefits, the variable is assumed to be
equal to zero or immaterial. Any resulting differences with actual numbers
are experience adjustments; and
• Where there is a change in a post-employment benefit cost without a

change in the employee benefits to be paid to employees, this change
cannot be accounted for as a plan amendment.
Q&A IAS 19: 7-2 — WHETHER AN INSURANCE POLICY ISSUED BY A

RELATED PARTY QUALIFIES AS A PLAN ASSET
Background
Company A (A) offers its employees defined pension benefits through a pension
fund. The pension fund acquires an insurance policy from A's subsidiary, Company B
(B).
Question
Can the insurance policy be included as part of plan assets in A's consolidated and
separate financial statements?
Answer
It depends.
IAS 19.7 defines plan assets as:
a. assets held by a long-term employee benefit fund; and
b. qualifying insurance policies.
IAS 19.7 also indicates that a qualifying insurance policy must be "issued by an
insurer that is not a related party (as defined in IAS 24 Related Party Disclosures) of
the reporting entity . . . ". Because the insurance policy is issued by B, a related
party, it does not meet the definition of a qualifying insurance policy.
Therefore, to qualify as a plan asset, the insurance policy must meet the following
definition of an asset held by a long-term employee benefit fund:
Assets held by a long-term employee benefit fund are assets (other than
non-transferable financial instruments issued by the reporting
entity) that:
a. are held by an entity (a fund) that is legally separate from the reporting
entity and exists solely to pay or fund employee benefits; and
b. are available to be used only to pay or fund employee benefits, are not
available to the reporting entity's own creditors (even in bankruptcy), and
cannot be returned to the reporting entity [except in specific
circumstances.] [Emphasis added]
In addition to criteria (a) and (b), for the consolidated financial statements (since the
policy is issued by an entity within the consolidated group), the insurance policy will
qualify as a plan asset only if it is a transferable financial instrument. An
insurance policy issued by a group entity that covers the employees in a fund will
often be a non-transferable financial instrument and thus will not meet the definition
of plan assets.
However, for A's separate financial statements, the insurance policy is not
considered to be issued by the "reporting entity". Accordingly, in these financial
statements, the insurance policy will qualify as a plan asset if criteria (a) and (b) are
met, even if the policy is a non-transferable financial instrument.
Note the IFRIC agenda decision published in the January 2008 IFRIC Update.
Q&A IAS 19: 10-1 — MEASUREMENT OF 'SHORT-TERM' EMPLOYEE

BENEFITS NOT EXPECTED TO BE SETTLED WITHIN 12 MONTHS
Background
Short-term employee benefits are defined in IAS 19.7 as “employee benefits (other
than termination benefits) that are due to be settled within twelve months after the
end of the period in which the employees render the related service”. Obligations
arising from such benefits are presented as current liabilities based on the
employees' entitlement to take the benefit, irrespective of when they are expected to
be paid (see Q&A IAS 1(2007): 60-2).
Some benefits (e.g. unused annual leave for which employees are entitled to receive
payment when they leave their employment) may meet the definition of short-term
employee benefits but settlement may not be expected for some years.
Nevertheless, the related obligations are presented as current liabilities.
Question
In measuring obligations arising from short-term employee benefits, should amounts
be discounted to reflect the expected timing of payment?
Answer
No. IAS 19.10 requires that “[w]hen an employee has rendered service to an entity
during an accounting period, the entity shall recognise the undiscounted amount
of short-term employee benefits expected to be paid in exchange for that service”
(emphasis added). In addition, IAS 19.9 states that “short-term employee benefit
obligations are measured on an undiscounted basis”.
These paragraphs clearly establish the measurement basis for all short-term
employee benefits. Irrespective of the expected timing of payment, the obligation
should not be discounted.
Q&A IAS 19: 13-1 — PROVIDING FOR VACATION LEAVE ENTITLEMENT

Question
Company R (R) is required by local law to provide an annual vacation entitlement to
its employees on the 1st day of each year. For example, Employee X (X) is entitled
to 20 days of vacation, which is worth $100. If X leaves R during the year, R must
pay him $100 in cash, less the value of used vacation, for the outstanding vacation
entitlement. If X takes only 15 days of vacation during the year, he will either
receive a cash reimbursement for five days at the end of the year or five days will be
carried-forward. This arrangement is only available for current employees who were
in employment as of 31 December of the previous period and continue to be
employed on 1 January of the following year.
How should Company R account for the vacation entitlement?
Answer
The arrangement relates to accumulating compensated absences (i.e. vacation).
Company R has a liability at 1 January ("a present obligation...arising from past
events, the settlement of which is expected to result in an outflow of resources
embodying economic benefits" [IAS 37.10]). The employee has the entitlement to
vacation payment from the date it is granted (the past event), and does not
necessarily have to render any further services.
As a result, R should record a liability of $100 and recognise the expense of $100 at
1 January.
Q&A IAS 19: 24-1 — ACCOUNTING FOR CAREER AVERAGE REVALUED

EARNINGS (CARE) PENSION PLANS
[Added 15 May 2009]
Background
In some jurisdictions, entities may offer employees 'career average revalued

earnings' (CARE) pension plans, also referred to as 'pension builder plans'. Such

plans generally provide a defined benefit pension that is determined by the
employee's years of service and the average salary earned over the period of
service. The plan formula is typically stated as follows:
A member shall accrue for each year of service: accrual rate x current (or
average) salary*
Question
Should estimated future salary increases be taken into account in the valuation of
the defined benefit obligation?
How should the costs be attributed to periods of service?
Answer
Entities should measure such plans by using the projected unit credit method, taking
into account estimated future salary increases as required by IAS 19.83(a) and IAS
19.84.
In determining the present value of its defined benefit obligations . . . an

entity shall attribute benefit to periods of service under the plan's benefit
formula. However, if an employee's service in later years will lead to a
materially higher level of benefit than in earlier years, an entity shall
attribute benefit on a straight-line basis . . . .
The CARE pension plan formula described above does attribute a higher level of
benefit to later years and, therefore, an entity will need to assess whether this is
likely to be materially higher, in which case the benefits will need to be attributed on
a straight-line basis.
* To maintain a pension benefit's purchasing power, the salary in each year is typically
re-valued (either to give an adjusted current salary or to determine the adjusted average
salary) in line with a specified index (e.g. price inflation) between the date of accrual and
the date of retirement. The index used to re-value salaries earned in past years is typically
lower than the wage increase over the period of service.
Q&A IAS 19: 25-1 — TARGET PLAN

[Issued 6 May 2005]

Question
An employer has a target benefit plan with the following features. Contributions to
the plan are determined based on each employee's age upon entrance to the plan,
projected average salary at retirement, projected mortality, and retirement age.
Each employee, upon entrance to the plan, has a contribution percentage computed
based on the applicable demographic information; thereafter, the employer
contributes that specific percentage of the employee's salary to the plan. If the
employee's salary or other factors change, the employer's contribution rate will not
change.
The plan is structured so that the employer's contributions accumulate to each

individual employee's account; investment gains or losses on assets in the plan
accrue to the employees on a pro rata basis and are not considered in computing the
employer's future contribution. If an employee's account balance at retirement or
termination either exceeds or falls short of the target amount, then the account
balance will not be adjusted by the employer; therefore, employees receive only the
funds credited to their accounts.
Does this plan represent a defined contribution or a defined benefit plan?
Answer
This plan represents a defined contribution plan. The employer's target benefit plan
currently has a complex formula to compute the employer's pension contribution.
However, the benefit computation is not adjusted for investment
gains/losses/forfeitures on the assets contributed to the employee's individual
account. As a result, the actuarial and investment risks associated with the plan
effectively fall to the employee, and, therefore, the plan is a defined contribution
pension plan.
Q&A IAS 19: 30-1 — CHANGE FROM DEFINED CONTRIBUTION TO

DEFINED BENEFIT ACCOUNTING — MULTI-EMPLOYER FUND
Question
Company A (A) contributes to a multi-employer defined benefit plan. However,
because the scheme has never been able to furnish the participants in the fund with
sufficient information in order for them to apply the accounting requirements in IAS
19.29, A has always accounted for the plan as if it were a defined contribution plan
in accordance with the exemption in IAS 19.30.

As at 31 December 2005, the fund is able to provide the participants in the fund with
sufficient information in order for them to apply the accounting requirements in IAS
19.29.
Should the effect of the change in accounting for the pension fund from defined
contribution accounting to defined benefit accounting be treated as a change in
accounting policy or as a change in estimate, and what are the accounting effects of
this change?
Answer
The change should be treated as a change in estimate in accordance with IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors.
In accordance with IAS 8, a change should be treated as a change in accounting

policy only if required by a Standard or if it results in a more fair presentation. IAS
8.16 states that a new accounting policy applied to conditions that did not exist
previously is not a change in accounting policy.
Previously, because the scheme was unable to provide sufficient information, A was
required to account for the fund as a defined contribution plan in terms of IAS 19.
Whilst A's accounting policy is to recognise its net pension fund liability (or asset), A
could not previously recognise its net liability (or asset), as measurement was
unreliable in accordance with IAS 19.30. Consequently, the cost of the pension
scheme in the income statement was measured at an amount equal to the
contributions made.
As at 31 December 2005, the fund provides new information that enables the net
pension fund liability (or asset) at that date, and the cost going forward, to be
measured reliably. The best estimate of the liability, and not the basis of accounting
for the fund, has changed and the adjustment to the carrying amount is therefore a
change in estimate. The effect of the change in estimate should be recognised in the
income statement in the year in which the new information is obtained.
Q&A IAS 19: 44-1 — RECOGNITION OF CONTRIBUTIONS TO A DEFINED

CONTRIBUTION PLAN THAT MAY REVERT BACK TO THE EMPLOYER
[Issued 6 May 2005]
Question
An employer sponsors a defined contribution plan. Under the terms of the plan, the
employer's contributions are discretionary and amounts forfeited by individual
participants that leave the company before vesting revert to the employer. In the
last two years, the employer was experiencing losses and made no contributions to
the plan. In the current year, the employer made a contribution to the plan that was
allocated to individual plan participant accounts. The employer estimates that a
portion of its contribution will eventually revert back due to employee forfeitures
(employer contributions for employees that do not vest).
Should the employer expense only the amount of the contribution it estimates will
actually be used to pay benefits?
Answer
No. IAS 19.44 provides guidance for contributions that may lead to a reduction in
future payments or a cash refund:
When an employee has rendered service to an entity during the period,

the entity shall recognise the contribution payable to a defined
contribution plan in exchange for that service…If the contribution already
paid exceeds the contribution due for service before the balance sheet
date [it shall be recognised] as an asset (prepaid expense) to the extent
that the prepayment will lead to, for example, a reduction in future
payments or a cash refund.
In the employer's case, all assets contributed relate to services received to date,
thus, there are no "excess assets".
Accordingly, since the employer contributed the amount required for the period, the
entire contribution should be charged to expenses. Any forfeitures reverting back to
the employer would be recognised as a reduction of employer contributions in the
year forfeited.
Q&A IAS 19: 52-1 — TAX GROSS-UP OF PENSION BENEFIT

[Issued 6 May 2005]
Question
There are entities that provide settlement of their defined benefit obligation for
certain employees through the purchase of non-participating annuity contracts that
are distributed to the employees. These contracts do not require any contribution
("participation") from employees. The receipt of the non-participating annuity
contracts by the employee may trigger a taxable event for the employee upon
distribution. Accordingly, some entities compensate the employees so that the
after-tax benefit to the employee is the same as if the contracts were not
distributed, although this is commonly not a formal feature of the plan.

Are the payments by the employer to the employees for the tax gross-up upon
distribution an amendment to the employer's defined benefit plan?
Answer
The tax gross-up payment made by an employer to an employee is an amendment
of the defined benefit plan only if the employer actually amends its plan to provide
for this benefit. If the employer does not amend its retirement plan to provide the
additional benefit, the cash payment would be additional compensation expense and
would be recorded in the current period.
However, if the employer establishes a pattern of providing such benefits, the

benefits would be considered part of the substantive written plan and should be
included in the basis for accounting for the plan pursuant to IAS 19.52.
Q&A IAS 19: 52-2 — TREATMENT OF EMPLOYER SOCIAL SECURITY

CONTRIBUTIONS ON PENSION BENEFIT PAYMENTS
[Issued 6 May 2005]
Background
An entity operates a defined benefit plan.
Assume:
The benefit to be paid out at the age of 60 amounts to CU1,000.
The entity, at the time the pension is paid, will pay employer social security
tax of CU200.
The entity will have to withhold the employee's social security tax of
CU150.
Net benefit received by the employee amounts to CU850 (1,000 – 150).
Cash paid out by the entity is CU1,200 (1,000 + 200).
The amount of social security tax contributed by the employer is calculated

as a per cent of the employee benefits granted.
Question
How should employer social security contributions levied on pension payments be
accounted for under IAS 19?

Answer
Employer social security tax levied on the pension benefits paid out to the employee
is a directly related inherent cost of receiving services from employees and as a
result a consideration paid in order to be able to receive these services.
As the social security tax payment by the employer is made as a consequence of the
pension payment, it forms part of the employer's cost to provide pension benefits to
the employee. It represents an actuarial assumption similar to a change in the state
benefits that affect the benefits payable under the defined benefit plan that have
been enacted.
In the above scenario, the social security contributed by the employer can be seen
as an employee defined benefit of CU1,200 under which the employee will have to
pay 100 per cent of the social security contributions that would reduce the net pay
out to CU850. Therefore, the entity by assuming a percentage of that contribution,
either voluntary or by legislation, should recognise the cost of that additional amount
similar to the pension benefit, by including its cost in the calculation of the present
value of the defined benefit obligation and should be accounted for as an integral
part of the pension scheme.
Q&A IAS 19: 57-1 — ACTUARIAL PROCESS USED TO MEASURE PENSION

COSTS AND OBLIGATIONS
[Issued 6 May 2005]
Background
The service cost component of net periodic pension cost and the present value of
defined benefit obligations are based on attributing the cost to the period of
employee service, as well as the use of actuarial assumptions. These actuarial
assumptions reflect both the time value of money (discount rate) and the probability
of payment (assumptions as to mortality, turnover, early retirement, and so forth).
Typically, actuaries will calculate a company's pension obligation based on
assumptions and company data.
Question
What is an example of the process actuaries use to measure pension costs and
obligations?
Answer
There are a number of procedures actuaries will use to measure pension costs and
obligations, and judgment will be required to determine whether those procedures
have resulted in amounts that comply with the requirements of IAS 19. As an
example, the following describes the process an actuary might use to measure
pension costs and obligations, for a company which applies the corridor approach
described in IAS 19.92:
Beginning of Year 1
Assume a company initiates a plan at the beginning of the year. At the beginning of
the plan year, the company's actuaries determine what the expense will be for that
upcoming year by estimating the obligation as of the end of the year, based on data
and assumptions available at the beginning of the year. The data and assumptions
as of the beginning of the year include the expected return on plan assets, the
discount rate, employee turnover, etc. During the year, the company will record an
expense in accordance with the actuarial calculation performed as of the first day of
the plan year.
End of Year 1
At the end of the year, the actuaries will "revise" the measurement of the
employee's obligation based on assumptions as of the year-end measurement date.
The actuary may use the same data as of the beginning of the year, as long as the
data has not materially changed. The end of the year measurement will reflect the
actual market value of the plan assets and the discount rate at that time. As a result,
the pension obligation amount determined at the year-end measurement date is
likely to be different than the amount projected at the beginning of the year. The
balance sheet amount accrued in a company's financial statements as the pension
liability or pension asset, however, is the expense calculated at the beginning of the
plan year, less any cash contributions (benefit payments for unfunded plans). The
increase or decrease in the unfunded pension obligation due to changes in
assumptions, assets, or using year-end data is reflected as an unrecognised gain or
loss in the reconciliation of funded status, and, therefore, there is no net impact on
the liability or asset balance recorded in the financial statements. The unrecognised
gain or loss will be reflected in the net periodic pension cost in subsequent periods to
the extent the unrecognised items are amortised. Typically, this information is
prepared by actuaries prior to the release of the company's year-end financial
statements and provides the basis for the pension plan financial statement footnote
disclosures.
Year 2 Valuation
During year two, typically, the actuaries perform another complete valuation, using
the (revised) assumptions used for the year-one disclosure, but using updated
employee data. This valuation determines the amount of expense to be recorded
during year two. From a practical standpoint, this actuarial valuation may be
finalised well after the beginning of the year. As a result, a company has to record its
pension expense for several months in year two based on either the preliminary
estimates, which would typically consider the year-one expense. Once the company
obtains the complete actuarial valuation as of the beginning of year two, the
company adjusts the amount of expense recorded to arrive at the appropriate annual
charge and liability or asset to be accrued by the end of year two.
Q&A IAS 19: 58(b)-1 — MEANING OF IAS 19.58(b)(i) IN THE CONTEXT

OF APPLICATION OF THE ASSET CEILING
Background
An entity has a defined benefit post-employment benefits plan with the following
characteristics:
• amount determined under IAS 19.54: asset (surplus) of CU100;
• unrecognised actuarial gain of CU40;
• unrecognised past service cost of CU10; and
• no economic benefits available through refunds or reductions in future

contributions.
Question
How should the entity determine the amount of “any cumulative unrecognised net
actuarial losses and past service cost” as defined in IAS 19.58(b)(i) when measuring
the asset ceiling?
Answer
IAS 19.58(b)(i) refers to the “cumulative unrecognised net actuarial losses and past
service cost” (emphasis added). Therefore, in calculating this amount, the entity
should include both unrecognised actuarial losses and unrecognised actuarial gains,
and both positive and negative unrecognised past service cost.
This reflects the fact that the restriction described in IAS 19.58 is intended to
prevent an entity from recognising an asset that exceeds the capacity to recover the
surplus in the plan. Because unrecognised gains and negative past service cost have
an impact on this capacity, they should be included in calculating the amount
described in IAS 19.58(b)(i).
In the fact pattern described, the asset recognised would be determined as follows.

Therefore, no asset shall be recognised in respect of the defined benefit plan.
Q&A IAS 19: 67-1 — MEASUREMENT OF INCAPACITY BENEFIT OR

DEATH IN SERVICE BENEFIT BASED ON SERVICE LIFE
Question
An entity operates a defined benefit post-employment scheme. Under the terms of
the scheme, the employee is entitled to a pension of 1/60th of final earnings for each
year of service until retirement. If an employee dies or becomes incapacitated prior
to the normal retirement date, the pension/benefit paid (to the employee or the
employee's dependant) is based on the years of employment until the date of
incapacity/death, and credit is given for 50 per cent of the years from that date until
the normal retirement date.
For example, an employee works for 20 years and then becomes incapacitated 10
years prior to the normal retirement date. The pension/benefit paid is 25/60ths
based on 25 years service; the 20 actually worked plus 50 per cent of the remaining
years to normal retirement date.
Should the assumptions used for attributing benefits to service periods reflect that,
for employees expected to die or become incapacitated prior to their normal
retirement date, the service period would only encompass the period until the
expected death or incapacity?

Answer
Yes. The expected benefit to be paid will be based on the years of service up to the
date of expected benefit or incapacity, and therefore the plan will have a consistent
benefit formula used over the years of service to reflect the value of the benefit. The
expense should be attributed to the periods of service under the benefit formula
because the employee's service does not result in a materially higher level of benefit
in later years than in early years.
In determining pension costs, actuaries will make assumptions about the number of
employees who are expected to die or become incapacitated prior to normal
retirement date. Therefore, for the employees not expected to reach retirement age,
the total expected benefit payable, including that related to credited years not
actually worked (i.e. 50 per cent of the years between the date of expected death or
incapacity and the normal retirement date), will be attributed to the years of
expected service up to the date of expected death or incapacity.
Q&A IAS 19: 67-2 — ACCOUNTING FOR DEATH-IN-SERVICE BENEFITS

Question
Death-in-service benefits are employee benefits payable if an employee dies while
employed by the entity. These arrangements may take various forms, including lump
sum payments and widow's pensions.
How should death-in-service benefits be accounted for under IAS 19?
Answer
The appropriate accounting for death-in-service benefits will depend on the nature of
the arrangement. Considerations include:
• whether the benefits vary according to the length of service or are the
same irrespective of the length of service; and
• whether the benefits are provided through a defined benefit plan or

through a stand-alone arrangement.
Benefits related to length of service
Although IAS 19 does not specifically mention death-in-service benefits, it does refer
to long-term disability benefits (which may have similar features to death-in-service
benefits) as an example of 'other long-term benefits'. IAS 19.130 states that if the
level of benefit depends on the length of service, an obligation arises when the
service is rendered. Measurement of that obligation reflects the probability that
payment will be required and the length of time for which payment is expected to be
made. Therefore, where the level of death-in-service benefits is related to the length
of service, the benefits should be attributed over the service life of the employee
until the expected date of death of the employee.
If death-in-service benefits are provided as part of a defined benefit plan, an entity

would recognise actuarial gains and losses arising on the death-in-service benefits in
line with their general policy for recognising such gains and losses under defined
benefit plans.
If death-in-service benefits related to the period of service are provided through a

stand-alone plan, they would represent an 'other long-term-employee benefit'.
Applying IAS 19.130 by analogy, such benefits would be attributed over the service
period until the expected date of death of the employee. However, actuarial gains
and losses arising on such plans would be recognised in profit or loss immediately, in
accordance with IAS 19.127.
Benefits unrelated to length of service — stand-alone plans
IAS 19.130 states that if the level of benefits is the same regardless of years of
service (e.g. a lump sum fixed amount), the expected cost of those benefits is
recognised when an event occurs that causes long-term disability. Applying IAS
19.130 by analogy for death-in-service benefits that are fixed irrespective of any
period of service, an expense should be recorded only when an employee dies.
Benefits unrelated to length of service — benefits provided under a defined

benefit plan
The calculation of the liabilities of a defined benefit retirement benefit plan will
include an assumption about employees dying before reaching normal retirement
age. Because such an assumption will generally result in a reduction in the liabilities
recognised, it might be thought imprudent to recognise that reduction without
recognising the additional liabilities that will arise under the death-in-service benefit
arrangements if an employee dies before normal retirement age.
The basic approach for defined benefit schemes under IAS 19 is to calculate the
expected obligation and attribute that benefit to periods of service. Where the
death-in-service benefit is a lump sum amount, there is no plan benefit formula that
can be used to attribute the benefit to periods of service. In the absence of such a
formula, it would seem appropriate to attribute the benefit on a straight-line basis
until the expected date of death of the employee. Therefore, recognition of a fixed
lump sum death-in-service benefit on this basis is recommended when the
death-in-service benefits are provided through a defined benefit plan, although it
appears that the alternative (i.e. recognition of an expense only when an employee
dies) may be justified by reference to IAS 19.130.
Q&A IAS 19: 68-1 — UNDISCOUNTED VESTED EMPLOYEE BENEFITS

Question
Can vested benefits that are payable when an employee leaves the entity be
recognised at an undiscounted amount, i.e. the amount that would be payable if all
employees left the entity at the balance sheet date?
Answer
No. IAS 19 requires that a liability for the vested benefit should be discounted to its
present value according to the Projected Unit Credit Method as described in IAS
19.65 to reflect the expected date at which employees are expected to leave.
Example 1 following IAS 19.68 illustrates this fact pattern.
Note: IFRIC agenda rejection published in the April 2002 IFRIC Update.
Q&A IAS 19: 73-1 — TREATMENT OF PENSION PROMISES BASED ON

PERFORMANCE TARGETS
Background
Defined benefit plans may include pension promises that are based on achieving
specific performance targets, such as additional pensionable earnings from
performance bonuses, arrangements relating to additional sponsor contributions, or
years of deemed service.
Question
How should defined benefit plans with such features be accounted for?
Answer
IAS 19.73 defines actuarial assumptions as "an entity's best estimates of the
variables that will determine the ultimate cost of providing post-employment
benefits". Performance targets are variables that will affect the ultimate cost of
providing post-employment benefits, and should be included in the determination of
the defined benefit obligation in accordance with IAS 19.50(a) and IAS 19.63.
IAS 19.67 requires benefits to be attributed "to periods of service under the plan's
benefit formula" unless "an employee's service in later years will lead to a materially
higher level of benefit than in earlier years . . . ". Consequently, when benefits are
affected by performance targets, the effect on the attribution of benefits must also
be considered.
Q&A IAS 19: 78-1 and 78-2 — DETERMINATION OF DISCOUNT RATE

WHERE NO DEEP MARKET FOR HIGH QUALITY CORPORATE BONDS
EXISTS
IAS 19: 78-1
Question
In certain countries with well developed financial markets, deep markets in high
quality corporate bonds expressed in the currency of the underlying defined benefit
obligation may not be available; however, there might be high quality corporate
bonds expressed in another currency. Also, because of an economic downturn, the
market for AA-rated bonds may be momentarily very narrow, whilst there might be a
deep market for A-rated bonds. If the economy booms, a deep market for AA-rated
bonds may be available again.
Does the term "high quality corporate bond" always refer to AA-rated and/or AAA
bonds?
Answer
Not necessarily. The term,"high quality corporate bonds," generally implies corporate
bonds with one of the two highest ratings from a recognised rating agency in
jurisdictions in which such an agency exists. This assessment should be made
separately for each dissimiliar economic environment. The determination of the
existence of "high quality corporate bonds" is based on the economy in which the
pension fund is located and whether the bonds are considered high quality in that
economy. For this requirement, it is essential to look at comparisons with the
government bond market and the rates for those bonds. Where AA- or AAA-rated
bonds do not exist, professional judgement must be exercised to determine whether
high quality corporate bonds should be considered to exist.
IAS 19: 78-2
Question
When dealing with defined benefit obligations located in countries that have
developed financial markets, but a deep market in high quality corporate bonds
expressed in the same currency as the underlying defined benefit obligation is not
available, is it possible to use the data obtainable from another jurisdiction to make
an estimate of what would be the market yield on high quality corporate bonds?
Answer
No. If, in the country where the currency of the defined benefit obligation is
denominated, there is no deep market available in high quality corporate bonds
expressed in the same currency as the underlying defined benefit obligation, the
market yield on government bonds must be used.
However, if there is a regional deep market for high quality corporate bonds in the
currency which is used in that country (for example, a country which does not have
a deep high quality corporate bond market of its own, but uses the Euro as its
currency), the entity can determine the appropriate discount rate with reference to
that regional market.
Q&A IAS 19: 85-1 — HISTORY OF ADJUSTMENTS TO PENSION

BENEFITS PLAN
[Issued 6 May 2005]
Question
Company O (O) is a manufacturer with a work force whose compensation and other
employee benefits are governed by a union contract established through a collective
bargaining process. Company O has a history of granting improvements in pension
benefits, to both retirees and active employees, during the collective bargaining
process. The improvements, sometimes, have taken the form of fixed euro increases
in the monthly benefit or, lump sum payments made outside the pension plans, or
formula-based COLA (cost-of-living adjustments) increases in the monthly benefit.
There is no other evidence of a present commitment to increase plan benefits other
than O's history of retroactive plan amendments.
Does O's practice of using a COLA to provide retroactive benefit increases imply
more of a commitment to make future amendments or raise employee expectations
than other methods of granting increases?
Answer
Careful judgment should be applied in assessing whether a constructive obligation
has arisen.
In the above situation, the entity's practice is to provide improvements only during
the collective bargaining process, not during any informal process. The increases in
benefits historically have been awarded in several different forms. Therefore, the
employer has not set a pattern of increases in pension benefits that can be projected
reliably to give rise to a constructive obligation. However, if the practice established
by an employer were that of a consistent pension benefit enhancement as part of
union negotiations that clearly established a pattern (always a COLA adjustment or
always fixed euro increase), it could be concluded that a constructive obligation
exists and that those additional benefits should be included in the measurement of
the projected benefit obligation consistent with the guidance set out in IAS 19.52,
IAS 19.83, and IAS 19.98.
Q&A IAS 19: 85-2 — EXPECTATION OF INCREASING EMPLOYEES'

CONTRIBUTIONS TO COVER DEFICIT IN A DEFINED BENEFIT PLAN
[Added 1 July 2010]
Background
Some defined benefit plans stipulate that employee contributions must be a fixed
proportion of the total contribution rate. These arrangements typically require
surpluses to be shared between the employer and employees. Additionally, if there is
a deficit in the plan, the plan terms require that additional contributions needed to
cover the deficit be shared between the employer and employees.
Question
How should a defined benefit obligation (DBO) be measured when there is an
expectation that employee contributions will be increased in the future to cover a
deficit?
Answer
IAS 19.73 states that "[a]ctuarial assumptions are an entity's best estimates of the
variables that will determine the ultimate cost of providing post-employment
benefits".
In measuring the DBO, the entity should make its best estimate (as one of the
actuarial assumptions) of the number of employees expected to remain in the plan
and the amount of contributions they are expected to make to finance the deficit.
IAS 19.85 states that "[i]f the formal terms of a plan (or a constructive obligation
that goes beyond those terms) require an entity to change benefits in future periods,
the measurement of the obligation reflects those changes". Therefore, if the terms of
a defined benefit plan include cost-sharing provisions, the requirement for employees
to make contributions to reduce or eliminate an existing deficit should be considered
when measuring the DBO.
Note: IFRS Interpretations Committee agenda decision published in the November

2007 IFRIC Update.
Q&A IAS 19: 92-1 — ACCOUNTING FOR THE EFFECT OF A CHANGE IN

PENSION LEGISLATION
Background
Entity X (X) operates a defined benefit pension plan. Under the scheme rules,
members can choose, on retirement, to receive an annual pension or to exchange
part of the pension for a tax-free lump sum payment. The scheme rules specify a
commutation rate of 9:1, which means that a member can exchange one unit of
annual pension for a tax-free lump sum payment of nine units. The lump sum
amount is subject to a maximum set by the tax authority.
Changes in tax legislation increase the maximum lump sum amount that a member
can receive tax-free.
In the past members usually preferred an immediate lump sum payment rather than
the ongoing pension, either from a liquidity perspective or because they
underestimate the effective value of the pension.
The increased lump sum maximum might allow X to mitigate the adverse effects of
increasing longevity and falling interest rates. For example, when the applicable
commutation rate no longer reflects a cost-neutral exchange rate of pension versus
lump sum, an increase in the maximum lump sum amount (with the same
commutation rate), will lead to a reduction in the defined benefit obligation on the
basis of the assumption that members will choose the maximum lump sum payment
on retirement.
Because of the change in tax legislation, X amends the scheme rules to permit
members to opt for the "increased" lump sum amount on retirement. No other
amendments are made to the scheme rules, and the commutation rate remains the
same.
Question
How should this amendment to the scheme rules be accounted for?
Answer
The legislative change alters how members can choose to receive the benefits, not
the overall benefits that members are entitled to. The amount available to members
on retirement, which can be taken as an annual pension or a lump sum, does not
change. Because members are no better or worse off, amending the pension scheme
solely to reflect this legislative change does not substantively alter the defined
benefit plan.
The pension fund retains the long-term risk for any amounts taken as a pension (i.e.
amounts the employee chooses not to receive as a lump sum). As part of the
actuarial valuation, the employer assesses how many employees are expected to
take part of their overall benefits as a lump sum and (2) how much each employee is
expected to take. If the legislation changes to allow more to be taken as a lump
sum, it is likely that the actuarial assumptions regarding the amounts taken as a
lump sum would change, resulting in an actuarial gain or loss that should be
accounted for in accordance with the entity's accounting policy for actuarial gains
and losses. Such gains and losses may be recognised in the statement of recognised
income and expense (SORIE) described in IAS 19.93B, the income statement, or
using the corridor approach described in IAS 19.92.
Note the IFRIC agenda decision published in the November 2007 IFRIC Update.
Q&A IAS 19: 93-1 — SYSTEMATIC APPLICATION OF THE CORRIDOR

APPROACH
Question
An entity has several employee defined benefit plans. The entity has chosen to apply
the corridor approach for the recognition of actuarial gains and losses. However, it
would like to recognise actuarial gains and losses in profit or loss immediately for

some plans that include a large portion of retirees. Can an entity apply different
accounting policies to the recognition of actuarial gains and losses for different
defined benefit plans?
Answer
No. The treatment for the recognition of actuarial gains and losses should be
consistent for all defined benefit plans in accordance with IAS 8.13 Accounting
Policies, Changes in Accounting Estimates and Errors, which requires that an entity
shall select and apply its accounting policies consistently for similar transactions,
events, and conditions.
However, even though the corridor approach must be applied in the same way to all
plans, the period over which actuarial gains and losses will be recognised is likely to
be shorter for employee benefit plans that include a large portion of retirees, as this
factor must be considered in determining the expected average remaining working
lives of the employees participating in each plan.
Q&A IAS 19: 96-1 — PRIOR SERVICE COST AMORTISATION

ATTRIBUTED TO INDIVIDUAL EMPLOYEES
[Issued 6 May 2005]
Question
Company N (N) established a supplemental executive retirement scheme (SERS) for
three key executives. When the plan was initiated, it granted benefits based on
services rendered in prior periods (prior service costs). Under the provisions of IAS
19.96, prior service costs were being amortized on a straight-line basis over the
average period until the benefits become vested. This amortisation method resulted
in an amortisation period of approximately 15 years.
Subsequent to the initial determination of the amortisation method, one executive

resigned. Additionally, because a second executive is nearing retirement, it is
apparent that the current amortisation method will result in amortisation of
unrecognised prior service costs during a period when only one participant will be
providing service.
Is a change from N's current method of amortisation to an amortisation method that

recognises the cost of each individual's added benefits over that individual's
remaining service period preferable under the circumstances?
Answer

No. The Board explained in IAS 19.BC56 the rationale for requiring a unique
amortisation method for unrecognised balance of past service cost stating:
Any amortisation method is arbitrary and decided to require straight-line

amortisation as that is the simplest method to apply and understand.
The same paragraph, BC56, further states:
Paragraph 99 confirms the amortisation schedule is not amended for

subsequent changes in the average remaining working life, unless there is
a curtailment or settlement.
Consequently, as the events described above do not represent a curtailment or
settlement, the amortisation period should not be modified.
Q&A IAS 19: 96-2 — ADDITION OF ONE EXECUTIVE IN A COMPANY'S

SUPPLEMENTAL EXECUTIVE RETIREMENT SCHEME
[Issued 6 May 2005]
Question
In connection with an acquisition, Company C (C) has given an executive of the
acquired company a three-year employment contract that includes 100 per cent
vested participation in C's supplemental executive retirement scheme (SERS). Under
the scheme, the executive will receive credit for prior service at the acquired entity.
As a result, the SERS's projected benefit obligation will increase. Company C does
not intend to fund any of the increase in the accumulated benefit obligation.
Should C immediately recognise the additional SERS obligation created by the

admission of the one executive into the plan?
Answer
Yes. The admission of the executive is analogous to a plan amendment and results in
prior service cost. In general, IAS 19.96 requires that the cost of providing
retroactive benefits of plan amendments be amortised over the period until the
benefits become vested.
However, in this case the employee is vested in these benefits upon entering into the
plan, such that as the benefits are already vested in the introduction of the change,
C should recognise the past service cost immediately.

Q&A IAS 19: 102-1 — FAIR VALUE OF PLAN ASSETS IN ACCORDANCE
WITH IAS 19
Question
IAS 19.102 requires pension fund assets to be measured at fair value in determining
the amount to be shown on the employer's balance sheet but does not provide
detailed guidance on how to determine their fair value. Should an entity apply the
guidance in IAS 39 Financial Instruments: Recognition and Measurement, in
determining the fair value of a pension plan's financial assets?
Answer
Yes. The definition of the fair value of a pension plan's financial assets is the same as
that required in IAS 39, and, therefore, the Application Guidance given in Appendix A
to IAS 39 should be applied to pension plan financial assets.
In particular, IAS 39.AG72 requires the use of bid prices for financial assets unless
the entity has financial liabilities with offsetting market risks. Accordingly, bid prices
generally should be used in determining the fair value of financial assets held by a
plan.
Q&A IAS 19: 104-1 — MEASUREMENT OF QUALIFYING INSURANCE

POLICIES
[Added 7 May 2010]
Background
Company A sponsors a defined benefit pension plan. Its defined benefit obligation
under IAS 19 is measured at CU100. Company A buys an insurance policy from an
insurance company, Company B, which will cover the entire obligation and exactly
match the payments due to the employees in accordance with the benefit formula in
the plan (both in amount and timing). Company B is not a related party as defined in
IAS 24 Related Party Disclosures. It is determined that the policy represents a
'qualifying' insurance policy as defined in IAS 19.7. Company B charges CU120 for
the insurance policy.
Question
What value should be attributed to the insurance policy for the purposes of
measuring plan assets and, if that value is not cost, how should Company A account
for the difference?
Answer
In accordance with IAS 19.104, qualifying insurance policies should be reflected in
plan assets at their fair value, which is deemed to be the present value of the related
defined benefit obligations (in this example, CU100).
In respect of the difference between this amount and the cost of the policy (CU120),
either of the treatments set out below would generally be acceptable:
• treatment A: the excess of CU20 is considered a cost of the obligation

being effectively assumed by Company B and is immediately recognised as
an expense in profit or loss; or
• treatment B: Company A initially recognises the insurance policy at

CU120. The policy is then immediately remeasured in line with IAS 19.104.
The difference of CU20 is treated as an actuarial loss and is accounted for
in line with the entity's policy for recognising actuarial gains and losses.
In some circumstances, it may be possible to determine that the difference (or a part
of it) clearly relates to transaction costs. In those circumstances, the amount
determined to represent transactions costs is immediately recognised as an expense
in profit or loss. Any remaining difference is recognised using either treatment A or B
above, based on the entity's accounting policy.
Q&A IAS 19: 106-1 — SUPPORT FOR LONG-TERM RATE OF RETURN

ASSUMPTION
[Issued 6 May 2005]
Background
IAS 19.106 states that the expected return on plan assets is based on market
expectations, at the beginning of the period, for returns over the entire life of the
related obligation.
Question
What specific factors might a plan sponsor consider in developing its long-term rate
of return (LTRR) assumption?
Answer

The development of future rate of return assumptions should be based on a coherent
methodology that is prudent and reasonable. By applying a formal analytical
approach, plan sponsors are equipped with the means to determine (and, if
necessary, defend) the reasonableness of the LTRR assumptions chosen for their
plans.
The plan sponsor must ensure that the approach used in determining its LTRR
assumption is clear, logical, and comprehensive. It is the responsibility of the
sponsor to ensure that adequate support for the LTRR assumption exists.
The following factors may be considered when a plan sponsor is developing its LTRR
assumption (this list is not meant to be all-inclusive):
• the assumed asset allocation of pension plan assets (common stock,

bonds, etc.);
• the assumed volatility of the portfolio;
• the location of the assets;
• the methods of constructing a best estimate range of investment returns,

such as the Building Block method or the Cash Flow Matching method; 1;
• historical return data by asset category;
• rolling averages by asset category over a long-term period (i.e. five, ten
years);
• current trends with respect to economic conditions, inflation, and market

sentiment;
• views and forecasts by market analysts;
• views of the plan sponsor;
• views of external investment managers;
• investment manager performance; and
• investment policy.
For additional information related to these and other methods used in establishing
the long-term rate of return assumption, contact your local Deloitte & Touche Human
Capital specialist.

1 In the Cash Flow Matching method, a high quality bond portfolio is constructed that
matches the pension plan's expected distributions; the rate of return on the portfolio is
then risk adjusted for uncertainties, mismatches, and future asset mix considerations. In
the Building Block method, the pension plan's expected asset mix and actual returns, as
well as historical data, are used to calculate an estimate of the real rate of return for the
plan, which is then adjusted for the expected level of inflation.
Q&A IAS 19: 109-1 — DEFINED BENEFIT PLANS: OPTION TO RECEIVE A

LUMP SUM PAYMENT
Background
Entity A's defined benefit plan provides plan members with an option to receive a
lump sum payment at retirement instead of ongoing pension payments. The
assessment as to whether members will take the lump sum is reflected in the
actuarial assumptions underlying the measurement of the defined benefit obligation.
Question
Does a lump sum payment made under Entity A's defined benefit plan represent a
settlement as defined in IAS 19.112?
Answer
No. If an employee of Entity A chooses to receive a lump sum payment, the lump
sum is not accounted for as a settlement under IAS 19.109. Any gain or loss arising
from the remeasurement of the defined benefit obligation as a result of a change in
the number of, or extent to which, employees choose to receive a lump sum
payment will be accounted for as an actuarial gain or loss, and will be recognised in
accordance with Entity A's accounting policy for actuarial gains and losses.
Note the IFRIC agenda decision published in the May 2008 IFRIC Update.
Q&A IAS 19: 111-1 — INTERPRETATION OF "MATERIAL" IN

DETERMINING A CURTAILMENT
[Issued 6 May 2005]

Question
An entity has several pension plans that are being discontinued as a result of an
isolated event. To determine whether a curtailment has occurred in accordance with
IAS 19, should the entity consider the impact on an overall basis or the impact on
each individual pension plan affected?
Answer
IAS 19.111 states that the discontinuance or suspension of a pension plan qualifies
as a curtailment "if the recognition of a curtailment gain or loss would have a
material effect on the financial statements".
Generally, the entity should consider the impact for each individual plan as if each is
being discontinued separately. Consequently, if an entity has more than one pension
plan that is being discontinued, the decision as to whether the impact is material for
the purposes of determining whether a curtailment has occurred must be made at
the individual plan level.
However, if terminations occur across various businesses as part of a single

reorganisation plan or as a result of a single action that affects employees in a
number of pension plans, the effects on the individual plans should be aggregated to
determine whether they are material for the financial statements as a whole. This is
true even when the impact of the curtailment on the plans has been individually
assessed as not material.
Q&A IAS 19: 111-2 — TIMING OF CURTAILMENT RECOGNITION

[Issued 6 May 2005]
Question
In what period should a company report a curtailment gain resulting from an
amendment to its pension benefit plan that (a) is approved by its Board of Directors
and announced to the participants during the current period but (b) is effective in
the subsequent period?
Answer
IAS 19.111 indicates that the gain should be recorded when the plan is amended,
not when it is effective. As curtailments frequently are linked with a restructuring in
determining when the plan is amended, it is relevant to determine when the
conditions to set a restructuring provision under IAS 37.72 would have been met.

Q&As IAS 19: 111-3, 111-4, and 111-5 — RECOGNITION AND
MEASUREMENT OF A CURTAILMENT GAIN RELATED TO
INVOLUNTARY TERMINATIONS EXPECTED TO OCCUR OVER AN
EXTENDED PERIOD
Background
Entity R (R) has a defined benefit pension plan that substantially covers all of its
employees. Entity R is in the process of restructuring its operations, which includes
an involuntary termination of its workforce and a spin-off of one of its subsidiaries.
The involuntary termination of employees is expected to occur over a 36-month
period, commencing on the announcement date of the restructuring.
IAS 19: 111-3
[Issued 6 May 2005]
Question
When should a curtailment gain related to the involuntary termination of employees
be recognised?
Answer
IAS 19.111 requires a curtailment to be recognised in earnings at the same time as
for a related restructuring.
Accordingly, the gain should be recognised in the period in which the conditions for
recognising a provision for termination benefits are met pursuant to IAS 19.133.
IAS 19: 111-4
[Issued 6 May 2005]
Question
How should the curtailment gain be measured for terminations over an extended
period?
Answer
As noted in the response to Q&A IAS 19: 111-3, the gain should be recognised in the
period in which the condition for recognising a provision for termination benefits is
met. If the number of employees expected to be terminated, or the value of the
related curtailment gain is not reliably measurable at that date, the gain should be
recognised when it becomes reliably measurable.
IAS 19: 111-5
[Issued 6 May 2005]
Question
How would Entity R account for differences between the number of employees
originally considered in the restructuring and the number of employees actually
terminated?
Answer
The differences would be accounted for as a gain or loss as they occur and would not
be included in the accumulated unrecognised gains and losses. Ordinarily, there
should not be significant differences between the number of employees considered in
the restructuring and the number of employees actually terminated. A significant
increase in the number of employees included in the restructuring provision would
require consideration of whether these employees were part of the original plan. If it
is not the case, a new curtailment should be accounted for.
Q&A IAS 19: 128-1 — MEASUREMENT OF 'OTHER' LONG-TERM

EMPLOYEE BENEFITS PRESENTED AS CURRENT LIABILITIES
Question
As discussed in Q&A IAS 1(2007): 60-2, some obligations for 'other' long-term
employee benefits may be presented as current liabilities (based on the employees'
entitlement to take their benefits within 12 months of the reporting period rather
than on the expected timing of payment). In measuring such obligations, should
amounts be discounted to reflect the expected timing of payment?
Answer
Yes. IAS 19.128 requires that 'other' long-term benefit obligations be measured
using the same valuation methodology as defined benefit post-employment benefit
obligations (except that all past service cost and actuarial gains and losses are
required to be recognised immediately through profit or loss). In particular, IAS
19.66 specifies that “[a]n entity discounts the whole of [an 'other' long-term] benefit
obligation, even if part of the obligation falls due within twelve months after the
reporting period”.

Therefore, a current liability arising from 'other' long-term employee benefits will be
measured as a discounted amount.
Q&A IAS 19: 133-1 — VOLUNTARY TERMINATION BENEFITS

REQUIRING REGULATORY APPROVAL
[Issued 6 May 2005]
Background
The company has offered voluntary special termination benefits to specific union
employees in certain jurisdictions. The identified employees have accepted the
termination benefits. The company has obtained the approval of the benefit
packages from the employees' union.
The company has not received required approval from a National Employment
Agency in the workers' country. However, the company has indicated that for many
years it has routinely obtained similar approval without challenge.
Question
Should the company recognise special termination benefits prior to receiving
regulatory approval?
Answer
Yes. The special termination benefits should be recognised in accordance with IAS 19
if the required approval from the National Employment Agency is virtually automatic
(that is, there are no situations envisaged in which the approval would be denied).
The company's history of obtaining approval of similar special termination benefits
without challenge appears to support the position that the required approval is
perfunctory. However, in order for the company to substantiate its position, it may
obtain an opinion from legal counsel.
Q&A IAS 19: 133-2 — EARLY RETIREMENT PLANS

Question
Company A (A) is an entity that encourages employees to retire at the age of 58
instead of the national retirement age of 65. The postretirement programme in A's
country is a state pension plan. The state sets out the conditions for an employee to
receive retirement benefits before the age of 65. This benefit does not form part of
an employee's contractual terms and conditions of employment, and every year, A
can decide whether to offer early retirement to its employees. Company A is not,
therefore, obligated to make such an offer. While the retirement benefit for persons
between the ages of 58 and 65 is paid for by the government, A is required to fund a
portion of those payments.
An employee who is offered an early retirement plan can either accept or reject the
offer. The offer is normally made prior to the employee's early retirement date (this
period may vary from a few months to a couple of years). If the employee does not
accept the offer, he or she will continue service until normal retirement age. Early
retirement plans are normally implemented to reduce the work force by a means
other than compulsory redundancy. A company may propose early retirement plans
to a selected category of employees.
Is the above transaction a post-employment benefit or a termination benefit under

IAS 19?
Answer
IAS 19.7 defines termination benefits as follows:
Termination benefits are employee benefits payable as a result of either:

a) an entity's decision to terminate an employee's employment before the
normal retirement date; or
b) an employee's decision to accept voluntary redundancy in exchange for

those benefits.
In addition, IAS 19.132 states, "This Standard deals with termination benefits
separately from other employee benefits because the event which gives rise to an
obligation is the termination rather than employee service".
The payments fit the definition of termination benefits because both of these criteria
have been met. A liability arises when the employer is demonstrably committed to
the payment in accordance with IAS 19.134.
At the point the entity is demonstrably committed, the full liability should be
recognised at the amount expected to be paid. If material, the liability should be
present-valued for the period until the payment is made. The recognition of the
expense cannot be spread over the remaining working life of the employee since the
payment has no relation to future employee service.
Q&A IAS 19: 133-3 — ACCOUNTING FOR COSTS OF EMPLOYEES

PLACED ON TEMPORARY SUSPENSION
[Added 28 May 2010]
Background
Company A temporarily suspends employees during difficult economic periods when

there is a downturn in production activity. Company A and the employees enter into
a temporary suspension agreement, under which:
• employees remain employed during periods of suspension on the same

terms as their current employment contracts;
• during the suspension period, employees collect unemployment benefits

from the State as well as a reduced salary from Company A so that the
amount of cash they receive each month equates to a percentage of their
current salary (i.e. Company A commits to pay employees the difference
between the unemployment insurance they receive and an agreed
percentage (e.g. 75 per cent) of their current salaries);
• employees are not required to physically be at work during the suspension

period;
• Company A has the right to call the employees back to work as necessary
during the suspension period (e.g. as production activity fluctuates); and
• employees cannot take up work elsewhere during the suspension period (

i.e. they are required to stay at home unless they resign, in which case a
fixed notice period is required).
The suspension of employees is expected to last for a period of between six months
and two years depending on Company A's needs and the economic environment.
Schemes such as these have been developed in countries where the State is
reluctant to change redundancy laws in favour of employers but is willing to offer a
form of subsidy by paying unemployment benefits to employees during suspension
periods.
Question
Should Company A recognise a liability for the expected cost of the suspended
employees when the temporary suspension agreement is first enforced?
Answer
The costs of employees placed on temporary suspension fall within the scope of IAS
19 because they represent employee benefits. They will be classified in one of the
categories identified by IAS 19 (i.e. short-term employee benefits, post-employment
benefits, other long-term employee benefits and termination benefits) based on facts
and circumstances (e.g. local social laws, local practices and the use made by the
employer of such arrangements).
When the employer uses a temporary suspension arrangement of this nature in

order to reduce its employment costs during periods of reduced activity, but it
intends to eventually resume normal working arrangements for the employees, the
costs of the temporary suspension are likely to be classified as a short-term benefit
similar to a compensated absence (i.e. holiday or leave pay) rather than as a
termination benefit. Short-term compensated absences only give rise to a liability
when they are accumulating, as discussed in IAS 19.11 and IAS 19.16. This is not
the case in the circumstances described because the employees only have a right to
receive payments as suspension occurs and for as long as suspension lasts.
Company A has the discretion to ask some or all of its employees to return to work
at any time and revert to normal working arrangements and remuneration.
In other circumstances, however, the temporary suspension may represent the first
phase of a restructuring plan, and the costs of the temporary suspension may meet
the definition of a termination benefit under IAS 19. For this to be the case, there
must be a plan to actually terminate the employees (the entity would have to have
offered and be committed to paying or be committed to terminating employment). In
such circumstances, the employer is required to make payments to employees but
does not expect to receive any more services in return; consequently, a provision
should be recognised for the employer's best estimate of the amount it will be
required to pay over the entire suspension period. This estimate should take into
account the number of employees expected to be suspended, the expected duration
of their suspension and the difference between the agreed percentage of employee
salaries and unemployment insurance. The amount of the provision should be
revised as circumstances and assumptions develop throughout the suspension
period.
If the entity has an option to terminate the employees immediately, but it chooses
instead to enter into the suspension arrangement, this indicates that the temporary
suspension arrangement is considered by management to be more beneficial for the
entity. In such circumstances, the amount of the provision recognised should be
limited to the amount that would have been payable had the employees been
terminated immediately (i.e. the least net cost of exiting the contract).
Q&A IAS 19: 134-1 — TIMING FOR RECOGNITION OF TERMINATION

BENEFITS OBLIGATIONS
[Added 1 July 2010]
Background
Paragraph 72 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets sets

out the specific application of that Standard's recognition criteria to provisions for
restructuring costs and states that a constructive obligation to restructure arises only
when an entity has a detailed formal plan for the restructuring and “has raised a
valid expectation in those affected that it will carry out the restructuring by starting
to implement that plan or announcing its main features to those affected by it”.
Under IAS 19.133, a provision for termination benefits should be recognised when,
and only when, the entity is “demonstrably committed” to the termination. IAS
19.134 clarifies that an entity is demonstrably committed “when, and only when, the
entity has a detailed formal plan for the termination and is without realistic
possibility of withdrawal”. Unlike IAS 37.72, IAS 19 does not require that the entity
have either started to implement the plan or announced its main features.
Question
Is there any substantive difference between the requirements for recognition of a
provision under IAS 37.72 and IAS 19.134?
Answer
No. For a termination benefit to be recognised, the entity must be demonstrably
committed to the termination at the end of the reporting period. Although worded
slightly differently, IAS 19.134's no “realistic possibility of withdrawal” condition is
similar to IAS 37.72(b)'s “valid expectation” condition. Generally, if the entity has
not started to implement the termination plan, some form of announcement to those
affected by it would be necessary in order to demonstrate that the entity has no
realistic possibility of withdrawal.
Q&A IAS 20: 12-1 — PROFIT OR LOSS PRESENTATION OF

GOVERNMENT GRANTS RELATED TO ASSETS USED IN THE
PRODUCTION OF INVENTORIES
Background
Entity X received a government grant for the purchase of new machinery for use in
its production plant. There are no other conditions attached to the government
grant. The machinery is used to produce inventories for sale in the ordinary course of
business. Depreciation of the machinery is reflected in the cost of inventories (cost of
conversion). As permitted by IAS 20.24, Entity X recognises the government grant
on a gross basis (i.e. by recognising deferred income in the statement of financial
position).
Question
How should Entity X recognise the amortisation of the deferred income related to the
government grant?
Answer
IAS 20.12 states that “[g]overnment grants shall be recognised in profit or loss on a
systematic basis over the periods in which the entity recognises as expenses the
related costs for which the grants are intended to compensate.”
IAS 20.12 specifies the period in which the grant should be recognised in profit or
loss but it does not indicate the manner in which it is eventually recognised in profit
or loss. Therefore, there may be more than one acceptable method.
The preferred treatment is to account for the amortisation of the deferred income in
the same manner as the depreciation of the related machinery. Under this method,
the amortisation of the deferred income should be included in production overheads
and included in the cost of inventories (thereby reducing the cost of inventories).
This treatment is preferred because it results in the same profit or loss treatment as
if the grant had been recognised on a net basis (i.e. offset against the cost of the
asset).
However, it may also be acceptable to recognise the amortisation of the grant

directly in profit or loss. Under this approach, the deferred income is not amortised
until the depreciation of the machinery eventually affects profit or loss (i.e. the
depreciation of the machinery 'transits' through inventories but the amortisation of
the government grant does not). This method is considered acceptable provided that
the amortisation is recognised in profit or loss in the same period as the cost of
inventories that include the depreciation of the machinery.
Q&A IAS 20: 12-2 — GOVERNMENT LOANS RECEIVED AT

BELOW-MARKET RATES OF INTEREST
[Added 7 May 2010]
Background
Entity Q received a loan of CU3 million from the government. The loan is at 2 per
cent interest and is repayable in five years. Using prevailing market interest rates of
5 per cent, the fair value of the loan is calculated at CU2,610,347.

Under paragraph 43 of IAS 39 Financial Instruments: Recognition and Measurement,
the loan is recognised at CU2,610,347. The difference between this amount and
proceeds received (CU389,653) is the benefit derived from the below-market interest
and is recognised as deferred income. Therefore, on the date that the loan is
received, the following journal entries are recorded.
The interest expense is recognised in profit or loss at 5 per cent in accordance with
IAS 39.
Question
How should Entity Q account for the government grant (CU389,653) under IAS 20?
Answer
In accordance with IAS 20.12, the amount of the government grant (CU389,653)
should be recognised in profit or loss on a systematic basis over the periods in which
Entity Q recognises as expenses the related costs for which the grant is intended to
compensate.
The costs for which the below-market interest rate is intended to compensate are
assessed on the basis of the particular circumstances. For example, the loan may be:

• intended to subsidise training costs over a three-year period. The costs
may be incurred on a straight-line basis, in which case the government
grant will be recognised in profit or loss on a straight-line basis — i.e.
CU129,884 (CU389,653/3) each year for three years; or
• intended as a rescue measure for the purpose of giving immediate financial

support. In such circumstances, under IAS 20.21, it may be appropriate to
recognise the benefit in profit or loss immediately; or
• intended to finance a depreciable asset, in which case the benefit would be

recognised on the same basis as depreciation.
Q&A IAS 20: 24-EX-1 — PRESENTATION OF GRANTS RELATED TO

ASSETS
Example
At the beginning of 20X1, an entity invests CU1,000,000 in an item of equipment,
which has an anticipated useful life of five years. Depreciation is recognised on a
straight-line basis. In the year of acquisition, the entity receives a government grant
of CU250,000 towards purchase of the equipment, which is conditional on certain
employment targets being achieved within the next three years (i.e. to the end of
20X3). Under the alternative methods permitted under IAS 20, the presentation is as
follows.
Method A: Grant shown as deferred income

Note that the condition requiring certain employment targets to be met within three
years is not relevant for determining the period over which deferred income is
recognised in profit or loss. The condition requires disclosure, however, as a
contingency.
Method B: Grant deducted from cost of asset

Q&A IAS 20: 26-1 — GOVERNMENT GRANTS RELATED TO
DEPRECIABLE ASSETS WITH INCREASING RESIDUAL VALUE
Background
Depreciable assets whose residual value increases over time will initially be
depreciated, but often depreciation will cease before the end of the asset's useful life
because its residual value has increased so as to exceed its carrying amount.
Question
In such circumstances, how should any associated grant be recognised in profit or
loss?
Answer
The following two approaches are considered acceptable, depending on the
circumstances.
• The grant is matched to the initial cost of the asset, so that it is in part
recognised with the depreciation expense but with the balance being
recognised only on disposal. For example, if an asset was initially
recognised at a cost of CU1,000, and ceased to be depreciated when its
carrying amount was CU860 (because the asset's residual value less the
remaining grant had risen to exceed the carrying amount), 14 per cent of
the grant would by then have been recognised in profit or loss, with 86 per
cent being held in the statement of financial position and released only on
disposal.
• A proportion of the remaining grant is released each year, so that the

remaining balance reflects the amount of the asset yet to be amortised
(i.e. the excess of carrying amount over updated residual value) as a
proportion of expected total depreciation on the asset.
IAS 20.12 indicates that government grants should be recognised "on a systematic
basis over the periods in which the entity recognises as expenses the related costs
for which the grants are intended to compensate". The first approach may be judged
closest to the requirements of IAS 20.12 if, in fact, the grant is intended to
compensate both the use of the asset and its subsequent disposal. It may also be
the most appropriate approach if there are any arrangements under which a
proportion of the grant must be repaid by reference to sale proceeds received.
It may be judged, however, that the grant is intended only to compensate for the
costs of using the asset, not disposing of it; if so, the second approach described
above perhaps best approximates this. The second approach is, arguably, also
closest to the requirement of IAS 20.17 that grants for depreciable assets should be
"recognised in profit or loss over the periods and in the proportions in which
depreciation expense on those assets is recognised". The application of the second
approach is illustrated in IAS 20: 26-EX-1.
Q&A IAS 20: 26-EX-1 — GOVERNMENT GRANTS RELATED TO A

DEPRECIABLE ASSET WITH INCREASING RESIDUAL VALUE
RECOGNISED AS A PROPORTION OF EXPECTED TOTAL
DEPRECIATION
Example
This example illustrates the second approach described in Q&A IAS 20: 26-1.
An entity purchases a film library on 1 January 20X1 for CU1,000, and receives a
related grant of CU200. There are no obligations to repay the grant if the library is
subsequently sold. The estimated useful life of the film library to the entity is five
years, and the pattern of depreciation for the first four years is as follows.

The release of the grant would be calculated as follows.
Q&A IAS 20: 32-EX-1 — REPAYMENT OF A GOVERNMENT GRANT

Example
At the beginning of 20X1, an entity invests CU1,000,000 in an item of equipment,
which has an anticipated useful life of five years. Depreciation is recognised on a
straight-line basis. In the year of acquisition, the entity receives a government grant
of CU250,000 towards purchase of the equipment, which is conditional on certain
employment targets being achieved within the next three years (i.e. to the end of
20X3).
At the end of 20X3, it is evident that the entity has failed to fulfil the employment
conditions attached to the receipt of the asset-related grant. The grant therefore
becomes repayable. Under the two methods of presentation of the grant (see Q&A
IAS 20: 24-EX-1), the treatment of the repayment is as follows.
Method A: Grant shown as deferred income
Note that, under this method, the repayment of the grant has no effect on the
carrying amount of the equipment or on the depreciation expense recognised.
Method B: Grant deducted from cost of asset

Q&A IAS 21: 8-1 — THE PRESENTATION CURRENCY

Question
What is presentation currency?
Answer
An entity normally presents its financial statements in the same currency as the
functional currency; however, an entity may choose to present its financial
statements in a different currency. This may be the case for foreign entities in the
preparation of consolidated financial statements for its parent. The currency used in
presenting the consolidated financial statements normally is the same as the parent's
functional currency but will often differ from the functional currencies used by
individual foreign entities. The method of translating from the functional currency to
a different currency for presentation is discussed in IAS 21.38–43. However, for
financial statements to present fairly the financial position, financial performance,
and cash flows, the translation method applied by an entity should not lead to
reporting in such a manner that is inconsistent with the measurement of items in the
financial statements using the functional currency.
Q&A IAS 21: 9-1 — THE FUNCTIONAL CURRENCY OF AN OPERATING

COMPANY VERSUS A SHELL CORPORATION
Question
Company M (M) has identified the euro as its functional currency. Company M
establishes two companies, P and Q. Company P is incorporated in the U.S. and Q is
incorporated in the UK Company M loaned two million pounds sterling to each
company, and both recorded the transaction as an intercompany payable. Company
Q also borrowed an additional three million pounds sterling from an unrelated third
party; P guaranteed this loan. Company Q invested the entire five million pounds
sterling in building a manufacturing facility to serve the domestic UK market.
Company Q intends to repay the loan to the third party through the profit generated
though its manufacturing operations. Company P used the loan to invest in
marketable securities in international markets.
What are the functional currencies of P and of Q?
Answer
IAS 21.8 defines functional currency as the currency of the primary economic
environment the entity operates in. IAS 21.9–11 provides criteria to determine an
entity's functional currency. As a general matter, the functional currency should
provide information about the entity that is useful and reflects the economic
substance of the underlying events and circumstances relevant to that entity. If a
particular currency is used to a significant extent in, or has a significant impact on,
the entity, that currency may be an appropriate currency to be used as the
functional currency. As such, the pound sterling would be Q's functional currency as
that is the currency of the country that influences the sale prices and costs of its
goods, as well as the regulations and competitive forces.
On the contrary, even though P is domiciled in the U.S., its activities, investing in
marketable securities, are carried out as an extension of M, such that those activities
could have been carried directly in the parent's books. Therefore, in accordance with
IAS 21.11(a), P should use the euro as its functional currency.
Q&A IAS 21: 9-2 — DETERMINATION OF THE FUNCTIONAL CURRENCY

OF INVESTMENT FUNDS
Background
Some features common to investment funds include the following (not an exhaustive
list):
• Investors in the fund subscribe and redeem their investment in a specific

currency. It may be impossible, depending on the fund's policies or
regulatory requirements, to subscribe or redeem such investments in any
other currency.
• The fund may conduct its investment activities through subsidiaries set up
in various jurisdictions to take advantage of tax treaties, double taxation
agreements, and concessions.
• The investment fund's policies may allow it to invest in various securities

regardless of jurisdiction, industry, or currency. Consequently, investment
transactions and the related income and expenses may be denominated in
various currencies.
• Investment management fees may be invoiced and received in a specific

currency.
• Other costs of operating the fund may be denominated in the local

currency of the jurisdiction in which the fund physically operates.
Question
How should the functional currency of an investment fund be determined?
Answer
IAS 21.12 clarifies that in determining the functional currency of a foreign operation,
management should consider the guidance in IAS 21.9–11, giving IAS 21.9 priority
before considering IAS 21.10 and 11.
In the context of an investment fund, IAS 21.9 does not seem immediately relevant
and is difficult to apply because its factors are directed towards manufacturing
entities that provide goods and services. However, the same underlying principle can
be applied to a fund with a mandate to buy and sell securities to generate a return
for investors. Hence, the currency of the country whose competitive forces and
regulations mainly determine the fund's revenue should be considered when
determining the functional currency. The currency in which management fees are
charged may provide an indication of the functional currency. In addition, the
currencies in which the fund's labour costs, and operating expenses are sourced and

incurred should also be considered.
However, when a fund's functional currency is not obvious from the analysis above,
consideration of the secondary indicators in paragraph 10 may provide additional
evidence. The currency in which the fund raises finance from investors (i.e. the
investor's participation in a fund) and makes distributions to investors (e.g. on
redemption) should be considered. The currency in which dividends on investments
or interest inflows are received will provide additional evidence of the functional
currency.
The indicators in IAS 21.11 should also be considered if they are relevant to an
investment fund (in a foreign operation).
IAS 21.12 states that when the indicators in IAS 21.9–11 are mixed and the
functional currency is not obvious, "management uses its judgement to determine
the functional currency that most faithfully represents the economic effects of the
underlying transactions, events, and conditions".
Q&A IAS 21: 11-1 — FACTORS TO CONSIDER IN DETERMINING THE

FUNCTIONAL CURRENCY OF A FOREIGN OPERATION
[Added 7 July 2006]
Question
IAS 21.11 provides factors to be considered in determining whether the functional
currency of a foreign operation is the same as that of the reporting entity. By
applying IAS 11.11(a), are there additional factors that might be considered in
determining whether the activities of the foreign operations are carried out as an
extension of the reporting entity?
Answer
Consideration of the following additional factors, based on the nature of the foreign
operation, may assist in the determination of functional currency:
a. Where an intermediate holding company carries out duties related to the

sub-group it holds investments in. For example, when the company:
i. has separate directors/employees from the ultimate parent entity;
ii. has its own reporting responsibilities and produces consolidated

accounts including the sub-group; and
iii. actively manages a series of operations in a geographic area, and,

therefore, incurs costs in a local currency.
This would indicate that the functional currency of the company is not the
same as that of the ultimate parent. Where the intermediate holding
company exists solely in order for the ultimate parent entity to obtain a
tax, regulatory, jurisdictional or legal type benefit it would not otherwise
receive, this indicates that it is an extension of its parent entity.
b. Where the foreign operation is clearly set up as a special purpose entity

(SPE), its activities are being conducted on behalf of the parent entity (e.g.
Employee Benefit Trusts (EBTs), leasing vehicles, etc.) and the SPE is an
extension of the reporting entity. Therefore, it should have the same
functional currency as that of the reporting entity.
c. For treasury entities it is necessary to assess whether they exist to serve

the funding and cash management needs of the group as a whole (i.e.
constitute an extension of the parent entity), or whether they exist solely
to service a specific sub-group. In the latter case, the functional currency
of the SPE may be different to that of the parent entity.
d. A "money box" entity is an entity that holds cash only. In accordance with
the factors in IAS 21.9–12, it is not the currency of the cash that the entity
holds that is the deciding factor in determining functional currency.
Consistent with (a) to (c) above, it is necessary to consider for whose
benefit the "money box" entity exists, which will determine its functional
currency.
Q&A IAS 21: 15-1 — TRANSACTION GAINS OR LOSSES TO BE

EXCLUDED FROM INCOME: ROLLING OR MINIMUM BALANCES
VIEWED AS LONG-TERM INVESTMENTS
Background
There are two circumstances in which a transaction gain or loss on a

foreign-currency-denominated transaction would not be recognised in income. The
first circumstance is when the foreign-currency-denominated asset or liability is
designated as a hedge of a net investment in a foreign entity in accordance with IAS
39 Financial Instruments: Recognition and Measurement. The second circumstance is
when the transaction is an intercompany transaction that is long-term in nature (i.e.
settlement is neither planned nor likely to occur in the foreseeable future).
"Foreseeable future" does not refer to a specific period (e.g. 20 or 50 years) but to
whether repayment is planned or anticipated. The transaction gains or losses on
such a transaction are recognised in equity.

Question
Company A, whose functional currency is the Singapore dollar, advances euros to its
foreign subsidiary, AB. Subsidiary AB has identified the euro as its functional
currency. Subsidiary AB may repay some of the advances; generally, however, they
are replaced with new advances within a short time frame (i.e. three to five days).
Subsidiary AB generally has 50 million euro advances outstanding at all times.
Do the advances from A to AB qualify as a long-term investment under IAS 21.15?
Answer
No. Rolling balances and minimum-balance intercompany accounts generally do not
qualify for consideration of an extension or deduction of a net investment under IAS
21. IAS 21.15 specifically excludes trade receivables or trade payables from being
considered qualifying assets and liabilities. Intercompany transactions must be
evaluated on an individual basis, not on an aggregate or net basis.
Since the rolling balances, or minimum-balance advances, do not qualify for the
exception in IAS 21.15, A should recognise transaction gains or losses on such
advances in its income statement.
Q&A IAS 21: 15-2 — PARENT GUARANTEE OF FOREIGN SUBSIDIARY'S

DEBT
Question
A Swiss company, AA, has a Mexican subsidiary, BB, with the Mexican peso as its
functional currency. BB borrowed Swiss francs from a Swiss bank, and AA
guaranteed repayment of the loan. AA had the ability to provide an intercompany
loan to BB; however, for tax reasons, AA decided not to provide the loan to BB. For
tax reasons, interest payments are made by BB, rather than AA. It is not anticipated
that the subsidiary itself will repay the loan in the foreseeable future to the third
party.
In preparing the consolidated accounts, does a parent company's guarantee of debt

qualify for the long-term investment exception in IAS 21.15?
Answer
No. A guarantee of a subsidiary's foreign-currency-denominated debt to a third party
does not meet the definition of being an extension of a net investment in the
subsidiary as defined by IAS 21.15. Consequently, BB is required to recognise the
transaction gains or losses in its income statement for the Swiss franc-denominated
bank debt.
Q&A IAS 21: 15-3 — CHANGING THE FORM OF A LONG-TERM

INVESTMENT IN A FOREIGN SUBSIDIARY
Question
A UK company, O, has a Canadian subsidiary to which it has made advances that are
denominated in Canadian dollars. Company O previously has represented its
intention that the advances are a long-term investment; therefore, exchange gains
and losses on the advances have been reported in equity in accordance with IAS
21.32. There have been no previous repayments of these advances.
As a result of a decline in the Canadian dollar compared to the pounds sterling, the
value of the advances has declined. In order to receive a tax deduction in the UK for
the decrease, O would like to require the Canadian subsidiary to repay the advances.
However, O does not want to realise a loss on the transaction for book purposes.
Company O proposes to contribute cash to the Canadian subsidiary in the form of a
capital contribution concurrent with the Canadian subsidiary using the cash received
to repay the advances.
Does the proposed transaction require O to recognise a loss for the elimination of the
amount of the cumulative translation adjustment pertaining to the advances?
Answer
No. In the proposed transaction, O is replacing essentially one form of long-term
investment with another form of long-term investment. The translation adjustment
attributable to the long-term intercompany advances should remain as a component
of equity until the Canadian subsidiary is disposed, as the permanent long term
nature of the investment continues.
If a transaction is settled for which settlement was not planned or anticipated, the
amounts included in a separate component of equity (applicable to the period for
which settlement was not planned or anticipated) should remain until the foreign
entity is disposed of.
Q&A IAS 21: 15-4 — FOREIGN-CURRENCY-DENOMINATED

INTERCOMPANY PAYABLES ARISING IN THE NORMAL COURSE OF
BUSINESS
Background
Company J, a Japanese parent has a wholly owned Mexican subsidiary, M.

Management of M previously had decided that the Mexican peso should be used as
M's functional currency since M's sales to third parties are denominated in the
Mexican peso, as are its labour costs. Raw material purchases from J are
denominated in Japanese yen and have resulted in intercompany payables to J that
are also denominated in Japanese yen. Previously, M made cash repayments to J
relating to these payables; however, no contemporaneous evidence exists
documenting the repayment terms of the intercompany payables.
Although no specific amount has been formally designated as such, management of

M believes that a portion of the payables from M to J are of a long-term nature, and
would like to account for any foreign currency losses related to such intercompany
payables in a manner similar to translation adjustments.
Question
In preparing the consolidated accounts, is it appropriate for M to account for the
foreign currency exchange gains or losses that are related to such intercompany
payables in equity?
Answer
No. IAS 21.15 specifically excludes trade receivables and payables as potential items
to form part of an entity's net investment in a foreign entity. Therefore, such
balances do not qualify for the exemption in IAS 21.15. Moreover, the fact that M
has made previous cash repayments to J implies the presumption that M had the
intent to repay the intercompany payables to J. In addition, there is the refutable
presumption, based on historical trends, that J will demand payment.
However, if M negotiates a separate financing long-term advance with its parent, J,

where repayment of the advance is not planned or anticipated in the foreseeable
future, gains or losses resulting from future foreign currency fluctuations may be
accounted for prospectively from the date of the advance or note payable in a
manner similar to translation adjustments. The company should provide refutable,
prospective evidence to overcome the presumption that J will not demand payment
based on historical payment trends.

Q&A IAS 21: 15-5 — SETTLING FOREIGN-CURRENCY-DENOMINATED
DEBT AND MAKING A LONG-TERM INVESTMENT
Question
Company L (L) is a Lesotho subsidiary of S, a South African parent. Company L has
the loti as its functional currency and S has the South African rand as its functional
currency. Company L has third-party rand-denominated debt on its books for which
it must recognise transaction gains and losses for the changes in the rand to loti
exchange rate. Company A, a South African affiliate of L, will repay L's foreign
currency (rand) denominated debt and S will provide an intercompany borrowing to
L denominated in the loti.
Would it be appropriate in this transaction for S to record the translation

adjustments related to settlement of the rand-denominated debt as a translation
adjustment instead of a transaction loss?
Answer
No. The intercompany borrowing and settlement of third-party debt should be
accounted for separately. Although IAS 21.15 discusses the accounting for an
intercompany foreign currency transaction that is of a long-term nature, the
transactions should be accounted for as they occur. Therefore, any foreign currency
adjustments related to settlement of the South African rand-denominated debt
should be recorded as a transaction loss in the period in which the exchange rate
changes. However, if S and L enter into an intercompany foreign currency
transaction of a long-term nature for which settlement is not planned or anticipated
in the foreseeable future, future foreign currency adjustments related to such an
intercompany loan may be accounted for as a translation adjustment pursuant to
IAS 21.15.
Q&A IAS 21: 15-6 — SHORT-TERM INTERCOMPANY DEBT

Question
Company C (C) is a wholly owned U.S. subsidiary of D, a Dutch-based holding
company. Company C has notes due to D that are denominated in euros. The notes
have stated maturities ranging from six months to one year. Although the notes are
short-term by contract, the parent provides a representation each year that it will
not demand payment for that year. Historically, the notes have been renewed each
year.
Would the short-term notes qualify for the exception in IAS 21.15?
Answer
No. In order to qualify as a long-term investment, settlement must neither be
planned nor likely to occur in the foreseeable future. Rolling intercompany balances
generally do not qualify for the consideration of an extension or deduction of net
investment under IAS 21. The facts state that the parent company only represents
that it will not require payment in the current year on the rolled over short-term
notes; it does not represent that in the foreseeable future it will not demand
payment on the notes.
If a company cannot represent that repayment will not be required in the anticipated
or foreseeable future, then application of the exception in IAS 21.15 is not
appropriate. See also Q&A IAS 21: 15-1.
Q&A IAS 21: 15-7 — THE DEFINITION OF FORESEEABLE FUTURE

Question
IAS 21.15 provides an exception that allows transaction gains or losses to be
recognised in equity for intercompany transactions that, in substance, form part of
an entity's net investment in a foreign entity. IAS 21.15 states that an item (such as
an intercompany payable or receivable) for which settlement is neither planned nor
likely to occur in the "foreseeable future" is, in substance, an extension or deduction
from the entity's net investment in that foreign entity.
In applying this guidance, what time period qualifies as foreseeable future?
Answer
IAS 21 is silent regarding identifying a specific time period, and therefore, the term
"foreseeable future" is not meant to imply a specific time period. Instead, this is an
intent-based indicator. A parent may qualify for the exception under IAS 21.15 if:
• There has been no history of repayments, and
• The parent company can represent that (1) it does not intend to require
repayment of an inter-company account (which cannot be represented if
the debt has a maturity date that is not waived), and (2) the parent
company's management views the inter-company account as part of its
investment in the foreign subsidiary.
Q&A IAS 21: 15-8 — TREATMENT OF A FOREIGN CURRENCY

PERPETUAL LOAN AS PART OF A NET INVESTMENT IN A SUBSIDIAY
[Added 23 May 2008]
Background
Entity A (A), whose functional currency is pound sterling, has a foreign operation in
the form of a wholly owned subsidiary, Entity B (B), with a euro functional currency.
Entity B issues to A perpetual debt (i.e. it has no maturity) denominated in euros
with an annual interest rate of 6 per cent. The perpetual debt has no issuer call
option or holder put option. Thus, contractually it is just an infinite stream of interest
payments in euros.
Question
In A's consolidated financial statements, can the perpetual debt be considered, in
accordance with IAS 21.15, a monetary item "for which settlement is neither planned
nor likely to occur in the foreseeable future" (i.e. part of A's net investment in B),
with the exchange gains and losses on the perpetual debt therefore being recorded
in equity in accordance with IAS 21.32?
Answer
Yes. Through the origination of the perpetual debt, A has made a permanent
investment in B. The interest payments are treated as interest receivable by A and
interest payable by B, not as repayment of the principal debt. Hence, the fact that
the interest payments are perpetual does not mean that settlement is planned or
likely to occur. The perpetual debt can, given the lack of specific guidance to the
contrary, be considered part of A's net investment in B. In accordance with IAS
21.15, the foreign exchange gains and losses should be recorded in equity at the
consolidated level because settlement of that perpetual debt is neither planned nor
likely to occur.
Q&A IAS 21: 16-1 — TRANSLATION OF FOREIGN CURRENCY DEFINED

BENEFIT PENSION SCHEME
Question
U.K. Entity A has a defined benefit pension scheme that invests in U.K. equities
under which the benefits to employees will be denominated in £ sterling. The
functional currency of A is US$ in accordance with IAS 21.
How should the pension balance be translated and any resulting exchange
differences reported in the US$ financial statements of A?
Answer
Pensions and other employee benefits to be paid in cash are classified as monetary
items in accordance with IAS 21.16; therefore, at the balance sheet date, the
pension balance should be translated using the closing rate.
The foreign exchange exposure arises as a result of the functional currency of A (i.e.
the pension scheme itself is not affected by the US$). Consequently, any exchange
difference arising from the translation of the pension balance at the balance sheet
date represents a foreign currency exposure for A, and should be recognised in profit
or loss in accordance with IAS 21.28. Amounts recorded in profit or loss in
accordance with IAS 19.61 Employee Benefits, are translated using the average rate
as an approximation of the exchange rates ruling at the dates of the transactions.
Q&A IAS 21: 16-2 — REMEASUREMENT OF A DECOMMISSIONING

OBLIGATION EXPECTED TO BE PAID IN A FOREIGN CURRENCY
Question
How should an entity account for the remeasurement of a decommissioning
obligation expected to be paid in a foreign currency?
Answer
It depends on whether the decommissioning obligation is a financial liability in the
scope of IAS 32 Financial Instruments: Presentation, or a provision in the scope of
IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
A decommissioning obligation qualifies as a financial liability under IAS 32.11 only if

there is a contractual obligation to deliver cash or another financial asset to settle
the obligation. Financial liabilities are monetary items for the purposes of IAS
21.23(a) and IAS 21.28 and, therefore, a foreign currency denominated
decommissioning obligation that meets the definition of a financial liability is
translated at the closing rate at the end of each reporting period and any exchange

differences arising are recognised in profit or loss in the period in which they arise.
A decommissioning obligation that does not meet the definition of a financial liability
is accounted for as a provision within the scope of IAS 37. IAS 37.14 requires that a
provision be recognised when (1) the entity has a present obligation (legal or
constructive) as a result of a past event, (2) it is probable that an outflow of
resources will be required to settle the obligation, and (3) a reliable estimate can be
made of the amount of the obligation. A provision is subject to subsequent
adjustments reflecting revisions to the original estimate or timing of undiscounted
cash flows to settle the obligation.
A provision, therefore, cannot be a contractual obligation to deliver a foreign

currency denominated amount. An entity may estimate the expected outflow in a
foreign currency (discounting these cash flows with the appropriate interest rate
relevant to the foreign currency) and then convert the provision into functional
currency using the spot rate at the date the provision is recognised. This is all part of
the estimation process which should be accounted for in accordance with IFRIC
Interpretation 1 Changes in Existing Decommissioning, Restoration and Similar
Liabilities. The required accounting treatment for changes in the estimated outflow of
resources required to settle the obligation depends on whether the related asset is
measured using the cost model or using the revaluation model, and is outlined in
paragraphs 5–7 of IFRIC 1.
Q&A IAS 21: 23-1 — USING A POST-BALANCE-SHEET-DATE EXCHANGE

RATE
Question
Company G is a German company with a Russian subsidiary. The subsidiary's
functional currency is the Russian ruble. The subsidiary has euro-denominated debt.
The Russian ruble exchange rate against the euro has significantly fluctuated in the
two months before and after year-end.
Is it appropriate to use an exchange rate subsequent to year-end if foreign exchange

rates are volatile at or near year-end?
Answer
No. IAS 21.23 states that foreign currency monetary items should be reported at the
balance sheet date using the closing rate, with no exceptions provided.
Therefore, the exchange rate at the date of the financial statements should be used
to remeasure the euro payable into ruble and to translate foreign currency financial
statements. However, due to the significant volatility in exchange rates at or near
year-end, disclosure of the effect on foreign currency monetary items on the
financial statements of a foreign operation of a change in exchange rates occurring
after the balance sheet date should be provided if the change is of such importance
that non-disclosure would affect the ability of users of the financial statements to
make proper evaluations and decisions. (See IAS 10 Events After the Balance Sheet
Date, for further guidance.)
Q&A IAS 21: 23-2 — TRANSACTION GAINS OR LOSSES ON DIVIDENDS

Question
If a foreign subsidiary, with a functional currency different to that of the parent,
declares a dividend to its parent, and there is a significant time lag between the
record date and the payment date, what is the appropriate accounting for the
transaction gain or loss related to the parent's dividend receivable account?
Answer
IAS 21 does not address this issue specifically; however, IAS 21.41 states that the
reason for not recognising translation adjustments in income or expense for the
period is that the changes in the exchange rates have little or no direct effect on the
present and future cash flows from operations of either the foreign entity or the
reporting entity. In this case, further cash flows are not affected, therefore, the
parent company should recognise transaction gains and losses in income.
Q&A IAS 21: 23-3 — TRANSACTION GAINS OR LOSSES: INVESTMENTS

VALUED AT COST
Background
Transaction gains or losses are the result of movements in the exchange rate
between the functional currency of an entity and the foreign currency in which
monetary assets or liabilities are denominated. For example, a company has the U.S.
dollar as its functional currency and has borrowed Japanese yen resulting in a
yen-denominated payable. Transaction gains or losses will be recognised in income
on the outstanding yen-denominated debt for changes in the spot rate of exchange

between the Japanese yen and the U.S. dollar at each balance sheet date.
Question
Company T holds an investment in a Japanese company. The investment is
accounted for appropriately using the cost method because the securities do not
have a readily determinable fair value. Company T's initial investment was made in
Japanese yen and represented 4.3 million euros upon acquisition of the investment.
At the most recent balance sheet date, the investment has a value of 6 million euros
based on changes only in the euro and Japanese yen exchange rate.
Would it be appropriate to recognise the 1.7 million euro increase in the investment
as a transaction gain?
Answer
No. IAS 21.23 states that non-monetary items, which are carried in terms of
historical cost denominated in a foreign currency, should be reported using the
exchange rate at the date of the transaction. As such, a transaction gain (or loss) on
the investment would be recognised only when the investment is sold. Company T
should use the historical exchange rate when remeasuring this investment into
euros. A transaction gain (or loss) on the investment would be recognised only when
the investment is sold; that is, there is no receivable or payable that results from
holding the cost-based investment. Just as there are no fair value adjustments for
the security, there are no exchange rate adjustments.
Q&A IAS 21: 23-4 — MULTILEVEL CONSOLIDATION AND

TRANSLATION OF FINANCIAL STATEMENTS
[Reserved 6 April 2007]
[Amended and Reissued 29 June 2007]
Question
A Swiss company wholly owns a second-tier German subsidiary. The German
subsidiary wholly owns a third-tier British subsidiary. The local currency is the
functional currency for all entities, and the presentation currency of the consolidated
entity is the Swiss franc. Each company has third-party
foreign-currency-denominated debt on its balance sheet.
Under IAS 21, what is the appropriate accounting for the foreign-currency
transactions and the foreign-currency financial statements in the consolidation of the
subsidiaries with the Swiss parent company?

Answer
An entity may perform a sub-consolidation at an intermediate parent company level
before the ultimate parent company performs its consolidation. The consolidation
process may affect the translation gains and losses recognised directly in equity on
consolidation.
The British and German subsidiaries would recognise transaction gains or losses on
their respective third-party foreign-currency-denominated debt by using the current
spot exchange rate on the balance sheet date in accordance with IAS 21.23. The
transaction gains or losses would be recorded in the income statement. These
transaction gains and losses would not be reversed out of income on consolidation.
The Swiss parent would recognise transaction gains and losses on its third-party
foreign-currency-denominated debt in the income statement, just as its subsidiaries
have done for their foreign-currency-denominated debt.
If an intermediate consolidation exercise is performed, the German subsidiary would

translate the British subsidiary's pounds-sterling-denominated financial statements
into euro-denominated financial statements. The pounds-sterling-to-euro translation
adjustment would be recorded in equity. The Swiss parent would then translate the
euro-denominated, consolidated financial statements of the German subsidiary into
Swiss francs and record the translation adjustment in consolidated equity.
If an intermediate consolidation exercise is not performed, the Swiss parent would

translate the pounds-sterling-denominated financial statements of the British
subsidiary and the euro-denominated financial statements of the German subsidiary
into Swiss francs. The translation adjustment arising from this exercise would be
recorded in consolidated equity.

Reserved
Q&A IAS 21: 23-6 — EXCHANGE RATE FOR A SUBSIDIARY WITH A

DIFFERENT REPORTING PERIOD WHEN SIGNIFICANT DEVALUATION
OCCURS

Question
A parent company includes a foreign subsidiary's financial statements for the year
ended 30 November in the parent company's consolidated financial statements for
the year ended 31 December. Between 30 November and 31 December, the
functional currency of the subsidiary devalues significantly against the parent
company's functional currency.
What rate should be used for translation of the foreign subsidiary's financial
statements in the consolidated financial statements for the year ended 31
December?
Answer
IAS 27.27 requires adjustments be made for significant events or transactions that
occur between the balance sheet dates of the subsidiary and the parent in the
consolidated financial statements when the financial statements of a subsidiary used
in preparation of consolidated financial statements are prepared as of a reporting
date different from that of the parent. Therefore, the current exchange rate should
be used to translate the foreign subsidiary's financial statements as of 31 December.
Q&A IAS 21: 26-1 — UNOFFICIAL EXCHANGE RATE FOR TRANSLATION

AND REMEASUREMENT
Question
Under what circumstances, if any, can an exchange rate other than the "official rate"
be used for translation and remeasurement purposes?
Answer
When there is both an official exchange rate and an unofficial exchange rate, and the
unofficial exchange rate is used both widely and legally for purposes of currency
conversions, a parallel or dual exchange rate situation exists. In such circumstances,
if it can be demonstrated reasonably that transactions have been, or will be, settled
at the unofficial rate (including currency exchanges for dividend or profit
repatriations), it is appropriate to use the unofficial rate for translation and
remeasurement purposes.
Q&A IAS 21: 26-2 — LACK OF EXCHANGEABILITY AT THE END OF THE

REPORTING PERIOD
Background
A country is experiencing turmoil, and the government has imposed an exchange

rate different from the spot market exchange rate for dividend payments and capital
repatriations in order to discourage capital from leaving the country. The new rate is
the dividend remittance rate (also known as the interest remittance exchange rate).
This specific exchange rate applies to all remittances of earnings or dividends
distributed outside the country.
Question
Which rate should be used by a parent in translating a subsidiary operating in such a
foreign country?
Answer
IAS 21 does not address specifically this issue. IAS 21.8 defines the closing rate as
"the spot exchange rate at the end of the reporting period". The closing rate should
be the rate the entity currently would pay or receive in the market. Therefore, under
the above scenario, using the dividend remittance rate would be appropriate because
cash flows to the reporting entity can only occur at this rate, and the realisation of a
net investment is dependent upon the cash flows from that foreign entity.
Unusual circumstances that may permit an entity to use the market exchange rate in
translating a foreign subsidiary in the circumstances described above would include
(1) a history of obtaining the market exchange rate for such transactions, and (2)
the ability to source funds at the market exchange rate to the extent that there is no
question of asset impairment. Otherwise, the dividend remittance rate should be
used.
Careful judgment should be applied to determine whether those circumstances result

in the loss of control in accordance with IAS 27(2008).32.
Q&A IAS 21: 30-1 — TRANSACTION GAINS OR LOSSES:

FOREIGN-CURRENCY-DENOMINATED AVAILABLE-FOR-SALE
SECURITIES
Background
Transaction gains or losses are the result of movements in the exchange rate
between the functional currency of an entity and the foreign currency in which
monetary assets or liabilities are denominated. For example, a company has the U.S.
dollar as its functional currency and has borrowed Japanese yen resulting in a
yen-denominated payable. Transaction gains or losses will be recognised in income
on the outstanding yen-denominated debt for changes in the spot rate of exchange
between the Japanese yen and the U.S. dollar at each balance sheet date.
Question
If a company invests in a foreign-currency-denominated debt security and classifies
that security as available-for-sale, setting its accounting policy in a way that changes
in fair value be recorded in equity, how is the translation gain or loss recognised on
that security?
Answer
IAS 39.AG83 states that an entity should apply IAS 21 to financial asset or liabilities
that are monetary items under IAS 21 and are denominated in a foreign currency,
and should be reported in profit or loss. An exception would be a monetary item that
is designated as a hedging instrument in a cash flow hedge. Any recognised change
in the fair value of such a monetary item, apart from foreign exchange gains and
losses, is accounted for under IAS 39.55(b).
However, with respect to financial assets that are non-monetary items under IAS 21,
any recognised change in fair value, including any component of that change that
may be related to changes in foreign exchange rates, is recognised in equity under
IAS 39.AG83.
As a debt security is a monetary item, the foreign exchange currency portion of the
change in fair value should be recorded in the income statement with the price
change portion of the fair value recorded in equity if that is the policy established by
the company in accordance with IAS 39.55(b), provided that the investment does
not qualify as a hedging instrument.
However, if the available-for-sale investment is an equity instrument (non-monetary

investment) of a foreign entity, the full amount of the change in fair value would
have been recorded in equity.
Q&A IAS 21: 35-1 — DATE TO RECORD A CHANGE IN FUNCTIONAL

CURRENCY
Question
Should a change in the functional currency be reported as of the beginning of the
year, as of the beginning of the reporting period (e.g. quarter, month), or as of the
date of change?
Answer
The change in a functional currency should be reported as of the date it is
determined that there has been a change in the underlying events and
circumstances relevant to that entity to justify a change in the functional currency.
This could occur on any date during the year. For convenience, and as a practical
matter, there is a practice of using a date at the beginning of the most recent period
(annual or interim, as the case might be).
Q&A IAS 21: 35-2 — SIGNIFICANT EURO BORROWING AND CHANGING

THE FUNCTIONAL CURRENCY
Question
Company K's functional currency is the euro. Company K accounts for its 43 per cent
investment in M, a Mexican company, using the equity method of accounting.
Company M's functional currency is the Mexican peso. During the current year, M
entered into a 200 million euro third-party borrowing denominated in euros. Most of
M's operations, labor costs, and purchases are denominated in the peso and incurred
in the domestic market.
Is it appropriate for M to change its functional currency from the peso to the euro?
Answer
No. IAS 21.9 provides, in part, that if a particular currency is used to a significant
extent in, or has a significant impact on, the entity, that currency may be an
appropriate currency to be used as the functional currency.
Since the majority of M's operations, sales, purchases, labor cost, etc., are
denominated in the Mexican peso, and Mexico is the country that drives the
competitive forces and regulations of that entity, M should continue using the
Mexican peso as its functional currency. Although a large third-party financing in the
significant shareholder's functional currency may provide some evidence to support a
change in the functional currency from the Mexican peso to the euro, in this
situation, a large financing denominated in the significant shareholder's currency
alone is not sufficient to demonstrate a change in the functional currency from the

peso to the euro if no other changes in the underlying operations of the entity exist.
Q&A IAS 21: 35-3 — CHANGING FUNCTIONAL CURRENCIES

Question
KI, located in Ireland, is a wholly owned subsidiary of Company K (K). The U.S.
dollar is K's functional currency and KI has identified the euro as its functional
currency. The functional currency was identified because KI's sales and purchases
were denominated primarily in euros, as were all of KI's labor costs. During the
fourth quarter, KI's operations began to change. KI's sales decreased due to a loss of
some sizable contracts while K's sales increased due to new significant contracts.
Company K began using KI's manufacturing facility in order to meet its sales orders.
KI terminated its sales force because KI will no longer need to generate its own sales
since more than 80 per cent would be coming from K's operations. Company K built
a new facility to produce the materials needed in its manufacturing processes. As of
the end of the fiscal year, KI began receiving all materials from K instead of from
outside vendors.
Based on the changes in KI's business, KI expects cash inflows and outflows, except
for wages, primarily to be denominated in U.S. dollars. Do these circumstances
justify a change in KI's functional currency from the euro to the U.S. dollar?
Answer
Yes. IAS 21.36 states that a change in the currency that influences mainly the sales
prices of goods and services may lead to a change in functional currency, as well as
the fact that the change in activities of the foreign operation to be carried out as an
extension of the reporting entity consistent with IAS 21.11(a).
The guidance provided in IAS 21.35 should be followed to determine if the changes
described support a change in classification of KI and, as a result, also a change in
the functional currency from the euro to the parent's U.S. dollar. For example, the
denomination of revenues has changed from primarily the euro to the U.S. dollar.
This change does not appear to be temporary since the sales force has been
terminated. Second, the denomination of cash outflows for materials also has
changed to the U.S. dollar. Company K built a new facility that will make these
materials so this change does not appear to be temporary either. Lastly, the
philosophy of KI's operations within K's overall operating strategy has changed from
a self-supporting, stand-alone operating company to a manufacturing facility of K.

Q&A IAS 21: 39-1 — SHARE CAPITAL AND OTHER EQUITY RESERVES
TRANSLATED INTO A PRESENTATION CURRENCY
[Added 8 June 2007]
Question
Company A (A), whose functional currency is pound sterling, chooses to use the
presentation currency rules in IAS 21 when presenting its financial statements in
U.S. dollars. How should share capital and other equity reserves be translated into
the presentation currency at the balance sheet date?
Answer
IAS 21.39 specifies that A should do the following when translating its results and
financial position into the U.S. dollar presentation currency:
• Translate assets and liabilities at the closing rate at the date of each
balance sheet presented.
• Translate income and expense at exchange rates at the dates of the

transactions.
• Recognise any resulting exchange differences as a separate component of

equity.
Paragraph 39, therefore, specifies the exchange differences to be included in the

separate component of equity. It does not refer to the translation of share capital or
other equity reserves.
In a manner consistent with the framework and the definition of equity as a residual,
share capital and other equity components should not be remeasured. The historical
rate (i.e. the exchange rate at the date of issue of the share capital, or at the date of
the transactions for other equity reserves) should be used for share capital and other
components of equity. For example:
• Company A should use the rate at the date of issue when translating share
capital into the presentation currency. More than one historical rate applies
when share capital is issued at different times.
• Company A should use the rate at the date of transaction (i.e. the date of
revaluation when translating a revaluation reserve arising, for example,
when an item of property, plant, or equipment is revaluated in accordance
with IAS 16 Property, Plant and Equipment) into the presentation currency.
At each revaluation date, any gain or loss arising from that revaluation

should be translated at the rate at the date of that revaluation.
Q&A IAS 21: 39-2 — INTRODUCTION OF THE EURO — COMPARATIVES

Background
The functional currency of Entity A, based in Slovakia, is the Slovak Crown. Entity A
presented its 31 December 2008 financial statements in that currency. Slovakia
adopts the euro (€) as its national currency on 1 January 2009. Consequently, Entity
A will need to recognise a change in functional currency as at 1 January 2009. It will
present its financial statements at 31 December 2009 in its new functional currency
of the €.
The conversion rate from the Slovak Crown to the € (also referred to as the 'parity'
rate) was fixed in July 2008.
Question
How should Entity A translate the comparative information at 31 December 2008
from Slovak Crowns to € when preparing its 31 December 2009 financial statements
in €?
Answer
Neither SIC-7 Introduction of the Euro nor IAS 21 directly addresses how
comparative amounts should be converted when a change in functional currency
arises not from a change in entity-specific circumstances, but because the original
functional currency has ceased to exist and is officially converted into another
currency at a fixed rate. Paragraph 11 of IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors indicates that, in the absence of a specific Standard
that applies to the transaction, the requirements in IFRSs dealing with similar and
related issues should be considered.
Therefore, Entity A has an accounting policy choice. There are two acceptable
alternatives:
1. it can chose to treat the changeover to € as similar to any other change in

presentation currency for the comparative period — in which case it would
translate the comparative amounts using rates applicable at the dates of
the transactions consistent with IAS 21.38–41; or
2. in the absence of guidance specific to these circumstances, when the

change in functional/presentation currency is not due to entity-specific
circumstances, Entity A can choose to maintain the relationship between
balances by applying the parity rate established on the changeover to the
€ to all the comparative amounts.
Q&A IAS 21: 39-3 — TRANSLATION OF FINANCIAL STATEMENTS FROM

A NON-HYPERINFLATIONARY FUNCTIONAL CURRENCY INTO A
HYPERINFLATIONARY PRESENTATION CURRENCY
[Added 1 July 2010]
Background
Entity A is located in a jurisdiction with a hyperinflationary economy. Entity A has

determined that its functional currency is the currency of a non-hyperinflationary
economy. However, due to local regulations, Entity A must present its financial
statements in its local currency (i.e. in the currency of a hyperinflationary economy).
Question
How should Entity A's financial statements be translated into its hyperinflationary
presentation currency?
Answer
Because Entity A's functional currency is not the currency of a hyperinflationary
economy, Entity A is outside the scope of IAS 29 Financial Reporting in
Hyperinflationary Economies (see IAS 29.1).
Accordingly, in order to translate its financial statements to the hyperinflationary

presentation currency, Entity A must use the following method described in IAS
21.39:
• assets and liabilities for each statement of financial position should be

translated at the closing rate of the date of that statement of financial
position;
• income and expenses should be translated at the exchange rates at the

dates of the relevant transactions; and
• all resulting exchange differences should be recognised in other

comprehensive income.
Q&A IAS 21: 42-1 — COMPARATIVE AMOUNTS IN THE CONSOLIDATED

FINANCIAL STATEMENTS OF A PARENT WHEN THE ECONOMY OF
THE FUNCTIONAL CURRENCY OF A SUBSIDIARY BECOMES
HYPERINFLATIONARY IN THE CURRENT REPORTING PERIOD
Background
In 20X9, Subsidiary A's functional currency is determined to be that of a

hyperinflationary currency. As required by IFRIC 7 Applying the Restatement
Approach under IAS 29 Financial Reporting in Hyperinflationary Economies, the
comparative amounts in Subsidiary A's individual financial statements are
retrospectively restated as if the subsidiary's functional currency had always been
that of a hyperinflationary currency. The functional currency of Subsidiary A's parent
is not that of a hyperinflationary economy.
Question
Should the comparative amounts relating to Subsidiary A in the 20X9 consolidated
financial statements of its parent be restated?
Answer
No. IAS 21.42 describes the procedures for the translation of a foreign operation
whose functional currency is the currency of a hyperinflationary economy. IAS
21.42(b) specifies that “when amounts are translated into the currency of a
non-hyperinflationary economy, comparative amounts shall be those that were
presented as current year amounts in the relevant prior year financial statements
(i.e. not adjusted for subsequent changes in the price level or subsequent changes in
exchange rates)”.
Therefore, in the circumstances described, the comparative amounts relating to

Subsidiary A in the 20X9 consolidated financial statements should not be restated.
Only the current period amounts reported in the consolidated financial statements
will be affected by Subsidiary A's accounting under IAS 29.
Q&A IAS 21: 47-1 — ALLOCATION OF GOODWILL RESULTING FROM

THE ACQUISITION OF A FOREIGN OPERATION: INTERACTION
BETWEEN IAS 21 AND IAS 36
Background
Company A, a French entity with the euro (€) as its functional currency, acquires
Company S, a Swiss entity. Following the acquisition, the functional currency of

Company S continues to be the Swiss franc (CHF).
One of Company A's other subsidiaries, Company D (also located in France with the
€ as its functional currency) is expected to benefit from the synergies of the
acquisition. Company D represents a cash-generating unit (CGU) as defined in
paragraph 6 of IAS 36 Impairment of Assets. Accordingly, in accordance with IAS
36.80, part of the goodwill arising on the acquisition of Company S is allocated to
Company D's CGU for the purposes of impairment testing.
Question
Should the goodwill allocated to Company D be considered a CHF or a € asset going
forward? At what rate should the goodwill allocated to Company D be converted for
the purposes of preparing the consolidated financial statements of Entity A and
performing goodwill impairment tests?
Answer
The goodwill allocated to Company D is a € asset.
IAS 21.BC31 states that “goodwill arises only because of the investment in the
foreign entity and has no existence apart from that entity. . . . [W]hen the acquired
entity comprises a number of businesses with different functional currencies, the
cash flows that support the continued recognition of goodwill are generated in those
different functional currencies”.
While one would generally expect that the 'foreign' operation supporting the
continued recognition of goodwill is part of the foreign operation acquired, this is not
always the case. In allocating a portion of the goodwill to Company D, Company A
has determined that it is the cash flows of a CGU with a € functional currency
(Company D), rather than those of the Swiss entity, that will support the continued
recognition of the goodwill. Therefore, goodwill should be treated as an asset of

Company D for the purposes of IAS 21.47.
The goodwill allocated to Company D should be translated at the rate in effect on the
date of its allocation to Company D (i.e. the date of acquisition).
Q&A IAS 21: 47-2 — REALLOCATION OF GOODWILL TO A FOREIGN

OPERATION: INTERACTION BETWEEN IAS 21 AND IAS 36
Background
Company A, a French entity with the euro (€) as its functional currency, acquires
Company B, a UK entity (functional currency £STG). In accordance with paragraph
80 of IAS 36 Impairment of Assets, the goodwill arising on the acquisition is
allocated to Company A's various UK operations (including Company B) that are
expected to primarily benefit from the synergies of the combination. In accordance
with IAS 21.47, the goodwill is considered a £STG asset and is translated at the
closing rate.
Several years later, Company A undertakes an internal reorganisation and some of

the UK operations are transferred to France. In accordance with IAS 36.87, Company
A reallocates a portion of the goodwill originally generated on the acquisition of
Company B to its French operations using a relative value approach.
Question
Following this reorganisation, should the portion of the goodwill reallocated to the
French operations be considered a £STG or a € asset going forward? At what rate
should that portion of goodwill be converted for the purposes of preparing the
consolidated financial statements of Entity A and performing goodwill impairment
tests?
Answer
In allocating a portion of the goodwill to operations with a € functional currency,
Company A has determined that it is the cash flows of its French operations that will
support the continued recognition of that portion of the goodwill following the
reorganisation. Therefore, that portion of the goodwill should be treated as an asset
of the French operations and should be converted from £STG at the rate in effect on
the date of the reallocation (in this case on the date of the internal reorganisation) to
determine the € carrying amount going forward.

Reserved

Reserved

Deleted

[Added 23 May 2008]
Reserved

Reserved
Q&A IAS 21: 50-1 — DEFERRED TAXES ON TRANSLATION

ADJUSTMENTS
Question
Company N is a Norwegian corporation with a wholly owned subsidiary, S, operating
in the Swedish tax jurisdiction. The functional currency of S is the Swedish kroner
and, historically, no earnings have been repatriated to N since the parent company
considers its investment to be permanent.
Should deferred income tax assets and liabilities be recognised on the adjustment
resulting from translation of S's financial statements into Norwegian kroner?
Answer
Maybe. IAS 21.50 provides that gains and losses on exchange differences arising
from the translation of the financial statements of foreign operations may have
associated tax effects, which are accounted for in accordance with IAS 12 Income
Taxes.
Under IAS 12.39, deferred income tax liabilities may not be accrued by the parent
company if both of these conditions are satisfied:
a. The parent, investor, or venturer is able to control the timing of the

reversal of the temporary difference, and
b. It is probable that the temporary difference will not reverse in the

foreseeable future.
Recognition of the deferred tax asset, in general, would not be appropriate if the
parent company's intention is to maintain the investment in the long term, such that
it is not probable that the deferred tax asset would be recovered.
Q&A IAS 21: 52-1 — PRESENTING FOREIGN CURRENCY GAINS OR

LOSSES WITH OPERATING MARGIN
Question
Company B recognises foreign currency gains and losses on its
foreign-currency-denominated receivables and payables as required by IAS 21.23.
Would it be appropriate for B to include the foreign currency gains and losses in a
separate line item below its operating margin within finance costs?
Answer
IAS 21 is silent regarding presentation in the income statement of foreign currency
exchange gains and losses. However, the presentation should follow the nature of
the transactions to which it is linked. As such, recording the foreign currency gains
and losses relating to operational activities (trade receivables, payables, etc.) within
income from operations, and recording foreign currency exchange gains and losses
related to debt in finance costs, would be appropriate. However, it may be
appropriate to show these gains and losses as a separate line item within the
operating margin to alert users of the financial statements of the impact foreign
currency fluctuations have in the entity financial performance.
Q&A IAS 23(2007): 4-1— EXEMPTIONS FROM SCOPE OF IAS 23(2007)

Question
How should the exemptions set out in IAS 23(2007).4 be applied?
Answer
IAS 23(2007).4 states, in part:
An entity is not required to apply [IAS 23(2007)] to borrowing costs

directly attributable to the acquisition, construction or production of:
1. a qualifying asset measured at fair value [(e.g. a biological asset or an
investment property under construction measured at fair value)]; or
2. inventories that are manufactured, or otherwise produced, in large

quantities on a repetitive basis.
The exemption for assets measured at fair value recognises that the measurement of
such assets will not be affected by the amount of borrowing costs incurred during
their construction or production period. The exemption for inventories manufactured
in large quantities on a repetitive basis acknowledges the difficulty both in allocating
borrowing costs to such inventories and monitoring those borrowing costs until the
inventory is sold. The IASB concluded that it should not require entities to capitalise
borrowing costs on such inventories because the costs of capitalisation were likely to
exceed the potential benefits.
These exemptions are optional rather than mandatory. Accordingly, an entity can
choose, as a matter of accounting policy, whether to apply the requirements of IAS
23(2007) to borrowing costs that relate to qualifying assets measured at fair value
and/or inventories produced in large quantities on a repetitive basis.
Q&A IAS 23(2007): 5-1 — EXTENDED DELIVERY PERIOD

Background
An entity orders and pays for a large piece of equipment from overseas that will take
more than six months (in this example judged to be a 'substantial period of time' for
the purposes of IAS 23) to arrive. A loan is raised to finance the acquisition. The
equipment is already manufactured and available for shipment. Therefore, the period
between payment for the equipment and its installation is only caused by shipping
time. The asset is recognised by the entity on the date of shipping by the supplier
because (in this example) that is the date on which the risks pass to the entity.
Question
Is the equipment a 'qualifying asset'? Should the entity capitalise borrowing costs
incurred during the shipping period?
Answer
IAS 23(2007).5 defines a qualifying asset as "an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale".
IAS 16 Property, Plant and Equipment identifies delivery and handling costs as part
of the cost of an item of property, plant and equipment. It includes such activities as
part of the process of preparing the asset for its intended use. The shipping of an
asset is therefore part of its acquisition and, consequently, borrowing costs
attributable to the shipping period can be considered to be borrowing costs directly
attributable to the acquisition of the asset as required by IAS 23(2007).9.
Borrowing costs incurred on the loan raised to finance the acquisition will be
capitalised as part of the cost of the equipment up to the date the asset arrives at its
destination, is installed and is ready for its intended use.
Q&A IAS 23(2007): 5-2 — WHAT CONSTITUTES A 'SUBSTANTIAL

PERIOD OF TIME'
Question
IAS 23(2007).5 defines a qualifying asset as “an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale”.
What constitutes a 'substantial period of time'?
Answer
IAS 23 does not provide any guidance on what constitutes a 'substantial period of
time'. The specific facts and circumstances should be considered in each case. For
example, it is likely that a period of twelve months or more might be considered
'substantial'.
Q&A IAS 23(2007): 6-1 — EXCHANGE DIFFERENCES TO BE INCLUDED

IN BORROWING COSTS
Question
IAS 23 defines borrowing costs to include exchange differences arising from foreign
currency borrowings "to the extent that they are regarded as an adjustment to
interest costs" How should the phrase "to the extent that they are regarded as an
adjustment to interest costs" be interpreted?
Answer
The question has been addressed by the IFRIC (see IFRIC Update January 2008).
The IFRIC reaffirmed that how an entity applies IAS 23 to foreign currency
borrowings is a matter of accounting policy requiring the exercise of judgement.
Where the accounting policy adopted is relevant to an understanding of the financial
statements, it should be disclosed as required by IAS 1 Presentation of Financial
Statements.
It is clear that not all exchange differences arising from foreign currency borrowings
can be regarded as an adjustment to interest costs; otherwise, there would be no
requirement for the qualifying terminology used in IAS 23(2007).6(e). The extent to
which exchange differences can be so considered depends on the terms and

conditions of the foreign currency borrowing.
Qualifying interest costs denominated in the foreign currency, translated at the

actual exchange rate on the date on which the expense is incurred, should be
classified as borrowing costs. Although exchange rate fluctuations may mean that
this amount is substantially higher or lower than the interest costs contemplated
when the original financing decision was made, the full amount is appropriately
treated as borrowing costs.
Some exchange differences relating to the principal may be regarded as an

adjustment to interest costs (and, therefore, taken into account in determining the
amount of borrowing costs capitalised) but only to the extent that the adjustment
does not decrease or increase the interest costs to an amount below or above a
notional borrowing cost based on commercial interest rates prevailing in the
functional currency at the date of initial recognition of the borrowing. In other words,
the amount of borrowing costs that may be capitalised should lie between the
following two amounts:
1. actual interest costs denominated in the foreign currency, translated at the

actual exchange rate on the date on which the expense is incurred; and
2. notional borrowing costs based on commercial interest rates prevailing in

the functional currency at the date of initial recognition of the borrowing.
Whether any adjustments for exchange differences are made to the amount
determined under (1) above is an accounting policy choice and should be applied
consistently.
Q&A IAS 23(2007): 6-EX-1 — EXCHANGE DIFFERENCES TO BE

INCLUDED IN BORROWING COSTS (WHERE EXCHANGE
DIFFERENCES INCREASE BORROWING COSTS)
Example
Entity X, which prepares its financial statements in its functional currency (Thailand
Baht (THB)), enters into a borrowing arrangement with terms and conditions as set
out below.

The following interest payments were made in 20X1.
Entity X should capitalise THB216 million, being the qualifying interest costs
denominated in the foreign currency, translated at the actual exchange rate on the
date on which the expense is incurred.
In addition, Entity X may choose as its accounting policy to regard exchange

differences as an adjustment to interest costs. If it does so, in order to determine
the maximum potential adjustment to interest costs for exchange differences, Entity
X should determine the borrowing costs that would have been incurred in the 20X1
reporting period if the funds had been borrowed in THB. The calculation is set out
below.
In the above scenario, the notional borrowing cost in the entity's functional currency
of THB300 million is the 'cap' on the amount to be classified as borrowing costs.
Consequently, where it has made the relevant accounting policy choice, Entity X
should capitalise an amount of borrowing costs between THB216 million and THB300
million.
The foreign exchange loss incurred on the retranslation of the principal amount of
the US$100 million borrowings at the end of 20X1reporting period is calculated as
follows:

As calculated above, the 'cap' on the amount to be classified as borrowing costs in
the 20X1 accounting period is THB300 million. The difference of THB84 million
between this amount and THB216 million (being the qualifying interest costs
date on which the expense is incurred) is the amount of foreign exchange losses on
the principal eligible for capitalisation. The remaining exchange loss on the principal
(THB2,116 million) is recognised in profit or loss in the year.
If the retranslation of the US$100 million at the end of 20X1 reporting period gave
rise to a foreign exchange gain, the entire gain should be recognised in profit or loss.
The amount of capitalised borrowing costs would be THB216 million (interest costs
date on which the expense is incurred). No adjustment to interest costs for exchange
differences should be made, as any such adjustment would result in an amount of
borrowing costs outside the acceptable range of amounts.
Q&A IAS 23(2007): 6-EX-2 — EXCHANGE DIFFERENCES TO BE

INCLUDED IN BORROWING COSTS (WHERE EXCHANGE
DIFFERENCES DECREASE BORROWING COSTS)
Example
Entity Y, which prepares its financial statements in its functional currency (Thailand
Baht (THB)), enters into a borrowing arrangement with terms and conditions as set
out below.

The following interest payments were made in 20X1.
Entity Y should capitalise THB216 million, being the qualifying interest costs
date on which the expense is incurred.
In addition, Entity Y may choose as its accounting policy to regard exchange

differences as an adjustment to interest costs. If it does so, in order to determine
the maximum potential adjustment to interest costs for exchange differences, Entity
Y should determine the borrowing costs that would have been incurred in the 20X1
reporting period if the funds had been borrowed in THB. The calculation is set out
below.
In the above scenario, the notional borrowing cost in the entity's functional currency
of THB200 million is the 'floor' on the amount to be classified as borrowing costs.
Consequently, where it has made the relevant accounting policy choice, Entity Y
should capitalise an amount of borrowing costs between THB200 million and THB216
million.
The foreign exchange gain on the retranslation of the principal amount of the
US$100 million borrowings during 20X1 is calculated as follows.

As calculated above, the 'floor' on the amount to be classified as borrowing costs in
the 20X1 accounting period is THB200 million. The difference of THB16 million
between this amount and THB216 million (being the qualifying interest costs
date on which the expense is incurred) is the amount of the foreign exchange gain
on the principal to be offset in borrowing costs. The remaining exchange gain on the
principal (THB284 million) is recognised in profit or loss in the year.
If the retranslation of the US$100 million at the end of 20X1 reporting period gave
rise to a foreign exchange loss, the entire loss should be recognised in profit or loss.
The amount of capitalised borrowing costs would be THB216 million (interest costs
date on which the expense is incurred). No adjustment to interest costs for exchange
differences should be made, as any such adjustment would result in an amount of
borrowing costs outside the acceptable range of amounts.
Q&A IAS 23(2007): 6-2 — COSTS ASSOCIATED WITH SHARES AND

SIMILAR INSTRUMENTS CLASSIFIED AS FINANCIAL LIABILITIES
Question
Do the requirements of IAS 23 apply to costs associated with shares and similar
financial instruments classified as liabilities in accordance with IAS 32 Financial
Instruments: Presentation (e.g. dividend payments on mandatorily redeemable
preference shares)?
Answer
Yes. IAS 23(2007).3 states that the “Standard does not deal with the actual or
imputed cost of equity, including preferred capital not classified as a liability”.
By implication, IAS 23 does apply to costs associated with shares and similar
financial instruments that are classified as liabilities in accordance with the
requirements of IAS 32. Under IAS 32.35, the dividends paid on such instruments
are recognised in profit or loss as an expense. IAS 32.36 states that "dividend
payments on shares wholly recognised as liabilities are recognised as expenses in the
same way as interest on a bond".
Although IAS 23 does not define what is meant by "the borrowing of funds", the
classification of shares and similar instruments as liabilities means that they should
be considered to represent such borrowings. As a result, the costs of servicing those
shares (e.g. dividends) fall within the definition of borrowing costs.
Q&A IAS 23(2007): 6-3 — IMPUTED INTEREST ON CONVERTIBLE DEBT

INSTRUMENTS
Question
Does the imputed interest recognised as an expense in respect of the liability
component of convertible debt fall within IAS 23's definition of borrowing costs?
Answer
In accordance with IAS 32 Financial Instruments: Presentation, the liability
component of a convertible debt instrument is presented on an amortised cost basis
using the coupon rate for an equivalent non-convertible debt. The imputed interest is
recognised in profit or loss using the effective interest method in IAS 39 Financial
Instruments: Recognition and Measurement. Therefore, it is appropriate for the
imputed interest expense in relation to the liability component of the convertible debt
instrument to be included in borrowing costs eligible for capitalisation.
Q&A IAS 23(2007): 6-4 — IMPACT OF TAX ON CAPITALISED

BORROWING COSTS
Question
Is the amount capitalised under IAS 23 affected by the tax treatment of the
borrowing costs?
Answer
No. Although the Standard does not specifically mention tax, it is clear from the way
that borrowing costs are defined that the amount to be capitalised is not affected by
whether tax relief will be obtained in respect of borrowing costs (i.e. borrowing costs
will be capitalised on a gross basis, and not net of any relevant tax relief).
In some jurisdictions, tax relief may be received on borrowing costs when they are
incurred, irrespective of whether those costs are capitalised. When this is the case, a
temporary difference will arise and the entity should apply the requirements of IAS
12 Income Taxes.
Q&A IAS 23(2007): 7-1 — DETERMINING WHETHER AN

EQUITY-ACCOUNTED INVESTMENT CAN BE A QUALIFYING ASSET
Background
Company X invests in construction contracts via participating interests in

single-purpose entities. The entities are generally either associates (as defined in IAS
28 Investments in Associates) or jointly controlled entities (as defined in IAS 31
Interests in Joint Ventures) of Company X, which accounts for all such investments
using the equity method of accounting.
Question
If Company X borrows funds for the purpose of funding the construction activities in
these equity-accounted vehicles, should it capitalise borrowing costs as part of the
carrying amount of the equity-accounted investments?
Answer
Borrowing costs should not be capitalised in these circumstances. Investments in
associates are financial instruments. IAS 23.7 states that financial assets are not
qualifying assets.
It is sometimes argued, where a financial asset is an equity-accounted investment in

a vehicle established for the purpose of constructing a qualifying asset, that the
substance of the arrangement is that the investment is a qualifying asset for the
investor. The logic is most appealing in the case of projects organised by a limited
number of investors to pool resources in developing production facilities or
properties. It is argued that, from the investor's perspective, the amount of
borrowing costs capitalised should not be different simply because construction of
the qualifying asset is through a separate investee vehicle, rather than by the
investing entity itself. However, this approach is not permitted by IAS 23.
In contrast, when a jointly controlled entity is accounted for using proportionate

consolidation under IAS 31's benchmark treatment, capitalisation of borrowing costs
is required in similar circumstances (see Q&A IAS 23(2007): 7-2).
Q&A IAS 23(2007): 7-2 — DETERMINING WHETHER AN INVESTMENT

IN A JOINTLY CONTROLLED ENTITY ACCOUNTED FOR USING
PROPORTIONATE CONSOLIDATION CAN BE A QUALIFYING ASSET
Question
When a venturer borrows funds for the purpose of investing in a jointly controlled
entity, and the jointly controlled entity is accounted for under IAS 31 Interests in
Joint Ventures using proportionate consolidation, should the borrowing costs incurred
on funds used by the jointly controlled entity to construct qualifying assets be
capitalised under IAS 23?
Answer
Yes. In contrast to the prohibition on capitalisation of borrowing costs in respect of
equity-accounted investments (see Q&A IAS 23(2007): 7-1), it appears that when a
jointly controlled entity is accounted for using proportionate consolidation under IAS
31's benchmark treatment, capitalisation of borrowing costs is required.
The investor's share of the qualifying assets of a jointly controlled entity accounted
for using proportionate consolidation can be considered to be qualifying assets for
the purposes of the consolidated financial statements and, therefore, capitalisation of
borrowing costs incurred by any group entity to fund the construction of those
qualifying assets is appropriate, provided that all of the conditions of IAS 23 are met.
Q&A IAS 23(2007): 12-1 — SPECIFIC BORROWING COSTS OFFSET BY

INVESTMENT INCOME ON EXCESS FUNDS
Background
An entity borrows CU20 million to finance the construction of a factory (a qualifying

asset). The funds are to be drawn down on a monthly basis in four equal amounts.
Payment of construction costs occurs throughout each month, rather than coinciding
with the draw-downs. During each month, the entity invests any excess funds,
drawn down in accordance with the financing arrangements, in short-term bank
deposits.

Question
Should interest income derived from the short-term bank deposits be taken into
account in determining the borrowing costs to be capitalised?
Answer
Yes. In its financial statements for the year, the entity should capitalise, as part of
the cost of construction of the factory, the actual borrowing costs on the CU20
million borrowing (incurred during the period of construction), less the interest
income derived from the temporary investments in bank deposits.
Q&A IAS 23(2007): 14-1 — REPORTING ENTITY HAS BORROWINGS,

BUT CONSIDERS THAT ASSET HAS BEEN FUNDED FROM AVAILABLE
CASH BALANCES
Question
When an entity has a general borrowing pool, is it required to capitalise deemed
borrowing costs under IAS 23(2007).14 in respect of the expenditure on all
qualifying assets, even where expenditure on certain assets is considered to be met
out of specified cash balances?
Answer
This question is not specifically dealt with in IAS 23. IAS 23(2007).14 refers to "the
extent that an entity borrows funds generally and uses them for the purpose of
obtaining a qualifying asset". Therefore, it appears that to the extent that the asset
is demonstrably not paid for out of borrowings (e.g. it is paid for out of the cash
proceeds of an equity issue), there is no requirement to capitalise a deemed interest
cost.
To understand this position, contrast the IAS 23 requirements with those of U.S.
GAAP, which state that the interest cost to be capitalised is that which would
theoretically have been avoided by using the funds expended to repay existing
borrowings. Therefore, whenever an entity has a general borrowing pool, it is
required to capitalise the borrowing costs that would have been avoided if the cash
balances had been used to repay those borrowings.
Under IAS 23(2007).14, there is no requirement to capitalise a 'deemed' interest

cost, although it appears that adopting the approach required by U.S. GAAP will be
acceptable.

Q&A IAS 23(2007): 14-2 deals with the special case of insurance proceeds.
Q&A IAS 23(2007): 14-2 — USE OF INSURANCE PROCEEDS TO FUND

RECONSTRUCTION OF AN ASSET
Question
Company A had a factory that was destroyed by fire. Insurance proceeds have been
received and are being used to reconstruct the factory. Company A has a general
borrowing pool. Because costs are incurred on the general borrowing pool, is
Company A required to capitalise a deemed interest cost in respect of the
reconstruction, even though the construction is funded from the insurance proceeds
which are lodged in a separate bank account?
Answer
The capitalisation of borrowing costs is not necessarily required in these
circumstances. The construction of the replacement asset is a distinct event and
should be assessed separately for the purpose of determining the appropriateness of
capitalisation of borrowing costs.
The general question as to whether an entity is required to capitalise borrowing

costs, even when it has identified the source of the funding for the qualifying asset
as cash balances, is dealt with in Q&A IAS 23(2007): 14-1.
The only distinction in the case of insurance proceeds is that the entity may be
legally required to use the insurance proceeds for the purposes of the reconstruction.
When this is the case, the option of repayment of the borrowings is not available,
and the borrowing costs are not avoidable. Therefore, the option of capitalising a
'deemed' interest cost is not available in such circumstances.
Q&A IAS 23(2007): 14-EX-1 — CALCULATION OF CAPITALISATION

RATE FOR A QUALIFYING ASSET FUNDED FROM A GENERAL
BORROWING POOL
Example
An entity centrally co-ordinates its financing activities through a treasury function,
with borrowings being raised to finance general requirements, including the
acquisition and development of qualifying assets.
During the year ended 31 December 20X1, the entity commenced a property
development project and incurred the following expenditure:
The entity had total borrowings outstanding during the period, and incurred interest
on those borrowings, as follows:
The appropriate capitalisation rate to be applied to the expenditure on the qualifying

asset is calculated as follows:

Interest capitalised is therefore calculated as follows:
Q&A IAS 23(2007): 14-3 — BORROWING COSTS CAPITALISED LIMITED

TO THE BORROWING COSTS INCURRED (IMPLICATIONS FOR
GROUPS)
Question
IAS 23(2007).14 states that “[t]he amount of borrowing costs that an entity
capitalises during a period shall not exceed the amount of borrowing costs it incurred
during that period”. What are the implications of this principle for groups with
centralised banking arrangements?
Answer
Because the amount of borrowing costs capitalised may not exceed the amount of
borrowing costs actually incurred, 'notional' interest expenses may not be
capitalised.
This point has particular relevance for groups with centralised banking arrangements
whereby the 'banking' entity charges or credits interest to the other group entities in
respect of its balances with those entities. Interest charged by one member of a
group to another cannot be capitalised in the consolidated financial statements
except to the extent that it represents an interest expense actually borne by the
group on capital borrowed externally to finance the construction or production of a
qualifying asset. Intragroup interest is eliminated on consolidation.
Q&A IAS 23(2007): 14-EX-2 illustrates the application of the principle.
Q&A IAS 23(2007): 14-EX-2 — EXAMPLE OF BORROWING COSTS

CAPITALISED LIMITED TO BORROWING COSTS INCURRED IN A
GROUP CONTEXT
Example
A group consists of a parent, P, and two subsidiaries, S1 and S2. S1 is engaged in
the construction of a power plant that is wholly financed by fellow subsidiary S2,
which obtains the necessary funds through bank borrowings. No intragroup interest
is charged by S2 to S1.
In the circumstances described, no interest should be capitalised in either of the

individual financial statements of S1 or S2. S1 has incurred no borrowing costs, and
S2 has no qualifying asset.
However, it will be appropriate to capitalise interest in the consolidated financial

statements of P, provided that the amount capitalised fairly reflects the interest cost
to the group of borrowings from third parties which could have been avoided if the
expenditure on the qualifying asset had not been made.
Q&A IAS 23(2007): 14-4 — INVESTMENT INCOME ON EXCESS FUNDS

WHEN FUNDS ARE BORROWED GENERALLY
Question
When funds are borrowed generally, and the entity earns interest income on excess
funds, should that interest income be offset against the interest costs on the general
borrowings in determining the appropriate capitalisation rate?
Answer
No. The interest income should not be offset against interest costs in determining
the appropriate capitalisation rate, nor in determining the limit on capitalisation by
reference to the amount of borrowing costs incurred during the period.
Q&A IAS 23(2007): 16-1 — CARRYING AMOUNT OF ASSET EXCEEDS ITS

RECOVERABLE AMOUNT

Question
An entity incurs borrowing costs in relation to a qualifying asset; if the borrowing
costs are capitalised, the resulting carrying amount will exceed the recoverable
amount of the asset. Should the entity capitalise the borrowing costs?
Answer
IAS 23(2007).16 requires that “[w]hen the carrying amount or the expected ultimate
cost of the qualifying asset exceeds its recoverable amount or net realisable value,
the carrying amount is written down or written off in accordance with the
requirements of other [IFRSs]”.
Therefore, once borrowing costs have been identified as appropriate for

capitalisation, they should be capitalised as part of the cost of the qualifying asset.
This is so even in those circumstances when the expected ultimate cost of the
qualifying asset exceeds its recoverable amount (or net realisable value for
inventories). In such cases, the appropriate treatment is to capitalise the borrowing
costs as part of the gross carrying amount of the asset, and then recognise an
impairment loss for any excess over the estimated recoverable amount or net
realisable value in accordance with the requirements of IAS 36 Impairment of Assets
or IAS 2 Inventories, as appropriate.
Q&A IAS 23(2007): 17-1 — DEPOSIT PAID FOR THE ACQUISITION OF AN

ASSET
Background
Company A places an order with a supplier for the acquisition of an asset. The asset
“necessarily takes a substantial period of time to get ready for its intended use or
sale” (the condition for a qualifying asset under IAS 23(2007).5). At the time of
placing the order, Company A pays a substantial deposit. The remainder of the cost
of the asset is paid on delivery.
Question
If Company A incurs borrowing costs in respect of the deposit paid, are those
borrowing costs eligible for capitalisation?
Answer

In determining whether any borrowing costs incurred are eligible for capitalisation,
an assessment is required of all the facts and circumstances and the nature of the
deposit paid by Company A. Some common examples are described below.
Deposit represents payment on account under a construction contract
An asset that is manufactured for Company A under a construction contract, in

accordance with Company A's specification, is a qualifying asset. The deposit
represents a payment on account for construction services.
For example, Company A contracts a supplier to construct a property on Company

A's land to Company A's specification based on architect's plans provided by
Company A. Any payments made by Company A to the supplier are for the
construction services provided by the supplier and, therefore, are directly related to
the manufacture or construction of the property. Consequently, borrowing costs
incurred by Company A during the construction period are eligible for capitalisation
and should be capitalised as part of the cost of the asset.
Deposit secures place in a waiting list to acquire standard goods
IAS 23(2007).7 states that “[a]ssets that are ready for their intended use or sale
when acquired are not qualifying assets”. In such cases, a deposit may primarily
serve to secure Company A's place in a waiting list.
A common example is the manufacture of top-end cars where the customer may
select from standard customisation options (e.g. paint colour, air conditioning,
parking sensors). There is generally a waiting list for such cars. In order to secure its
place in the waiting list and guarantee delivery of the new car, Company A may pay
a substantial deposit when the order is placed. However, if the deposit does not
affect the total amount payable to the supplier for the car, any borrowing costs
Company A incurs on the deposit do not qualify for capitalisation as they do not arise
in relation to the manufacture of the car.
Q&A IAS 23(2007): 22-1 — INVESTMENT PROPERTY SUBJECT TO

LESSEE FIT-OUT
Background
A lessor completes a property subject to fit-out, and transfers it to the lessee, who
then carries out further work to bring the property to the condition necessary for its

intended use.
Question
At what stage should the lessor cease capitalisation of borrowing costs?
Answer
An entity should cease capitalisation of borrowing costs when substantially all of the
activities necessary to prepare the qualifying asset for its intended use or sale are
complete. The property is available for its intended use at the time that the lessee
takes possession. This is the 'commencement of the lease term' as defined in
paragraph 4 of IAS 17 Leases. It is also the date at which the lessor ceases
capitalisation of borrowing costs, unless there is a delay between the lessor
completing work and the lessee taking possession, in which case capitalisation will
cease at the earlier date.
Q&A IAS 23(2007): 22-2 — WHEN ARE 'SUBSTANTIALLY ALL' THE

ACTIVITIES NECESSARY TO PREPARE AN ASSET FOR ITS INTENDED
USE COMPLETED?
Question
In accordance with IAS 23(2007).22, capitalisation of borrowing costs should cease
“when substantially all the activities necessary to prepare the qualifying asset for its
intended use or sale are complete”. How should 'substantially all' be interpreted?
Answer
IAS 23(2007).23 states that an asset is normally ready for its intended use or sale
when the physical construction is complete; at that stage the asset will be
substantially ready for its intended use, notwithstanding that further time might be
necessary to complete routine administrative work, market the asset or, in the case
of an investment property, find a tenant.
Regulatory consents (e.g. health and safety clearance) are sometimes required
before an asset is permitted to be brought into use. Management will normally seek
to ensure that such consents are in place very close to the time frame for physical
completion and testing, so that the consents do not slow down the commencement
of operations. When an entity could have avoided a delay in obtaining consents,
which prevents the start of operations, the delay should be seen as abnormal and
similar in effect to a suspension of development, so that capitalisation of borrowing
costs should cease (see IAS 23(2007).20). However, when it is not possible to avoid
a delay between physical completion and obtaining such consents (e.g. when it is not
possible to apply for consents until after physical completion), capitalisation of
borrowing costs will continue to be appropriate until the consents are obtained, i.e.
until the asset is ready for its intended use.
When the completion of an asset is intentionally delayed, continued capitalisation of

borrowing costs is not permitted. For example, in the case of property development,
it is customary for the developer to defer installation of certain fixtures and fittings
and the decoration work until units are sold, so that purchasers may choose their
own specifications. Such delays relate more to the marketing of units than to the
asset construction process.
Q&A IAS 23(2007): 22-3 — CESSATION OF CAPITALISATION FOR

MATURING INVENTORIES
Question
When should an entity cease capitalisation of borrowing costs for maturing
inventories?
Answer
For maturing inventories, it is sometimes difficult to determine when the 'period of
production' ends, i.e. when inventories are being held for sale as opposed to being
held to maturity. For example, whisky is 'mature' after three years, but goes on
improving with age for many more years. Provided that it is consistent with the
entity's business model to hold such items so that they mature further, it would
seem acceptable to continue to add borrowing costs to the value of such maturing
inventories for as long as it can be demonstrated that the particular item of
inventory continues to increase in value solely on account of increasing age, rather
than because of market fluctuations or inflation. If this cannot be demonstrated,
then the inventories should be regarded as held for sale and no further borrowing
costs should be capitalised.
Q&A IAS 23(2007): 24-1 — CESSATION OF CAPITALISATION OF

BORROWING COSTS WHEN THE CONSTRUCTION OF AN ASSET IS
COMPLETED IN STAGES

Background
A cable service supplier is building a cable network covering many franchise areas.
The construction is carried out sequentially for each franchise area. Once the
construction in each franchise area is completed, the network is available for use in
that area. The expenditure is being funded from a general borrowing pool.
Question
Should capitalisation of borrowing costs cease at the end of the entire project, or at
the completion of each individual franchise area?
Answer
Capitalisation related to each stage ceases on the completion of the individual stage
of the project, rather than when the project as a whole is completed.
Under IAS 23(2007).24, when the construction of a qualifying asset is completed in

parts, and each part is capable of being used while construction continues on other
parts, capitalisation of borrowing costs should cease when substantially all the
activities necessary to prepare that part for its intended use or sale are completed.
In this example, therefore, capitalisation of borrowing costs for each franchise area
ceases as and when substantially all of the activities necessary to prepare the cable
network in the particular franchise area for use are completed. Note that
capitalisation of borrowing costs in other franchise areas still under construction may
continue.
Q&A IAS 23(2007): 27-1 — TRANSITION TO IAS 23(2007) — ENTITY HAS

PREVIOUSLY EXPENSED ALL BORROWING COSTS WHEN INCURRED
Question
How should the transitional provisions for IAS 23(2007) be applied when an entity
applied the benchmark treatment of expensing all borrowing costs under the
previous version of the Standard?
Answer
When an IFRS reporter previously adopted the benchmark treatment of expensing all
borrowing costs, the new accounting policy of capitalisation should be applied
prospectively for qualifying assets with a commencement date on or after the
effective date of the revised Standard, or any earlier date designated in accordance
with IAS 23(2007).28. Thus, the new policy (of capitalisation) will not be applied to
qualifying assets with an earlier commencement date, and all borrowing costs
relating to such assets, including any incurred after the effective (or designated)
date, will continue to be expensed.
In all cases, the effect of the transitional provisions of the revised Standard is that
assets with a commencement date before the effective (or designated) date will not
be restated.
See Q&A IAS 23(2007): 27-EX-1 for an illustration of the application of these
transitional provisions.
Q&A IAS 23(2007): 27-2 — TRANSITION TO IAS 23(2007) — ENTITY

CAPITALISED BORROWING COSTS UNDER THE PREVIOUS VERSION
OF THE STANDARD
Question
How should the transitional provisions of IAS 23(2007) be applied when an entity
applied the allowed alternative treatment of capitalising borrowing costs related to
qualifying assets under the previous version of the Standard?
Answer
When an IFRS reporter previously adopted the allowed alternative treatment of
capitalising borrowing costs relating to qualifying assets, there will generally be no
change of accounting policy on application of IAS 23(2007). An exception may be
where the entity has voluntarily elected to take one of the new scope exemptions set
out in IAS 23(2007).4 (see Q&A IAS 23(2007): 4-1), having previously capitalised
borrowing costs for such assets.
In accordance with IAS 23(2007).27 and 28, such a change of accounting policy
should be accounted for prospectively from the effective date, or from any earlier
date designated in accordance with IAS 23(2007).28. Thus, the new policy (of
expensing borrowing costs for such exempt assets) will not be applied to assets with
an earlier commencement date, and borrowing costs relating to such assets,
including any incurred after the effective (or designated) date, will continue to be
capitalised in accordance with the previous version of the Standard.
In all cases, the effect of the transitional provisions of the revised Standard is that
assets with a commencement date before the effective (or designated) date will not

be restated.
Q&A IAS 23(2007): 27-EX-1 — TRANSITION TO IAS 23(2007) —

EXAMPLE
Example
Prior to adopting IAS 23 (as revised in 2007), Entity A followed the benchmark
treatment under the previous version of the Standard and expensed all borrowing
costs when incurred. Entity A is applying the revised Standard for the first time in its
financial statements for the year ended 31 December 2009.
Entity A has engaged in the following construction projects prior to and during the
2009 reporting period:
• Asset 1 — construction commenced 1 January 2006, construction

completed 30 June 2007 (still held by Entity A as property, plant and
equipment);
• Asset 2 — construction commenced 1 January 2006, construction

completed 30 June 2009 (still held by Entity A as property, plant and
equipment);
• Asset 3 — construction commenced 1 July 2005, expected completion date

31 December 2011; and
• Asset 4 — construction commenced 1 July 2009, expected completion date

31 December 2011.
All of these assets meet the definition of 'qualifying assets' under IAS 23(2007).
Assume that the 'construction commenced' noted in each case is the appropriate
date for commencement of capitalisation of borrowing costs under IAS 23(2007).
Under IAS 23(2007).27, the revised Standard is applied to borrowing costs relating
to qualifying assets for which the commencement date for capitalisation is on or after
the effective date. However, under IAS 23(2007).28, an entity may designate any
date before the effective date and apply the revised Standard to borrowing costs
relating to all qualifying assets for which the commencement date for capitalisation is
on or after that date.
Entity A needs to make an accounting policy choice to either apply the revised
Standard from 1 January 2009 (the effective date) or to designate an earlier date
from which to apply it (e.g. 1 January 2006).

If Entity A chooses to apply the revised Standard from 1 January 2009, it will only
capitalise borrowing costs incurred on Asset 4. Borrowing costs incurred on the other
assets (even after 1 January 2009) are not capitalised.
If Entity A designates 1 January 2006 as its date for application of the revised
Standard, it will capitalise borrowing costs incurred on Assets 1, 2 and 4 from the
date of commencement to the date of completion. A prior period adjustment will be
required to restate the borrowing costs incurred in relation to those assets previously
recognised as an expense and, in the case of Asset 1, to adjust the depreciation
charged on the asset before 1 January 2009. The borrowing costs incurred on Asset
3 will not be capitalised because the date of commencement is before 1 January
2006.
Q&A IAS 26: 9-1 — ACCOUNTING AND REPORTING BY RETIREMENT

BENEFIT PLANS
[Issued 17 November 2006]
Question
Does IAS 26 apply to retirement benefit plans other than those sponsored by
employers, given the apparent conflict between IAS 26.8 and IAS 26.9?
Answer
IAS 26.8 defines retirement benefit plans as "arrangements whereby an entity
provides benefits for its employees on or after termination of service (either in the
form of an annual income or as a lump sum) when such benefits, or the
contributions towards them, can be determined or estimated in advance of
retirement from the provisions of a document or from the entity's practices".
However, IAS 26.9 states, "Some retirement benefit plans have sponsors other than
employers; this Standard also applies to the financial statements of such plans".
The IFRIC concluded in March 2004 that the intention, as expressed in IAS 26.9, was
clear that the Standard applies both to plans sponsored by employers and plans with
sponsors other than employers.

Note: IFRIC agenda rejection published in the March 2004 IFRIC Update.
Q&A IAS 27(2008): 1-1 — LEGAL FORM OF SUBSIDIARY (LIMITED

PARTNERSHIPS)
Question
Does the legal form of an entity (e.g. in the case of limited and real estate
partnerships), by itself, change a determination as to whether it should be
consolidated?
Answer
No. The legal form of an entity would not, by itself, change a determination as to
whether it should be consolidated. IAS 27(2008).4 defines a subsidiary as "an entity,
including an unincorporated entity such as a partnership, that is controlled by
another entity (known as the parent)". This definition does not prescribe any
particular legal form for a subsidiary.
In certain jurisdictions, for example, entities create limited and real estate
partnerships; however, structures for limited partnerships and the functions of a sole
general partner of a limited partnership vary widely from partnership to partnership
and from jurisdiction to jurisdiction.
A limited partnership generally must meet certain legal and tax criteria to qualify as
a limited partnership. Therefore, the structure is often form-driven. The rights and
obligations of general partners in limited partnerships are usually different from
those of limited partners. Some general partners perform a function designed solely
to satisfy the criteria to qualify the entity as a limited partnership. Those general
partners may have little, if any, real economic or beneficial interest in the
partnership, but will exercise control.
When applying the definition of a subsidiary, which requires both (1) control of
operating and financial policies and (2) the ability to benefit from that control, a
partnership in which the general partner has no beneficial interest in the partnership
net assets or net income is unlikely to meet the definition of a subsidiary of the
general partner. Similarly, a partnership in which a limited partner has an economic
interest, but no ability to control the operating and financial policies, is unlikely to
meet the definition of a subsidiary of the limited partner (although care should be
taken also to consider the requirements of SIC-12 Consolidation — Special Purpose
Entities when assessing whether control is present). However, a limited partner who
is also the general partner, or who holds the power to remove the general partner,
may have both the elements of control and benefit such that the partnership meets
the definition of a subsidiary of the limited partner.
The determination as to whether a general partner controls the partnership is a

matter of careful judgement based on the relevant facts and circumstances.
Q&A IAS 27(2008): 4-1 — DETERMINATION OF NON-CONTROLLING

INTEREST WHEN PART OF THE INTEREST IN A SUBSIDIARY IS HELD
INDIRECTLY THROUGH AN ASSOCIATE
Background
Parent P owns 70 per cent of Subsidiary S. It also owns 40 per cent of Associate A,
over which it has significant influence and which it accounts for using the equity
method. Associate A owns the remaining 30 per cent of Subsidiary S.
Question
How should Parent P determine the non-controlling interest (NCI) in Subsidiary S for
the purposes of its consolidated financial statements?
Answer
It depends on whether Parent P views the equity method of accounting as a one-line
consolidation or as a valuation methodology. (See Q&A IAS 28: 33-3.)
Whether the equity method is considered a one-line consolidation or a valuation

methodology is a matter of accounting policy to be applied consistently to all
associates and to all aspects of the application of the equity method.
Equity method as a one-line consolidation
Under this view, many of the adjustments and calculations normally performed for
consolidation purposes are also performed when applying the equity method.
If Parent P's accounting policy is to apply the equity method as a one-line

consolidation, it should include in its percentage of ownership in Subsidiary S the
interest held indirectly through Associate A; that is, it should determine the NCI
using the indirect method. Under the indirect method, the proportion of equity and
total comprehensive income of Subsidiary S allocated to the NCI in Parent P's
consolidated financial statements is 18 per cent (i.e. 30% × 60%), the proportion
not held by Parent P, its subsidiaries, joint ventures or associates.
Equity method as a valuation methodology
This is often referred to as a 'closed box' view approach to the equity method.
If Parent P's accounting policy is to apply the equity method as a valuation

methodology, it should not include the interest in Subsidiary S held by Associate A in
determining its percentage of ownership in Subsidiary S; that is, it should determine
the NCI using the direct method. Under the direct method, the proportion of equity
and total comprehensive income of Subsidiary S allocated to the NCI in Parent P's
consolidated financial statements is 30 per cent, the proportion not held by Parent P
or its subsidiaries.
Q&A IAS 27(2008): 4-2 — DEFINITION OF CONTROL

Question
What are the characteristics of control?
Answer

The definition of control encompasses both the notion of governance and the
economic consequence of that governance (i.e. benefits and risks).
Governance relates to the power to make decisions. In the definition of control, the
phrase 'power to govern' implies having the capacity or ability to accomplish
something — in this case, to govern the decision-making process through the
selection of financial and operating policies. This does not require active participation
or ownership of shares. Benefits may relate to current or future cash inflows either
remitted to the controlling entity or remaining in control of the controlling entity.
Benefits also may encompass non-monetary increases in value to the controlling

entity. Risks may relate to current or future cash or non-monetary outflows paid
either by the controlling entity or through assets controlled by the entity.
Ultimately, the assessment of whether an entity controls another is a matter of

careful judgement based on all relevant facts and circumstances.
Q&A IAS 27(2008): 4-3 — DEFINITION OF FINANCIAL AND OPERATING

POLICIES
Question
How are 'financial and operating policies' defined for the purposes of the definition of
control in IAS 27(2008).4?
Answer
Financial and operating policies are not defined in IAS 27(2008).
Operating policies generally would include those policies that guide activities such as
sales, marketing, manufacturing, human resources, and acquisitions and disposals of
investments. Financial policies generally would be those policies that guide capital
expenditures, budget approvals, credit terms, dividend policies, issuance of debt,
cash management and accounting policies.
Q&A IAS 27(2008): 9-1 — PARENT HAS NO SUBSIDIARY AT THE END

OF THE REPORTING PERIOD

Background
Company A has one subsidiary at the beginning of the accounting period which it
disposes of during the accounting period. Therefore, at the end of the accounting
period, Company A has no subsidiaries.
Question
Is Company A required to prepare consolidated financial statements for the
accounting period reflecting the results of the subsidiary up to the date of disposal?
Answer
Yes. IAS 27(2008).26 requires that the income and expenses of a subsidiary should
be included in the consolidated financial statements until the date on which the
parent ceases to control the subsidiary. Accordingly, when a parent has had
subsidiaries at any time during a reporting period, IAS 27(2008) requires
consolidated financial statements to be produced (unless the exemption in IAS
27(2008).10 is available).
Company A should also consider the potential impact of IFRS 5 Non-current Assets
Held for Sale and Discontinued Operations.
Q&A IAS 27(2008): 9-2 — HORIZONTAL GROUPS

Question
Are consolidated financial statements required for 'horizontal groups' (i.e. where two
or more reporting entities are controlled by a common shareholding, such as that
held by a private individual)?
Answer
No. Because this individual is not subject to a requirement to prepare financial
statements, there is no mechanism, either legal or professional, by which
consolidated financial statements can be required.
The existence of the controlling individual, and transactions between entities that are
under common control and other related parties, are disclosable under IAS 24
Related Party Disclosures.

Q&A IAS 27(2008): 13-1 — FACTORS TO CONSIDER IN EVALUATING
CONTROL
Question
What factors should be considered in evaluating control?
Answer
Control is presumed to exist when an investor owns, either directly or indirectly
through subsidiaries, more than half of the voting power of another entity unless, in
exceptional circumstances, it can be clearly demonstrated that such ownership does
not constitute control. IAS 27(2008).13 provides indicators of control when an entity
owns half or less of the voting power of an entity.
In addition to the control indicators in IAS 27(2008).13, the following factors should
be considered in evaluating whether control exists. No one factor is a determinant of
control without a complete analysis of all the relevant facts and circumstances:
• currently exercisable potential voting rights (e.g. options or other securities

convertible into voting shares) or other voting interests as addressed in
IAS 27(2008).14–15;
• the level of total equity or 'at risk' capital, thereby resulting in potential
influence beyond voting share percentage (e.g. financial obligations due to
the owner);
• the ability to sell, lease, or otherwise dispose of the entity's assets;
• the ability to enter into contracts or commitments on behalf of the entity;
• the ability to establish or take any action that could change the operating
or financial policies of the entity, including selecting, terminating, or setting
the compensation of the entity's management responsible for
implementing the entity's policies;
• responsibility for all supervision, operation and maintenance of the entity's

business and property;
• whether the entity is a mechanism to finance a project, and the investor

will eventually acquire the project;
• whether the entity is an integral part of the investor's business;
• guarantee of the entity's debt; and

• possession of the right or obligation to offer to buy out the other
ownership interests in the entity.
Q&A IAS 27(2008): 13-2 — MINORITY RIGHTS AND CONTROL

Question
Can the rights of a minority owner prevent consolidation by the majority owner?
Answer
Yes. In some instances, the power of a shareholder with a majority voting interest to
control the operations or assets of an entity are restricted in certain respects by
approval or veto rights granted to the minority shareholder. Those minority rights
may have little or no impact on the ability of a shareholder with a majority voting
interest to control an entity's financial and operating policies. In certain cases,
however, those rights may be so restrictive as to call into question whether control
rests with the majority owner.
The following are illustrative minority rights (whether granted by contract or by law)
that may require careful consideration in the determination of control:
• selecting, terminating and setting the compensation of management

responsible for implementing the investee's policies and procedures;
• establishing operating and financial decisions of the investee, including

budgets, in the ordinary course of business;
• the ability to participate in determining the priority directions of an

investee's activities;
• the ability of a minority investor to veto certain decisions to maintain the

operation of an investee, such as the addition or deletion of certain
essential services of an investee; and
• the right to veto the termination of management responsible for

implementing the investee's policies and procedures.
While the existence of minority rights should be considered, the primary focus of
such assessment should be on whether one entity controls another. This assessment
should take into consideration the rights of all parties involved.
Q&A IAS 27(2008): 13-3 — FACTORS IN THE DETERMINATION OF

WHETHER AN ENTITY IS A SINGLE ENTITY OR MULTIPLE ENTITIES
Question
Some jurisdictions may include legal entities that are divided into separate parts,
sometimes referred to as 'cells' or 'silos'. In such cases, under what circumstances is
it possible to consider only an individual cell (rather than the entire legal entity) as a
distinct entity for the purposes of determining whether that entity (i.e. the individual
cell) is a subsidiary controlled by the parent as defined in IAS 27(2008).13 (or
SIC-12 Consolidation — Special Purpose Entities as applicable)?
Answer
For a single cell to be considered a distinct entity for the purposes described, the
following questions in particular (if substantive) should be addressed.
• Is there strict legal segregation of the assets and liabilities of the

individual cells during the life of the cells and upon liquidation with no
commingling of assets and liabilities?
• Does each cell have distinct and separate funding?
• Are the risk management, investment strategy and income distribution

decisions undertaken by the single cell only?
• Are there mechanisms for the sharing of risks and risk transfer between
different cells?
• Does the strict legal segregation of assets and liabilities hold true on
bankruptcy of any of the cells?
Considering an individual cell as a separate entity for the purposes of IAS

27(2008).13 (or SIC-12, as appropriate) effectively means viewing the whole legal
entity (containing within it multiple cells) as, in substance, a group of
special-purpose entities (SPEs) rather than one single SPE. The determination as to
whether the whole legal entity is, in substance, a group of separate SPEs is a matter
requiring careful judgement, based on all of the relevant facts and circumstances.
Q&A IAS 27(2008): 13-4 — SPECIAL-PURPOSE ENTITY CONTROL

INDICATORS

Question
What consideration should be given in applying the control indicators set out in
SIC-12 Consolidation — Special Purpose Entities?
Answer
In addition to the circumstances described in IAS 27(2008).13, where control may
exist despite the absence of a majority shareholding, SIC-12.10 describes the
following circumstances that may indicate that a relationship exists in which an
entity controls a special-purpose entity (SPE) and consequently should consolidate
the SPE:
• in substance, the activities of the SPE are being conducted on behalf of

the entity according to its specific business needs so that the entity obtains
benefits from the SPE's operation;
• in substance, the entity has the decision-making powers to obtain the

majority of the benefits of the activities of the SPE or, by setting up an
'autopilot' mechanism, the entity has delegated those decision-making
powers;
• in substance, the entity has rights to obtain the majority of the benefits of
the SPE and, therefore, may be exposed to risks incident to the activities of
the SPE; or
• in substance, the entity retains the majority of the residual or ownership

risks related to the SPE or its assets in order to obtain benefits from its
activities.
The Appendix to SIC-12 provides specific examples of these indicators.
The application of the indicators listed above should be consistent with the notion of
control, as defined in IAS 27(2008) — that is, control encompasses both governance
and benefits aspects. The first two indicators relate to the governance aspect of
control (i.e. the activities of the SPE and its decision-making powers), while the
second two indicators relate to the benefits aspect of control (i.e. benefits and risks).
In its November 2006 meeting, when discussing potential agenda items, the IFRIC
emphasised that the factors are indicators only and not necessarily conclusive,
because circumstances vary case by case. SIC-12 requires that the party having
control over an SPE should be determined through the exercise of careful judgement
in each case, after taking into account all relevant factors.
Q&A IAS 27(2008): 13-5 — FACTORS TO DETERMINE WHETHER AN

ENTITY IS A SPECIAL-PURPOSE ENTITY
Question
What is a special-purpose entity (SPE)?
Answer
Paragraph 1 of SIC-12 Consolidation — Special Purpose Entities describes an SPE as
a corporation, trust or unincorporated entity that has been created “to accomplish a
narrow and well-defined objective (eg to effect a lease, research and development
activities or a securitisation of financial assets)”.
SIC-12.1 further states: “SPEs are often created with legal arrangements that
impose strict and sometimes permanent limits on the decision-making powers of
their governing board, trustee or management over the operations of the SPE.
Frequently, these provisions specify that the policy guiding the ongoing activities of
the SPE cannot be modified, other than perhaps by its creator or sponsor (ie they
operate on so-called 'auto-pilot')”.
Central to the determination as to whether an entity is, in substance, an SPE is the

extent to which there are limitations or restrictions on the entity's operations or
activities and decision-making ability. The following factors, at a minimum, should be
considered in determining whether an entity is, in substance, an SPE:
• the nature and scope of the entity's activities (e.g. whether the activities
are limited (1) to a single transaction type, (2) to certain industries or (3)
by the number or amount of activities or transactions that can be entered
into);
• the ability of another entity (e.g. a sponsor or entity on whose behalf the
entity was created) to limit or restrict the activities of the entity;
• the extent to which the entity can modify or change the nature and scope
of its operations and activities;
• the nature and scope of the entity's customer base (e.g. whether the
entity is restricted to serving a limited number of customers);
• the nature and scope of the entity's decision-making ability (e.g. the
relationship between the entity's permitted activities and its ability to effect
or carry out those activities); and
• the extent to which the entity's ability to make decisions is contingent on

approval by another entity (e.g. a sponsor or entity on whose behalf the
entity was created).

Q&A IAS 27(2008): 13-6 — CONSOLIDATION OF FUNDS
Background
An unlisted fund with sub-funds has both voting shares and preference shares. Its
voting shares are owned by a management company who also make up the board of
directors of the fund. The preference shareholders, however, have the power to
remove and replace the fund's board of directors (i.e. the management company)
with directors of their choice.
The management company receives a management fee which is based on the fund's
net asset value, including realised and unrealised gains. The preference
shareholders, whose return is based on the performance of the sub-funds less the
management fee, receive their return at the time they redeem their shares.
Question
Does the management company control the fund?
Answer
No. “Control is the power to govern the financial and operating policies of an entity
so as to obtain benefits from its activities” [IAS 27(2008).4]. Control relates to the
ability to govern the decision-making through the selection of financial and operating
policies, regardless of whether this power is actually exercised. The ability to govern
the decision-making alone, however, is not sufficient to establish control and,
therefore, must be accompanied by the objective of obtaining benefits from the
entity's activities.
When a party has the power to appoint or remove the majority of the board of
directors or equivalent governing body, a careful analysis of the policies regarding
the replacement of these members is essential. In addition, it is essential to consider
the party's ability to remove the majority of these members without delay and
expense. If the evidence shows that the board of directors only 'temporarily' exercise
decision-making powers, because another party has the right to remove and replace
the majority of the board of directors at their choice with immaterial delay and
expense, those with the ultimate power to remove and replace the majority of the
board members have the power to govern the decision-making of the entity.
However, control only exists if the party which has the power to govern the financial
and operating policies also obtains benefits from its activities. The criterion to obtain
these benefits has to be viewed as benefits derived from having the power to govern
the financial and operating policies. Therefore, in addition to analysing the control
rights in IAS 27(2008).13, an analysis of the benefits obtained is required. In
circumstances in which the fee received by a management party represents only a
'normal' level for the management service provided and no more, the party receives
no further benefits from its activities.
In the circumstances described, due to the right of the preference shareholders to

replace the management company with directors of their choice with no delay and at
no expense, and the fact that the fee is at a 'normal' rate for the level of service
provided, the current holding of the management company in the fund does not
constitute control. Overall, its relationship with the fund can be viewed as a fiduciary
relationship rather than one of control.
Q&A IAS 27(2008): 13-7 — INVESTMENT MANAGERS

Question
When an investment manager has discretion over the investment decisions of a
fund, does this constitute 'control' for the purposes of IAS 27?
Answer
It depends. Control requires that the investor have the power to govern the financial
and operating policies of an entity so as to obtain benefit from its activities. When
the other investors have the power to remove and replace the investment manager
at relatively short notice, and could exercise that power in practice, the fund is
unlikely to be a subsidiary. The manager would not seem to have the power to
govern the fund's financial and operating policies, in that it can be removed from its
role.
When this is not the case, however, it will be necessary to consider the nature of the
manager's interest in the fund. Provided that the manager takes only an insignificant
equity stake in the fund, so that its return from the fund (if any) is equivalent to a
normal performance-related fee, the fund is unlikely to meet the definition of a
subsidiary of the investment manager because, although the investment manager
has some powers associated with control of policies, it does not derive benefit from
the exercise of those powers. Where, alternatively, the manager does hold a
significant equity interest in the capital and income of the fund, and cannot be
removed by the other investors, it is more likely to be considered the parent of the
fund.
Q&A IAS 27(2008): 13-8 — MAJORITY-OWNED ENTITIES NOT

CONSOLIDATED
Background
In exceptional circumstances, ownership of more than half of the voting power of an

entity does not constitute control of that entity, and, therefore, it is not consolidated
as a subsidiary in the investor's consolidated financial statements.
Question
In such circumstances, how is the investee accounted for in the investor's
consolidated financial statements?
Answer
Although the investor does not have control of the investee, the investor may still
have joint control or significant influence. When the investor has significant influence
over the investee, the investment will be accounted for in accordance with the
requirements of IAS 28 Investments in Associates. When the investor has joint
control over the investee, the investor will account for the investee in accordance
with IAS 31 Interests in Joint Ventures.
In the very rare circumstances when an investor with more than half of the voting
power does not have significant influence over the investee, the investment would
fall within the scope of IAS 39 Financial Instruments: Recognition and Measurement.
Q&A IAS 27(2008): 13-EX-1 — SPECIAL-PURPOSE ENTITY — EXAMPLE

Example
Bank A sets up a special-purposes entity (SPE), which is used to issue credit-linked
notes to third-party investors. Bank A sets up the SPE in order to raise funding from
investors whose return on that funding is driven by the performance of the
underlying assets in the SPE, usually investments in corporate debt. Bank A markets
the credit-linked notes to third-party investors. The notes will be issued in different
tranches to reflect the relative credit risk on the underlying cash that may be paid to
the investors. All notes bear risk of the underlying assets, though the most junior
notes will bear the first loss. The expected loss on the assets may be greater than
the maximum absolute loss on the most junior notes. In this case, the note holders
other than the most junior note holders also bear some of the expected losses. Bank
A will acquire the most junior of the notes, i.e. the 'equity' tranche, with the
intention of either retaining them, or selling them to third-party investors in the
future.
Bank A will also act as fund manager in the instance where the fund is actively
managed, where the manager can trade and substitute assets within a specified
mandate. Profits and losses from trading the assets accrue to the holders of the
notes. Bank A will be remunerated at market rates for the fund management service.
Entity B, independent from Bank A, acquires 51 per cent of the equity tranche from
Bank A after the SPE has been set up (i.e. in the secondary market). Entity B had no
involvement in the SPE at inception and it cannot exercise any decision-making
powers as those are retained by the fund manager acting in accordance with the
investment mandate on behalf of all note holders.
The consolidation decision is based on a balanced assessment of all indicators.
Bank A will consolidate the SPE at inception because it set up the SPE, acquired a
significant beneficial interest in the SPE by acquiring the equity tranche, and is
counterparty to the fund management contract with the SPE.
At the date Bank A sells 51 per cent of its equity tranche, Bank A would need to
reconsider its consolidation decision. Because Bank A retains a significant beneficial
interest (49 per cent of equity tranche), and was the party that set up the SPE at
inception, it is likely Bank A will continue to consolidate.
Entity B is unlikely to consolidate because its interest in part of the equity tranche is
simply an interest in a high yielding security. This security does not give the investor
any decision-making powers nor was Entity B involved in setting up the activities of
the SPE when it was created. It is necessary to consider all facts and circumstances
in each specific case, so it is not possible to apply a generalised answer to all
potential scenarios.
Q&A IAS 27(2008): 18-1 — RECIPROCAL INTERESTS

Question
What are reciprocal interests and how should a parent account for reciprocal equity
interests with its subsidiary in its consolidated financial statements?
Answer

Reciprocal interests represent situations in which two entities hold equity interests in
each other.
An analogy to paragraph 33 of IAS 32 Financial Instruments: Presentation is

appropriate (i.e. reciprocal interests should be treated in a similar manner to
treasury shares). In its consolidated financial statements, reciprocal interests should
be presented by a parent as a reduction of both its investment in the subsidiary and
its equity in the earnings of the subsidiary.
Q&A IAS 27(2008): 20-1 — UNREALISED PROFIT IN INVENTORIES —

SELLER IS A NON-WHOLLY-OWNED SUBSIDIARY
Question
When goods are sold by a non-wholly-owned subsidiary to another group entity
(whether the parent or a fellow subsidiary), how should the elimination of unrealised
profits be calculated?
Answer
As required by IAS 27(2008).21, the whole of the unrealised profit should be
eliminated. In these circumstances, however, a question arises as to how the
amount of profit to be shown as attributable to non-controlling interests should be
calculated.
• Method 1: allocate to non-controlling interests their proportionate share of

the unrealised profit. This approach eliminates the profit in the selling
entity.
• Method 2: no part of the unrealised profit is allocated to the

non-controlling interests, acknowledging that they are still entitled to their
full share of profit arising on intragroup sales. Under this approach, the
figure for non-controlling interests reflects their entitlement to the share
capital and reserves of the subsidiary.
IAS 27 does not specify which treatment is more appropriate and, in practice, both
alternatives are commonly adopted. Whichever approach is adopted, it should be
applied consistently as an accounting policy choice.
See Q&A IAS 27(2008): 20-EX-2 for an illustration of Method 1 described above.

Q&A IAS 27(2008): 20-EX-1 — UNREALISED PROFIT IN INVENTORIES
— EXAMPLE
Example
A Limited has an 80 per cent subsidiary, B Limited. During 20X1, A Limited sells
goods, which originally cost CU20,000, to B Limited for CU30,000. At 31 December
20X1, B Limited continues to hold half of those goods as inventories.
The inventories held by B Limited include an unrealised profit of CU5,000. This profit
must be eliminated in full — irrespective of any non-controlling interest.
Therefore, the required entries on consolidation, to eliminate all of the effects of the
transaction, are as follows:
Q&A IAS 27(2008): 20-EX-2 — UNREALISED PROFIT IN INVENTORIES

— SELLER IS A NON-WHOLLY-OWNED SUBSIDIARY — EXAMPLE
Example
C Limited has two subsidiaries: D Limited, in which it has an 80 per cent interest;
and E Limited, in which it has a 75 per cent interest. During the reporting period, D
Limited sold goods to E Limited for CU100,000. The goods had been manufactured
by D Limited at a cost of CU70,000. Of these goods, E Limited had sold one half by
the end of the reporting period.
In the preparation of C Limited's consolidated financial statements, the unrealised

profit remaining in inventories still held by E Limited will be eliminated. These
inventories were transferred from D Limited to E Limited at a value of CU50,000, and
their cost to the group was CU35,000. The intragroup profit to be eliminated from
inventories, therefore, is CU15,000.
Assuming that C Limited's accounting policy is to allocate a proportion of unrealised

profit to the non-controlling interests (Method 1 as described in Q&A IAS 27(2008):
20-1), the proportion attributed to the non-controlling interests is determined by
reference to their proportionate interest in the selling subsidiary, D Limited (i.e. 20
per cent). The unrealised profit attributed to the non-controlling interests is therefore
CU15,000 × 20 per cent = CU3,000.
Q&A IAS 27(2008): 20-2 — UNREALISED PROFIT ARISING ON

CONSTRUCTION CONTRACTS
Question
In the context of the elimination of intragroup profits, what special considerations
apply if a construction or contracting entity is a member of a group and carries out
work for other group entities?
Answer
If the building or other asset being constructed will, on completion, be acquired as
an item of property, plant and equipment by another group entity (e.g. a new
factory or an investment property) then any profit made by the constructing entity
should be eliminated on consolidation in accordance with the general requirements of
IAS 27(2008).20. However, if the asset being constructed is the subject of a contract
for sale by the buying entity to a third party, then any profit made by the
constructing entity need not be eliminated, provided that it is measured in
accordance with the requirements of IAS 11 Construction Contracts (see IAS 11.42).
In these circumstances, the profit recognised is not the intragroup profit, but profit
recognised in accordance with IAS 11 as the contract progresses.
If the constructing entity includes borrowing costs in the cost of construction, the
amount capitalised will need to be recomputed from the group's perspective and
adjusted if necessary. If financing for the project is being provided by another group
entity, which is charging interest, the interest charged may not correspond to the
amount to be capitalised by the group in accordance with IAS 23 Borrowing Costs
(see Q&As IAS 23(2007): 14-3 and IAS 23(2007): 14-EX-2).

Q&A IAS 27(2008): 20-EX-3 — UNREALISED PROFIT ON TRANSFER OF
NON-CURRENT ASSET — EXAMPLE
Example
Assume that F Limited holds 80 per cent of the issued share capital of G Limited. G
Limited purchased a machine on 1 January 20X1 at a cost of CU4 million. The
machine has a life of 10 years.
On 1 January 20X3, G Limited sells the machine to F Limited at a price of CU3.6

million.
In preparing the consolidated financial statements of F Limited at 31 December

20X3, the effects of the sale from G Limited to F Limited have to be eliminated.
At 31 December 20X3, the carrying amount of the machine in the books of F Limited
will be CU3.15 million, after depreciation of CU450,000 has been recognised (i.e.
assuming that the cost to F Limited of CU3.6 million will be written off over the
asset's remaining life of eight years).
G Limited will have recognised a profit on transfer of the asset of CU400,000

(disposal proceeds of CU3.6 million less carrying amount after two years depreciation
of CU3.2 million).
If there had been no transfer, the asset would have been included in the statement
of financial position at 31 December 20X3 at CU2.8 million and depreciation of
CU400,000 would have been recognised in the 20X3 reporting period.
Therefore, the required consolidation entries are as follows.

Assuming that F Limited's accounting policy is to allocate a proportion of the
unrealised profit to non-controlling interests (Method 1 described in Q&A IAS
27(2008): 20-1), the proportion of the profit or loss adjustment attributable to the
non-controlling interests is determined as follows.
Q&A IAS 27(2008): 20-EX-4 — UNREALISED LOSSES — EXAMPLE

Example
The facts are as in Q&A IAS 27(2008): 20-EX-3 except that the machine was
transferred from G Limited to F Limited at CU2.4 million.
As noted in IAS 27(2008).21, losses arising on intragroup transaction may indicate

an impairment that requires recognition in the consolidated financial statements.
At 31 December 20X3, the carrying amount of the machine in the books of F Limited
will be CU2.1 million, after depreciation of CU300,000 has been recognised (i.e.
assuming that the cost of CU2.4 million will be written off over the asset's remaining
life of eight years).
G Limited will have recognised a loss on transfer of the asset of CU800,000 (disposal
proceeds of CU2.4 million less carrying amount of CU3.2 million).
If there had been no transfer, the asset would have been included in the statement
of financial position at 31 December 20X3 at CU2.8 million and depreciation of
CU400,000 would have been recognised in the 20X3 reporting period.
Provided that the entity is satisfied that the original carrying amount of the asset can
be recovered, the following consolidation entries are required.

However, when the transfer at the lower amount indicates that the previous carrying
amount of the asset cannot be recovered, an impairment loss will be recognised in
accordance with IAS 36 Impairment of Assets.
Q&A IAS 27(2008): 22-1 — CIRCUMSTANCES IN WHICH A SUBSIDIARY

MIGHT HAVE A DIFFERENT REPORTING PERIOD
Question
IAS 27(2008) requires that, for the purposes of preparing consolidated financial
statements, the financial statements of all subsidiaries should, wherever practicable,
be prepared as of the same date. Under what circumstances might it be necessary or
appropriate for a subsidiary to have a different reporting period from its parent?
Answer
The following are examples of circumstances in which it may be necessary or
appropriate for a subsidiary to have a different reporting period from its parent:
• local legislation requires financial statements to be prepared to a specified

date;
• the normal trading cycle in certain activities (e.g. agriculture) may make it
desirable for subsidiaries to have financial years which end at a particular
time of the year (e.g. when crops have been harvested). In addition,
subsidiaries with cyclical trades such as retail businesses may wish to avoid
a year-end routine during busy pre-Christmas trading when inventory
levels are high; or
• a change in reporting date may have seriously adverse tax consequences,

or significant tax advantages may arise from having a different reporting
date.
Nevertheless, in such circumstances, the subsidiary should prepare additional
financial statements corresponding to the group's reporting period for consolidation
purposes, unless to do so is impracticable. Such impracticability may arise when
entities in remote territories are unable to comply with the parent's timetable for
preparing annual financial statements (which will usually be framed with a view to
avoiding undue delay in publication). This may result in some foreign subsidiaries
closing their books one or two months earlier than the parent in order to allow time
to complete and transmit information for consolidation. Even then, under IAS
27(2008).23 a time lag between the ends of the reporting periods of longer than
three months is not permitted.
If the subsidiary does not prepare financial statements corresponding to the group's
reporting period, adjustments should be made for the effects of significant
transactions or events that occur between the end of the subsidiary's reporting
period and the end of the parent's reporting period.
Q&A IAS 27(2008): 23-1 — CHANGE IN REPORTING PERIOD OF A

SUBSIDIARY
Background
In prior reporting periods, a subsidiary (Company S) used a 31 December reporting

date whereas its parent's reporting date was 31 March. In accordance with IAS
27(2008).23, for consolidation purposes each year the parent adjusted Company S's
financial statements for the period ended 31 December for significant transactions or
events that took place between 1 January and 31 March.
In 20X2, Company S changes its reporting date to align to its parent's (31 March).
As a result of this change, Company S will prepare financial statements for the
12-month periods ended 31 March 20X1 and 31 March 20X2. The financial
statements for the year ended 31 March 20X1 may differ from those used for
consolidation in the prior period, since the latter used financial statements as of 31
December 20X0 adjusted for significant events that took place between 1 January
20X1 and 31 March 20X1.
Question
Should the adjustment resulting from Company S's change in reporting date be
recognised in the consolidated financial statements as a change in accounting policy
or a change in estimate?
Answer
In prior reporting periods, for consolidation purposes the parent estimated what
Company S's financial statements for the period ended 31 March would have been by
adjusting the subsidiary's financial statements for the period ended 31 December for
significant transactions or events that took place in the intervening period. The
change in Company S's reporting date will result in a revision of the parent's
previous estimate of Company S's 31 March 20X1 financial statements. Therefore,
the adjustments required in preparing the consolidated financial statements should
be recognised as a change in estimate.
Because Company S's reporting date was changed in the accounting period ending
31 March 20X2, in accordance with paragraph 36 of IAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors, the impact of the change in estimate
should be recognised prospectively in the consolidated profit or loss for the year
ended 31 March 20X2.
Q&A IAS 27(2008): 23-2 — CLASSIFICATION AS CURRENT OR

NON-CURRENT WHEN PARENT AND SUBSIDIARY HAVE DIFFERENT
REPORTING PERIODS
Background
A subsidiary preparing its financial statements to 31 December 20X1 has a loan

outstanding that is due for repayment on 1 January 20X3. The debt is appropriately
classified as non-current in the subsidiary's statement of financial position.
The subsidiary is consolidated in the financial statements of its parent, which are
prepared to 31 March 20X2.
Question
Should the subsidiary's loan be classified as current or non-current in the parent's
consolidated financial statements?
Answer
The loan should be classified as current in the consolidated financial statements.
Due to the time lag, the subsidiary's loan falls due less than 12 months from the end
of the parent's reporting period. The appropriate classification of the loan as current
or non-current should be determined by reference to the reporting date of the
parent, which, in this example, results in classification of the loan as a current
liability because the amount is repayable nine months from the parent's reporting
date.
Q&A IAS 27(2008): 23-3 — 'SIGNIFICANT TRANSACTIONS OR EVENTS'

LEADING TO ADJUSTMENTS
Question
What types of 'significant transactions or events' may lead to adjustments when a
parent and its subsidiary have different reporting dates?
Answer
IAS 27(2008) does not define 'significant transactions or events', but they may
include business combinations, asset impairments, and the crystallisation of
contingent liabilities. A potentially significant transaction or other event requires a
careful analysis of the relevant facts and circumstances to determine if an
adjustment is required.
When a subsidiary prepares financial statements for a different reporting period, it is

also necessary to review the subsidiary's statement of financial position to ensure
that items are still correctly classified as current or non-current at the end of the
parent's reporting period (see Q&A IAS 27(2008): 23-2).
Q&A IAS 27(2008): 28-1 — ATTRIBUTING ITEMS TO

NON-CONTROLLING INTERESTS BASED ON AGREEMENT BETWEEN
THE SHAREHOLDERS
Question
How should profit or loss and components of other comprehensive income be
attributed to non-controlling interests when the shareholders have agreed to a basis
of allocation other than by reference to the proportion of shares held?
Answer
IAS 27(2008) does not specify any particular method for attributing earnings
between the controlling and non-controlling interests. Generally, profit or loss will be
attributed to the non-controlling interests by reference to the proportion of shares
held, because this proportion typically determines the amounts that will ultimately be
received by the non-controlling interest.
But sometimes this will not be the case. For example, when there is a separate
agreement between parties that results in profits being allocated on some other
basis, there is a need to consider whether that other basis determines the attribution
of earnings to the non-controlling interests. Careful consideration should be given as
to whether the effect of such a contractual agreement is to create an obligation that
needs to be recognised as a liability by the group.
Q&A IAS 27(2008): 30-1 — MEASUREMENT OF NON-CONTROLLING

INTERESTS ARISING OTHER THAN IN A BUSINESS COMBINATION
Background
For each business combination, paragraph 19 of IFRS 3(2008) Business

Combinations allows a choice of measurement for any non-controlling interest (NCI)
in the acquiree (either at fair value or at the NCI's proportionate share of the
acquiree's identifiable net assets).
Under IAS 27(2008), once control is obtained, all subsequent increases or decreases
in ownership interests that do not involve the loss of that control are treated as
transactions among owners.
Question
When NCI is created through a transaction other than a business combination (e.g. a
parent disposes of 25 per cent of a previously wholly-owned subsidiary), how should
the NCI be measured?
Answer
IAS 27(2008) does not specify the basis to be used to measure NCI following a
change in relative interests, where a parent retains control of the subsidiary. The
requirements of IAS 27(2008).30 and 31 are as follows.
Changes in a parent's ownership interest in a subsidiary that do not result

in a loss of control are accounted for as equity transactions (i.e.
transactions with owners in their capacity as owners).
In such circumstances, the carrying amounts of the controlling and
non-controlling interests shall be adjusted to reflect the changes in their
relative interests in the subsidiary. Any difference between the
amount by which the non-controlling interests are adjusted and the fair
value of the consideration paid or received shall be recognised directly in
equity and attributed to the owners of the parent. [Emphasis added]
One approach to reflecting this change in relative interests is to recognise any
difference between the fair value of the consideration paid and the non-controlling
interest's proportionate share of the carrying amount of the identifiable net assets
directly in equity attributable to the owners of the parent. There may be other
acceptable approaches to reflecting the change in relative interests; these
approaches should similarly result in no adjustment to goodwill or to profit or loss.
Q&A IAS 27(2008): 30-2 — COSTS OF BUYING OUT A

NON-CONTROLLING INTEREST
Question
Under IAS 27(2008), the buy-out of a non-controlling interest (NCI) will be
accounted for as an equity transaction. How should the costs relating to such a
buy-out be treated in the consolidated financial statements?
Answer
IAS 27(2008).30 states that “[c]hanges in a parent's ownership interest in a
subsidiary that do not result in a loss of control are accounted for as equity
transactions (i.e. transactions with owners in their capacity as owners)”.
Paragraph 37 of IAS 32 Financial Instruments: Presentation requires that the

“transaction costs of an equity transaction are accounted for as a deduction from
equity (net of any related income tax benefit) to the extent they are incremental
costs directly attributable to the equity transaction that otherwise would have been
avoided”. In addition, IAS 32.33 requires that “[n]o gain or loss shall be recognised
in profit or loss on the purchase, sale, issue or cancellation of an entity's own equity
instruments”.
Therefore, it follows that the costs of buying out a NCI should also be accounted for
as a deduction from equity in the consolidated financial statements provided that the
requirements of IAS 32.37 are met.
Q&A IAS 27(2008): 30-EX-1 — PARENT ACQUIRES THE

NON-CONTROLLING INTEREST — EXAMPLE

Example
When a parent acquires a non-controlling interest (NCI), in accordance with IAS
27(2008).30 this is accounted for as an equity transaction. “[T]he carrying amounts
of the controlling and non-controlling interests [are] adjusted to reflect the changes
in their relative interests in the subsidiary. Any difference between the amount by
which the [NCIs] are adjusted and the fair value of the consideration paid or
received [is] recognised directly in equity and attributed to the owners of the
parent”. [IAS 27(2008).31]
The adjustment to the carrying amount of NCIs and the consequential adjustment to
equity will be affected by the entity's choice of measurement basis (fair value or
proportionate share of net assets) for the NCI at acquisition date. The following
example highlights the difference.
In 20X1, Entity A acquired a 75 per cent equity interest in Entity B for cash
consideration of CU90,000. Entity B's identifiable net assets at fair value were
CU100,000. The fair value of the 25 per cent NCIs was CU28,000. Goodwill, on the
two alternative bases for measuring NCIs at acquisition, is calculated as follows:
In the subsequent years, Entity B increased net assets by CU20,000 to CU120,000.

This is reflected in the carrying amount within equity attributed to NCIs as follows:

In 20X6, Entity A then acquired the 25 per cent equity interest held by NCIs for cash
consideration of CU35,000. The adjustment to equity will be:
The reduction in equity is greater when the option is taken to measure NCIs at
acquisition date as a proportionate share of the acquiree's identifiable net assets.
The treatment has the effect of including the NCI's share of goodwill directly in
equity, although the goodwill itself is unaffected. This outcome will always occur
when the fair value basis is greater than the net asset basis at acquisition date.
Q&A IAS 27(2008): 30-EX-2 — PARENT ACQUIRES PART OF A

NON-CONTROLLING INTEREST — EXAMPLE
Example
The facts are as in Q&A IAS 27(2008): 30-EX-1 except that, rather than acquire the
entire non-controlling interest (NCI), Entity A acquires an additional 15 per cent
equity interest held by NCIs for cash consideration of CU21,000. The adjustment to
the carrying amount of NCIs will be:

The adjustment to equity will be:
Q&A IAS 27(2008): 32-1 — CIRCUMSTANCES WHEN THE DISPOSAL OF

A SUBSIDIARY SHOULD NOT BE RECOGNISED AS A SALE
Question
In what circumstances should the disposal of a subsidiary not be recognised as a
sale?
Answer
Circumstances when the disposal of a subsidiary should not be recognised as a sale
typically relate to when the parent sells the subsidiary but retains a degree of
continuing involvement such that risks and rewards of ownership and control have
not been transferred. Examples of circumstances that should be considered include,

but are not limited to, the following:
• the seller has effective veto power over major contracts or customers;
• the buyer or any successor has the ability to put (sell) the subsidiary back
to the seller at other than fair value;
• the seller can require the buyer or any successor owner to sell the
subsidiary back to it at other than fair value;
• the seller has significant voting power on the subsidiary's board;
• the seller has continuing involvement in the company's affairs with risks
and management authority similar to ownership;
• the buyer does not make a significant financial investment in the company
(e.g., a minimal down payment);
• the buyer's repayment of debt that constitutes the principal consideration

in the acquisition is dependent on future profitable operations of the
acquired subsidiary; or
• the seller continues to guarantee debt or contract performance of the

acquired subsidiary.
All facts and circumstance should be assessed carefully to determine the substance
of the transaction. In particular, if circumstances similar to those listed above exist,
judgement should be exercised to establish whether these circumstances would
preclude the seller from accounting for the transaction as a disposal.
When a subsidiary is placed into liquidation or administration, it will be necessary to

consider carefully whether this results in a loss of control. This is likely to depend on
the particular laws of the jurisdiction in which it operates. An important question is
whether, as a result of the liquidation or administration, the shareholders continue
collectively to have the power to set the operating and financial policies, albeit with
some restrictions.
Q&A IAS 27(2008): 32-EX-1 — LOSS OF CONTROL — COMMON

EXAMPLES
Example
A common example of loss of control is when a subsidiary becomes subject to
insolvency proceedings involving the appointment of a receiver or liquidator, if the
effect is that the shareholders cease to have the power to govern the financial and
operating policies. Although this will often be the case in a liquidation, a receivership
or administration order may not involve loss of control by the shareholders.
Another example of loss of control would be the seizure of the assets or operations
of an overseas subsidiary by the local government.
Short-term restrictions on cash flows from a subsidiary, perhaps because of

exchange controls or restrictions on distributions of profits in a foreign jurisdiction,
do not generally result in a loss of control. The fact that a parent may not be able to
remit dividends from the subsidiary, or use the funds for other parts of the group
outside the country of operation, does not by itself indicate that the ability to
transfer funds in the longer term has been significantly impaired. Indeed,
subsidiaries are often set up in the face of such restrictions and are, presumably,
expected to produce economic benefits for the parent.
Q&A IAS 27(2008): 35-1 — DISPOSAL OF SUBSIDIARY — AMOUNTS

PREVIOUSLY RECOGNISED IN OTHER COMPREHENSIVE INCOME
Question
When a parent loses control of a subsidiary, IAS 27(2008).35 requires that all
amounts recognised in other comprehensive income in relation to that subsidiary are
accounted for on the same basis as would be required if the parent had directly
disposed of the related assets or liabilities. Is this treatment affected by whether the
parent has retained a residual interest in the former subsidiary?
Answer
No. IAS 27(2008).35 states, in part:
• if a gain or loss previously recognised in other comprehensive income

would be reclassified to profit or loss on the disposal of the related assets
or liabilities, the parent reclassifies the gain or loss from equity to profit or
loss (as a reclassification adjustment) when it loses control of the
subsidiary. For example, if a subsidiary has available-for-sale financial
assets and the parent loses control of the subsidiary, [all of the gain or loss
previously recognised in other comprehensive income in relation to those
assets is reclassified to profit or loss; and]
• if a revaluation surplus previously recognised in other comprehensive

income would be transferred directly to retained earnings on the disposal
of the asset, [all of the revaluation surplus is transferred] directly to
retained earnings when [the parent] loses control of the subsidiary.

This treatment applies to the entire amount recognised in other comprehensive
income, irrespective of whether the parent will continue to hold a residual interest in
the former subsidiary.
In addition, paragraph 48 of IAS 21 The Effects of Changes in Exchange Rates sets

out specific requirements regarding the treatment of foreign exchange differences
accumulated in equity when control is lost on disposal of a subsidiary.
Q&A IAS 27(2008): 35-EX-1 — PARENT DISPOSES OF ITS

CONTROLLING INTEREST BUT RETAINS AN ASSOCIATE INTEREST —
EXAMPLE
Example
In 20X1, Entity A acquired a 100 per cent equity interest in Entity B for cash
consideration of CU125,000. Entity B's identifiable net assets at fair value were
CU100,000. Goodwill of CU25,000 was identified and recognised.
In the subsequent years, Entity B increased net assets by CU20,000 to CU120,000.

Of this, CU15,000 was reported in profit or loss and CU5,000, relating to fair value
movements on an available-for-sale financial asset, was reported within other
Entity A then disposed of 75 per cent of its equity interest for cash consideration of
CU115,000. The residual 25 per cent equity interest is classified as an associate
under IAS 28 Investments in Associates and has a fair value of CU38,000.
The gain recognised in profit or loss on disposal of the 75 per cent equity interest is

Subsequent accounting under IAS 28 on an equity-accounting basis will require an
exercise to assess the fair value of Entity B's identifiable net assets on the date that
control is lost. Goodwill will be identified by comparing the initial fair value of the
interest of CU38,000 with the residual share (25 per cent) of identifiable net assets
at fair value.
IAS 27(2008).41(f) requires disclosure of "the portion of that gain or loss

attributable to recognising any investment retained in the former subsidiary at its
fair value at the date when control is lost”. The amount would be determined as
follows:
For the purposes of the calculation of the gain or loss on disposal, the carrying
amount of the subsidiary would include any amount of goodwill carried in the
statement of financial position in respect of the subsidiary. However, where goodwill
has previously been eliminated against reserves prior to transition to IFRSs, IFRS 1
First-time Adoption of International Financial Reporting Standards prohibits it from
being reclassified to profit or loss on subsequent disposal.
Q&A IAS 27(2008): 38-1 — ACQUISITION COSTS: SEPARATE

FINANCIAL STATEMENTS

Question
How should acquisition-related costs be accounted for in the separate financial
statements of the acquirer where a business combination is effected through the
acquisition of a legal entity?
Answer
IAS 27(2008).38 allows entities an accounting policy choice, such that investments
in subsidiaries (other than those falling within the scope of IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations, can be accounted for at cost or in
accordance with IAS 39 Financial Instruments: Recognition and Measurement.
Where an entity has chosen to account for its investments in subsidiaries in

accordance with IAS 39, the initial measurement requirements of IAS 39.43 should
be applied. This requires that financial assets should initially be measured:
• for financial assets not classified as at fair value through profit or loss, at
fair value plus transaction costs that are directly attributable to the
acquisition;
• for financial assets classified as at fair value through profit or loss, at fair
value.
IAS 27(2008) does not define 'cost'. Therefore where an entity has chosen to
account for investments in subsidiaries at cost, the determination of that amount is
not specified. In accordance with paragraphs 10–11 of IAS 8 Accounting Policies,
Changes in Accounting Estimates and Errors, it is appropriate to apply IAS 39.43 by
analogy. Therefore, directly attributable transaction costs should also be included in
the initial measurement of an investment accounted for at cost under IAS 27(2008).
Irrespective of whether the investments in subsidiaries are accounted for at cost or

in accordance with IAS 39 (where the investment is not categorised as at fair value
through profit and loss), care should be taken to ensure that only directly
attributable costs are included in the initial measurement of the investment.
Q&A IAS 27(2008): 38B-1 — ACCOUNTING FOR GROUP

REORGANISATIONS UNDER IAS 27(2008).38B
Background
When a parent reorganises the structure of its group by establishing a new entity as
its parent, and the criteria in IAS 27(2008).38B are met, the new parent accounts
for its investment in the original parent at cost in its separate financial statements.
The new parent measures cost at the carrying amount of its share of the equity
items shown in the separate financial statements of the original parent at the date of
the reorganisation.
Question
How should these requirements be applied when (a) the original parent has net
liabilities, and (b) the new parent does not acquire all of the equity instruments of
the original parent?
Answer
In the straightforward scenario where the original parent becomes a wholly-owned
subsidiary of the new parent, the cost shown in the new parent's separate financial
statements will simply be the total equity (assets less liabilities) of the original
parent shown in the separate financial statements of the parent at the date of the
reorganisation.
IAS 27 does not address the appropriate accounting if the original parent has net
liabilities. Consistent with the general accounting for investments in subsidiaries in
separate financial statements, the investment should be recognised at nil. However,
this treatment would only be appropriate to the extent that the transferee does not
assume a liability beyond the cost of the shares at the time of the transfer.
When the new parent does not acquire all of the equity instruments of the original
parent, care will be needed in assessing whether the condition in IAS
27(2008).38B(c) is met (i.e. whether the owners of the original parent before the
reorganisation have the same absolute and relative interests in the net assets of the
original group and the new group immediately before and after the reorganisation).
But, provided that all three conditions in IAS 27(2008).38B are met, the cost shown
in the new parent's separate financial statements will be its share of the total equity
(assets less liabilities) of the original parent at the date of the reorganisation.
Note that the accounting under IAS 27(2008).38B is not a choice: it is required if the
conditions are met.
Q&A IAS 27(2008): 45(a)-1 — TRANSITIONAL REQUIREMENTS

REGARDING ALLOCATION OF PROFIT OR LOSS TO
NON-CONTROLLING INTERESTS
Background
IAS 27(2003) required losses that exceeded the minority interest (referred to as the
'non-controlling' interest under IAS 27(2008)) in the equity of a subsidiary to be
attributed to the parent's interest unless the minority interest had a binding
obligation to fund the losses and was able to make an additional investment to cover
the losses. In contrast, IAS 27(2008) requires that total comprehensive income
(positive or negative) be allocated between the parent's interest and the
non-controlling interest (NCI) even if this results in the NCI having a deficit balance.
Entity A applied IAS 27(2003) in its 20X1 accounting period. At 1 January 20X1, the
NCI's share of equity in Subsidiary S was CU5 million. Subsidiary S incurred losses of
CU20 million during 20X1, of which CU8 million was attributable to the NCI. Because
there was no binding obligation on the NCI to cover the losses, only CU5 million was
attributed to the NCI and CU15 million was attributed to Entity A.
Entity A adopts IAS 27(2008) from 1 January 20X2.
Question
Should the NCI be adjusted at 1 January 20X2 to reflect the CU3 million excess
losses previously absorbed by Entity A?
If Subsidiary S makes a profit in 20X2, how should it be allocated between Entity A

and the NCI?
Answer
IAS 27(2008).45(a) specifies that the revised treatment under that Standard should
be applied prospectively and that the profit or loss attribution for reporting periods
before the adoption of IAS 27(2008) should not be restated.
Paragraph 5 of IAS 8 Accounting Policies, Changes in Accounting Estimates and

Errors defines 'prospective application' of an accounting policy as the application of
the new accounting policy “to transactions, other events and conditions occurring
after the date at which the policy is changed”. Therefore, the NCI should not be
adjusted at 1 January 20X2 in respect of losses incurred before the date of
application of the Standard. In the circumstances described, the balance on the NCI
at 1 January 20X2 remains at nil.
The transitional provisions of IAS 27(2008) do not specifically address the question
of the subsequent allocation of profits earned by Subsidiary S. However, prospective
application implies that the profit in 20X2 should be allocated on the basis of the
present ownership interests of Entity A and the NCI. No adjustment should be made
to make up for the NCI's share of losses that were absorbed by the parent in the
past under IAS 27(2003).

Note: IASB Update published in May 2009.
Q&A IAS 28: 1-1 — ACCOUNTING FOR AN ASSOCIATE AT THE GROUP

LEVEL
Background
Company P (P), which is not a venture capital organisation, is a parent entity in a

group that has an 80 per cent ownership in a subsidiary, Company S (S). Company
S has a 40 per cent ownership in an associate, Company A (A). Company S is a
venture capital organisation, and has made the designation under IAS 28.1(a) to
account for its interest in the associate at fair value through profit or loss.

Question
Is it acceptable that the venture capital organisation designation made by Company
S in accordance with IAS 28.1(a) is carried forward to Company P's consolidated
financial statements even though Company P is not eligible for that designation?
Answer
Yes. The designation made by Company S under IAS 28.1(a) can be carried forward
to Company P's consolidated financial statements.
As a result, Company P has an accounting policy choice either to carry the associate
at fair value under IAS 39 Financial Instruments: Recognition and Measurement or to
apply the equity method in its consolidated financial statements. This accounting
policy choice can be made on an associate-by-associate basis (provided that the
associate is held by a subsidiary that qualifies for the scope exemption), i.e. some
associates may be accounted for at fair value and some may be accounted for using
the equity method.
The accounting policy choice should be made upon recognition of an associate and
should be applied consistently from one period to the next.
Q&A IAS 28: 1-2 — ACCOUNTING FOR TREASURY SHARES OF

VENTURE CAPITAL ORGANISATIONS
Background
Company A owns an interest in an associate, Company B, and Company B

concurrently owns an interest in Company A. The investments are determined to be
reciprocal interests. Company A is a venture capital organisation that measures its
investment in Company B at fair value in accordance with IAS 39 Financial
Instruments: Recognition and Measurement.
[Note that judgement is required to determine whether the interest held by

Company B is considered to be a reciprocal interest as distinct from an investment
held as part of a trading portfolio. This Q&A does not consider the factors affecting
such a judgement.]
Question
How should Company A account for the reciprocal equity interest held by Company

B?
Answer
The reciprocal interest should not be eliminated.
Although IAS 28.20 states, in part, that "the concepts underlying the procedures
used in accounting for the acquisition of a subsidiary are also adopted in accounting
for the acquisition of an investment in an associate", venture capitalists that
measure their investment at fair value in accordance with IAS 39 are not required to
apply IAS 28. Therefore, IAS 28.20 does not apply. Consequently, the reciprocal
equity interests are not eliminated at the investor level.
Q&A IAS 28: 2-1 — SCOPE EXEMPTION FOR VENTURE CAPITAL

ORGANISATIONS
Background
IAS 28 excludes from its scope certain investments in associates held by venture
capital organisations, mutual funds, unit trusts and similar entities (including
investment-linked insurance funds).
Question
What criteria must the investment in associate fulfil in order to qualify for the above
mentioned exemption?
Answer
In order to qualify for exclusion, the investments held by venture capital
organisations and similar entities must be identified and appropriately designated at
the time of their initial recognition. Investments held by such entities that are not
designated at the time of their initial recognition as at fair value through profit or
loss or classified as held for trading will fall within the scope of IAS 28.
The Standard gives no guidance on the term 'venture capital organisation'. In

deciding whether the exemption is available, it will be necessary to consider whether
an organisation (whether or not structured as a legal entity) has the characteristics
of a venture capital organisation. Such characteristics may include, but are not
limited to:
• investments are held for the short- to medium-term rather than for the

long-term;
• the most appropriate point in time for exit is actively monitored; and
• investments form part of a portfolio, which is monitored and managed

without distinguishing between investments that qualify as associate
undertakings and those that do not.

[Issued 7 May 2004]
[Renumbered to IAS 27: 13-8 on 29 October 2010]
Renumbered
Q&A IAS 28: 6-2 — INDICATORS OF THE ABILITY TO EXERCISE

SIGNIFICANT INFLUENCE
[Issued 7 May 2004]
Background
If an investor holds, directly or indirectly through subsidiaries, “less than 20 per cent
of the voting power of the investee, it is presumed that the investor does not have
significant influence, unless such influence can be clearly demonstrated”. [IAS 28.6]
Question
What are the indicators of the existence of an investor's ability to exercise significant
influence over a less than 20 per cent-owned corporate investee?
Answer
Decisions regarding the propriety of utilising the equity method of accounting for a
less than 20 per cent-owned corporate investee require careful evaluation of voting
rights and their impact on the investor's ability to exercise significant influence. The
existence of the following circumstances cited in IAS 28.7 may indicate that an
investor is in a position to exercise significant influence over a less than 20 per
cent-owned corporate investee:
• representation on the board of directors or equivalent governing body of

the investee;
• participation in policy-making processes, including participation in decisions

about dividends or other distributions;
• material transactions between the investor and the investee;
• interchange of managerial personnel; or
• provision of essential technical information.
IAS 28.8 states that the existence and effect of potential voting rights that are
currently exercisable or currently convertible should also be considered when
assessing whether an entity has significant influence.
In addition, the following indicators could provide evidence of significant influence:
• the investor has veto power over significant operating and financial
decisions but affirmative voting is not required for their approval;
• the investor's extent of ownership is significant relative to other

shareholdings (i.e. a lack of concentration of other shareholders);
• the investor's significant stockholders, its parent, fellow subsidiaries, or

officers of the investor, hold additional investment in the investee (indirect
ownership); and
• the investor is a part of significant investee committees, such as the

executive committee or the finance committee.
Q&A IAS 28: 6-3 — CIRCUMSTANCES THAT MAY INDICATE LACK OF

SIGNIFICANT INFLUENCE
[Issued 7 May 2004]
Background
If an investor holds, directly or indirectly through subsidiaries, “20 per cent or more
of the voting power of the investee, it is presumed that the investor has significant
influence, unless it can be clearly demonstrated that this is not the case”. [IAS 28.6]
Question
What circumstances might indicate that an investor holding 20 per cent or more of
the voting power of an investee lacks the ability to exercise significant influence?
Answer
The following circumstances may call into question whether an investor has the

ability to exercise significant influence. The list is not exhaustive, and all facts and
circumstances need to be assessed carefully.
• The chairman of the investee owns a large, but not necessarily controlling,
block of the investee's outstanding stock; the combination of the
chairman's substantial shareholding and his position with the investee may
preclude the investor from having an ability to influence the investee.
• Adverse political and economic conditions exist in the foreign country

where the investee is located.
• Opposition by the investee, such as litigation or complaints to

governmental regulatory authorities, challenges the investor's ability to
exercise significant influence.
• The investor and the investee sign an agreement under which the investor
surrenders significant rights as shareholder.
• Majority ownership of the investee is concentrated among a small group of

shareholders who operate the investee without regard to the views of the
investor.
• Litigation against an investee, particularly where the investee is in

bankruptcy, is to be settled by the investee issuing shares to the settling
parties and it is probable the new shares, when issued, will reduce the
investor's ownership percentage.
• Severe long-term restrictions impair the investor's ability to repatriate

funds.1
1 Previous versions of IAS 28 included an exemption from applying the equity method to an
associate operating under severe long-term restrictions that impaired the investor's ability
to repatriate funds. In 2003, as part of its improvements project, the IASB removed this
exemption, implying that while in some cases severe long-term restrictions on the ability to
repatriate funds may affect the investor's ability to exercise significant influence, in other
cases it will not and judgement has to be applied on the basis of individual facts and
circumstances.
Q&A IAS 28: 6-4 — INVESTMENTS IN PREFERRED SHARES

[Renumbered from IAS 28: 8-1 on 24 February 2006]
Question
Are there circumstances in which an investment in preferred shares should be
accounted for using the equity method?
Answer
Yes. When an investment in preferred shares is determined to be substantively the
same as an investment in ordinary shares, the investment may give the investor
significant influence, in which case the investment should be accounted for using the
equity method. Factors that either individually or collectively may indicate that a
preferred share investment is substantively the same as an ordinary share
investment include:
• the investee has little or no significant ordinary shares or other equity, on

a fair value basis that is subordinate to the preferred shares;
• the investor, regardless of ownership percentage, has demonstrated the

power to exercise significant influence over the investee's operating and
financial decisions. The power to participate actively is an important factor
in determining whether an equity interest exists by virtue of preferred
shareholdings;
• the investee's preferred shares have essentially the same rights and
characteristics as the investee's ordinary shares as regards voting rights,
board representation, and participation in, or rate of return approximating,
the ordinary share dividend; and
• the preferred shares have a conversion feature (with significant value in

relation to the total value of the shares) to convert the preferred shares to
ordinary shares.
Q&A IAS 28: 6-5 — APPLICATION OF SIGNIFICANT INFLUENCE IN A

GROUP SCENARIO
Background
Company A (A) has two subsidiaries, Company B (B) and Company C (C). Company
B has a 15 per cent ownership interest in Company C. The group structure is as
follows.

Company A has appointed an executive of Company B as a director to the board of
Company C. Because of the number of directors on the board, this director is able to
significantly influence Company C's board. Company A has the right to remove the
executive from the board at any time. Company B has also been directed by
Company A to manage Company C in a way that maximises the return from both
Company B and Company C, which are located in the same jurisdiction. Company A
can amend this directive at any time.
Note that Company B has not chosen to apply the equity method exemption in IAS
28.13(c). Also, Company A and Company B have no further agreements regarding
Company C's financial and operating policy decisions.
Question
Does Company B have significant influence over Company C such that Company C is
an associate of Company B?
Answer
No. IAS 28.6 indicates that "[a] substantial or majority ownership by another
investor does not necessarily preclude an investor from having significant influence".
In this scenario, however, Company B does not have significant influence over
Company C. Although Company B can participate in policy-making decisions,
Company A can remove Company B's executive from Company C's board at any
time. Therefore, Company B's apparent position of significant influence over
Company C can be removed by Company A and Company B does not have the power
to significantly influence Company C.

[Issued 7 May 2004]
[Renumbered to IAS 28: 6-4 on 24 February 2006]

Renumbered
Q&A IAS 28: 8-EX-1 — OPTIONS TO PURCHASE INVESTMENTS IN AN

ENTITY
[Issued 7 May 2004]
Example
Company A holds a 15 per cent voting ordinary share interest in Company B, as well
as a European call option (i.e. one that can only be exercised at the end of the
option period) to acquire an additional 10 per cent voting ordinary share interest in
Company B. The European call option matures in three years. Company A's
ownership of the call option which, if converted, would give Company A a 25 per cent
voting interest in Company B, does not create the presumption that Company A
currently exercises significant influence over Company B because the call option
currently is not exercisable.
However, if instead of a European call option, Company A holds an American call

option (i.e. one that can be exercised at any time during the option period),
Company A may effectively exert significant influence over Company B because the
call option is currently exercisable.
When assessing significant influence, it is also important to consider the potential

impact of options held by other investors.
Q&A IAS 28: 11-1 — DISTRIBUTIONS RECEIVED FROM AN ASSOCIATE

[Issued 7 May 2004]
Question
How should distributions by an equity method investee to an investor in excess of
the investor's carrying amount be accounted for?
Answer
IAS 28 does not address the accounting for distributions by equity method investees
to an investor in excess of the investor's carrying amount. If distributions by an
equity method investee to an investor are in excess of the investor's carrying
amount, and (a) the distributions are not refundable by agreement or law, and (b)
the investor is not liable for the obligations of the investee or otherwise committed to
provide financial support to the investee, then cash distributions received in excess
of the investment in the investee should be recognised as income (see Q&A IAS 28:
11-EX-1).
If the investee subsequently reports net income, the investor should resume
applying the equity method in accordance with IAS 28 once the investee has made
sufficient profits to cover the aggregate of any investee losses not recognised by the
investor (due to the investor's zero balance in the investment) and any income
previously recognised for excess cash distributions.
Even when the investor is not legally obliged to refund the distribution, the exercise
of judgement and consideration of specific facts and circumstances (including the
relationship among the investors) is still required. If distributions by an investee to
an investor are in excess of the investor's carrying amount, and (a) the distribution
may be refundable by convention, or (b) the investor may become liable for the
obligations of the investee or is otherwise expected to provide financial support to
the investee, then cash distributions received in excess of the investment in the
investee should be recognised as a liability. If the investee subsequently reports net
income, the investor should first reverse the liability and then recognise its
investment in the investee as an asset. Q&A IAS 28: 11-EX-2 illustrates an example
of a distribution which should be recognised as a liability.
In circumstances when the investor has undertaken to provide financial support to

the investee, it will be necessary to consider whether any additional provision or
disclosure is required in accordance with IAS 37 Provisions, Contingent Liabilities and
Contingent Assets.
Q&A IAS 28: 11-2 — INVESTOR'S SHARE OF INVESTEE'S EARNINGS

AND LOSSES
[Issued 7 May 2004]
[Amended and Renumbered from IAS 28: 27-1 on 24 February 2006]
Question
How should an investor record its share of an investee's earnings and losses?
Answer
The investor generally recognises its share of the investee's earnings and losses
based on the percentage of the equity interest owned by the investor. However,
when agreements designate allocations among the investors of profits and losses,
certain costs and expenses, distributions from operations, or distributions upon
liquidation that are different from ownership percentages, recognising equity-method
income based on the percentage of the equity interest owned may not be
appropriate.
The substance of these agreements should be reflected in determining how an

increase or decrease in net assets of the investee will affect cash payments to the
investor over the life of the investee, and upon its liquidation.
Q&A IAS 28: 11-3 — ACCOUNTING BY INVESTOR FOR SHARE OPTIONS

ISSUED BY AN ASSOCIATE TO ITS OWN EMPLOYEES
[Renumbered from IAS 28: 29-2 on 22 October 2010]
Background
Entity E grants share options to its employees. The options entitle the employees to
acquire shares of Entity E. Entity A holds a 20 per cent interest in Entity E and
accounts for its interest in Entity E using the equity method.
Question
How should Entity A account for its share of the share-based compensation
recognised by Entity E? In particular, what is the impact in the financial statements
of Entity A of the increase in equity recognised in Entity E's financial statements?
Answer
IAS 28.11 states that “[a]djustments to the carrying amount [of the investment in
an associate] may also be necessary for changes in the investor's proportionate
interest in the investee arising from changes in the investee's other comprehensive
income”. Therefore, in addition to amounts recognised in profit or loss (including
compensation expense), Entity A should recognise its proportionate share of items of
income and expense recognised in other comprehensive income.
However, the increase in equity recognised by Entity E is not part of other

comprehensive income and therefore, under IAS 28.11, should not be used to adjust
the carrying amount of Entity A's investment in Entity E. When the employees
exercise their share options, Entity A will recognise the impact of the resulting
dilution.
Q&As IAS 28: 11-EX-1 and 11-EX-2 — ACCOUNTING FOR

DISTRIBUTIONS BY AN EQUITY-METHOD INVESTEE TO AN INVESTOR
IN EXCESS OF THE INVESTOR'S CARRYING AMOUNT
IAS 28: 11-EX-1
[Issued 7 May 2004]
Example
Company A has invested CU1 million for a 50 per cent ownership interest in
Company C. Company A uses the equity method to account for its investment in
Company C. Company C subsequently incurs a loss of CU2.4 million, which exceeds
Company A's investment balance by CU200,000. Because the losses are due to
non-cash depreciation expense and Company C has available cash, it distributes
CU100,000 to Company A.
The CU100,000 distribution made to Company A is not refundable by agreement or

law, and Company A is not liable for the obligations of Company C or otherwise
committed to provide financial support to Company C. Therefore, Company A should
reduce its investment in Company C to zero and recognise the CU100,000 received
as income. When Company C becomes profitable such that Company A's share of
Company C's earnings exceeds the distributions and share of unrecognised losses
attributable to Company A (i.e. CU300,000), Company A will resume applying the
equity method in accordance with IAS 28.
IAS 28: 11-EX-2
[Issued 7 May 2004]
Example
Company B has invested CU1 million for a 50 per cent ownership interest in
Company C. Company B uses the equity method to account for its investment in
Company C. Company C subsequently incurs a loss of CU2.4 million, which exceeds
Company B's investment balance by CU200,000. Because the losses are due to
non-cash depreciation expense and Company C has available cash, it distributes
CU100,000 to Company B.
The CU100,000 distribution made to Company B is not refundable by agreement or

law, and Company B is not liable for Company C's obligations. However, Company B
has committed to providing financial support to Company C. Therefore, Company B
should reduce its investment in Company C to zero, recognise the CU100,000
received as income, and also recognise a liability of CU300,000 in respect of the
losses of CU200,000 and the CU100,000 cash received. When Company C becomes
profitable such that Company B's share of Company C's earnings exceeds the
distributions and share of unrecognised losses attributable to Company B, Company
B will reverse the liability before increasing the carrying amount in its investment in
Company C.

Separately, Company B should consider whether any additional provision or
disclosure is required in accordance with IAS 37 Provisions, Contingent Liabilities and
Contingent Assets.
Q&A IAS 28: 13-1 — TRANSACTIONS AND EVENTS OTHER THAN A

CHANGE IN OWNERSHIP THAT MIGHT RESULT IN THE USE OF THE
EQUITY METHOD
[Issued 7 May 2004]
Background
An investor will generally begin to use the equity method of accounting when it first
acquires or increases its interest in an entity such that significant influence is
achieved.
Question
What other transactions or events other than a change in absolute or relative
ownership levels could require an investor to begin to use the equity method for an
investment?
Answer
Transactions and events that could require an investor to begin to use the equity
method for an investment include, but are not limited to:
• the investor acquires potential voting rights that affect its ability to
exercise significant influence;
• the shareholders of the investee enter into an agreement that affects the
degree of control or significant influence held by each investor;
• an investee in which the investor holds more than a 20 per cent interest
emerges from bankruptcy. During the bankruptcy, the investee's board of
directors had no power to direct the investee's operating and financial
policies, with all decisions instead being made by an independent
administrator appointed following a vote by the investee's creditors. The
investor had stopped applying the equity method of accounting for its
investment during the bankruptcy because it was unable to exercise
significant influence over the investee;
• an investor's representation on the board of directors of an investee

increases without a corresponding increase in the investor's investment
(e.g. a board member resigns and is not replaced, thereby increasing the
investor's representation, or alternatively, the investor is given or gains
another seat on the board for no consideration); and
• an investment in an associate previously classified as held for sale [in

accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations no longer meets the criteria to be so classified. [IAS 28.15]
Q&A IAS 28: 13(a)-1 — RENUMBERED

[Renumbered to IFRS 5: 15-5 on 30 July 2010]
Renumbered
Q&A IAS 28: 20-1 — PRESENTATION OF TAX EFFECTS OF EQUITY IN

EARNINGS OF AN EQUITY-METHOD INVESTEE
[Issued 7 May 2004]
Background
The investor's income tax provision usually will equal the sum of current and
deferred tax expense, including any tax consequences of its interest in earnings and
temporary differences attributable to its investment in an equity-method investee.
Question
Should the investor's tax consequences of its interest in earnings and temporary
differences attributable to its investment in an equity-method investee be offset
against the investor's interest in that investee's earnings?
Answer
No. The tax consequences of the investor's interest in earnings and temporary
differences attributable to its investment in the investee should not be offset against
the investor's interest in earnings, because it is the investor's tax provision, not the
investee's.
Q&As IAS 28: 20-2 and 20-3 — ACCOUNTING FOR TREASURY SHARES
HELD BY AN ASSOCIATE
Background
Company A, an investor, owns an interest in an associate, Company B, and
Company B concurrently owns an interest in Company A. Company A applies the
equity method of accounting to its investment in Company B. Company B's
investment is determined to be a reciprocal interest.
Note that judgement is required when determining whether the interest held by
Company B is a reciprocal interest rather than an investment held as a trading
portfolio. This Q&A does not address the factors affecting such a judgement.
IAS 28: 20-2
[Issued 7 May 2004]
[Amended 25 April 2008]
Question
How should Company A account for the reciprocal equity interest held by Company B
when the reciprocal equity interest is accounted for in Company B's financial
statements:
• using the equity method under IAS 28?
• as an investment (either at cost or in accordance with IAS 39 Financial

Instruments: Recognition and Measurement)?
Answer
The reciprocal interest should be eliminated.
The requirements of IAS 28.20 apply to accounting for reciprocal equity interests
regardless of how the investee has accounted for the reciprocal interest.
Consequently, the accounting treatment of the investment in Company B's financial
statements does not affect how Company A should account for the reciprocal
interest.
IAS 28.20 states that "[m]any of the procedures appropriate for the application of
the equity method are similar to the consolidation procedures described in IAS 27 .
Furthermore, the concepts underlying the procedures used in accounting for the
acquisition of a subsidiary are also adopted in accounting for the acquisition of an
investment in an associate".
Reciprocal interests should be treated in a similar manner to an investor's own

shares, resulting in consolidation elimination entries to eliminate the investor's share
of the reciprocal interests. Therefore Company A, the investor, will show a reduction
in its investment in the equity-method investee and its own share capital as though
it held treasury shares. It will also eliminate any dividends received on those shares
by the associate from its share of the associate profits.
This approach is illustrated in Q&A IAS 28: 20-EX-1.
Note the IFRIC agenda decisions published in the August 2002 and April 2003 IFRIC
Updates.
IAS 28: 20-3
[Issued 7 May 2004]
Question
How should an investor with reciprocal equity interests with an equity-method
investee calculate net income and earnings per share?
Answer
An analogy to IAS 32.33 is drawn, whereby the reciprocal interest is treated as 'own
shares' of the entity. Use of the treasury stock method is illustrated in Q&A IAS 28:
20-EX-1 and Q&A IAS 28: 20-EX-2.
Q&As IAS 28: 20-EX-1 and 20-EX-2 — ACCOUNTING FOR TREASURY

SHARES HELD BY AN ASSOCIATE — EXAMPLES
IAS 28: 20-EX-1
[Issued 7 May 2004]
Example
Company A owns a 30 per cent interest in Company B, and Company B owns a 20
per cent interest in Company A. Company A and Company B respectively have
10,000 and 5,000 ordinary shares issued and outstanding, and each paid CU100 per
share for their respective ownership interests in each other.

Company A's basis in its investment in Company B, and Company B's corresponding
reciprocal interest in Company A, are calculated as follows.
• Company B's basis in Company A = CU100/share × (20 per cent × 10,000

shares) = CU200,000.
• Company A's reciprocal interest in Company B = 30 per cent × CU200,000

= CU60,000.
The reduction in Company A's investment should be offset by a decrease in retained

earnings, and the offset to the reduction may be presented as a separate line item in
the equity section in a manner similar to treasury shares.
Company B's investment in Company A, and Company A's reciprocal interest in

Company B, would be calculated and accounted for in a similar fashion as shown
below.
• Company A's basis in Company B = CU100/share × (30 per cent × 5,000

shares) = CU150,000.
• Company B's reciprocal interest in Company A = 20 per cent × CU150,000

= CU30,000.
IAS 28: 20-EX-2
[Issued 7 May 2004]
Example
Assume the same facts described in Q&A IAS 28: 20-EX-1. If earnings of Company A
exclusive of any equity in Company B total CU100,000 ('direct earnings of Company
A'), and earnings of Company B exclusive of any equity in Company A total
CU50,000 ('direct earnings of Company B'), net income and earnings per share for
Company A and Company B, respectively, are calculated as follows.
• Income of Company A before equity in Company B = CU100,000.
• Equity in direct earnings of Company B = 30 per cent × CU50,000 =

CU15,000.
• Net income of Company A = CU100,000 + CU15,000 = CU115,000.
• 10,000 shares of Company A – [30 per cent × (20 per cent × 10,000
shares held by Company B)] = 10,000 – 600 = 9,400.
• Earnings per share of Company A = CU115,000 ÷ 9,400 shares =

CU12.23/share.
Although Company A owns 30 per cent of Company B, Company A's investment in

Company B is reduced for its ownership interests in itself through the reciprocal
holdings by Company B of Company A's shares. Company B's ownership of Company
A is reduced in a similar fashion as shown below.
• Income of Company B before equity in Company A = CU50,000.
• Equity in direct earnings of Company A = 20 per cent × CU100,000 =

CU20,000.
• Net income of Company B = CU50,000 + CU20,000 = CU70,000.
• 5,000 shares of Company B – [20 per cent × (30 per cent × 5,000 shares
held by Company A)] = 5,000 – 300 = 4,700.
• Earnings per share of Company B = CU70,000 ÷ 4,700 shares = CU14.89

per share.
Q&A IAS 28: 21-EX-1 — AGGREGATION OF GROUP INTERESTS —

EXAMPLE
Example
IAS 28.21 states that “[a] group's share in an associate is the aggregate of the
holdings in that associate by the parent and its subsidiaries. The holdings of the
[parent's] other associates or joint ventures are ignored for this purpose”.
Company A has a 70 per cent interest in Group B. Group B has a 20 per cent
investment in an associate.
Company A's consolidated financial statements fully consolidate the assets and
liabilities of Group B, i.e. they include 100 per cent of the assets and liabilities from
Group B's consolidated financial statements (which include Group B's associate on an
equity accounting basis). Therefore, when determining the appropriate share of the
associate's results to include in the Company A's consolidated statement of
comprehensive income, it is the full 20 per cent share in the associate that is
brought into Company A's consolidated financial statements, not 14 per cent (70 per
cent × 20 per cent).
Assume the net assets of the associate are CU100 million, including a net profit for
the period of CU40 million. For simplicity, assume that no adjustments are required
for the purpose of applying the equity method of accounting. The investment in the
associate is shown as CU20 million in the consolidated statement of financial position
of Company A and the share of the associate's profit is CU8 million (20 per cent of

CU40 million).
Of that profit of CU8 million, CU2.4 million (30 per cent × CU8 million) is attributed
to the non-controlling interest and CU5.6 million to the equity holders of the parent.
Q&A IAS 28: 22-1 — PROFIT ELIMINATION ON SALE TO AN ASSOCIATE

Background
Entity A has a 30 per cent stake in an associate, Entity B. Entity A accounts for
Entity B using the equity method. The carrying amount of Entity B in Entity A's
consolidated financial statements is CU15 million.
Entity A sells plant and equipment to Entity B in exchange for cash of CU100 million,
which Entity B finances through bank borrowings. Immediately before the sale, the
plant and equipment was recognised in Entity A's financial statements at a
depreciated amount of CU20 million. Entity A will have no further involvement with
the plant and equipment and the derecognition criteria in IAS 16 Property, Plant and
Equipment are met. Entity A has no interests in Entity B other than its equity
interest and is not committed to any reimbursement should Entity B generate losses.
Of the profit of CU80 million made by Entity A, 30 per cent (CU24 million) would
normally be eliminated as unrealised, but this exceeds the carrying amount of the
investment in Entity B (CU15 million).
Question
Should the excess of unrealised profit over the carrying amount of the investment in
Entity B (i.e. CU9 million) be eliminated in the consolidated financial statements of
Entity A?
Answer
IAS 28.22 applies to profits and losses resulting from 'upstream' and 'downstream'
transactions between an investor and an associate. It requires unrealised profits and
losses to be eliminated to the extent of the investor's interest in the associate, but it
does not discuss the possibility that this might exceed the carrying amount of the
associate. In the absence of guidance, it seems appropriate to analogise to IAS
28.30, which deals with an associate that is making losses. In that scenario:
• after the investor's interest is reduced to zero, additional losses are

provided for, and a liability recognised, only to the extent that the investor
has incurred legal or constructive obligations or made payments on behalf
of the associate to satisfy obligations of the associate; and
• if the associate subsequently reports profits, the investor resumes

including its share of those profits only after its share of the profits equals
the share of net losses not recognised.
Applying the same logic here:
• Entity A should reduce the profit on sale of plant and equipment by CU15
million, being the carrying amount of Entity B immediately before the sale.
Thus, it should report a profit of CU65 million on the sale; and
• Entity A should not recognise any further share of Entity B's profits until
Entity B has made sufficient profits (CU30 million, of which Entity A's share
is CU9 million) to cover the amount of unrealised profit not eliminated at
the time of sale.
Q&A IAS 28: 22-2 — ELIMINATION OF TRANSACTIONS WITH

ASSOCIATES WHEN APPLYING THE EQUITY METHOD
Background
An entity lends CU10,000 to an associate in which it has a 20 per cent interest. The
entity earned finance income of CU1,000 on this loan during the year.
Question
In applying the equity method, should the entity eliminate its interest in the finance
income earned on the loan made to the associate against the related finance cost
included in the earnings of the associate?
Answer
IAS 28.22 requires the elimination of profits and losses resulting from downstream
transactions (described in Q&A IAS 28: 22-EX-1). However, it does not address the
treatment of revenue derived from transactions with associates (e.g. revenue from
the sale of goods, or interest revenue) and whether that revenue should be
eliminated from the consolidated financial statements.
While IAS 28.20 indicates that many of the procedures appropriate for the
application of the equity method are similar to consolidation procedures, the entity
may choose to apply paragraph 20 of IAS 27(2008) Consolidated and Separate
Financial Statements and eliminate its interest in the finance income. However, such
elimination is not required.
The entity should select an accounting policy for such transactions that it discloses
and applies consistently.
Q&A IAS 28: 22-EX-1 — ELIMINATION OF PROFITS AND LOSSES ON

TRANSACTIONS WITH ASSOCIATES — EXAMPLE
[Issued 7 May 2004]
[Amended 17 August 2007]
Example
When an associate is accounted for using the equity method, under IAS 28.22,
unrealised profits and losses resulting from upstream (associate to group) or
downstream (group to associate) transactions should be eliminated to the extent of
the investor's interest in the associate.
Upstream: If an investor purchases goods from an associate and the goods have
not been sold by the investor to a third party at period end, the journal entry to
eliminate the investor's share of the unrealised profit on the inventories would be
taken against income from associates.
Downstream: If an investor sells goods to an associate and the goods have not
been sold by the associate to a third party at period end, the journal entry to
eliminate the investor's share of the unrealised profit on the inventories would be
taken against consolidated profit or loss (usually cost of sales).
Assume the following facts.
• An investor owns 30 per cent of an investee.
• The investment is accounted for using the equity method.
• The income tax rate for both investor and investee is 40 per cent.
• Both are able, under IAS 12 Income Taxes, to recognise deferred tax
assets for net deductible temporary differences.
Downstream transaction
The investor sells inventory items to the investee. At the end of the investee's
reporting period, the investee holds inventory for which the investor has recognised
a gross profit of CU300,000. The investor's net income would be reduced by
CU54,000 to reflect a CU90,000 (300,000 × 30 per cent) reduction in gross profit
and a CU36,000 (90,000 × 40 per cent) reduction in income tax expense. The
investor reduces its investment in the investee by CU90,000 and recognises a
CU36,000 deferred tax asset (subject to the IAS 12 recognition criteria).
Upstream transaction
The investee sells inventory items to the investor. At the end of the investor's
reporting period, the investor holds inventory for which the investee has recognised
a gross profit of CU200,000. In the computation of the investor's equity in the
investee's earnings, CU120,000 (CU200,000 less 40 per cent of income tax) would
be deducted from the investee's net income and CU36,000 (the investor's 30 per
cent share of the gross profit earned on the transaction after income tax) would be
eliminated from the investor's equity income. The investor also would reduce the
carrying amount of its inventory by CU60,000 (the investor's share of the investee's
gross profit) and recognise a deferred tax asset of CU24,000 (CU60,000 × 40 per
cent).
Q&A IAS 28: 23-1 — RECORDING THE INITIAL INVESTMENT IN AN

ASSOCIATE
[Issued 7 May 2004]
Background
IAS 28.23 requires that, on the acquisition of an investment in an associate, any

difference between the cost of the investment and the investor's share of the net fair
value of the associate's identifiable assets and liabilities is accounted for as follows:
• goodwill relating to an associate is included in the carrying amount of the

investment. IAS 38 Intangible Assets does not permit the amortisation of
goodwill; and
• any excess of the investor's share of the net fair value of the associate's
identifiable assets and liabilities over the cost of the investment is included
as income in the determination of the investor's share of the associate's
profit or loss in the period in which the investment is acquired.
Question
How should the requirements of IAS 28.23 be applied?
Answer
The investor's proportionate share of the assets acquired and liabilities assumed
should be adjusted for write-ups or write-downs to fair value in the same manner as
a business combination accounted for using the purchase method under IFRS
3(2008) Business Combinations. The investor would then amortise its proportionate
share of any purchase accounting adjustments over the period necessary to match
them against the related assets and liabilities.
Any goodwill that is recognised in the statement of financial position of the associate
is ignored when recognising the identifiable assets and liabilities assumed by the
investor and is effectively absorbed into the goodwill number, calculated in
IAS 28.23 makes it clear that any excess of the investor's share of the net fair value
of the associate's identifiable assets and liabilities on acquisition over the cost of the
investment should be included in income. In these cases, it may be necessary to
reassess whether the investor's proportionate share of all of the assets acquired and
the liabilities assumed has been identified correctly and whether the fair values of
the associate's assets and liabilities have been determined appropriately.
Q&As IAS 28: 23-EX-1 and 23-EX-2 — RECOGNITION OF INITIAL

INVESTMENT — EXAMPLES
IAS 28: 23-EX-1
[Issued 7 May 2004]
Example
Company A purchased 35 per cent of Company B's outstanding shares for an amount
in excess of 35 per cent of the carrying amount of Company B's net assets. For
illustrative purposes, it is assumed that Company B's assets and liabilities are
composed of (1) investments in debt securities that Company B has classified as
held-to-maturity in accordance with IAS 39 Financial Instruments: Recognition and
Measurement and (2) related deferred income taxes. The fair value of the debt
securities is in excess of the carrying amount, and the proportionate difference
between the amount Company A paid for its investment and its proportionate
interest in Company B's net assets is equal to the difference between the carrying
amount and fair value of the debt securities after consideration of income taxes.
In this case, the difference can be attributed to the specific assets and the amounts
should be recognised accordingly. In applying the equity method, Company A will
need to adjust its share of Company B's profit or loss to reflect the fair value
adjustment on the debt securities determined on initial recognition. Any future gain
or loss on disposal of the assets reported by Company B would also be adjusted by
Company A to reflect the fair value recognised on acquisition.
IAS 28: 23-EX-2

[Issued 7 May 2004]
[Amended 17 December 2004]
Example
Company A purchased 35 per cent of Company B's outstanding shares for an amount
in excess of 35 per cent of the carrying amount of Company B's net assets. Company
A's purchase price cannot be attributed to specific assets of Company B. Therefore,
the difference would remain a component of the recognised investment as goodwill
accounted for in accordance with IFRS 3 Business Combinations. Such goodwill is not
amortised (IAS 28.23), but is tested for impairment as part of the carrying amount
of the investment (see Q&A IAS 28: 33-1).

[Deleted 6 August 2010]
Deleted
Q&A IAS 28: 23-3 — ASSOCIATE ACQUIRED IN STAGES — EQUITY

ACCOUNTING
Question
How should a piecemeal acquisition of an associate be recognised in the financial
statements in which the associate is accounted for using the equity method of
accounting?
Answer
Prior to the adoption of IFRS 3(2008) Business Combinations, when an associate is
acquired in stages, goodwill may be calculated on a mixed measurement basis as the
aggregate of the amounts of goodwill determined for each tranche of shares
purchased. Under this approach, for each tranche, the associated goodwill is
determined by deducting the share of the net fair value of the identifiable assets and
liabilities acquired from the price paid for that tranche. This is by analogy to the
guidance in IFRS 3(2004) on business combinations achieved in stages (also
commonly referred to as 'piecemeal' acquisitions).

This response is changed by the amendments to IAS 28 as a result of IFRS 3(2008),
which is effective for annual periods beginning on or after 1 July 2009. Earlier
adoption is permitted in limited circumstances (see IFRS 3(2008).64). If an entity
applies IFRS 3(2008) for an earlier period, the amendments to IAS 28 should also be
applied for that earlier period.
The revised IAS 28.23 requires that goodwill be calculated only at the time at which
the investment becomes an associate (i.e. when significant influence is achieved).
The goodwill is calculated as the "difference between the cost of the investment and
the investor's share of the net fair value of the associate's identifiable assets and
liabilities". Therefore, following the adoption of IFRS 3(2008) and the consequential
amendments to IAS 28, it is no longer appropriate to calculate goodwill on a mixed
measurement basis.
In accordance with IAS 28.11, the investment in the associate is initially recognised
at cost. When the investor has previously held an investment in the associate
(generally accounted for under IAS 39 Financial Instruments: Recognition and
Measurement), the deemed cost of the investment in the associate is the fair value
of the original investment at the date that significant influence is achieved plus the
consideration paid for the additional stake. However, IAS 28 is not clear as to
whether any gains or losses arising on the original investment since its acquisition
should be reflected in profit or loss at this point.
Because IAS 28 does not mandate a particular accounting treatment in this regard,
an entity may either:
• (by analogy to IFRS 3(2008)), treat the transaction as a disposal of the

original investment for fair value and an acquisition of an associate, with
the result that a gain or loss on the 'disposal' will typically be reflected in
profit or loss; or
• recognise a revaluation gain on the original tranche in an appropriate

component of equity in order to establish the appropriate starting point for
equity accounting. Under this approach, when the original investment had
been classified previously as an available-for-sale financial asset under IAS
39, the revaluation gain or loss previously recognised in other
comprehensive income should not be reclassified from equity to profit or
loss. When the original investment was measured at cost in accordance
with IAS 39.46(c), a revaluation gain is required to recognise the
investment at fair value and to calculate goodwill. No gain or loss should
be recognised in profit or loss under this approach on the basis that there
has been no realisation event (e.g. a disposal).
The choice between these approaches is an accounting policy choice, which should
be applied consistently for all acquisitions of associates achieved in stages.

[Issued 7 May 2004]
[Renumbered to IAS 28: 11-2 on 24 February 2006]
Renumbered
Q&A IAS 28: 29-1 — ACCOUNTING FOR A LONG-TERM LOAN TO AN

EQUITY-ACCOUNTED INVESTMENT
Background
An entity (investor) grants a long-term interest-free loan to one of its

equity-accounted associates (investee). The loan has no fixed repayment terms and
settlement of the loan is neither planned nor likely to occur in the foreseeable future.
From the standpoint of the investee, the investee has a contractual obligation to
deliver cash or another financial asset to the investor. Accordingly, the loan payable
shall be classified as a financial liability and hence will be within the scope of IAS 39
Financial Instruments: Recognition and Measurement because it does not meet the
definition of equity.
While the investor has a contractual right to receive cash or another financial asset
from the investee, the investor views the loan as part of the net investment in the
investee because, in accordance with IAS 28.29, the settlement of the loan is neither
planned nor likely to occur in the foreseeable future.
Question
How should the interest-free loan be accounted for in the investor's financial
statements?
Answer
In the investor's financial statements (both consolidated and, if applicable,
separate), the interest-free loan is classified and measured in accordance with IAS
39. In general, the loan asset will be classified as 'loans and receivables' or it may be
designated as an available-for-sale financial asset.
IAS 28 determines whether the long-term interest-free loan can be viewed as part of
the interest in the investee when accounting for losses of the investee in accordance
with IAS 28.29, which states, in part:
The interest in an associate is the carrying amount of the investment in

the associate under the equity method together with any long-term
interests that, in substance, form part of the investor's net investment in
the associate.
For the purpose of accounting for losses of an investee, the loan would form part of
the investor's net investment in the investee because its settlement is neither
planned nor likely to occur in the foreseeable future.

[Renumbered to IAS 28: 11-3 on 22 October 2010]
Renumbered
Q&A IAS 28: 30-EX-1 — ASSOCIATE WITH NET ASSET DEFICIENCY —

EXAMPLE
Example
An investor invests CU10 million in an associate: CU5 million to acquire 25 per cent
of the equity share capital of the associate and CU5 million as an unsecured
shareholder's loan (for which settlement is neither planned nor likely to occur in the
foreseeable future). The investor has entered into no other guarantees or
commitments in respect of the associate. Assume that the associate is in a start-up
situation and expects significant losses in the first year, but will generate profits
thereafter. The associate has sufficient cash resources to meet its liabilities as they
fall due.
Assuming that the associate loses CU50 million in the first year, the investor should
recognise a loss of CU5 million in respect of its equity stake. It will recognise a
further loss of CU5 million in respect of the shareholder's loan if, in substance, the
loan forms part of the investor's net investment in the associate (as would appear to
be the case). However, the balance of the investor's share of the net loss (i.e. 25 per
cent of CU50 million, less CU10 million) is not recognised.
If, in the next year, the associate makes a profit of CU10 million, the investor
recognises no profit since its share of the profit (CU2.5 million) equals the amount of
the unrecognised loss in the previous period. For any profits made in excess of CU10
million, the investor recognises its proportionate share.
Q&A IAS 28: 33-1 — INDICATORS THAT AN EQUITY-METHOD

INVESTMENT IS IMPAIRED
[Issued 7 May 2004]
Question
In addition to the guidance in IAS 36 Impairment of Assets, what are other examples
of indicators that an equity-method investment is impaired?
Answer
The existence of the following indicators provides additional evidence as to whether
an investment in an associate might be impaired:
• the financial condition and near-term prospects of the associate, including

any specific events that may influence the operations of the associate
(such as changes in technology that may impair the earnings potential of
the investment, or the discontinuance of a segment of the business that
may affect the future earnings potential);
• the intent and ability of the holder to retain its investment in the associate
for a period of time sufficient to allow for any anticipated recovery in
market value;
• the associate's financial performance and projections;
• trends in the general market;
• the associate's capital strength;
• the associate's dividend payment record;
• known liquidity crisis;
• bankruptcy proceedings; and
• going concern commentary in the auditor's report on the investee's most

recent financial statements.
IAS 39 Financial Instruments: Recognition and Measurement requires that financial

assets be assessed at the end of each reporting period to determine whether there is

any objective evidence that they are impaired. IAS 39.59–62.
Q&A IAS 28: 33-2 — IMPAIRMENT OF AN ASSOCIATE THAT INCLUDES

GOODWILL
Question
When an impairment loss has previously been recognised in respect of the carrying
amount of an associate that included goodwill, does IAS 28 permit the impairment
loss to be reversed to the extent that it related to the goodwill?
Answer
Generally, in appropriate circumstances, impairment losses recognised in respect of
equity accounted investments can be reversed. However, the question arises as to
whether this is permitted in respect of goodwill included in the carrying amount of an
equity-accounted investment, given the general prohibition on reversing impairment
losses relating to goodwill (see IAS 36 Impairment of Assets).
If the equity carrying amount of an associate included CU100 goodwill, and an

impairment loss of CU150 was recognised, the goodwill effectively has been
eliminated. If the recoverable amount subsequently increases to its original value,
can the entire impairment of CU150 be reversed, or is the reversal restricted to
CU50?
IAS 28.33 states that because goodwill included in the carrying amount of an
investment in an associate is not separately recognised, it is not tested for
impairment separately under the principles of IAS 36. Instead, the entire carrying
amount of the investment is tested under IAS 36 for impairment by comparing its
recoverable amount with its carrying amount, whenever application of the
requirements in IAS 39 Financial Instruments: Recognition and Measurement
indicates that the investment may be impaired. Although not specifically addressed
in IAS 28, the treatment of reversals of impairment losses should mirror the
requirements of IAS 28.33. The investment, therefore, is treated as a whole, and the
goodwill is not treated separately; thus, there is no prohibition against restoring the
carrying amount of the investment to its pre-impairment value, in appropriate
circumstances. Therefore, in the example above, the entire impairment loss of
CU150 could be reversed.
Q&A IAS 28: 33-3 — RECOGNISING IMPAIRMENT FOR

EQUITY-METHOD INVESTMENTS
Background
IAS 28.31 states that, “[a]fter application of the equity method, including
recognising the associate's losses in accordance with paragraph 29, the investor
applies the requirements of IAS 39 [Financial Instruments: Recognition and
Measurement] to determine whether it is necessary to recognise any additional
impairment loss”.
IAS 28.33 states that, “the entire carrying amount of the investment [in an
associate] is tested for impairment in accordance with IAS 36 [Impairment of Assets]
as a single asset, by comparing its recoverable amount (higher of value in use and
fair value less costs to sell) with its carrying amount, whenever application of the
requirements in IAS 39 indicates that the investment may be impaired. An
impairment loss recognised in those circumstances is not allocated to any asset,
including goodwill, that forms part of the carrying amount of the investment in the
associate".
Question
How should an investor account for an impairment loss arising on an investment in
an associate?
Answer
There are differing views regarding the nature of equity accounting. How an entity
views equity accounting is critical in its consideration of an appropriate accounting
policy under IAS 28 for recognising impairment losses in respect of its associates.
In its guidance on the equity method of accounting, IAS 28.23 states that,
"[a]ppropriate adjustments to the investor's share of the associate's profits or losses
after acquisition are also made to account, for example, for depreciation of the
depreciable assets based on their fair values at the acquisition date. Similarly,
appropriate adjustments to the investor's share of the associate's profits or losses
after acquisition are made for impairment losses recognised by the associate, such
as for goodwill or property, plant and equipment". Therefore, the equity method of
accounting has some of the features commonly associated with consolidation.
However, in accordance with IAS 28.31–33, interests in associates and the

investor's share of the profit or loss of the associate are both presented as one-line
items in the statement of financial position and the statement of comprehensive
income respectively and the investor is required to monitor its investment in an
associate for impairment as a whole. Furthermore, in accordance with IAS 28.29–30,
the investor ceases to recognise its share of the associate's losses once it has
reduced its investment in the associate to zero and only recognises a liability for
subsequent losses to the extent that it has incurred legal or constructive obligations
or made payments on behalf of the associate. Therefore, the equity method of
accounting has some of the features commonly associated with a valuation
methodology (sometimes referred to as a 'closed box' view).
The table below outlines possible approaches to accounting for impairment losses
arising on equity-method investments. An investor should select its accounting policy
based on its view regarding the nature of equity accounting (i.e. either as a form of
consolidation accounting or as a form of valuation methodology).
The accounting policy selected should be applied consistently to all investments in

associates of the entity.
Accounting for impairment losses in an associate
Policy consistent with a one-line Policies consistent with a 'closed

consolidation approach box' approach

consolidation approach box approach
Step 1: The investor recognises its Accounting policy 1

share of profit or loss of its
Step 1: The investor recognises its
associate, including any
share of profit or loss of its
impairment losses recognised by
associate, including any
the associate.
Step 2: The investor makes the the associate.
limited 'consolidation' and fair
Step 2: The investor makes the
value adjustments required by IAS
limited 'consolidation' and fair
28 to:
value adjustments required by IAS
• eliminate unrealised gains; and 28 to:
• adjust • eliminate unrealised gains; and
depreciation/amortisation when
• adjust
the fair value of an asset at the
depreciation/amortisation (but
date of obtaining significant
not impairment losses) when
influence was greater or lower
the fair value of an asset at the
than the carrying amount in the
date of obtaining significant
associate's own financial
influence was greater or lower
statements.
than the carrying amount in the
Step 3: The investor performs a associate's own financial
separate (additional) impairment statements.
review in respect of the
Step 3: The resulting carrying
cash-generating units (CGUs)
amount of the investment in
within the associate, but using the
associate is then tested for
associate's figures as amended to
impairment as a whole.
reflect 'consolidation' and fair
value adjustments. As a result, the Accounting policy 2
investor may adjust the
As above, except the investor
makes adjustments to the
the associate itself because:
impairment loss on those assets
• the investor and associate impaired by the associate based
recognised different amounts on the acquisition date fair values
for the assets subject to the of those assets.
impairment analysis due to fair
value adjustments; or
• the investor recognised an
asset not recognised by the
associate.
Step 4: The resulting carrying
amount of the investment in
associate is then tested for
impairment as a whole.

Q&A IAS 28: 33-EX-1 — NON-RECOURSE DEBT AND IMPAIRMENT —
EXAMPLE
[Issued 7 May 2004]
Example
Company A and Company B each make a CU6 million investment in a real estate
venture, Company C. Their investments are financed in part by each borrowing CU5
million. The terms of the borrowing are such that, to the extent that they fail to
recover their investments from Company C, Company A and Company B are not
required to repay their borrowings.
If Company A's and Company B's investments in Company C are determined to be

impaired under the principles set out in IAS 28.33, Company A and Company B must
write their investments down in accordance with that paragraph. The existence of
non-recourse debt is not justification for limiting the impairment loss. The
borrowings are accounted for separately under the principles of IAS 39 Financial
Instruments: Recognition and Measurement.
Q&A IAS 29: 12-1 — EXAMPLES OF MONETARY AND NON-MONETARY

ITEMS
Background
Under IAS 29.12, monetary items are not restated. IAS 29.14 specifies the
requirements for non-monetary items. Monetary items are defined in IAS 29.12 as
"money held and items to be received or paid in money".
Question
What are some examples of monetary and non-monetary items?
Answer
The following table lists a number of the most common monetary and non-monetary
items.
Monetary items Non-monetary items
Cash Property, plant and equipment
Bank balances and loans Intangible assets
Deposits* Goodwill
Employee benefit liability** Shareholders' equity
Accrued expenses Prepaid expenses*
Trade payables Investments in associates
Taxation Advances received on sales or paid

on purchases provided that they
are linked to specific sales or
purchases
Debt securities Inventories
Trade receivables Allowance for inventory

obsolescence (because inventories
are non-monetary)
Allowance for doubtful debts Deferred income

(because trade receivables are
monetary)
Notes and other receivables Equity securities
Notes and other payables
Holiday pay provision
Deferred tax assets/liabilities
Payables under finance leases
* When an entity has prepaid expenses, it is necessary to consider

whether the prepayment is refundable. When it is refundable, a
prepayment is similar in nature to a deposit and, therefore, is a
monetary item (i.e. it is a right to receive a fixed or determinable
number of units of currency). Conversely, when it is not refundable, it is
non-monetary (see paragraph 16 of IAS 21 The Effects of Changes in
Foreign Exchange Rates)
Foreign Exchange Rates).
** It may be appropriate to regard a defined benefit asset or obligation

as a monetary item. But it is possible to argue that some components,
particularly relating to equity securities, should be regarded as
non-monetary. However, for most entities, this would lead to a level of
complexity that is unwarranted. It is relatively uncommon for a defined
benefit arrangement to be denominated in a currency other than the
functional currency of the entity.

Deleted
Q&A IAS 29: 15-EX-1 — RESTATEMENT OF PROPERTY, PLANT AND

EQUIPMENT — EXAMPLE
Example
An entity acquires an item of property, plant and equipment on 31 December 20X1
for CU1,000 when the general price index is CU100. At 31 December 20X2, the index
is CU140 and the asset has been depreciated by 10 per cent. At 31 December 20X3,
the index is CU190 and the asset has been depreciated at 10 per cent for a second
year.

Q&A IAS 29: 15-EX-2 — RESTATEMENT OF INVENTORIES — EXAMPLE
Example
An entity operating in a hyperinflationary economy is preparing financial statements
at its period end, 31 December. Assume labour and overheads are utilised evenly
over a period, and the following changes in the general price index apply:

Q&A IAS 29: 15-EX-3 — RESTATEMENT OF COMPONENTS OF EQUITY
RELATING TO REVALUED PROPERTY, PLANT AND EQUIPMENT —
EXAMPLE
Example
An entity acquires an item of property, plant and equipment on 31 December 20X1
for CU1,000 when the general price index is CU100. At 31 December 20X2, the index
is CU140. The entity's policy is to revalue its property, plant and equipment. At 31
December 20X2, the item of property, plant and equipment has a fair value of
CU1,500.

Q&A IAS 29: 17-1 — IMPUTING A GENERAL PRICE INDEX
Question
IAS 29 states that a general price index may not be available and that it may be
necessary to use, for example, an estimate based on the movements in the
exchange rate between the reporting currency and a relatively stable foreign
currency. How should an index be imputed?
Answer
In the absence of a reliable independently determined index (either by the
government or the private sector), the movement in the exchange rate between a
stable currency (e.g. the U.S. dollar) and the local currency from the beginning to
the end of the reporting period may be used as a guideline to determine the index.
In making this estimate, it is important that the impact of inflation in the stable
currency is excluded.
Q&A IAS 29: 17-EX-1 — IMPUTING A GENERAL PRICE INDEX

Example
Assume that the exchange rate at 1 January 20X5 between Local Currency and
Stable Currency is 200:1. At 31 December 20X5, the exchange rate is 350:1. There
has been a 75 per cent depreciation in Local Currency in relation to Stable Currency.
Assuming that inflation in the Stable Currency economy for the 20X5 calendar year is
three per cent, the index should be an increase of 80.25 per cent (1.75 × 1.03).

Deleted
Q&A IAS 29: 26-1 — RESTATEMENT OF CURRENT TAXATION

Question
IAS 29 requires that all items in the statement of comprehensive income be
expressed in terms of the measuring unit current at the end of the reporting period.
How should the current taxation expense be restated (i.e. is it a year-end item or an
expense that accrues over the period)?
Answer
The current taxation expense accrues over the period. Therefore, the restated
current taxation expense is calculated by restating the tax expense for each month
in terms of purchasing power at the end of the reporting period, using the increase
in the general price index from the related month until the end of the reporting
period. When the movement in the index is not material, the current tax at the end
of the reporting period may be indexed using average rates (i.e. as for other
expenses).
The difference between the opening restated deferred tax balance, and the revised
closing deferred tax balance should be added to the above amount. (In the deferred
tax example set out in Q&A IAS 29: 32-EX-1, this amount would be CU112.50).
Q&A IAS 29: 26-EX-1 — RESTATEMENT OF CURRENT TAXATION —

EXAMPLE
Example
Refer to parts B and C on the "hyperinflation calculations" sheet for a detailed

example. In summary:
• When the 31 December 20X1 historical cost statement of comprehensive

income is restated to the index at 31 December 20X1 to calculate the
restated statement of comprehensive income, current tax is restated by
multiplying the historical amount by [(index at the end of the reporting
period, i.e. 20X1) ÷ (average index for current year, i.e. 20X1)].
• To this is added: the 20X0 deferred tax of 207,000 Local Currency indexed
to the end of 20X1 (i.e. 331,200 Local Currency) less deferred tax as
recomputed at the end of 20X1 of 507,913 Local Currency equals 176,713
Local Currency, to arrive at the total restated current tax charge of
324,405 Local Currency.
• When the 31 December 20X1 restated statement of comprehensive income

is restated to the index at 31 December 20X2 to arrive at a comparative
statement of comprehensive income restated to current year-end amounts,
tax expense is restated by multiplying the 20X1 restated amount (i.e.
324,405 Local Currency) by [(index at the end of the reporting period, i.e.
20X2) ÷ (index at end of the prior year, i.e. 20X1)].
• The liability that is due to the tax authorities is a monetary item, and
therefore, is not restated in the current year. However, comparative
information will be restated in line with IAS 29.34.
Q&A IAS 29: 26-2 — RESTATEMENT OF CURRENT YEAR COST OF

GOODS SOLD
Question
IAS 29 requires that all amounts be restated by applying the change in the general
price index from the dates when the items of income and expenses were initially
recognised in the financial statements. How should this be applied to cost of goods
sold?
Answer
All amounts included in cost of goods sold should be restated by applying the change
in the general price index from the dates when the items of income and expenses
were initially recognised in the financial statements.The following steps may be
required:
• obtain the monthly breakdown of the items included in production costs;
• restate all components of production costs, except depreciation and raw

materials, from the month when the costs were incurred to the end of the
reporting period;
• calculate raw material used in the production process through the

reconciliation of restated opening raw materials and closing raw materials
balances;
• calculate depreciation related to production costs on the basis of the

restated property, plant and equipment, and replace the historic
depreciation with this restated depreciation; and
• restate opening and closing historical finished goods and work in progress
as explained in the statement of financial position section.
The amount of the restated cost of goods sold is obtained by adding the restated
opening finished goods and work in progress to purchases and other production costs
restated from the date when the cost was incurred, and deducting the restated
closing finished goods and work in progress. The restated opening finished goods
and work in progress are derived by:
• restating amounts to the purchasing power at the end of the prior

reporting period; and
• inflating the restated cost of opening amounts as calculated above by the

conversion factor for the entire year.
Refer to parts C and G on the "hyperinflation calculations" sheet for a detailed

example of restating the current period income statement.
Q&A IAS 29: 26-EX-2 — RESTATEMENT OF COST OF GOODS SOLD —

EXAMPLE
Example
An entity has inventories of CU200 at the beginning of the period, when the general
price index is at CU100. Purchases of CU1,200 are made at an even rate throughout
the year and closing inventories are CU200. The closing inventories were acquired in
two instalments in the last two months of the year, when the index was CU120 and
CU122 respectively. At the end of the reporting period, the general price index is
CU124, and inflation rose steadily all year, giving an average rate of CU112.

Q&A IAS 29: 27-EX-1 — GAIN OR LOSS ARISING ON NET MONETARY
POSITION — EXAMPLE
Example
An entity has a loan linked to an index, which was CU100 at the start of the period
and at the period end is CU125. In preparing its financial statements, the entity uses
a different index, which at the start of the period was CU100 and at the period end is
CU120. Inflation is assumed to have occurred at an even rate throughout the period.
The unadjusted depreciation expense for the period relates to assets acquired (on
average) when the index stood at CU80. (Note that, for simplicity, the example
ignores the effects of taxation.)

Note that the loss of CU25 on the index-linked loan has been shown separately in
the column on the right as separate disclosure is suggested by IAS 29.
Q&A IAS 29: 32-1 — RESTATEMENT OF DEFERRED TAXATION

Question
IAS 29 states that the restatement of financial statements may give rise to
differences between the carrying amount of individual assets and liabilities and their
tax bases. These differences are accounted for in accordance with IAS 12 Income
Taxes. How should this be applied in practice?

Answer
For financial statements restated under IAS 29, deferred tax is not calculated by
simply indexing the historical cost deferred tax amount. Instead, a revised closing
deferred tax calculation should be performed using the carrying amounts and tax
bases that exist after the restatement for hyperinflationary purposes. Generally,
there is no tax relief for hyperinflation and, as such, the tax base will remain
unchanged. The difference between the opening restated deferred tax balance and
the revised closing deferred tax balance is the deferred tax expense or credit for the
period.
See Q&A IAS 29: 32-EX-1 for an illustration.
Q&A IAS 29: 32-EX-1 — RESTATEMENT OF DEFERRED TAXATION —

SIMPLE EXAMPLE
[Amended 3 September 2010]
Example
At 31 December 20X1, an entity recognised a deferred tax liability related to a
non-current asset with a carrying amount of CU1,600 and a tax base of CU750. The
resulting temporary difference of CU850 gave rise to a deferred tax liability of CU255
(tax rate 30 per cent).
At 31 December 20X2, assuming an index rate of CU1.5 and no other movements in

the carrying amount or the tax base of the asset, the deferred tax liability is
The opening deferred tax balance of CU255 should be indexed by CU1.5. The effect
of this is that the comparative information in respect of deferred tax is restated to
CU382.50. However, in performing a revised deferred tax computation at the end of
the current year, the closing deferred tax balance should be CU495. Accordingly, the
difference between the closing deferred tax amount of CU495 and the restated
opening deferred tax amount of CU382.50 (i.e. CU112.50) is the current year
deferred tax expense.
Q&A IAS 29: 32-EX-2 — RESTATEMENT OF DEFERRED TAXATION —

DETAILED
Example
Refer to parts B and C on the "hyperinflation calculations" sheet for the detailed
example. In summary:
• When the 31 December 20X1 historical cost statement of financial position

is restated to the index at 31 December 20X1 to calculate the restated
statement of financial position, deferred tax is recomputed using the
restated hyperinflationary amounts and comparing those to the tax base to
arrive at new temporary differences. The new deferred tax amount (based
on the new temporary differences) will be the amount in the restated 20X1
statement of financial position. In the example, this amount is 507,913
Local Currency (refer to the "deferred tax calculations" sheet).
• The 20X0 deferred tax of 207,000 Local Currency indexed to the end of
20X1 (i.e. 331 200 Local Currency) less deferred tax as recomputed at the
end of 20X1, as noted above, of 507,913 Local Currency equals 176,713
Local Currency. This difference of 176,713 Local Currency should be
presented as a current tax expense. The increase in the deferred tax
liability is a result of a current period change in the value of the tax base,
measured in year-end currency units, and should be included as part of the
current tax charge.
• When the 31 December 20X1 restated balance sheet is restated to the

index at 31 December 20X2 to arrive at a comparative balance sheet
restated to current year-end amounts, deferred tax is restated by
multiplying the 20X1 restated amount (i.e. 507,913 Local Currency) by
[(index at end of the current reporting period, i.e. 20X2) ÷ (index at end of
the prior reporting period, i.e. 20X1)].
Q&A IAS 29: 35-1 — CONSOLIDATED FINANCIAL STATEMENTS

Question
IAS 29 states that the financial statements of a subsidiary that reports in the
currency of a hyperinflationary economy need to be restated by applying a general
price index of the country in whose currency it reports before the results are included
in the consolidated financial statements issued by its parent. Where such a
subsidiary is a foreign subsidiary, its restated financial statements are translated at
closing rates.
Assume that a holding company based in the United States, Company H, is an

investment company and its only investment is a wholly owned subsidiary (Company
S) based in Zimbabwe. Company S and Company H did not trade during the current
year. The index in the current year is 1.5. Assume that on 1 January 20X1, when
Company H invested in Company S, the exchange rate for Zimbabwean dollars and
U.S. dollars was 200:1. At 31 December 20X1, the exchange rate was 350:1. What
happens to intragroup eliminations when Company S reports in Zimbabwean dollars
and these are translated into U.S. dollars for consolidated reporting purposes?
Company S has equity of Z$100,000 and net assets of Z$100,000. The net assets
consist of monetary assets of Z$50,000 and non-monetary assets of Z$50,000, and
were acquired at the beginning of the current year.
Answer
The above is applicable for foreign entities, as defined in IAS 21 The Effects of

Changes in Foreign Exchange Rates.
Q&A IAS 29: OTHER-EX-1 — PRACTICAL APPLICATION OF IAS 29 —

HYPERINFLATION CALCULATIONS
Example
The following facts and example apply to any detailed examples outlined in the
remainder of the IAS 29 guidance. Z$ refers to Zimbabwean dollars.
Clued-up commenced operations on 1 January 20X0, at which date the share capital
was paid and land and buildings of Z$1,000,000 and plant of Z$500,000 were
purchased. The only other fixed asset addition was on 1 January 20X2 when plant of
Z$100,000 was purchased. Land and buildings are depreciated at five per cent per
annum and plant at 20 per cent per annum. Tax depreciation rates are the same as
accounting depreciation rates. Clued-up has four months of inventory purchases on
hand at 31 December 20X2 and two months at 31 December 20X1 and 31 December
20X0. Income is earned evenly throughout the year. At the beginning of 20X1, the
company adopted IAS 29.
The general price indices were as follows:

The attached Excel file consists of a detailed worked example on how to apply the
following in practice:
• At the beginning of the first period of application, conversion of the 31

December 20X0 historical cost statement of financial position to the index
at 31 December 20X0 to calculate restated opening retained earnings (part
A on the "hyperinflation calculations" sheet). The 31 December 20X0
historical cost statement of comprehensive income also has been
converted.
• Conversion of 31 December 20X1 historical cost statement of financial

position to the index at 31 December 20X1 to calculate the restated
statement of financial position (part B on the "hyperinflation calculations"
sheet).
• Conversion of 31 December 20X1 historical cost statement of

comprehensive income to the index at 31 December 20X1 to calculate the
restated statement of comprehensive income (part C on the "hyperinflation
calculations" sheet).
• Restatement of 31 December 20X1 hyperinflated statement of financial

position to the index at 31 December 20X2 to arrive at a comparative
statement of financial position restated to current year end amounts (part
D on the "hyperinflation calculations" sheet).
• Restatement of 31 December 20X1 hyperinflated statement of

comprehensive income to the index at 31 December 20X2 to arrive at a
comparative statement of comprehensive income restated to current year
end amounts (part E on the "hyperinflation calculations" sheet).
• Conversion of 31 December 20X2 historical cost statement of financial

position to the index at 31 December 20X2 to calculate the restated
statement of financial position (part F on the "hyperinflation calculations"
sheet).
• Conversion of 31 December 20X2 historical cost statement of

comprehensive income to the index at 31 December 20X2 to calculate the
restated statement of comprehensive income (part G on the "hyperinflation
calculations" sheet).
• Deferred tax calculations for 20X0, 20X1, and 20X2 — both historical and
restated for each period (on the "deferred tax calculations" sheet).

[Issued 25 June 2004]
Deleted
Q&A IAS 33: 2-1 — SEGMENT REPORTING REQUIREMENT FOR

PUBLICLY TRADED ENTITIES
Question
Shares of Company A are listed on the Luxembourg exchange. It is not expected
that these shares will be traded. Company A has completed a listing for marketing
purposes only (e.g., investors are restricted to investing in listed companies such as
Canadian Pension Funds). Are segment and EPS disclosures required?
Answer
Yes. IAS 14.4, Segment Reporting, and IAS 33.2 note that "publicly traded" entities
must comply with the requirements of these Standards. The notion of "publicly
traded" does not require the actual trading of shares, but the ability to trade the
shares publicly.
Q&A IAS 33: 5-1 — NATURE OF POTENTIAL ORDINARY SHARES IN EPS

COMPUTATIONS
Question
What is the nature of potential ordinary shares?
Answer
The term "potential ordinary shares" is defined in IAS 33.5 as, "a financial
instrument or other contract that may entitle its holder to ordinary shares".
However, there is ambiguity as to the nature of a potential ordinary share.
The concept that an instrument may be considered the equivalent of ordinary shares
has evolved to meet the reporting needs of investors in corporations that have
issued certain types of convertible and other complex securities. The holders of these
instruments can expect to participate in the appreciation of the value of the ordinary
shares resulting principally from the earnings and earnings potential of the issuing
corporation. The attractiveness of these instruments to investors often is based
principally on the potential right to share in increases in the earnings potential of the
company, rather than on its fixed return or other senior security characteristics
(refer to Q&A IAS 33: 49-1). The value of instruments that are considered potential
ordinary shares is derived largely from the value of the ordinary shares to which it
relates. Changes in the value of those instruments tend to reflect changes in the
value of the ordinary shares.
Q&A IAS 33: 5-2 — WRITTEN CALL OPTION

Question
If an entity enters into a forward sale of its ordinary shares or writes a call option on
its own shares, and such derivative is not an equity instrument in terms of IAS 32
Financial Instruments: Presentation, is the instrument a potential ordinary share?
Answer

It depends. If the settlement terms of the derivative permit or require settlement net
in ordinary shares of the entity or in a fixed number of ordinary shares for a fixed
amount of cash, the derivative is a potential ordinary share. This is true irrespective
of whether the settlement terms are at the option of the holder or the issuer.
If, however, the settlement terms of the derivative permit only net settlement in
cash or other financial assets, and/or settlement by the exchange of gross amounts
of cash or other financial assets, the instrument does not "entitle its holder to
ordinary shares" and is not a potential ordinary share. This is true irrespective of
whether the settlement terms are at the option of the holder or the issuer.
Q&A IAS 33: 10-EX-1 — COMPUTATION OF BASIC EPS

Example
This example illustrates the first quarter computation of basic EPS for Corporation A,
which has a complex capital structure. The facts assumed are as follows:
• Corporation A has 20,000, $1,000 par value six per cent participating
preference shares outstanding for the entire period.
• Net income for the first quarter was $4 million.
• Corporation A had 4 million shares issued and outstanding on 1 January.

On 1 March, A issued 500,000 shares in a secondary offering, and on 15
March, employees exercised options for 50,000 ordinary shares. Employees
hold options on 200,000 additional ordinary shares that will vest and
become exercisable over the next three to seven years.
Weighted average shares outstanding during the first quarter for the ordinary shares
issued by A can be summarised as follows:

Basic EPS for A in the first quarter is calculated as follows:
Q&A IAS 33: 12-1 — PREFERENCE SHARES ISSUED BY THE

SUBSIDIARY TO THE PARENT HOLDING COMPANY AS A MEANS OF
FUNDING THE DIVIDENDS ON PREFERENCE SHARES ISSUED BY THE
PARENT
Question
Company S is a majority-owned subsidiary of Company P. Company P issued $100
million five-per cent preference shares to the public. In connection with the offering,
S issued $100 million five-per cent preference shares to P (i.e. same terms and
features as the public-preference) primarily as a means of funding the
public-preference dividends, since P is a holding company with no independent
operations or cash flows. The public-preference shares are not convertible,
participating, or mandatorily redeemable, nor are any of the shares held by the
minority-interest holders in S.
What impact do the public-preference and subsidiary-preference shares, and related

dividends, have on the computation of basic and diluted EPS in P's consolidated
financial statements?
Answer
The public-preference shares held by third parties reduce basic and diluted EPS
because the dividends on these shares are deducted to determine the numerator.
The subsidiary's preference shares do not affect P's computation of basic and diluted
EPS, since all of the subsidiary-preference shares and related dividends are
eliminated on consolidation.
Q&A IAS 33: 12-2 — TREATMENT OF CONTINGENT DIVIDENDS ON

PREFERENCE SHARES IN CALCULATING BASIC EPS
Question
Company X, a public company, issued to Company Y convertible preference shares
("Preference Shares") that earn a seven per cent dividend per year. Conversion is at
Y's option. Company X may elect to redeem the preference shares at any time.
The terms of the Preference Shares state that if Y were to convert the Preference
Shares into ordinary shares, Y would not receive any Preference Share dividends,
including any cumulative dividends in arrears. Conversion is based on the initial issue
price of $1,000 per share of Preference Shares divided by the 30-day average
market price of X's ordinary shares. If, however, X redeems the shares from Y, then
Y would receive cumulative dividends, including any in arrears.
How should the contingent dividends be reflected in basic EPS?
Answer
While IAS 33.12 states that preference share dividends should be subtracted from
net income available to ordinary shareholders for purposes of calculating basic EPS
whether paid or earned, it does not address how to account for dividend payments
contingent on future events. In X's situation, the future event is whether X redeems
the Preference Shares or Y converts the Preference Shares.
The dividends potentially will be paid in the future unless Y elects to convert. If Y
elects to convert the Preference Shares into ordinary shares, Y no longer has the
right to receive the Preference Shares dividends, including any in arrears. This is
analogous to how IAS 33 treats convertible debt where interest is accrued until
conversion occurs.
Based on the above, dividends on the Preference Shares for each period should be
subtracted from income available to ordinary shareholders for computing basic EPS
until the conversion occurs, whether or not the dividends are declared. If conversion
occurs, thus removing Y's right to receive the dividends, including those in arrears,
the EPS calculation should be adjusted prospectively in accordance with IAS 33.18 in
the period that conversion occurs. Company X should not restate prior EPS amounts.
Q&A IAS 33: 12-3 — DIVIDENDS RECEIVED ON SHARE OPTIONS

Background
Company B grants share options to its employees, which will only vest if the
employee remains employed for three years. The employees are entitled to:
a. Dividends in cash on the options. If the options do not vest, the employee
retains the dividends paid.
b. Dividends, but they are applied to reduce the exercise price.
Question
How do the dividends affect the basic and diluted earnings per share (EPS)
calculation in each scenario?
Answer
Scenario A
In the calculation of basic EPS, earnings is the profit or loss attributable to ordinary
equity holders of the parent. IAS 33.12 requires that profit and loss be adjusted for
the after-tax amounts of preference dividends. IAS 33.12 states, "For the purpose of
calculating basic earnings per share, the amounts attributable to ordinary equity
holders of the parent entity in respect of (a) profit or loss from continuing operations
attributable to the parent entity; and (b) profit or loss attributable to the parent
entity, shall be the amounts in (a) and (b) adjusted for the after-tax amounts of
preference dividends, differences arising from the settlement of preference shares,
and other similar effects of preference shares classified as equity". The dividends
paid on the share options that are payable irrespective of whether the options vest
reduce the share of profit available to ordinary equity holders; therefore, profit or
loss should also be adjusted in the basic EPS calculation. (According to IFRS 2,
BC54–BC57, "Earnings per Share Is 'Hit Twice'", the IASB acknowledged this
outcome on the basis that there are effectively two transactions, (1) the
compensation paid to employees and (2) the dividends paid to the option equity
class.)
Dividends would be added back to the calculation of diluted EPS when the share
options are dilutive potential ordinary shares.
Scenario B
Earnings should not be adjusted for dividends that are applied to reduce the exercise
price. In this scenario, the dividends do not leave the group and, therefore, should
not affect earnings attributable to ordinary shareholders.
However, when calculating dilutive potential ordinary shares and the number of
shares deemed to have been issued for no consideration, the exercise price will be
adjusted by dividends applied. (Refer to IAS 33.45-48.)
Q&A IAS 33: 14(a)-1 — DIVIDENDS "DECLARED IN RESPECT OF THE

PERIOD"
Question
IAS 33.14(a) requires dividends "declared in respect of the period" for
non-cumulative preference shares to be deducted from profit or loss to determine
EPS. What are dividends "declared in respect of the period"?
Answer
Dividends "declared in respect of the period" are the dividends on the preference
shares which are accrued at the end of the period in accordance with IAS 10.12
Events After the Reporting Period, plus any dividends paid during the period which
were not accrued at the end of the prior period.

Q&A IAS 33: 14(b)-1 — DETERMINATION OF PROFIT OR LOSS
ATTRIBUTABLE TO ORDINARY SHAREHOLDERS WHEN THERE IS A
LIQUIDATING DIVIDEND
Question
Company X issued one share of Series A Non-Voting Convertible Preference Shares
for $1,000,000. The liquidation preference on these preference shares is $1,000,000,
plus a 12 per cent cumulative dividend from the issuance date. Company X also
issued one share of Series B Non-Voting Convertible Preference Shares for
$2,000,000. The shareholder of the Series B Preference share is entitled to a
non-cumulative dividend at the rate of five per cent per annum on the liquidation
preference. The liquidation preference is $2,000,000, plus a 12 per cent cumulative
dividend from the issuance date.
In calculating EPS, do the 12 per cent cumulative liquidating dividends for both the
Series A Preference and Series B Preference Shares need to be considered in
determining profit or loss attributable to ordinary shareholders?
Answer
No. Although cumulative, the liquidating dividends are intended to provide a
liquidation preference to the Series A and Series B Preference shareholders in the
event of a liquidation and do not need to be considered in determining profit or loss
attributable to ordinary shareholders until a liquidating event occurs.
Q&A IAS 33: 16-1 — IMPACT OF REDEMPTION OF TRACKING SHARES

FOR OTHER ORDINARY SHARES ON PROFIT OR LOSS ATTRIBUTABLE
TO ORDINARY SHAREHOLDERS
Question
The terms of tracking shares often allow the company, at its option, to exchange or
redeem one class of tracking shares for another class of tracking shares, such that
the company would have one less class of ordinary shares outstanding. (See Q&A
IAS 33: 66-1 for a discussion of tracking shares.) The terms of this feature generally
require a premium to be paid to the class being redeemed as a result of the

transaction.
How should the premium be treated in calculating EPS?
Answer
Profit or loss attributable to ordinary shareholders (whose shares are being used for
the redemption) should be reduced by the premium over market value paid to
redeem the tracking shares. The holders of the tracking shares being redeemed have
received a benefit that constitutes an additional contractual return to them.
Q&A IAS 33: 16-EX-1 — IMPACT OF REDEMPTION OF TRACKING

SHARES FOR OTHER ORDINARY SHARES ON PROFIT OR LOSS
ATTRIBUTABLE TO ORDINARY SHAREHOLDERS
Example
Company X (X) has two classes of ordinary shares outstanding that separately track
the results of operations of two different businesses, Company A and Company B.
Company X decided to redeem all of its outstanding Company B tracking shares in
exchange for Company A tracking shares. The terms of the Company B shares being
redeemed in connection with the offering of that security provided X with the right to
redeem the Company B tracking shares, at its discretion, by issuing its Company A
tracking shares with a market value equal to a 15 per cent premium over the market
price of the Company B tracking shares at the time of redemption. As such, the fair
value of Company A tracking shares to be exchanged for the Company B tracking
shares will exceed the fair value of the Company B tracking shares by 15 per cent on
the date the redemption is announced. The income available to Company A tracking
shares should be reduced by the amount of the 15 per cent premium when
calculating income available for Company A tracking shareholders for EPS purposes
of X for the period.
Q&A IAS 33: 16-2 — IMPACT OF PREMIUM PAID BY THE PARENT

COMPANY TO REDEEM PREFERENCE SHARES ISSUED BY THE
SUBSIDIARY ON PROFIT OR LOSS ATTRIBUTABLE TO ORDINARY
SHAREHOLDERS
Question
Company P, a public company, has a wholly owned subsidiary, Company S.
Company S has preference shares outstanding. The preference shares are
redeemable at the option of S (with P's consent) in whole or in part, at varying
dates, at $100 per share plus accumulated and unpaid distributions to the date fixed
for redemption. Consistent with the view that the subsidiary's preference shares
represent a minority interest in the parent's group financial statements, dividends or
accretions to a redemption price should be classified as income allocated to minority
interests in the consolidated income statement of the parent.
Company P is contemplating the acquisition of S's preference shares. The premium

paid by P to the third-party preference shareholders in the acquisition of S's
preference shares is not recognised in the income statement of the consolidated
entity as this represents a capital transaction. Accordingly, the consolidated entity
would not recognise in its income statement any gain or loss from the acquisition.
Should the premium paid to redeem S's preference shares be deducted from net
income to compute net income available to ordinary shareholders in the calculation
of earnings per share in P's consolidated financial statements?
Answer
Yes. The premium represents a return on investment to the holders of the preference
shares and is not available to ordinary shareholders, similar to preference share
dividends and accretion charges. As dividends and accretion charges on preference
securities of a subsidiary are treated as income allocated to minority interests, which
reduces P's consolidated net income, premiums on redemptions paid to redeem S's
preference shares also should be deducted from net income to compute profit or loss
attributable to ordinary shareholders in the calculation of earnings per share in P's
consolidated financial statements.
Q&A IAS 33: 19-1 — IMPACT OF FORWARD EQUITY TRANSACTIONS ON

CALCULATION OF EPS
Question
What is the impact on the calculation of basic and diluted EPS of a contract which
obliges an entity to repurchase its ordinary shares in the future (e.g. a forward
purchase contract or written put over own equity)?
Answer
Basic EPS
Paragraph 23 of IAS 32 Financial Instruments: Presentation requires an entity that

enters into the forward purchase contract or written put over own equity that may
be gross physically settled (i.e. an exchange of cash or other financial asset for own
equity) to recognise a financial liability for the present value of the amount payable
under the contract (often referred to as a 'gross obligation'). IAS 33 does not specify
whether shares that are subject to a forward purchase contract or written put where
a gross obligation is recognised should be treated for EPS purposes as if the shares
were acquired when the entity entered into the contract. The following two
accounting policies are acceptable.
Accounting policy 1
Shares subject to a forward purchase contract or written put should be treated for
EPS purposes as outstanding until the date the shares are acquired under the
arrangement (i.e. until consideration is paid and the shares are delivered to the
entity). The number of ordinary shares included in the denominator is therefore not
reduced by the number of shares that will be acquired under the forward contract, or
potentially acquired under the written put if the written put is exercised.
Accounting policy 2
Shares subject to a forward purchase contract or written put should be treated for
EPS purposes as if the shares were acquired when the entity entered into the
arrangement. The number of ordinary shares included in the denominator is reduced
by the number of shares that will be acquired under the forward contract, or
potentially acquired under the written put if the written put is exercised. If the
written put expires unexercised, the number of shares will be added back to the
denominator on the expiration date.
Diluted EPS
Forward purchase or written put contracts over an entity's own equity shares may be
dilutive in accordance with IAS 33.63 and IAS 33.A10. To the extent that the forward
rate under the forward purchase contract or strike price under the written put option
is higher than the average market price of the ordinary shares for the period, and
the adjustment for the number of shares in the denominator is greater in proportion
than the adjustment to the earnings in the numerator, then the arrangement will be
dilutive in the period.
Q&A IAS 33: 19-2 — TREATMENT OF REDEEMABLE ORDINARY

SHARES IN CALCULATING BASIC EPS
[Amended and Reissued 13 March 2009]
Background
Company B, a public company, issued redeemable ordinary shares that contain a

redemption provision entitling the holder of the ordinary shares to put the shares at
fair value to B five years after the issuance of the shares, or at any time thereafter.
The redeemable ordinary shares represent approximately 20 per cent of total
ordinary shares in issue. The redeemable ordinary shareholders are entitled to the
same benefits as the other ordinary shareholders. The redeemable ordinary shares
do not meet the definition of equity under paragraphs 16A–16D of IAS 32 Financial
Instruments: Presentation (as amended in February 2008) because they are not the
most subordinate instruments issued by the entity (i.e. the non-redeemable ordinary
shares are more subordinate).
Question
How should the redeemable ordinary shares be treated in the calculation of basic
earnings per share (EPS)?
Answer
Under IAS 32.18(a), the redeemable ordinary shares are classified as a financial
liability because the entity has an obligation to deliver cash or other financial assets
equal to the redemption price. Therefore, the shares should not be included as
outstanding ordinary shares (i.e. included in the denominator) in the calculation of
basic EPS because, not being equity instruments, they do not meet the definition of
ordinary shares under IAS 33.5.
The shares are also not potentially dilutive because, since they do not entitle the
holder to ordinary shares, they do not meet the definition in IAS 33.5 of potential
ordinary shares.
The redeemable ordinary shares are not ordinary shares during their life because (1)
they are not classified as equity (due to the presence of the redemption feature),
and (2), when exercised, the shares will be redeemed and will cease to be
outstanding.
Q&A IAS 33: 19-3 — COMPUTATION OF BASIC EPS WHEN THERE ARE
PREFERENCE SHARES WITH CHARACTERISTICS OF ORDINARY
SHARES

Question
Company B, a public company, issued convertible preference shares to Company C,
with terms substantially the same as ordinary shares. The relevant terms of the
preference shares are as follows:
• No rights to preferential or cumulative dividends; however, preference

shares participate rateably with ordinary shares in the event a dividend is
declared on ordinary shares. (In addition, ordinary shareholders participate
rateably in the event a dividend is declared on the preference shares.)
• Not publicly traded. (Company B's ordinary shares are publicly traded.)
• Voting rights are limited to certain events including liquidation.
• Nominal preference in liquidation of $0.01 per share.
• Each share is convertible into one share of ordinary shares at any time
upon the transfer of the preference shares to a person other than C.
• Antidilution provisions are limited to only share splits and dividends.
Should the preference shares be included in the determination of basic EPS?
Answer
Yes. For purposes of computing basic EPS, instruments should be evaluated based
on their substance rather than their form (e.g. legal name) and if they share the
characteristics of ordinary shares and have no preference attributed to them, such
instruments should be considered as ordinary shares for purposes of basic EPS
regardless of the legal name assigned to them. There is no substantive difference
between the preference shares and the ordinary shares. In substance, the
preference shares have the characteristics of non-voting ordinary shares.
Company C, as a holder of the preference shares, can sell these shares to a third
party at any time, at which point the securities would convert into ordinary shares
with all the characteristics of the current outstanding ordinary shares. The sale of the
preference shares is completely outside of B's control and there are no restrictions
on the sale of the preference shares. Further, preference shares have the exact
same rights to receive dividends as ordinary shares and have no substantive
preference (as the liquidation preference of $0.01 per share is insignificant).
Furthermore, calculating basic EPS involves determining the amount of profit or loss
attributable to ordinary shareholders. If the preference shares are not included in the
basic EPS calculation, the calculation will be misleading because it excludes a group
of shareholders that currently have identical rights to earnings and dividends as the

ordinary shareholders.
Q&A IAS 33: 19-4 — ORDINARY SHARES ISSUED TO TRUSTS TO FUND

RETIREMENT BENEFIT PAYMENTS
Question
How should ordinary shares issued to a trust that is established to fund future
retirement benefit payments be treated in the computation of earnings per share if
the trust is consolidated? In many instances, the trusts created do not protect the
assets from creditors in the case of the entity's bankruptcy (e.g."rabbi trusts").
Answer
Some sponsors of defined benefit pension plans have issued ordinary shares to
trusts established to fund future retirement payments (usually through rabbi trusts).
The ordinary shares of the sponsor are held until the rabbi trust is required to meet
retirement obligations, at which time, the shares are sold to the public. The shares
held by the trust should not be considered outstanding in the computation of EPS
because the trust is consolidated by the sponsor and will not sell shares until funds
are required. The shares held by the trust are excluded from the definition of plan
assets in IAS 19 Employee Benefits.
Q&A IAS 33: 19-5 — MUTUAL TO SHARES CONVERSIONS

Question
How is EPS computed in mutual to shares conversions?
Answer
An entity with a mutual form of ownership has no equity under International
Financial Reporting Standards (IFRS). EPS for an entity converting from a mutual
form of ownership to share ownership should be based on earnings subsequent to
conversion. Reporting EPS based on earnings subsequent to conversion may result in
an earnings-per-share amount that will not be comparable to earnings-per-share
amounts determined in future years. Further, such an earnings-per-share amount
may not reflect fully the expected relationship between earnings for the year and the
amount of outstanding shares at the balance-sheet date. Therefore, the income
statement caption should be sufficiently descriptive to inform the reader of the
unique nature of EPS in the year of conversion, and the method of presentation
should be disclosed in the notes.
Q&A IAS 33: 19-6 — SHARES HELD IN TRUST FOR THE PURPOSE OF
EQUITY-SETTLED SHARE-BASED PAYMENT
Background
Company B (B) grants its employees share options that will vest after three years of
employment. Company B provides money to a trust to purchase shares in B in the
market. The shares are then used to satisfy the exercise of the share options on
vesting.
Company B controls the trust and, thus, consolidates the trust in accordance with
IAS 27 Consolidated and Separate Financial Statements.
Question
How should the shares held in trust be treated in the basic and diluted earnings per
share (EPS) calculation in the consolidated financial statements?
Answer
In accordance with the requirements of IAS 33, basic EPS is determined with
reference to the weighted average number of "ordinary shares" outstanding during
the reporting period. Diluted EPS is determined with reference to the weighted
average number of "ordinary shares" and "potential ordinary shares" outstanding
during the reporting period.
In accordance with IAS 33.5 and IAS 33.6, "ordinary shares" are those equity
instruments that are subordinated to all other classes of equity instruments (for
example, ordinary shares participate in profit for the period only after other types of
shares have participated).
In the consolidated financial statements, the shares held in trust will be recognised
as treasury shares. Treasury shares are not taken into account for the purpose of
calculating basic or diluted EPS since, in accordance with IAS 33.5 and IAS 33.6,
they do not represent "ordinary shares" outstanding from the date acquired.
However, the share options represent potential ordinary shares that are considered
in determining diluted EPS when the potential ordinary shares are dilutive at year
end, in accordance with the guidance in IAS 33.45–48.

Q&A IAS 33: 21-1 — PARTLY PAID SHARES
Background
Partly-paid shares are included in the weighted average calculation as fractional

shares to the extent that they are entitled to participate in dividends relative to a
fully-paid ordinary share during the period.
At 1 January 20X2, an entity has 1,000 ordinary shares outstanding. It issued 400
new ordinary shares at 1 October 20X2. The subscription price is $2.00 per share. At
the date of issue, each shareholder paid $0.50. The balance of $1.50 per share will
be paid during 20X3. Each partly-paid share will be entitled to dividends in
proportion to the percentage of the issue price paid up on the share.
Question
How should management calculate the weighted average number of shares when
there are partly-paid shares?
Answer
In accordance with IAS 33.A15 and IAS 33.A16, the new shares issued should be
included in the calculation of the weighted average number of shares in proportion to
the percentage of the issue price received from the shareholder during the period.
Calculation of the weighted average follows:

Q&A IAS 33: 24-1 — CONTINGENTLY ISSUABLE SHARES
Question
What are some examples of contingently issuable shares?
Answer
For a variety of reasons, a company may issue instruments that obligate it to issue
ordinary shares in the future upon the resolution of various contingencies. Such
circumstances may include (1) the issuance of contingent share purchase warrants
to customers that become exercisable based on the attainment of a certain level of
purchases, or (2) the guarantee of a minimum share price for shares issued by an
acquirer in a purchase business combination that may result in the issuance of
additional shares, if the share price is less than the guaranteed price. Contingent
issuances are based usually on the passage of time combined with other conditions,
such as the market price of an entity's shares, or a specified level of earnings.
Contingently issuable shares include shares that (1) will be issued in the future upon
the satisfaction of specified conditions, (2) have been placed in escrow and all, or
part, must be returned if specified conditions are not met, or (3) have been issued
but the holder must return all, or a portion, of the shares, if specified conditions are
not met.
IAS 33 requires that shares issuable for little or no cash consideration upon the
satisfaction of certain conditions pursuant to a contingent share agreement
(contingently issuable ordinary shares) be considered outstanding ordinary shares
and included in the computation of basic EPS as of the date that all necessary
conditions have been satisfied, and no circumstance could occur at any time in the
future that would cause the shares not to be issued (i.e. when issuance of the shares
no longer is contingent).
Q&A IAS 33: 24-2 — CONTINGENTLY ISSUABLE SHARES BASED ON

NET INCOME IN BASIC EPS CALCULATION
Question
Company X, a public company reporting on a calendar year basis, purchased
Subsidiary Y on 1 January for $100 million plus 20,000 X ordinary shares for each
year within the next five years in which Y has net income of $10 million or more. By
30 June of Year 1, Y has net income of $15 million. Should the 20,000 shares be
treated as outstanding in the interim financial statements for the period ended 30
June of Year 1?
Answer
While the 20,000 shares would be issuable if the end of the contingency period were
30 June instead of 31 December, the 20,000 ordinary shares should be excluded
from basic EPS for the six months ended 30 June, because events could transpire in
the next six months that would cause X not to issue the shares (i.e. Y could lose $6
million in the next six months).
If Y's net income for the year ended 31 December was $12 million, the shares would
be included in the denominator for basic EPS for only that portion of the year for
which the contingency was resolved (i.e. nothing could happen that would cause X to
not issue the shares). Since this could only be on 31 December, the shares would
have no impact on basic EPS for the annual reporting period.
As there are five separate measurement periods for the contingency, each
measurement period in which a finite number of ordinary shares may be issued
should be treated as a separate contingency and evaluated based on whether X may
be required to issue the ordinary shares for each period on a stand-alone basis for
basic EPS. If the purchase agreement required X to issue 100,000 shares of X
ordinary shares if Y achieved $50 million in cumulative net income at the end of five
years, no shares would be included in basic EPS until the end of the contingency
period, and then only if Y had cumulative earnings in excess of $50 million. See Q&A
IAS 33: 41-1 for the effect of contingently issuable instruments on diluted EPS.
Q&A IAS 33: 24-3 — CONTINGENTLY ISSUABLE SHARES BASED ON

EMPLOYMENT IN BASIC EPS CALCULATION
Question
Company M, a public company, has a mandatory deferred compensation plan
whereby covered employees are required to defer the amount of compensation
payable in one calendar year in excess of $500,000 until completion of the deferral
period. The deferral period ends when the employee ceases to earn $500,000
annually or reaches the defined retirement age as an employee of M. If the employee
is terminated or resigns, he/she is not eligible to receive any distribution under the
plan. The compensation deferred under the plan is only payable to the participant in
shares of M's ordinary shares over a five-year period once the participant is eligible
to receive the distribution.
A participant's deferred compensation is held in an escrow account until the

individual is eligible to receive distributions. The escrow account does not bear
interest; however, it receives the dividend based on the equivalent number of
ordinary shares that the cash value of the account would convert to, based on the
closing price of the ordinary shares on the NYSE for the trading day preceding the
original deferral. Distributions from the account are based on the equivalent number
of ordinary shares that the cash value of the distribution would convert to, based on
the closing price of the shares on the NYSE for the trading day preceding the
distribution. Are the ordinary shares issuable under the plan considered contingently
issuable?
Answer
Yes. The issuable ordinary shares will only be issued if the employee is not
terminated or resigns and retires in the employment of M (or the employee's
earnings fall below $500,000). The shares issuable under the plan should be
excluded from the calculation of basic EPS because there is still the possibility that
the employee will never receive the shares.
Further, the number of shares contingently issuable may depend on the market price
of the shares at a future date. If the market price changes in a future period, such
contingently issuable shares should not be included in basic EPS because all
necessary conditions have not been satisfied.
Additionally, outstanding ordinary shares that are contingently returnable (i.e.,

subject to recall) should be treated in the same manner as contingently issuable
shares. If shares are returnable or placed in escrow until the shares are vested or
some other contingent criteria are met, the shares should be excluded from the
denominator in computing basic EPS even if they have been issued legally.
Q&A IAS 33: 24-4 — CONTINGENTLY ISSUABLE SHARES —

RETURNABLE SHARES IN BASIC EPS CALCULATION
[Renumbered from IAS 33: 25-1 on 4 June 2010]
Question
Company X granted options to its employee, Employee A. The options vest over a
four-year period. However, A may exercise his options at any time before their
vesting. If A initiates this early exercise provision, A will receive restricted ordinary
shares in X that vest under the same schedule as A's original option grants. How

should the restricted ordinary shares be treated for basic EPS purposes?
Answer
For purposes of computing basic EPS, shares which are contingently returnable (i.e.
subject to repurchase if the employee is terminated or resigns) should not be
considered outstanding for basic EPS until all necessary conditions that could require
return of the shares have been satisfied (i.e. they are vested).

[Renumbered to IAS 33: 24-4 on 4 June 2010]
Renumbered

[Renumbered to IAS 34: 11-3 on 23 July 2010]
Renumbered
Q&A IAS 33: 27-1 — DEFINITION OF A RIGHTS ISSUE

Question
IAS 33 uses the term "rights issue", but does not define this term. What is a rights
issue?
Answer
A rights issue is similar to an issuance of options to existing shareholders in that it
gives each existing shareholder the right, but not the obligation, to purchase
additional shares in the entity at a fixed price. Generally, these rights may be sold by
the existing shareholders to other shareholders or potential shareholders. The Basic
and Diluted EPS calculations are affected by a rights issue. After a rights issue is
issued, but before exercise of the rights, diluted EPS should consider these rights to
the extent they are dilutive. After the rights are exercised and the shares are issued,
these shares are fully included in the weighted average share calculation from the
date of exercise. A restatement should be made to the weighted average share
calculation for prior years and periods up to the date of exercise. See Example 4 in
Illustrative Examples for an illustration of the adjustments required to the
denominator as a result of the rights issue.
Q&A IAS 33: 31-1 — FORWARD PURCHASE OF OWN SHARES

Question
An entity enters into a forward purchase of its ordinary shares. How should the
entity calculate diluted earnings per share (EPS)?
Answer
A forward purchase of shares is similar in substance to a written put option at the
forward sale price and a purchased call option at the forward sale price. Under IAS
33.62, the purchased call option is not dilutive. The effect of the written put option
on the denominator should be determined in accordance with IAS 33.63. That is, the
shares subject to forward purchase should be regarded as outstanding for the period
(even though they are not regarded as outstanding for basic EPS) and should be
adjusted by the number of shares required by IAS 33.63.
The interest cost recognised in the income statement for the forward purchase
liability should be added back when determining diluted EPS.
Q&A IAS 33: 31-2 — FORWARD SALE OF OWN SHARES

Question
An entity enters into a forward sale of its ordinary shares. The forward sale contract
permits settlement net in ordinary shares of the entity or by the exchange of a fixed
number of ordinary shares for a fixed amount of cash. How should the entity
calculate diluted earnings per share (EPS)?
Answer
A forward sale of shares is similar in substance to a written call option at the forward
sale price and a purchased put option at the forward sale price. Under IAS 33.62, the
purchased put option is not dilutive. The effect of the written call option on the
denominator should be determined in accordance with IAS 33.45.
If the forward sale contract has been recognised as a derivative, any gain or loss
recognised in earnings should be adjusted when calculating diluted EPS.
Q&A IAS 33: 33-1 — COMPENSATION PLANS BASED ON A COMPANY'S

SHARE PRICE THAT DO NOT ANTICIPATE ACTUAL ISSUANCE OF
SHARES
Question
Is there any effect on EPS computations of compensation plans, which are based on
the price of the company's shares but do not require or permit actual issuance of
shares?
Answer
Compensation plans are based on the price of a company's shares (e.g. phantom
shares and formula plans) and do not require or permit actual issuance of shares to
the employee; rather, the compensation to the employee under the plan is settled
entirely in cash. For plans with this characteristic, the computation of EPS will not be
affected by the existence of the plan other than for the effect of the compensation
cost charged as an expense against the profit or loss attributable to ordinary equity
holders.
Q&A IAS 33: 41-1 — APPLICATION OF THE IF-CONVERTED METHOD

WHEN THERE ARE PREFERENCE SHARES AND CONVERTIBLE DEBT
OUTSTANDING
Question
Company A issues 1,000 shares of $1,000 face value, convertible, cumulative
seven-per cent preference shares on 1 January at par. On 15 July, A issues at par
value $1,000,000 face value convertible debt bearing interest at 12 per cent. Both
the preference shares and the convertible debt convert at face value divided by the
current market price of A's ordinary shares. At 31 December, A's shares traded at $5
per share. For the year ended 31 December, profit or loss attributable to ordinary
shareholders was $5 million and there were 10 million weighted average ordinary
shares outstanding. Company A's income tax rate is 40 per cent.
In the computation of diluted EPS, should the preference shares and the convertible
debt be considered dilutive?
Answer
The shares should be considered dilutive. The preference dividend added back to the
numerator divided by the number of ordinary shares they convert to would be less
than basic EPS. The calculation would appear as follows:
If A's ordinary share price at year-end had been $10, the convertible preference
shares would have been antidilutive and excluded from the diluted EPS calculation.
The calculation appears as follows:

In the computation of diluted EPS, the convertible debt is considered dilutive
because the interest expense added back to the numerator divided by the number of
ordinary shares is less than basic EPS. The calculation would appear as follows:
The impact of the potentially dilutive ordinary shares on the denominator assumes
conversion at the beginning of the year or the time of issuance, if later. In this
example, the convertible preference shares would have been outstanding for 12
months, while the convertible debt only would have been outstanding for 5.5

months.
Q&A IAS 33: 41-EX-1 — DELETED

Deleted
Q&A IAS 33: 45-1 — OPTIONS OR WARRANTS THAT REQUIRE

PROCEEDS FROM EXERCISE BE APPLIED TO RETIRE DEBT OR OTHER
SECURITIES OF THE ISSUER
Question
Company A issued 400,000 options, which allow the holder to purchase ordinary
shares at $40 per share, and that if exercised, require A to retire 1,000 shares of
$2,750 face value preference shares with the proceeds. The preference shares pay
dividends at 10 per cent annually and had an average fair value of $2,800. The
following year, A had net income of $15,000,000, weighted average shares
outstanding of 4,000,000, and the ordinary shares of A had an average market price
of $50 per share. How should A compute basic and diluted EPS?
Answer
Since the exercise of the options does not require the holder to be the holder of a
preference share, the dilutive effect of these options should be determined in
accordance with IAS 33.45. The options on the ordinary shares are "in the money"
so, under the treasury shares method, A would assume that the holders of the
options would elect to exercise their options. As the exercise of the option would
dilute EPS, A would apply the treasury shares method to compute the incremental
dilutive shares as follows:

Q&A IAS 33: 45-2 — APPLICATION OF TREASURY SHARES METHOD TO
OPTIONS TO PURCHASE CONVERTIBLE PREFERENCE SHARES
Question
Company A issued 1,000 options that allow the holder to purchase convertible
preference shares at $5,000 per share. The convertible preference shares are
convertible to ordinary shares at $25 per ordinary share after two years, and pay an
annual dividend of $500 per share. On the date the options were issued, the ordinary
shares of A were trading at $25 per share. Three years later on 31 December, the
ordinary shares of A had an average market price of $40 per share. How should A
apply the treasury shares method in computing diluted EPS?
Answer

The options on the ordinary shares are "in the money", so under the treasury shares
method, A would assume that the holders of the options would elect to exercise their
option and receive the convertible preference shares for $5,000 per share. Because
the convertible preference shares would dilute EPS, the treasury shares method
should be applied to compute the incremental dilutive shares as follows:

Deleted
Q&A IAS 33: 45-4 — COMPUTATION OF AVERAGE MARKET PRICE

WHEN TRADING VOLUME IS LIMITED
Question
Company A's shares currently trade in the over-the-counter market. During the
fourth quarter of 2000, there were only 15 days that the ordinary shares of A traded.
The frequency of trades during the fourth quarter is representative of the normal
trading volume on A's ordinary shares.
In applying the treasury shares method, should the average of the limited trading
prices be used, or is another method more appropriate?
Answer
When a company's ordinary shares trade on a very irregular basis (e.g. limited
trading volume), such that an average of the closing ordinary share price is not
meaningful, it would be acceptable for a company to use the average of the bid and
ask pricefor the ordinary shares for the period to determine the average ordinary
trading price. This method should be applied until the company's ordinary shares
trade on a regular basis and an average of the closing prices would yield an effective
average ordinary share price.
Q&A IAS 33: 45-5 — COMPUTING DILUTED EPS

Question
Company A acquired Company B in a purchase business combination. The purchase
price of $16 million was to be paid in three instalments: $3 million at the close of the
transaction, $10 million in one year, and $3 million in two years. At the seller's
option, the final payment will be made either in cash or 100,000 of A's ordinary
shares. During the contingency period, should diluted EPS reflect the dilution
resulting from the issuance of the 100,000 shares?
Answer
The terms of the final instalment constitute a written call option. The seller may call
for 100,000 shares at a strike price of $3 million. Diluted EPS should be determined
in accordance with IAS 33.45.

Deleted
Q&A IAS 33: 47-1 — AVERAGE FAIR VALUE FOR OPTIONS GRANTED
DURING THE REPORTING PERIOD
Question
IAS 33.47 requires options and warrants to be included in the diluted EPS calculation
when the strike price on the options or warrants is less than the "average market
price of the ordinary shares during the period." When options or warrants are issued
in the middle of the reporting period, is the "average market price" only the average
for the period the options or warrants were outstanding, or for the reporting period?
Answer
IAS 33 does not provide guidance on this matter. The fair value of an instrument
prior to it being issued should have no bearing on whether that instrument is dilutive
or anti-dilutive. Therefore, the average for the shorter of a) the period the options or
warrants were outstanding, or b) the reporting period, should be used.
Q&A IAS 33: 49-1 — COMPUTATION OF DILUTIVE EPS

Question
Company A issued 1,000 options that, if exercised, require the holder to tender a
share of A's outstanding $2,750 face value preference shares in exchange for 500
ordinary shares. On the date the option was issued, the ordinary shares of A were
trading at $5 per share. The preference shares pay dividends at 10 per cent
annually. The following year, A had a net profit of $15,000,000, weighted average
shares outstanding of 4,000,000, and the ordinary shares of A had an average
market price of $15 per share. How should A compute basic and diluted EPS?
Answer
Because the terms of the options require the holder to tender a preference share,
the effect of the options is to change 1,000 preference shares into convertible
instruments. The exercise of the option is dilutive to EPS under the if-converted
method, computed as follows:

Q&A IAS 33: 49-2 — EFFECT OF CURRENT VALUE OF ORDINARY
SHARES ON DILUTED EPS CALCULATION
Question
Is the current value of the ordinary shares a determinant of whether a convertible
instrument is dilutive?
Answer
No. The current value of the ordinary shares relative to the conversion price of the
convertible instrument is not, by itself, a determinant of whether an instrument is
dilutive or antidilutive.
In applying the if-converted method, conversion is not assumed for purposes of

computing diluted EPS if the effect is antidilutive. Convertible preference shares are
antidilutive whenever the amount of the dividend declared or accumulated for the
current period per ordinary share obtainable on conversion to ordinary shares
exceeds basic EPS. Similarly, convertible debt is antidilutive whenever the interest
(net of tax and nondiscretionary adjustments) per ordinary share obtainable on
conversion exceeds basic EPS. The determination of whether a convertible
instrument is dilutive to EPS should be made at each reporting date.

Deleted
Q&A IAS 33: 52-2 — CONTINGENTLY ISSUABLE SHARES IN DILUTED

EPS
Question
How should shares that are contingently issuable upon the favourable outcome of a
lawsuit be treated in the computation of diluted EPS?
Answer
Shares that are contingently issuable upon the favourable outcome of a lawsuit
should be excluded from the calculation of basic and diluted EPS until the outcome of
the lawsuit is determined. When the outcome of the lawsuit is final, the shares
should be included in basic EPS from the date of finalisation of the lawsuit and shall
be included in diluted EPS from the beginning of the period in which the lawsuit is
finalised. The outcome of the lawsuit shall be considered final if the outcome under
appeal and management's lawyers can represent that a change in the previous
decision is not likely.

Deleted
Q&A IAS 33: 63-1 — APPLICATION OF REVERSE TREASURY SHARES

METHOD WHEN THERE ARE PUT OPTIONS

Question
Company A issued $100 million in debt instruments with detachable put options on
its ordinary shares. Purchasers of each $1,000 note will receive 10 put options each,
giving the holder the right to require A to purchase one share of its ordinary shares
for $25 per share, the market price of the ordinary shares on the date the put
options were issued. The puts are exercisable at any time during a three-year period.
Assuming the average market price of the ordinary shares for the period was $20
per share, how many incremental shares must be added to the denominator of the
diluted EPS calculation?
Answer
The number of incremental shares is computed as follows:
If the market price for the ordinary shares exceeds $25 per share for the period
being reported on, the put options are antidilutive, and therefore, would not be
included in the computation of diluted EPS.
Q&A IAS 33: 64-1 — SHARE DIVIDEND OR SHARE SPLIT AFTER THE
CLOSE OF THE PERIOD BUT PRIOR TO THE ISSUANCE OF THE
FINANCIAL STATEMENTS
Question
When a share dividend or share split occurs after the close of the period, but prior to
the issuance of the financial statements, what factors would override retroactive
restatement?

Answer
The overriding consideration in these situations is the basis on which the shares are
trading at the date of "issuance" of the financial statements. EPS should not be
retroactively adjusted as a result of a share dividend or share split until the shares
are trading on a post-split or dividend basis. Typically, this occurs the day after the
dividend or split has been distributed for larger distributions (i.e. those greater than
20 per cent). In situations in which the share dividend or share split is declared and
approved prior to, but distributed subsequent to, the "issuance" of the financial
statements, EPS should be calculated using the number of shares on a pre-split
basis, and disclosure should be made of the post-split effects on EPS on the face of
the financial statements, with footnote disclosure of the significant terms of the
pending share dividend or share split. However, because the timing of the switch to
trading on a post-split basis is actually governed by the exchanges and may vary
depending on the size of the distribution, it is necessary to monitor the timing of the
switch and adjust the EPS reporting accordingly.
Financial statements are "issued" as of the date they are distributed for general use
in a format that complies with IFRS, and in the case of annual financial statements,
contain an audit report which indicates that the auditors have complied with the
relevant auditing standards in completing their audit. Issuance of financial
statements generally would be the earlier of when the annual or interim financial
statements are widely distributed to all shareholders and other financial statement
users, or filed with a regulatory body. Furthermore, the issuance of an earnings
release does not constitute issuance of financial statements, because the earnings
release would not be in a format that complies with IFRS or auditing standards.
Q&A IAS 33: 64-2 — REVERSE ACQUISITION

Question
Should the weighted average shares outstanding for purposes of presenting EPS on a
comparative basis be retroactively restated following a reverse acquisition?
Answer
A purchase business combination is not one of the circumstances in which IAS 33
specifically permits the retroactive restatement of EPS. However, because the
number of shares outstanding following a reverse acquisition often is significantly
different from the number of shares outstanding prior to the combination, the
weighted average shares outstanding for purposes of presenting EPS on a
comparative basis should be retroactively restated to the earliest period presented in
order to reflect the effect of the recapitalisation that occurs in a reverse acquisition.
In effect, the reverse acquisition is similar to a share split for the accounting
acquirer, and retroactively restating the weighted average shares outstanding is
consistent with the accounting required by IAS 33 for share splits, share dividends,
and reverse share splits.
Q&A IAS 33: 66-1 — EPS DISCLOSURES FOR "TRACKING" OR

"TARGETED" SHARES
Question
Some companies issue certain classes of shares characterised as "tracking" or
"targeted" shares to measure the performance of a specific business unit or activity
of the company. The presentation of complete financial statements of the targeted
business generally is discouraged, and requires clear, cautionary disclosures,
because investors may get an inaccurate view that their investment in targeted
shares represents a direct investment in a legal entity. However, condensed financial
statements that allow investors to understand fully the computation of earnings
available for dividends are preferable to complete statements.
How should EPS be presented for "tracking" or "targeted" shares in a company's

financial statement?
Answer
EPS should not be shown in separate financial statements of the business unit
represented by the tracking shares. EPS disclosures should only be presented in the
legal issuer's financial statements. Per IAS 33.66, the company should determine
EPS for each class of shares using the two-class method.
Q&A IAS 34: 3-1 — REFERENCE TO INTERNATIONAL FINANCIAL

REPORTING STANDARDS IN PRELIMINARY INTERIM EARNINGS
ANNOUNCEMENT
[Issued 5 September 2003]
Question
Is it appropriate to describe a preliminary interim earnings announcement (i.e. an
earnings announcement issued shortly after the end of an interim period that
discloses abbreviated preliminary financial information for the interim period just
ended) as having been prepared in accordance with International Financial Reporting
Standards (IFRSs)?
Answer
IAS 34 does not address the content of preliminary interim earnings
announcements; IAS 34.3 does state, however, that if an interim financial report is
described as complying with IFRSs, it must comply with all of the requirements of
IAS 34. Therefore, if any reference to IFRSs is made in a preliminary interim
earnings announcement that does not comply with IAS 34, the following sentences
(or something substantively similar), should be included in the release:
While the financial figures included in this preliminary interim earnings

announcement have been computed in accordance with International
Financial Reporting Standards (IFRSs) applicable to interim periods, this
announcement does not contain sufficient information to constitute an
interim financial report as that term is defined in IAS 34 Interim Financial
Reporting. The directors expect to publish an interim financial report that
complies with IAS 34 in March 20X2.

[Renumbered to IAS 34: 10-3 on 20 August 2010]
Renumbered
Q&A IAS 34: 9-2 — EXPLANATORY NOTE DISCLOSURES IN COMPLETE

SET OF INTERIM FINANCIAL STATEMENTS
[Amended 28 April 2006]
Question
An entity chooses to publish a complete set of financial statements in its interim
financial report. In such circumstances, should the selected interim explanatory
notes required under IAS 34.15–16A (prior to 2010 Improvements to IFRSs, IAS
34.15–18) be presented in the complete set of financial statements?

Answer
Yes. IAS 34.7 states that complete financial statements prepared for an interim
period must include all of the disclosures required by IAS 34, and specifically draws
attention to the note disclosures required under that Standard.
In practice, virtually all of the disclosures required by IAS 34.15–18 are also required
by other IFRSs to be included in complete sets of financial statements. Therefore,
the information will be disclosed, as required, in accordance with those Standards.
When an entity takes this alternative, the form and content of the financial
statements must conform to the requirements of IAS 1 Presentation of Financial
Statements for a complete set of financial statements, in addition to complying with
the requirements of IAS 34. Therefore, the measurement and disclosure
requirements of all relevant Standards apply. These include all measurement and
disclosure requirements of IAS 34 and, in particular, details of significant events and
transactions required under IAS 34.15 and the explanatory disclosures listed in IAS
34.16A.
Q&A IAS 34: 10-1 — LINE ITEMS IN CONDENSED INTERIM FINANCIAL

STATEMENTS
Background
IAS 34.10 states that condensed interim financial statements should include "at a
minimum, each of the headings and subtotals that were included in its most recent
annual financial statements".
Question
What is meant by "each of the headings and subtotals"?
Answer
The wording of IAS 34.10 could be taken to imply that not all of the line items that
were presented in the most recent annual financial statements are necessarily
required. Such an interpretation would do a disservice, however, to a user of the
financial statements who is trying to assess trends in the interim period in relation to
financial years. Therefore, the phrase should be interpreted, in nearly all cases, to
mean the line items that were included in the entity's most recent annual financial
statements. The line items in most published financial statements are already highly
aggregated and it would be difficult to think of a line item in the annual statement of
comprehensive income, in particular, that would not also be appropriate in an interim
statement of comprehensive income. For example, it would not be appropriate to
begin a condensed statement of comprehensive income with the gross profit figure,
omitting figures for revenue and cost of goods sold.
For the statement of financial position, a literal interpretation of 'each of the

headings and subtotals' might lead to an interim statement of financial position that
presented lines for only total current assets, total non-current assets, total current
liabilities, total non-current liabilities and total equity, which will generally be
insufficient for trend analysis.
For the statement of changes in equity, all material movements in equity occurring in
the interim period should be disclosed separately.
In the case of the statement of cash flows, some aggregation of the lines from the
annual statement may be appropriate, but subtotals for 'operating', 'investing' and
'financing' only are unlikely to be sufficient.
If a particular category of asset, liability, equity, income, expense or cash flows was
so material as to require separate disclosure on the face of the financial statements
in the most recent annual financial statements, such separate disclosure will
generally be appropriate in the interim financial report. Further aggregation would
only be anticipated when the line items in the annual statements are unusually
detailed.
Under IAS 34.10, additional line items should be included if their omission would
make the condensed interim financial statements misleading. Therefore, a new
category of asset, liability, income, expense, equity or cash flow arising for the first
time in the interim period may require presentation as an additional line item in the
condensed financial statements.
A category of asset, liability, income, expense, equity or cash flow may be significant
in the context of the interim financial statements even though it is not significant
enough to warrant separate presentation in the the annual financial statements. In
such cases, separate presentation on the face of the condensed interim financial
statements may be required.

Deleted

Q&A IAS 34: 10-3 — USE OF THE DESCRIPTION 'CONDENSED'
[Amended and Renumbered from IAS 34: 9-1 on 20 August 2010]
Question
The requirements of IAS 34.10 discussed in Q&A IAS 34: 10-1 will result in the
presentation of at least some statements that include all of the line items, headings
and subtotals that were presented in the most recent financial statements. Is it
appropriate to describe such financial statements as 'condensed'?
Answer
Given that the notes supplementing the interim financial statements are limited, the
presentation package taken together is condensed from what would be reported in a
complete set of financial statements under IAS 1 Presentation of Financial
Statements and other Standards. In such circumstances, the information presented
in the statement of financial position, statement of comprehensive income,
statement of changes in equity and statement of cash flows is condensed — even if
the appearance of the statements has not changed.
If these interim statements are not identified as 'condensed', the user would infer
that they constitute a complete set of IFRS financial statements under IAS 1, which
they do not. A complete set of IFRS financial statements for the purposes of IAS 34
must include a full note presentation consistent with the annual presentation.
Q&A IAS 34: 11-1 — INTERIM PERIOD DILUTED EARNINGS PER SHARE
ON A YEAR-TO-DATE BASIS
Question
Will the sum of diluted earnings per share (EPS) for the first quarter plus diluted EPS
for the second quarter always equal diluted EPS for the six-month period?
Answer
No. Diluted EPS for the first quarter is based on assumptions that were valid during
and at the end of that quarter. Paragraph 65 of IAS 33 Earnings per Share states
that diluted EPS for prior periods should not be restated for changes in the
assumptions used in EPS calculation or for the conversions of potential ordinary
shares into outstanding ordinary shares. Therefore, diluted EPS for the second
quarter and for the half-year period may be based on different assumptions than
those used in computing diluted EPS for the first quarter. Also, certain outstanding
potential ordinary shares may have been 'antidilutive' (their conversion to ordinary
shares would increase EPS) in the first quarter and, therefore, they may have been
excluded from first quarter diluted EPS. However, in the second quarter and on a
six-month basis they may have been dilutive, and would, therefore, be included in
diluted EPS.
Q&A IAS 34: 11-EX-1 — INTERIM PERIOD DILUTED EARNINGS PER

SHARE ON A YEAR-TO-DATE BASIS
Example
The following details relate to a quarterly reporter.
Throughout the half-year, Company A had outstanding 100 options each allowing the
holder to purchase one ordinary share for CU10. No options were exercised. For
Company A's second quarter interim report, IAS 34.20(b) requires a statement of
comprehensive income (and when appropriate, a separate income statement) for the
second quarter and an income statement for the half-year. Calculations of basic and
diluted earnings per share (EPS) are as follows.

Note that the sum of EPS for the first quarter (CU1.00) and EPS for the second
quarter (CU0.9524) does not equal diluted EPS for the first half-year (CU1.9444).
Q&A IAS 34: 11-2 — MEASURES OF EARNINGS PER SHARE REQUIRED

TO BE PRESENTED IN INTERIM FINANCIAL REPORTS
Question
Which measures of earnings per share (EPS) are required to be presented in interim

financial reports?
Answer
IAS 34 does not make any specific reference to the requirements of IAS 33 Earnings
per Share regarding which measure of basic and diluted EPS should be presented.
Nevertheless, to enable users to compare trends, the same EPS figures should be
presented in the interim financial report as in the annual financial statements.
Therefore, irrespective of whether the interim financial statements are described as

'condensed', the following should be presented in the interim financial report, with
equal prominence for all periods presented:
• basic and diluted EPS for profit or loss attributable to the ordinary equity
shareholders of the parent entity; and
• when a discontinued operation is reported, basic and diluted EPS for profit
or loss from continuing operations attributable to the ordinary equity
holders of the parent entity.
These should be presented for each class of ordinary shares that has a different right
to share in profit for the period.
EPS figures should be provided for all income statement periods presented in the
interim financial report. Therefore, for an entity presenting information separately for
the current interim period and the current year-to-date, with comparatives for each,
EPS (both basic and diluted) should be presented for the same four periods.
Q&A IAS 34: 11-3 — CALCULATION OF WEIGHTED AVERAGE NUMBER

OF SHARES FOR AN INTERIM REPORTING PERIOD
[Renumbered from IAS 33: 26-1 on 23 July 2010]
Background
A publicly traded entity is required to prepare interim financial statements in

accordance with IAS 34. Thirty days before the end of the six-month interim period,
the entity issues a substantial number of shares.
Question
How should the additional shares issued be weighted for inclusion in the denominator
of the interim earnings per share calculation?

Answer
These new shares should be weighted for inclusion in the denominator of the interim
earnings per share calculation based on the number of days that the shares are
outstanding as a proportion of the total number of days in the period. A reasonable
approximation of the weighted average number of shares is adequate in many
circumstances.
The number of shares issued should be weighted by the number of days that the
shares were outstanding (i.e. 30 days) divided by the number of days in the period
(i.e. 182 days).
Q&A IAS 34: 11-4 — EARNINGS PER SHARE CALCULATION AT INTERIM

REPORTING DATE FOR AN ENTITY WITH CONTINGENTLY ISSUABLE
SHARES
Background
Company X, a publicly traded entity reporting on a calendar-year basis, purchased

Subsidiary Y on 1 January. The consideration for the acquisition was CU100 million
plus an additional 20,000 Company X ordinary shares if Subsidiary Y earns net
income of CU10 million or more in the year following the acquisition. By 30 June of
Year 1, Subsidiary Y had earned net income of CU15 million.
Question
How will the contingently issuable shares affect the calculation of earnings per share
(EPS) for the interim financial report?
Answer
Although the 20,000 shares would be issuable if the end of the contingency period
were 30 June instead of 31 December, the 20,000 ordinary shares should be
excluded from the denominator for the calculation of basic EPS for the six months
ended 30 June because events could transpire in the following six months that would
cause Company X not to issue the shares (e.g. Subsidiary Y could lose CU6 million in
the following six months). The contingently issuable ordinary shares should be
included in the denominator for the calculation of diluted EPS for the six months
ended 30 June because, based on the circumstances on that date, the contingency is
met.
See IAS 33 Earnings per Share for a more detailed examination of the impact of

contingently issuable shares on the calculation of basic and diluted EPS.
Q&A IAS 34: 14-1 — ENTITY HAS DISPOSED OF ALL OF ITS

SUBSIDIARIES DURING THE INTERIM PERIOD
Question
Should an entity prepare its interim financial statements on a consolidated basis
when it has disposed of all of its subsidiaries during the interim period, such that it
has no subsidiaries at the end of the interim reporting period?
Answer
Yes. It should prepare its interim financial statements on a consolidated basis
because it had subsidiaries at some point during the interim period. The statement of
comprehensive income, statement of changes in equity and statement of cash flows
will include the impact of the subsidiaries up to the date(s) of disposal and the
effects of the disposal.

[Deleted 24 September 2010]
Deleted
Q&A IAS 34: 15B-1 — LEVEL OF DETAIL IN EXPLANATORY NOTE

DISCLOSURES
Question
Should the disclosures required by IAS 34.15, 15B and 16A be at the entity-wide
level or a more detailed level within the entity?
Answer
IAS 34 does not specify the level of detail for the disclosures required by IAS 34.15,
15B and 16A (required by IAS 34.16 and 17 prior to the amendments to IAS 34
arising from Improvements to IFRSs in 2010). The guiding principle is that the
interim disclosures should be those that are useful in understanding the changes in
financial position and performance of the entity since the last annual reporting
period. It seems clear that detailed disclosures required by other IFRSs are not
required in an interim financial report that includes condensed financial statements
and selected explanatory notes. Therefore, in general, the level of detail in interim
note disclosures will be less than the level of detail in annual note disclosures. The
following examples illustrate this point.
• Paragraph 37 of IAS 2 Inventories suggests that amounts of inventories at

the end of a period and changes in inventories during the period are
normally classified between merchandise, production supplies, materials,
work in progress, and finished goods. That level of detail would not
normally be required in condensed interim financial statements unless it is
significant to an understanding of the changes in financial position and
performance of the entity since the end of the last annual reporting period.
Therefore, the disclosure of "write-down of inventories to net realisable
value and the reversal of such a write-down" required by IAS 34.15B(a)
will generally be made at the entity-wide level in condensed interim
financial statements, rather than analysed between different classes of
inventories.
• Paragraph 126 of IAS 36 Impairment of Assets requires disclosure of

impairment losses and reversals for each class of assets. The disclosure of
impairment losses and reversals required by IAS 34.15B(b) will generally
be made at the entity-wide level in condensed interim financial statements
except when a particular impairment or reversal is deemed significant to an
understanding of the changes in financial position and performance of the
entity since the end of the last annual reporting period.
• Paragraph 16 of IAS 24 Related Party Disclosures requires disclosure of

key management personnel compensation by category. Such detailed
disclosures of the remuneration of key management personnel are not
generally required in interim financial reports unless there has been a
significant change since the end of the last annual reporting period and
disclosure of that change is necessary for an understanding of the interim
period. For example, a bonus granted or share options awarded to
members of key management personnel during the interim period are
likely to be significant to an understanding of the interim period and
therefore should be disclosed.

[Renumbered to IAS 34: 15B-1 on 27 August 2010]

Renumbered

[Renumbered to IAS 34: 16A-2 on 27 August 2010]
Renumbered

Renumbered

[Renumbered to IAS 34: 16A-EX-1 on 27 August 2010]
Renumbered

Renumbered


Renumbered

Renumbered
Q&A IAS 34: 16A-1 — NARRATIVE DISCUSSION OF INTERIM TRENDS

AND PROSPECTS FOR THE FULL FINANCIAL YEAR
[Renumbered from IAS 34: 17-1 on 27 August 2010]
Question
IAS 34.16A(b) (IAS 34.16(b) prior to the amendments to IAS 34 arising from
Improvements to IFRSs in 2010) requires that interim explanatory notes include
"explanatory comments about the seasonality or cyclicality of interim operations". Is
it acceptable to include discussion of changes in the business environment (such as
changes in demand, market shares, prices and costs) and of prospects for the full
current financial year of which the interim period is a part?
Answer
Discussion of the nature described will normally be presented as part of a
management discussion and analysis or financial review outside of the notes to
interim financial statements.
Q&A IAS 34: 16A-2 — INCLUSION OF INTERIM PERIOD DISCLOSURES

IN NEXT ANNUAL FINANCIAL
Question
If an item of information is deemed significant and, therefore, is disclosed in an
entity's interim financial report, should that item of information automatically be
disclosed in the entity's next annual financial report that includes the interim period
in which the disclosure was made?
Answer
Not necessarily. Under IAS 34, interim period disclosures are determined based on
materiality levels that are assessed by reference to the interim period financial data.
The Standard recognises that the notes to interim financial statements are intended
to explain events and transactions that are significant to an understanding of the
changes in financial position and performance of the entity since the end of the last
annual reporting period. A disclosure that is useful for that purpose may not be
useful in the annual financial statements.
To illustrate, IAS 34.16A(c) requires disclosure of the nature and amount of any item
that affects assets, liabilities, equity, net income or cash flows if it is unusual
because of its nature, size or incidence. Such an item may be unusual in size in the
context of a single quarter or half-year period, for example, but not so with respect
to the full financial year.
IAS 34.26 does require disclosure in the notes to the annual financial statements
when an estimate of an amount reported in an earlier interim period is changed
significantly during the final interim period of the financial year but a separate
financial report is not produced for that final interim period.
IAS 34.27 makes clear that, when such a change in estimate occurs and is required
to be disclosed in the annual financial statements, the disclosure represents
additional interim period financial information. Consequently, although the disclosure
is made in the annual financial statements, materiality will be determined by
reference to interim period financial data.
Q&A IAS 34: 16A-3 — INCLUSION OF INTERIM PERIOD DISCLOSURES

IN SUBSEQUENT INTERIM PERIODS OF THE SAME FINANCIAL YEAR
Question
If an item of information is deemed significant and, therefore, is disclosed in an
entity's interim financial report for the first quarter, should that item of information
continue to be disclosed in the interim financial reports for the subsequent quarters
of the same financial year?
Answer
Not necessarily. Under IAS 34, materiality is assessed by reference to each interim
period's financial data. Therefore, an item that is considered material in the context
of one interim period may not be material for subsequent interim periods of the
same financial year. IAS 34.16A states that note disclosures are normally on a
year-to-date basis.
Q&A IAS 34: 16A-EX-1 — INCLUSION OF INTERIM PERIOD

DISCLOSURES IN SUBSEQUENT INTERIM PERIODS IN THE SAME
FINANCIAL YEAR — EXAMPLE
[Amended and Renumbered from IAS 34: 16-EX-1 on 27 August 2010]
Example
The supplementary notes to financial statements in an interim report as of 30 June
for a 31 December year-end entity that reports quarterly would cover the period 1
January to 30 June. An item of information that was deemed significant in the first
quarter report and, therefore, was disclosed in the notes to the interim financial
report for the three months ending 31 March, may not be significant on a 30 June
six-month year-to-date basis. If that is the case, disclosure in the six-month interim
report is not required.
Q&A IAS 34: 16A-4 — COMPARATIVE INFORMATION REQUIRED FOR

NOTE DISCLOSURES
Question
When an entity is preparing a condensed interim financial report under IAS 34, is
comparative information required for the supplementary note disclosures provided
under IAS 34.16A? If such comparative information is required, what period should it
cover?
Answer
IAS 34 does not explicitly require that comparative information be provided for the
supplementary note disclosures in condensed interim financial statements. However,
the notes support the financial statements for which comparative information is
required. Therefore, although IAS 34.16A contains no express reference to the
requirement for comparative information, it is recommended that paragraph 38 of
IAS 1(2007) Presentation of Financial Statements be applied, and that comparative
information be provided for all numerical information, and for narrative and
descriptive information to the extent that it is relevant to an understanding of the
current interim period's financial statements.
For the purposes of interim financial statements, the 'previous period' referred to in
IAS 1(2007).38 should be taken to mean the equivalent interim period. Therefore,
for example, when disclosures are made under IAS 34.16A in respect of business
combinations or share issues on a financial year-to-date basis, then comparative
information for the equivalent year to date should be reported. The share issue
results in dilution, which is important for understanding the changes to earnings per
share, and may be significant for understanding the financial position at the end of
the interim period. If this is the case, additional comparative information supporting
the statement of financial position may be required.
When an entity prepares a complete set of financial statements for interim reporting
purposes, then all of the requirements of IAS 1 apply and, therefore, comparative
information is required for the note disclosures under IAS 34.16A.
Q&A IAS 34: 16A-5 — DISCLOSURE OF SEGMENT INFORMATION IN

THE FIRST INTERIM FINANCIAL REPORT FOLLOWING ADOPTION OF
IFRS 8
Background
Entity A first adopts IFRS 8 Operating Segments in the period beginning 1 January
20X1. It prepares its first interim financial report in accordance with IAS 34 for the
six months ended 30 June 20X1.
IAS 34 requires certain segment information to be disclosed in interim financial

reports if an entity is required to disclose segment information in accordance with
IFRS 8 in its annual financial statements. In particular:
• IAS 34.16A(g)(iv) requires the disclosure of "total assets for which there
has been a material change from the amount disclosed in the last annual
financial statements"; and
• IAS 34.16A(g)(v) requires the disclosure of "a description of differences

from the last annual financial statements in the basis of segmentation or in
the basis of measurement of segment profit or loss".
Question

What, if any, disclosures must Entity A make to comply with IAS 34.16A(g)(iv) and
IAS 34.16A(g)(v) in its interim financial report for the six months ended 30 June
20X1?
Answer
The disclosure requirements set out in IAS 34.16A(g) are based on the premise that
the full segment disclosures in the most recent annual report are available and that
insignificant updates to that information are not generally required in interim
periods.
This premise will not necessarily be true in the first year of adoption of IFRS 8 unless
the segments under IFRS 8 are not materially different to those previously presented
under IAS 14 Segment Reporting. Therefore, in the first interim report affected by
IFRS 8, it would seem appropriate to disclose:
• a measure of total assets for each reportable segment if that amount is

provided regularly to the chief operating decision maker (rather than
simply explaining material changes as is required on an ongoing basis);
• if the chief operating decision maker is not provided regularly with an

amount for total segment assets, a statement to that effect; and
• a comprehensive description of the basis of segmentation of information

and the basis of measurement of segment profit or loss (rather than simply
explaining any changes in those bases as is required on an ongoing basis).
If the segments identified in accordance with IFRS 8 do not differ materially from
those previously disclosed under IAS 14, a statement to that effect should be
included in the first interim report affected by IFRS 8 in order to comply with the
disclosure requirements for changes in accounting policies in accordance with IAS
34.16A(a). Any segment information presented should be sufficient to ensure that
the interim financial report includes all information that is relevant to understanding
an entity's financial position and performance during that interim period.
Q&A IAS 34: 16A-6 — REASSESSMENT OF SEGMENT AGGREGATION

CRITERIA IN INTERIM PERIOD
Question
Is an entity required to reassess the aggregation criteria in paragraph 12 of IFRS 8
Operating Segments in each interim period when determining reportable segments?

Answer
It depends on the circumstances.
In the absence of a change in the structure of an entity's internal organisation during

an interim period that causes the composition of its reportable segments to change,
the entity generally does not need to reassess the aggregation criteria in each
interim period. However, if a change in facts and circumstances suggests that
aggregation of operating segments in the current or a future period is no longer
appropriate, management should reassess the aggregation criteria in the period in
which the change occurred. If an entity identifies different reportable segments as a
result of this reassessment, it should provide the disclosures required by IFRS
8.29–30.
For example, assume that an entity has appropriately aggregated two segments in
prior periods. However, in the current interim period, the segments no longer exhibit
similar economic characteristics because of a change in gross profit margin and sales
trends. Management does not believe the trends will converge in future periods. In
this case, the entity should reassess the aggregation criteria in the current interim
period to determine its appropriate reportable segments.
Q&A IAS 34: 16A-7 — BUSINESS COMBINATIONS AFTER THE

REPORTING PERIOD
Background
When business combinations have occurred during the interim period, IAS 34.16A(i)
requires an entity to provide disclosures in accordance with IFRS 3 Business
Combinations (i.e. it requires the same disclosures as those required in annual
financial statements).
IFRS 3(2008).B66 also requires detailed disclosures for business combinations that
occurred after the end of the reporting period but before the financial statements are
authorised for issue "unless the initial accounting for the business combination is
incomplete at the time the financial statements are authorised for issue". In such
circumstances, the acquirer describes which disclosures could not be made and the
reasons why they could not be made.
Question
When a business combination occurs after the end of the interim reporting period but
before the interim financial statements are authorised for issue, should an entity
provide the disclosures regarding the business combination in accordance with IFRS
3(2008).B66?
Answer
Yes. IAS 34 requires disclosure of information that is significant to an understanding
of the changes in financial position and performance of an entity since the end of the
last annual reporting period. Consistent with the principle in IAS 34 that an interim
period is a discrete period to which the same policies and procedures should be
applied as at the end of the financial year, all of the IFRS 3 disclosure requirements
for business combinations should be applied to interim periods in the same way as to
annual financial statements.
IAS 34.16A(h) requires events subsequent to the end of the interim period that have
not been reflected in the interim financial statements to be disclosed, and IFRS 3
sets out the specific disclosures required in relation to business combinations after
the reporting period. Consequently, the disclosures required by IFRS 3 should be
provided for material business combinations after the end of the interim period,
unless the initial accounting for the business combination is incomplete by the time
the interim report is authorised for issue. In that case, consistent with IFRS
3(2008).B66, the interim report should describe which disclosures could not be made
and why. In many jurisdictions, this is likely to be more prevalent in interim reports
due to shorter reporting deadlines for interim reports as compared to annual
financial statements.

Renumbered
Q&A IAS 34: 19-1 — IS IT APPROPRIATE TO DESCRIBE A CONDENSED

INTERIM FINANCIAL REPORT AS HAVING BEEN PREPARED 'IN
ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING
STANDARDS'?
Question
When an entity is preparing a condensed interim financial report under IAS 34, can
that report be described as having been prepared 'in accordance with International
Financial Reporting Standards (IFRSs)'?
Answer
No. IAS 34.19 states that "[a]n interim financial report shall not be described as
complying with IFRSs unless it complies with all the requirements of IFRSs". Because
condensed interim financial reports do not include all of the disclosures required by
IAS 1 Presentation of Financial Statements and other Standards, they do not meet
this requirement.
They are, therefore, more appropriately described as having been prepared 'in
accordance with IAS 34' (as required by IAS 34.19) rather than 'in accordance with
IFRSs'.
Q&A IAS 34: 20-1 — COMPARATIVE FINANCIAL STATEMENTS FOR

FIRST INTERIM FINANCIAL REPORTS
Question
Is an entity required to include comparative financial statements in its first interim
financial report?
Answer
Yes. When an entity is preparing its first interim financial report under IAS 34, unless
the report relates to the first period of operation, it should generally include
comparative financial statements as required by IAS 34.20. In the exceptional
circumstances when the entity does not have available in its accounting records the
financial information needed to prepare the comparative interim financial
statements, the entity has no choice but to omit prior period comparative financial
statements.
In the circumstances described, however, the omission of the comparative financial

statements represents a non-compliance with IAS 34. Therefore, the interim financial
report cannot be described as complying with IAS 34 without an 'except for'
statement regarding the omission of prior period comparative financial statements.
Both the fact of, and the reason for, the omission should be disclosed.
Q&A IAS 34: 20-2 — COMPARATIVE INTERIM PERIODS WHEN THE

REPORTING PERIOD CHANGES
[Amended and reissued 20 November 2009]
Background
Entity A's reporting period ends 31 March. It also prepares a half-year interim
financial report under IAS 34. It prepared full-year financial statements for the
reporting period ended 31 March 20X1. Subsequently, it published a half-year report
for the six months ended 30 September 20X1.
In December 20X1, Entity A changes its reporting period end from 31 March 20X2 to
31 December 20X1 and prepares 'full-year' financial statements for the nine months
ended 31 December 20X1.
Question
IAS 34.20(b) requires that the statement of comprehensive income for an interim
period include comparatives for the "comparable interim periods . . . of the
immediately preceding financial year". In preparing the interim period statement of
comprehensive income for the six months ended 30 June 20X2, what comparative
statement of comprehensive income should be presented?
Answer
IAS 34 does not address this question. In many circumstances, presenting a
comparative period that covers the period from 1 January 20X1 to 30 June 20X1
may be preferable to the period from 1 April 20X1 to 30 September 20X1 because
this would enable users to compare trends over time, particularly for a seasonal
business. However, based on facts and circumstances, other presentations may be
appropriate — in particular when local regulations prescribe the comparative
period(s) to be presented following a change in reporting period.
Q&A IAS 34: 20-3 — SHOULD INTERIM FINANCIAL REPORTS INCLUDE

A STATEMENT OF FINANCIAL POSITION AT THE BEGINNING OF THE
EARLIEST COMPARATIVE PERIOD WHEN THERE HAS BEEN A
RESTATEMENT?
Background
Paragraph 39 of IAS 1(2007) Presentation of Financial Statements requires the

presentation of a statement of financial position at the beginning of the earliest
comparative period "[w]hen an entity applies an accounting policy retrospectively or
makes a retrospective restatement of items in its financial statements or when it
reclassifies items in its financial statements".
Question
Does this requirement also extent to interim financial reports prepared in accordance
with IAS 34?
Answer
No. In line with the general principles established in IAS 1(2007).4, this requirement
does not apply to interim financial reports. This is further confirmed by IAS 1.BC33
which explains that the IASB decided not to reflect in IAS 34.8 (minimum
components of an interim report) its decision to require the inclusion of a statement
of financial position at the beginning of the earliest comparative period in a complete
set of financial statements.
Q&A IAS 34: 20-EX-1 — STATEMENTS REQUIRED FOR ENTITIES THAT

REPORT HALF-YEARLY
Example
Based on the requirements of IAS 34.20, the statements required to be presented in
the interim financial report of an entity that reports half-yearly, with a 31 December
20X9 year end, are as follows.
Current Comparative
Statement of financial position at 30 June 20X9 31 December

20X8
Statement of comprehensive income 30 June 20X9 30 June 20X8

(and, where applicable, separate
income statement)
6 months
d d

ended
Statement of changes in equity 30 June 20X9 30 June 20X8
6 months
ended
Statement of cash flows 30 June 20X9 30 June 20X8
6 months
ended
Q&A IAS 34: 20-EX-2 — STATEMENTS REQUIRED FOR ENTITIES THAT

REPORT QUARTERLY
Example
Based on the requirements of IAS 34.20, the statements required to be presented in
the half-year interim financial report of an entity that reports quarterly, with a 31
December 20X9 year end, are as follows.
Current Comparative
Statement of financial position at 30 June 20X9 31 December

20X8
Statement of comprehensive income

(and, where applicable, separate
income statement)
30 June 20X9 30 June 20X8

6 months
ended
3 months
ended
Statement of changes in equity

Statement of changes in equity

6 months
ended
Statement of cash flows

6 months
ended
Q&A IAS 34: 28-1 — MAJOR ADVERTISING CAMPAIGN EARLY IN THE

FINANCIAL YEAR
Background
An entity reports quarterly. In the first quarter of the financial year, the entity
introduces new models of its products that will be sold throughout the year. At that
time, it incurs a substantial cost for running a major advertising campaign
(completed by the end of that quarter) that will benefit sales throughout the year.
Question
Is it appropriate to spread the advertising cost over the period in which benefits (in
the form of revenues) are expected (all four quarters of the year), or is the entire
cost an expense of the first quarter?
Answer
The entire cost is recognised in profit or loss in the first quarter. Explanatory note
disclosure may be required. IAS 34.28 states that "an entity shall apply the same
accounting policies in its interim financial statements as are applied in its annual
financial statements". Paragraph 69(c) of IAS 38 Intangible Assets requires that all
expenditure on advertising and promotional activities should be recognised as an
expense when incurred. IAS 34.30(b) states that a cost that does not meet the
definition of an asset at the end of an interim period is not deferred in the statement
of financial position either to await future information as to whether it has met the
definition of an asset or to smooth earnings over interim periods within a financial
year.
Q&A IAS 34: 28-2 — PRODUCTION LINE RETOOLING COSTS INCURRED

EARLY IN THE FINANCIAL YEAR
Background
An entity reports quarterly. In the first quarter of each financial year, the entity
introduces new models of its products that will be sold throughout the year. At that
time, it incurs a substantial cost for retooling its production line to manufacture the
new models.
Question
Is it appropriate to recognise those retooling costs as an asset and amortise them
over the benefit period (all four quarters of the year), or is the entire cost an
expense of the first quarter?
Answer
It is appropriate to recognise the retooling costs as an asset provided that they meet
the recognition criteria in paragraph 7 of IAS 16 Property, Plant and Equipment.
Those criteria require that an item of property, plant and equipment shall be
recognised as an asset if, and only 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.
Assuming that the expenditure on retooling costs results in an asset that can be
recognised, the expenditure should be capitalised and depreciated over the model
year regardless of the entity's interim reporting policy. To illustrate, if the entity's
financial year end is 31 December, but new products are introduced in September for
a model year from 1 September to 31 August, then at 31 December, some portion of
the asset recognised would remain to be depreciated in the next financial year,
whether or not the entity prepared any interim financial reports.
Q&A IAS 34: 28-3 — VACATION ACCRUALS AT INTERIM DATES

Background
An entity reports quarterly. Its financial year end is 31 December. Holiday

entitlement accumulates with employment over the year, but any unused
entitlement cannot be carried forward past 31 December. Most of the entity's
employees take a substantial portion of their annual leave (vacation) in July or
August.
Question
Should an appropriate portion of employees' salaries during the July/August vacation
period be accrued in the first and second quarter interim financial statements?
Answer
A portion should be accrued if the employees' vacation days are earned
(accumulated) through service during the first and second quarters. Vacations are a
form of short-term compensated absence as defined in IAS 19 Employee Benefits.
IAS 19.11 requires that the expected cost of short-term accumulating compensated
absences be recognised "when the employees render service that increases their
entitlement to future compensated absences". This principle is applied at both annual
and interim financial reporting dates.
Q&A IAS 34: 28-4 — CAPITALISATION OF BORROWING COSTS IN

INTERIM PERIODS
Background
Company A capitalises borrowing costs directly attributable to the construction of

qualifying assets under IAS 23 Borrowing Costs. Company A funds its asset
construction with general borrowings, rather than project-specific borrowings.
Further, Company A uses general borrowings for purposes other than construction,
so the amounts of borrowings in any period is not necessarily related to the amount
of construction during that period. Company A reports quarterly.
IAS 23(2007).14 requires that the capitalisation rate for general borrowings be the
"weighted average of the borrowing costs applicable to the borrowings of the entity
that are outstanding during the period" (which would include the annual period and
individual interim periods within the annual period).
Question
For interim periods, how should Company A determine the weighted average of the
borrowing costs applicable to the borrowings of the entity that are outstanding

during the period?
Answer
For interim reporting purposes, the reference to 'period' in IAS 23.14 should be
interpreted to mean the year-to-date period, not each individual quarter so that, in
accordance with IAS 34.28 and IAS 34.36, the amount of borrowing costs capitalised
is 'trued-up' each quarter on a year-to-date basis.
Q&A IAS 34: 28-5 — LOOK-FORWARD PERIOD FOR GOING CONCERN

ASSESSMENT AT INTERIM REPORTING PERIODS
Question
When preparing an interim financial report, what is the look-forward period required
under IFRSs to assess an entity's ability to continue as a going concern?
Answer
A 12-month period from the interim reporting date should be considered in applying
the going concern guidance in IAS 1 Presentation of Financial Statements.
IAS 1(2007).4 states that “[t]his Standard does not apply to the structure and
content of condensed interim financial statements prepared in accordance with IAS
34 Interim Financial Reporting. However, paragraphs 15–35 apply to such financial
statements”.
This means that the going concern requirements set out in IAS 1(2007).25 and 26
apply to interim financial reports. In particular, the guidance in IAS 1.26 states that
“[i]n assessing whether the going concern assumption is appropriate, management
takes into account all available information about the future, which is at least, but is
not limited to, twelve months from the end of the reporting period”.

Deleted

Q&A IAS 34: 30-EX-1 — TAX RATE COMPUTATION FOR AN INTERIM
PERIOD — GRADUATED TAX RATES
Example
• The entity is computing its annual effective tax rate for the first quarter of
20X1 based on estimated results and tax rates expected for the full fiscal
year ending 20X1.
• There are no deferred tax assets or liabilities at the beginning of 20X1.
• Graduated tax rates are a significant factor in measuring the entity's

deferred tax assets.
• Enacted tax rates are as follows:
1. In the case of a corporation that has taxable income in excess of

CU100,000 (but less than CU15 million, see (2) below) for any taxable
year, the amount of tax determined shall be increased by the lesser of
(a) five per cent of such excess, or (b) CU11,750.
2. Corporations with taxable income in excess of CU15 million are

additionally required to increase their tax liability by the lesser of three
per cent of the excess or CU100,000.
• Available evidence supports a conclusion that deferred tax benefits will be

realisable at the end of 20X2.
Actual pretax and taxable income for the first quarter of 20X1, and estimated pretax
and taxable income for the full 20X1 and 20X2 years are as follows:

1. The applicable income tax rate used for interim period tax allocation in this
example is determined in accordance with the guidance contained in
paragraph 49 of IAS 12 Income Taxes as interpreted in IAS 34.B14.
Because the CU25,000 deductible temporary difference reverses in 20X2,
the estimated applicable tax rate is 15 per cent based on the tax rate that
applies to the CU50,000 of estimated taxable income in 20X2.
Based on the foregoing, the income statement for the first quarter 20X1 is as
follows:

Comments:
• Determining the effective rate will require estimating the current and
deferred tax consequences for the full year.
• If a deferred tax asset is expected at the end of the current year, an

assessment based on available evidence is necessary to determine if
realisation at the end of the current year is probable.
• Graduated rates may impact the estimated annual effective rate.
Q&As IAS 34: 30-2 AND 30-3 — DEVELOPMENT COSTS THAT MEET THE
IAS 38 CAPITALISATION CRITERIA PART WAY THROUGH AN
INTERIM PERIOD
Background
An entity engaged in the pharmaceutical sector, with a December year end, reports
quarterly. Throughout 20X2, its research department is engaged in a major drug
development project. Development costs incurred in 20X2, by quarter, are as
follows.

The entity publishes its half-year report on 15 August, and the CU200 of
development costs incurred during the first and second quarters are recognised in
profit or loss. On 1 September, the entity's research department determines that the
criteria for recognising the development costs as an intangible asset set out in
paragraph 45 of IAS 38 Intangible Assets have been met.
IAS 34: 30-2
Deleted
IAS 34: 30-3
Question
To what extent should development costs be recognised as an internally generated
intangible asset in the interim report at 30 September 20X2 and in the annual
financial statements at 31 December 20X2?
Answer
IAS 38 requires that asset recognition (cost capitalisation) begins at the point in time
at which the recognition criteria are met, not at the start of the financial reporting
period in which those criteria are met. Therefore, the following amounts are reported
in the interim report at 30 September 20X2 and in the annual financial statements at
31 December 20X2.
Q&A IAS 34: 39-1 — FIXED COSTS OF A MANUFACTURER WHOSE

BUSINESS IS SEASONAL
Background
A manufacturer's shipments of finished products are highly seasonal (quarterly

shares of annual sales are respectively 20 per cent, 5 per cent, 10 per cent, and 65
per cent for the four quarters of the financial year). Manufacturing takes place more
evenly throughout the year. The entity incurs substantial fixed costs, including fixed
costs relating to manufacturing, selling and general administration.
Question
The entity wishes to allocate all of its fixed costs to the four quarters based on each
quarter's share of estimated annual sales volume. Is this approach acceptable under
IAS 34?
Answer
No. Such an allocation is not acceptable under IAS 34. IAS 34.39 states that "[c]osts
that are incurred unevenly during an entity's financial year shall be anticipated or
deferred for interim reporting purposes if, and only if, it is also appropriate to
anticipate or defer that type of cost at the end of the financial year".
In the circumstances described, the fixed costs should be split between

manufacturing fixed costs and non-manufacturing fixed costs. Paragraph 12 of IAS 2
Inventories requires that the cost of manufactured inventories should include a
systematic allocation of fixed production overheads (i.e. fixed manufacturing costs).
Because manufacturing takes place evenly throughout the year, the entity will
recognise cost of goods sold expense only when sales are made and, therefore, it will
achieve its objective of allocating fixed manufacturing costs to the four quarters
based on sales volume.
Fixed non-manufacturing costs, however, are different. IAS 2.16 makes clear that
administrative overheads that do not contribute to bringing inventories to their
present location and condition, and selling costs (whether variable or fixed), are
excluded from the cost of inventories and recognised as expenses in the period in
which they are incurred. Therefore, the entity must recognise its fixed
non-manufacturing costs in profit or loss as incurred in each of the four quarters. As
required by IAS 34.16, "explanatory comments about the seasonality or cyclicality of
interim operations" should be disclosed in the notes to interim financial statements.
In addition, IAS 34.21 encourages seasonal businesses to present 'rolling' 12 month
financial statements in addition to interim period financial statements.

Deleted
Q&A IAS 34: 44-1 — ACCOUNTING CHANGES MIDWAY THROUGH A

FINANCIAL YEAR
Background
Company A reports quarterly. In its first quarter interim report for the current year,
it used the same accounting policies as in its latest annual financial statements.
Company A wants to make a voluntary change in accounting policy starting in its
second quarter interim report. It can demonstrate that the change "results in the
financial statements providing reliable and more relevant information about the
effects of transactions, other events or conditions on the entity's financial position,
financial performance or cash flows", as required by paragraph 14 of IAS 8
Accounting Policies, Changes in Accounting Estimates and Errors. However, IAS
34.44 states that an objective of the principle in IAS 34.43 "is to ensure that a single
accounting policy is applied to a particular class of transactions throughout an entire

financial year".
Question
Is Company A permitted to make this change in accounting policy in its second
quarter interim report?
Answer
Yes, provided that the conditions of IAS 8 are met. IAS 34.44 requires that the
interim financial statements for the first quarter of the year be restated to reflect the
new accounting policy adopted in the second quarter. As IAS 34.45 suggests, what is
prohibited is allowing "accounting changes to be reflected as of an interim date
within a financial year" (emphasis added). Accounting changes can be made at an
interim date within a financial year, with retrospective application to earlier interim
periods of that year.
Q&A IAS 34: Appendix B, 13-1 — IMPACT OF CHANGE IN ESTIMATE OF

ANNUAL TAX RATE
Question
How should an entity deal with a change in tax rate that has an effect on a deferred
tax balance carried forward or arising during the interim period but which is not
expected to be reversed until the next financial year?
Answer
Two approaches are acceptable.
• The guidance in IAS 34 could be read to mean that the effective tax rate is
based on the total tax expense for the year, recognised rateably based on
the income in the interim period. Because the total tax expense for the
year includes movements in a deferred tax balance, this would mean that
the effect of the change in a deferred tax balance as a result of a change in
tax rate would be included in estimating the average annual income tax
rate, effectively spreading the effect throughout the financial year.
• Alternatively, IAS 34.B13 (which states that the estimated average annual
rate should include changes that are enacted or substantively enacted and
which are scheduled to take effect during the current financial year) could
be read to require that the estimated average annual tax rate effectively
represents the current tax rate for the current financial year, but excludes
the impact of the changes on deferred tax balances expected to be
recognised at the end of the financial year. Any change in existing deferred
tax balances as a result of the change in tax rate would therefore be
recognised in full in the period in which the change in tax rate occurs.
An entity should select one of these two approaches as its accounting policy and
apply it consistently. The two alternative approaches are illustrated in Q&As IAS 34:
Appendix B, 13-EX-1 and IAS 34: Appendix B, 13-EX-2.
Q&A IAS 34: Appendix B, 13-EX-1 — IMPACT OF CHANGE IN ESTIMATE

OF ANNUAL TAX RATE ON DEFERRED TAX LIABILITY
Example
An entity reporting quarterly expects to earn CU10,000 pre-tax each quarter and
operates in a jurisdiction with a tax rate of 20 per cent on the first CU20,000 of
annual earnings and 30 per cent on all additional earnings. During the third quarter,
the tax rate on annual earnings in excess of CU20,000 increases from 30 per cent to
40 per cent. The tax rate on the first CU20,000 of annual earnings remains at 20 per
cent. Actual earnings match expectations.
Assume that the entity recognised a deferred tax liability of CU15,000 as at the
beginning of the financial year. As a result of the change in tax rate from 30 per cent
to 40 per cent, the deferred tax liability increases by CU5,000 to CU20,000. Under
the alternative approaches described in Q&A IAS 34: Appendix B, 13-1, this increase
could be reflected either:
• by re-estimating the average annual income tax rate (thereby recognising

the effect rateably in the third and fourth quarters on a year-to-date
basis); or
• by recognising the effect of the tax rate change on the deferred tax
liability in full when the change in tax rate is enacted or substantively
enacted.
The following tables show the amounts of income tax expense reported in each
quarter under the two alternatives.
Alternative 1

The tax rate on the first CU20,000 of annual earnings remains at 20 per cent. Based
on expected earnings of CU10,000 pre-tax each quarter, the average annual income
tax rate therefore increases from 25 per cent ((CU20,000 × 20 per cent + CU20,000
× 30 per cent) / CU40,000) to 42.5 per cent ((CU20,000 × 20 per cent + CU20,000
× 40 per cent + 5,000)/ CU40,000). Therefore, the tax expense in the third quarter
is CU7,750 (42.5 per cent tax based on CU30,000 pre-tax earnings to date, less tax
expense of CU5,000 already recognised in the first and second quarter).
Alternative 2
The impact of the tax rate change on the deferred tax liability is recognised in full in
the third quarter. Based on expected earnings of CU10,000 pre-tax each quarter, the
average annual income tax rate therefore increases from 25 per cent ((CU20,000 ×
20 per cent + CU20,000 × 30 per cent) / CU40,000) to 30 per cent ((20,000 × 20
per cent + CU20,000 × 40 per cent)/ CU40,000). The expense recognised in the
third quarter is CU9,000 ((CU30,000 × 30 per cent) plus 5,000 increase in deferred
tax liability less tax expense of 5,000 already recognised in the first and second
quarters).
Q&A IAS 34: Appendix B, 13-EX-2 — CHANGE IN THE TAX RATE

EFFECTIVE IN THE NEXT FINANCIAL YEAR
Example
An entity reports quarterly. It earns CU15,000 pre-tax in each of the first and second
quarters and CU10,000 pre-tax in each of the third and fourth quarters. The tax rate
applicable is 20 per cent. At the beginning of 20X1, the entity has a temporary

difference of CU2,000 and recognised a related deferred tax liability of CU400
(CU2,000 × 20 per cent). CU500 of this temporary difference is expected to reverse
in the fourth quarter of 20X1 and CU1,500 in 20X2. During the first quarter of 20X1,
the tax rate increases from 20 per cent to 30 per cent, effective from 20X2. Assume
that no other temporary differences arise throughout 20X1.
In determining the carrying amount of the deferred tax liability at the end of the first
quarter, the entity should apply an effective tax rate of 20 per cent to the temporary
differences expected to reverse in 20X1 and the increased rate of 30 per cent to
those temporary differences expected to reverse in 20X2. Consequently, the
deferred tax liability should be recognised at CU550 (CU500 × 20 per cent +
CU1,500 × 30 per cent).
Under the alternative approaches described in Q&A IAS 34: Appendix B, 13-1, the
increase would be reflected as follows.
• Alternative 1 — The remeasurement of the deferred tax liability expected

to be recognised at the end of the financial year of CU150 (CU1,500 × (30
per cent – 20 per cent) is factored into the average annual income tax
rate. This would result in the remeasurement of CU150 being recognised
rateably in each interim period. The entity would revise its average annual
income tax rate to 20.3 per cent ((CU50,000 × 20 per cent + CU150) /
CU50,000), recognise tax of CU3,045 (CU15,000 × 20.3 per cent) and
recognise the deferred tax liability at CU445 for the first quarter.
• Alternative 2 — The remeasurement of the deferred tax liability expected

to be recognised at the end of the financial year of CU150 (CU1,500 × (30
per cent – 20 per cent) is recognised in full in the first quarter. The entity
therefore recognises tax of CU3,150 (CU15,000 × 20 per cent + CU150) in
the first interim period.
Q&A IAS 34: Appendix B, 19-1 — TAX CREDITS

Background
Tax in previous years may have been under-provided or over-provided, resulting in a

correcting tax charge or credit in the current year.
Question
How should the entity report the related tax charge or credit in an interim financial
report?

Answer
Appendix B of IAS 34 states that tax benefits that relate to a one-time event are
recognised in computing income tax expense in the interim period in which that
event occurs.
In the circumstances described, the related tax charge or credit relates to prior year
profits rather than current year earnings. Therefore, the correcting tax charge or
credit should be treated as a one-off event and recognised in the interim period in
which it becomes probable that such a correction is required. It should not be
reflected in the average annual income tax rate.
Q&A IAS 34: Appendix B, 21-1 — RECOGNITION OF THE TAX BENEFIT

OF LOSSES IN AN INTERIM PERIOD
Question
When should the tax benefit of a loss be recognised in an interim period of a fiscal
year?
Answer
Appendix B of IAS 34 requires that the tax effect of losses that arise in the early
portion of a financial year should be recognised only when the tax benefits are
expected to be realised either during the current year or as a deferred tax asset at
the end of the year. For the purpose of applying this guidance, an established
seasonal pattern of losses in the early interim periods followed by profits in later
interim periods is generally sufficient to support a conclusion that realisation of the
tax benefit from the early losses is probable. Recognition of the tax benefit of losses
incurred in early interim periods would not occur in those interim periods if available
evidence indicates that profits are not expected in later interim periods.
If the tax benefits of losses that are incurred in early interim periods of a financial
year are not recognised in those interim periods, no income tax expense should be
recognised in respect of profits generated in later interim periods until the tax effects
of the previous losses are offset.
The tax effect of a deferred tax asset expected to be recognised at the end of a
financial year for deductible temporary differences and carryforwards that originate
during the current financial year should be spread throughout the financial year by
an adjustment to the annual effective tax rate.

Q&A IAS 34: Appendix B, 21-2 — DELETED
Deleted
Q&A IAS 34: Appendix B, 21-3 — CHANGE IN ESTIMATE AS TO THE

RECOVERABILITY OF A TAX LOSS CARRYFORWARD
[Amended and Reissued 27 August 2010]
Question
When a previously recognised deferred tax asset is no longer expected to be
recovered, how should that change in estimate be reflected in interim reporting
periods?
Answer
It is not clear whether IAS 34.B21 applies equally to all circumstances when a
previously recognised deferred tax asset is no longer expected to be recovered.
There appear to be two acceptable approaches.
• Alternative 1 — Derecognise at the interim reporting date all the

amounts assessed as not recoverable.
• Alternative 2 — Spread the derecognition via the estimated annual

effective tax rate.
Q&A IAS 34: Appendix B, 21-EX-2 illustrates both approaches.
Q&A IAS 34: Appendix B, 21-EX-1 — RECOGNITION OF DEFERRED TAX

ASSETS AT THE END OF AN INTERIM PERIOD — EXAMPLE
Example
Assume that during the first quarter of 20X1, an entity, operating in a tax
jurisdiction with a 50 per cent tax rate, generates a tax credit of CU4,000 (i.e.
sufficient to cover taxable profits of CU8,000). Under tax law, the tax credit will
expire at the end of 20X2. At the end of the first quarter of 20X1, available evidence
about the future indicates that taxable income of CU2,000 and CU4,000 will be
generated during 20X1 and 20X2, respectively. Therefore, the entity expects to
utilise CU1,000 (CU2,000 × 50 per cent) of the tax credit to offset tax on its 20X1
taxable income, and CU2,000 (CU4,000 × 50 per cent) to offset tax on its 20X2
income. It expects to recognise a deferred tax asset in its statement of financial
position at the end of 20X1 of CU2,000 (relating to the tax relief available in 20X2),
and the balance of CU1,000 will not be recognised because it is not probable that
sufficient taxable profit will be available against which it can be utilised before the
losses expire.
The CU1,000 of the tax credit expected to be utilised during the current year (20X1)
is included in calculating the estimated annual effective tax rate.
Because the tax credit is generated during the current year, the tax consequence of
the CU2,000 deferred tax asset expected to be recognised at the end of 20X1 is
applied rateably to each of the interim periods during 20X1.
Therefore, if profits arise on a straight-line basis through 20X1, a benefit for income
taxes of CU500 (CU2,000 × 1/4) will be recognised during the first interim period.
Assuming the estimates about the future do not change during the remainder of the
year, the tax benefit of the remaining CU1,500 (CU2,000 – CU500) of net deferred
tax asset will be recognised rateably over the pre-tax accounting income generated
in the later interim periods of 20X1.
Q&A IAS 34: Appendix B, 21-EX-2 — CHANGE IN ESTIMATE AS TO THE

RECOVERABILITY OF A TAX LOSS CARRYFORWARD — EXAMPLE
[Amended 24 March 2006]
[Amended and Reissued 27 August 2010]
Example
An entity operates in a tax jurisdiction with a 50 per cent tax rate. In 20X1, the
entity incurs tax losses of CU50,000, which can be carried forward to offset against
future taxable profits until 20X3. At 31 December 20X1, the entity estimates that
CU40,000 of the losses can be recovered against profits in 20X2 (budgeted profit
CU15,000) and 20X3 (budgeted profit CU25,000), and therefore recognises a
deferred tax asset of CU20,000 (CU40,000 × 50 per cent) in its annual financial

statements for 20X1.
At the end of the first quarter of 20X2, actual year-to-date profits and expectations
for the remainder of the year are in line with budget. However, the budgeted profit
for 20X3 is revised downward to CU20,000.
Under the alternative approaches described in Q&A IAS 34: Appendix B, 21-3, the
following amounts will be recognised.
Alternative 1
If the derecognition of the deferred tax asset is accounted for entirely at the date at
which it is assessed as not recoverable, at the end of the first quarter of 20X2 the
carrying amount of the deferred tax asset should be reduced by CU2,500 (CU5,000
at 50 per cent). Therefore, in quarter 1 of 20X2, assuming taxable profits of CU6,000
and an estimated effective annual rate of 50 per cent, the income tax expense for
the quarter is estimated as follows.
Tax expense in quarter 1 (CU6,000 × 50%) + CU2,500 =

CU5,500
Deferred tax asset carrying amount at CU14,500

the end of quarter 1
(Original carrying amount of CU20,000
less utilised in the quarter CU3,000 less
write-off CU2,500)
Alternative 2
If the effect of the derecognition of the deferred tax asset is spread throughout the
year as part of the computation of the annual effective tax rate, the carrying amount
of the deferred tax asset should be reduced by CU2,500 (CU5,000 at 50 per cent)
only at the end of 20X2. Therefore, in quarter 1 of 20X2, assuming taxable profits of
CU6,000 out of estimated annual profits of CU15,000, the income tax expense for
the quarter is estimated as follows.
Estimated effective annual tax rate [(CU15,000 × 50%) + CU2,500]

/CU15 000 = 66 7%
/CU15,000 = 66.7%
Tax expense in quarter 1 CU6,000 × 66.7% = CU4,000
Deferred tax asset carrying amount at CU16,000

the end of quarter 1
(Original carrying amount of CU20,000
less utilised in the quarter CU3,000
less write-off CU1,000)
The remaining write-down of CU1,500 will be recognised rateably over the remainder
of the year using the effective tax rate approach.
Q&A IAS 34: Appendix B, 26-1 — RESERVED

Reserved
Q&A IAS 36: 6-1 — IDENTIFICATION OF CASH-GENERATING UNITS IN

THE RETAIL INDUSTRY
Background
Entity A, a retail company, operates three stores that generate largely independent
cash inflows. The three stores share expenditures (cash outflows) such as
infrastructure, marketing, pricing policies, and human resources.
Question
When A is tested for impairment under IAS 36, can A's cash-generating unit be
composed of the three stores, on the basis that the net cash flows associated with
the stores are interdependent?

Answer
No. IAS 36.6 defines a cash-generating unit as "the smallest identifiable group of
assets that generates cash inflows that are largely independent of the cash inflows
from other assets or groups of assets".
The definition of a cash-generating unit requires the identification of an asset's

cash-generating unit on the basis of independent cash inflows generated by the
asset, not independent net cash flows (i.e. cash inflows and outflows). Therefore,
outflows such as shared infrastructure and marketing expenditures are not
considered when identifying a cash-generating unit. When a store is tested for
impairment under IAS 36, the store's cash-generating unit is the store itself.
Note the IFRIC agenda decision published in the March 2007 IFRIC Update.
Q&A IAS 36: 10-1 — TIMING OF GOODWILL IMPAIRMENT TEST

Question
Under what circumstances is an entity required to test goodwill for impairment?
Answer
Goodwill must be tested for impairment in the following circumstances:
• On date of transition to IFRS (IFRS 1.B2(g)(iii))
• Annually at the same time each year (IAS 36.10(b))
• At reporting date, if an indicator of impairment exists (IAS 36.9).
The requirement to test goodwill for impairment at reporting date extends to interim
reporting dates. At an interim reporting date, the entity applies the same impairment
testing, recognition, and reversal criteria as it applies at the end of year reporting
date. This will result in an entity reviewing events since the end of the most recent
financial year in order to determine whether a detailed impairment calculation is
required.
Q&A IAS 36: 10-2 — REQUIREMENT FOR SECOND GOODWILL

IMPAIRMENT TEST IN YEAR OF ADOPTION

Question
If an entity wishes to establish an annual impairment testing date for goodwill other
than the date of adoption of IAS 36, would a second impairment test in the year of
adoption be required?
Answer
Yes. Entities that wish to establish an annual testing date other than the date of
adoption of IAS 36 must perform a second impairment test in the year of adoption to
establish this later date as the recurring date. Entities should evaluate their own
facts and circumstances in assessing whether to set a recurring date for annual
testing different from the date of adoption.
Q&A IAS 36: 12-1 — OTHER EVENTS AND CIRCUMSTANCES

INDICATING A CARRYING AMOUNT MAY NOT BE RECOVERABLE
Question
What are the other events and circumstances that indicate the carrying amount of an
investment property carried at cost may not be recoverable?
Answer
In addition to the events and circumstances detailed in IAS 36.12, the following
conditions may indicate that the investor may be unable to realise the carrying
amount of an investment property:
• The investor recently sold a portion of its income producing investment

properties and realised losses on the sale transactions.
• The business plan indicates that the investor may liquidate a portion of its
investment property portfolio in the coming year, but has not identified yet
which properties will be sold.
• Income producing properties have significant vacancy rates or are

expected to be vacant in the near future (e.g. because of non-competitive
lease terms).
• Depressed market conditions are adversely affecting the rental or sale

activities of significant properties.
• The investor does not appear to have the ability to recover the current net
carrying amount of investment properties from future cash flows because
of declines in rental rates or occupancy rates.
• The investor is encountering cash flow difficulties, which may require

forced sale of some or all of its investment properties.
The above list is not meant to be all inclusive. Circumstances that may indicate
impairment in the carrying amount of an investment property or group of properties
will be subject to judgement. The timing of the events and circumstances that
indicate possible impairment also is an important consideration in recoverability
assessments, as depreciation estimate changes and impairment charges should be
made in the period in which such events and circumstances occur. An entity should
ensure that it maintains proper documentation supporting the evaluation of all
impairment indicators in the context of the event or change in circumstance, and the
timing of such indicators.
Q&A IAS 36: 12-2 — CONSIDERATION OF ALTERNATIVE USES OF AN

ASSET IN DETERMINING IF AN IMPAIRMENT INDICATOR HAS BEEN
MET
Question
Company C (C), a regional railroad operator, has been in the process of constructing
a pier which would accept waterborne freight for transfer on to its railroad cars.
Company C is two years into construction, and the project has exceeded its original
budget and time schedule. Due to the delays and other advances in waterborne
freight transfer, C's management is considering alternative uses for the project.
Specifically, C is considering using the facility as a container yard for offloading bulk
products such as salt and construction aggregate. Company C's intent is to begin
operating the site as a container yard, as opposed to an off-loading facility for ocean
going vessels, as originally intended.
Should the entity perform an impairment test of the asset?
Answer
Yes. In accordance with IAS 36.12(f), the intent to begin operating the site as a
container yard clearly represents a significant change in the manner in which an
asset is used, and it would appear reasonable that a change such as the one
described above, may have an adverse effect on the entity. As such, C should
perform an impairment assessment by comparing recoverable amount, being the
higher of value in use and fair value less costs to sell, to the carrying amount of the
asset. If the recoverable amount is lower than the carrying amount, an impairment
loss must be recognised.
Q&A IAS 36: 12-3 — IMPAIRMENT INDICATED BY APPRAISAL OR

OTHER VALUATION INFORMATION BELOW CARRYING AMOUNT
Question
If a company believes, because of an appraisal or other valuation information, that
the fair value less costs to sell of a held and used asset is below its carrying amount,
is an impairment write-down automatically required?
Answer
No. The existence of an appraisal or other independent valuation information that
indicates the fair value less costs to sell of a held and used asset is below its carrying
amount does not, in and of itself, require that an impairment loss be recognised.
Where the asset's carrying amount was previously assessed using value in use, the
entity should consider whether the appraisal is an indicator of impairment — it is
possible that the factors resulting in the lower valuation do not affect the value in
use calculations. Where the entity does consider the lower valuation to be an
indicator of impairment, the entity should calculate the value in use of the asset. If
the recoverable amount of the asset, that is the higher of the asset's fair value less
costs to sell and value in use, is less than its carrying amount, then an impairment
loss should be recognised.
Q&A IAS 36: 12-4 — IMPAIRMENT INDICATORS OF CAPITALISED

COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR
INTERNAL USE
Question
What are the events and circumstances that may indicate that capitalised computer
software developed or obtained for internal use should be tested for impairment?
Answer
In addition to the general indicators of impairment in the standard, capitalised
computer software costs should be tested for impairment if, for example, any of the
following events and circumstances occur:
• The internal-use computer software is not expected to provide service

potential as originally planned.
• A significant change occurs in the extent or manner in which the software

is used or is expected to be used such that previously capitalised costs are
not expected to have further benefit.
• A significant change is made or will be made to the software program such

that previously capitalised costs are not expected to have further benefit.
• The costs of developing or modifying internal-use computer software

significantly exceed the amount originally expected to develop or modify
the software.
Some software may, during development or after development, no longer be

expected to provide any service. When it is no longer probable that computer
software being developed will be completed and placed into service, the asset should
be impaired.
Indications that the software may no longer be expected to be completed and placed
in service include the following:
• A lack of expenditures budgeted or being incurred for the project.
• Programming difficulties that cannot be resolved on a timely basis.
• Significant cost overruns.
• Information has been obtained indicating that the costs of internally

developed software will significantly exceed the costs of comparable
third-party software. Management intends to acquire the third-party
software instead of completing the internally developed software.
• Technologies are introduced in the marketplace, so that management now

intends to obtain third-party software instead of completing the internally
developed software.
• The business segment or unit to which the software relates, or relates in

part, is unprofitable and has been or will be discontinued.
The above lists are not meant to be all inclusive. Circumstances that may indicate
impairment in the carrying amount of internal-use computer software, also, will be
subject to judgement. Timing of the events and circumstances that indicate possible
impairment also is an important consideration in impairment testing. An entity
should ensure that it maintains proper documentation supporting the evaluation of
all impairment indicators in context of the event or change in circumstances, and the
timing of such indicators.

Q&A IAS 36: 12-5 — IMPAIRMENT INDICATORS AFTER THE BALANCE
SHEET DATE
Question
How should significant impairment indicators that arise after the balance sheet date,
but before the date the financial statements are approved, be dealt with?
Answer
If management has assessed impairment indicators as at the balance sheet date,
impairment events (including those arising as a result of management decisions)
occurring thereafter usually are not indicative of conditions existing at the balance
sheet date and, therefore, should not be adjusted for. Instead, they should be
disclosed when they are of such importance that non-disclosure would affect user
decisions.
If information is received after the balance sheet date that indicates the asset was
impaired at that date, then an impairment exercise should be carried out.
Q&A IAS 36: 12-6 — EVENTS AND CIRCUMSTANCES INDICATING AN

IMPAIRMENT OF GOODWILL
Question
In addition to testing goodwill for impairment annually, goodwill should be tested for
impairment whenever there is an indicator that it might be impaired (as for other
assets). What are potential indicators of impairment of goodwill?
Answer
Goodwill arising on an acquisition represents a payment an acquirer made in
anticipation of, for example, the future economic benefits that are expected to arise
from the synergy between two business operations or as a result of new
management. Goodwill may become impaired where events following the acquisition
do not occur as expected.
The following are examples of events and circumstances that might lead to the
determination that goodwill is impaired:
• The merger of business information systems does not occur as planned,

and the acquirer does not achieve the savings that were expected from
operating a merged system.
• Industrial agreements do not permit the level of workplace reform that the
acquirer had planned, and the employee headcount is higher than that
planned at acquisition.
• The acquirer identified at acquisition the feasibility of developing several

research projects, and these projects subsequently have been abandoned.
• A regulatory ruling prevents the acquirer from operating in certain

markets, and the acquirer will not achieve the level of sales planned at
acquisition.
• A competitor introduces a new product earlier than expected, and the

acquirer will not achieve the level of sales planned at acquisition.
The above list is not meant to be all inclusive. Circumstances that may indicate
impairment of goodwill will be subject to judgement. The timing of the events and
circumstances that indicate possible impairment also is an important consideration in
recoverability assessments as changes in the estimate of depreciation and
impairment charges should be made in the period in which such events and
circumstances occur. An entity should ensure that it maintains proper documentation
supporting the evaluation of all impairment indicators in context of the event or
change in circumstance, and the timing of such indicators.
Q&A IAS 36: 22-1 — REQUIREMENT TO DETERMINE FAIR VALUE LESS

COSTS TO SELL
Question
Entity A is reviewing all of its assets for impairment as a result of a fall in the market
of their products. The plant is 10 years old and has a carrying amount of €80 million
and a value in use of €75 million, considering the revised price of the products. A
similar plant (one of the entity's competitors) was sold for €82 million. Costs
attributable to the disposal would be around €1 million. There is an active market for
the plant assets. Management has no intention to sell the plant.
Can the entity recognise an impairment loss of €5 million based on the value in use?
Answer
No. The entity should not recognise an impairment loss, as the fair value less costs
to sell is higher than the value in use, and, therefore, is identifiable as the
recoverable amount. The carrying amount is less than the recoverable amount and
no impairment loss should be recognised.
Note: As noted in IAS 36.20, in real situations, it may be very difficult to find a
market for similar specialized assets from which to analogise in determining fair
value; nevertheless, the entity should make efforts to determine the fair value less
costs to sell.
Q&A IAS 36: 30-1 — IMPACT OF CASH FLOW HEDGES ON

VALUE-IN-USE CALCULATIONS
Background
Entity A has entered into derivative contracts to hedge the cash flows related to the
purchase and sale of commodities in a specific cash-generating unit (CGU). These
contracts are designated and qualify as cash flow hedges.
Question
Should Entity A include the cash flows on the hedging contracts in determining the
value-in-use of the CGU in which the contracts are used?
Answer
Entity A may either include or exclude the cash flows on the hedging contracts in
determining the value-in-use of the CGU, as long as the carrying amount of the CGU
is established in a consistent manner.
If Entity A includes the cash flows on the hedging contracts in determining the
value-in-use of the CGU, it must also include the fair value of the hedging contracts
in the carrying amount of the CGU. Conversely, if the cash flows on the hedging
contracts are excluded, it would be appropriate to also exclude the hedging contracts
and their cash flows from the carrying amount of the CGU.
IAS 36.68 defines a cash-generating unit as “the smallest group of assets that
includes the asset and generates cash inflows that are largely independent of the
cash inflows from other assets or groups of assets”. IAS 36.69 explains that “[i]n
identifying whether cash inflows from an asset (or group of assets) are largely
independent of the cash inflows from other assets (or groups of assets), an entity
considers various factors including how management monitors the entity's operations
(such as by product lines, businesses, individual locations, districts or regional areas)
or how management makes decisions about continuing or disposing of the entity's
assets and operations”.
Accordingly, the decision to include or exclude the effect of hedging instruments and
associated cash flows for the purposes of testing the carrying amount of a CGU for
impairment should reflect how management defines its CGUs.
Entity A may define its CGUs strictly based on the independence of cash flows (i.e.
by including only those assets that may not be operated without other assets).
Where this approach is taken, Entity A may consider that the CGU could operate
without the hedging instruments and that the hedging instruments generate their
own independent cash flows. Therefore, it would exclude the hedging instruments
and their cash flows in testing the CGU for impairment.
Alternatively, Entity A may define its CGU based on the manner in which it operates
the assets. Where this approach is taken, Entity A may consider that the CGU should
include the hedging contracts if they are acquired specifically for the operations of a
specific CGU and have no other business purposes.
Both perspectives are acceptable.
Q&A IAS 36: 42-1 — ESTIMATING FUTURE CASH FLOWS WHEN

TESTING AN ASSET UNDER CONSTRUCTION FOR RECOVERABILITY
Background
Company D (D) designs, develops, and manufactures components for high speed
optical networks. The majority of D's customers are building communication
infrastructures. In December of 20X5, D purchased a plot of land in an industrial
complex with the intent to build a state-of-the-art production facility for D's
integrated circuit and module products. Construction of the new facility began in
March of 20X6 and is expected to be completed by the end of August 20X6. In June
20X6, a number of D's customers announced plans to cut the level of capital
expenditures related to their infrastructure development, and D has received several
order cancellations. At 30 June 20X6, due to the significant change in business
climate, D has identified indicators for impairment of the new production facility
under IAS 36.
Question
Should D include the remaining costs associated with completing the production
facility in its estimates of future cash flow when assessing the asset group for
impairment?
Answer
Yes. IAS 36.42 clearly states that when a carrying amount of an asset does not yet
include all the cash outflows to be incurred before it is ready for use, the estimate of
future cash outflows includes an estimate of any further cash outflow that is
expected to be incurred before the asset is ready for use.
Q&A IAS 36: 50-1 — INCLUSION OF INTEREST PAYMENTS IN

ESTIMATES OF CASH FLOWS FOR ASSETS UNDER DEVELOPMENT
Question
Should an entity include interest payments that will be capitalised as part of the cost
of an asset in an estimate of future cash flows when testing an asset under
development for recoverability?
Answer
No. IAS 36.50 prohibits the inclusion of financing cash outflows or inflows in a value
in use calculation, and does not provide for any exceptions to this rule.
Q&A IAS 36: 54-1 — FUTURE CASH FLOWS IN HYPERINFLATIONARY

CURRENCIES
Question
Future cash flows are estimated in the currency in which they will be generated and
then discounted using a discount rate appropriate for that currency. The present
value obtained is to be converted using the spot exchange rate at the date of the
impairment calculation.
Should a different method be applied when the future cash flows are estimated in a
currency that is hyperinflationary?
Answer
According to IAS 36.40, estimates of future cash flows should take into account price
increases due to general inflation and notes that:
• If the discount rate includes the effect of price increases due to general
inflation, future cash flows are estimated in nominal terms.
• If the discount rate excludes the effect of price changes due to general
inflation, future cash flows are estimated in real terms.
In principle, this guidance also applies when a currency is hyperinflationary.

However, in the case of hyperinflation, frequently there will be difficulties in
determining the likely future rate of inflation and the relevant nominal interest rate.
Calculating the value in use generally will be easier in real terms.
Q&A IAS 36: 55-1 — INFLATION

Question
Should inflation be taken into account when estimating future cash flows?
Answer
There are two ways to deal with inflation when estimating future cash flows. One
method is to forecast cash flows in real terms; that is, not to increase them to reflect
likely future inflation. These cash flows are then discounted at a real discount rate.
Alternatively, the forecasted cash flows can include estimated inflation, but they then
need to be discounted at a nominal rate of interest (that is, a rate which includes
inflation). The first method must be used where revenues and costs are expected to
be subject to different inflation rates in the future. For example, the regulator may
restrict the revenues of a regulated entity, but its costs will be unrestricted. The
entity's costs and revenues, therefore, will be subject to different inflation
assumptions.
Q&A IAS 36: 59-1 — ASSET LIFE SHORTENED BY PHYSICAL DAMAGE

TO THE ASSET
Question
If an asset has been damaged such that the life of the asset has been shortened, but
the carrying amount of the asset will still be recovered by future cash flows over the
shortened life, should impairment be recognised?
Answer
No. The damage to the asset will provide an indicator of impairment in accordance
with IAS 36.12(e), and therefore, the asset must be tested for impairment. However,
because the carrying amount of the asset still will be recovered by future cash flows
during the revised useful life, no impairment should be recognised. Nevertheless, the
useful life of the asset is changed and the depreciation amount should be
recalculated prospectively and accounted for as a change in estimate in accordance
with the requirements of IAS 8 Accounting Policies, Changes in Accounting Estimates
and Errors.
Q&A IAS 36: 60-1 — CAPITAL ADDITIONS TO AN ASSET GROUP THAT

HAS BEEN IMPAIRED
Question
Application of IAS 36 has required that an entity write down several plant balances
to their recoverable amount. How should the cost of capital additions related to
impaired assets be accounted for?
Answer
The cost should be recognised in accordance with IAS 16 and capitalised if they meet
the criteria of IAS 16.7. In order to meet those recognition criteria, the future
economic benefits must be probable. If the value in use or fair value less costs to sell
of the improved asset in its entirety is insufficient to recover the carrying amount of
such assets, some or all of the capital additions will be unlikely to satisfy the
probability criteria and, accordingly, should not be capitalised.
Q&A IAS 36: 62-1 — ACCRUAL OF A LIABILITY IF AGGREGATE LOSSES

EXCEED CARRYING AMOUNT
Question
Does IAS 36 require accrual of a liability if the aggregate losses associated with the

asset being tested for impairment exceed the carrying amount of the asset?
Answer
There is no requirement arising from IAS 36 to accrue a liability for expected cash
flow losses in excess of the carrying amount of the asset. However, a liability should
be recognised in respect of the negative future cash flows attributable to an asset if
and only if the recognition of that liability is required by another standard (for
example, a requirement to recognise an onerous contract or decommissioning costs
in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets).
Q&As IAS 36: 68-EX-1 thru 68-EX-5 — IDENTIFYING

CASH-GENERATING UNITS FOR AN ENTITY OPERATING IN MULTIPLE
LOCATIONS
Background
Dividing the entity's activities into cash-generating units (CGUs) for the purposes of
testing goodwill for impairment practically can be difficult for service and product
providers that trade through a number of outlets. It may be impracticable to prepare
separate cash flow forecasts for large numbers of individual outlets. Where regional
or other groupings of establishments are the normal basis for carrying out
impairment reviews, any specific indicators of impairment affecting a smaller
grouping is considered in order to ensure that material impairments are properly
identified. Examples might include the entry of a major competitor into a local area,
or the closure of a town's principal employer, both of which could have a long-term
effect on the income of establishments in that area. A specific review of the smaller
grouping or individual establishments affected by a local impairment indicator then
would be necessary. The following brief scenarios may assist in determining what
comprises a CGU, but each case should be determined according to the particular
fact pattern.
IAS 36: 68-EX-1

RESTAURANT CHAINS
For restaurant chains with multiple restaurants in one location (e.g. McDonalds, Pizza
Hut, etc.), demand for one affects demand for the other so it is unlikely to be
appropriate to look at the income of one restaurant in isolation of the others in the
same location. Also, it is unlikely that any one restaurant would be material.
Therefore, where there are many outlets, impairment reviews normally would be
carried out on the basis of groupings in the same location/affected by the same
economic conditions.

For restaurant chains without multiple restaurants in a single location, each
restaurant is likely to be a separate CGU for the purposes of determining whether
goodwill is impaired, because its income is independent of the income of other
restaurants. The cash inflows of each restaurant can be individually monitored and
sensible allocations of costs to each restaurant can be made. However, since any
impairment of individual restaurants is unlikely to be material, it is likely that
management might monitor goodwill at a higher level than the individual restaurant
level for internal reporting purposes. Accordingly, groups of restaurants that are
affected by the same economic factors may be reviewed for impairment together if
that is the methodology for monitoring the performance of goodwill used by
management.
IAS 36: 68-EX-2

RETAILERS
Often, it is difficult to determine for retail chains whether a CGU is an individual site,
a group of sites in a region, a country, or the whole business. For the majority of
modern multi-site retailers, some level of aggregation of sites is normally
appropriate. A larger grouping can be treated as a CGU or each site can be taken to
be a CGU but with a pragmatic view of aggregation taken on grounds of materiality,
as in the restaurant example referred to in IAS 36: 68-EX-1. Apart from other
considerations, in some circumstances it may be impractical (or at least costly) to
prepare detailed cash flow forecasts for each individual site — in any case, forecasts
may, to some extent, be based on macro-assumptions about factors that affect
larger groupings in a similar way.
IAS 36: 68-EX-3

BANK BRANCHES
Bank branches generally sell a variety of products that are supported by central
operations. In many ways, the outlets represent a conduit for the central
organisation which determines product pricing on a national basis. Whilst it may be
possible to look at the income of each branch as being separate from the others, it is
likely that very broad assumptions would need to be made to arrive at a measure of
profitability, particularly in respect of recurring products such as life policies and
savings schemes. It is unlikely that a branch is a CGU, unless for some reason
management addresses profitability or contribution at a branch level. Also, it is
unlikely that an individual branch would be material to the organisation.
IAS 36: 68-EX-4

HOTELS

Individual hotels usually would generate income that is largely independent of

others, and their performance would be monitored closely by management on an
individual basis. It is, therefore, probable that they form individual CGUs, even if
there are central sales, marketing, and finance functions. A hotel chain that markets
itself centrally to business customers might operate a loss making hotel in a higher
cost location to secure group wide contracts or a nationally advertised price pledge.
In such circumstances, it might be argued that the performance of goodwill is
managed by reference to a larger group than the individual hotel, and, accordingly, a
number of hotels would be combined in testing for impairment of the related
goodwill.
IAS 36: 68-EX-5

PETROL STATIONS
The income of individual petrol stations likely is to be closely monitored by

management, and costs are likely to be able to be determined to arrive at a measure
of profitability. If management would consider closing one station depending upon its
individual performance, each petrol station may be a CGU — similar to the restaurant
example, IAS 36: 68-EX-1. However, it is unlikely that any one station owned by a
major operator would be material, and, therefore, it is likely that the performance of
goodwill is measured at a higher level for the purposes of internal reporting.
Accordingly, where a large number of outlets are involved, impairment reviews
normally would be carried out on the basis of groupings affected by the same
economic conditions.
Q&A IAS 36: 68-1 — GROUPING OF ASSETS TO BE HELD AND USED

Question
Company X (X), a national wireless communication provider, owns each set of
antennas, radio transmitters, and receivers (collectively referred to as "antennas"
herein) installed on cell towers which together provide the infrastructure of its
telecommunications network. A set of antennas is damaged in an electrical storm to
the extent that the antennas will no longer be able to provide services to customers
within a particular region. However, a mile away, on another cell tower, a similar set
of unused antennas is available to replace the service provided by the damaged set
of antennas such that the service to the regional area will be virtually uninterrupted,
and all cash flow streams will remain intact. This interchangeability is a feature
deliberately built into the integrated logistical design of the network.
Are the identifiable cash flows of each set of antennas largely independent?
Answer
No. In this case, there is not a specific cash flow attributable to the individual set of
antennas as they are almost instantaneously interchangeable, and as a result, on an
individual antenna set basis, their ability or inability to operate does not affect cash
flows. However, the set of antennas are part of a group of assets that make up X's
national network of towers and antennae, and this national network generates joint
cash flows. As the wireless communication provider operates using a national
network, the national network infrastructure asset group would be the asset group
representing the lowest level of cash flows for the purposes of analysing the network
infrastructure for impairment. The national wireless communication provider should
assess the network infrastructure for impairment and write down, if necessary, the
carrying amount of the antennae, based on the joint cash flows provided by the
group.
Q&As IAS 36: 68-2 and 68-3 — GROUPING OF ASSETS SUBSEQUENT TO

DISPOSAL OF THE PRIMARY ASSET
Background
Company G, in the retail industry, has several retail locations. One of G's stores has
had negative operating results for the past year. Company G identified the store as a
cash-generating unit. Appropriately, G performed a test for impairment of its assets
as of G's year end, 30 June 20X1. Company G is the lessee of the physical store
location, and accounts for this lease as a finance lease. Additionally, G owned certain
assets (computers, forklifts, etc.), which could be sold or transferred to other G
stores. Company G's impairment calculation determined the assets under finance
lease had negative cash flows of 600,000. However, the assets other than the assets
under finance lease had positive cash flows of 250,000.
IAS 36: 68-2
Question
Could the entity allocate both assets under finance lease and the other assets to the
cash-generating unit of the store?
Answer

Yes. The entity has to determine the value in use of the cash-generating unit, which
is the store. The other assets are assigned to the store, which is tested for
impairment. The cash inflows of the store, and, therefore, the operations of the store
depend on the assets under finance lease and the other assets which are
inter-related; therefore, the impairment test should be carried out by aggregating all
the assets, resulting in a total impairment of 350,000.
IAS 36: 68-3
Question
If G subsequently commits to a plan to abandon the finance lease and transfer or sell
the other assets, can it continue to group the assets for determining the recoverable
amount of the cash-generating unit of the store at subsequent reporting dates?
Answer
No. Once G has determined that it will abandon the assets under the finance lease,
the other assets would be independent of the finance lease, because they will not
form part of the generation of cash inflows from the store. Therefore, for purposes of
recognition and measurement of an impairment loss, the other assets should no
longer be grouped with the assets under the finance lease. The other assets may fall
within IFRS 5, Non-current Assets Held for Sale and Discontinued Operations, if they
meet the definition of a disposal group (IFRS 5, Appendix A) and should be
measured at fair value less costs to sell. Alternatively, they may be reallocated to
other cash generating units if they are to be transferred to other stores.
Q&A IAS 36: 80-1 — LEVEL AT WHICH GOODWILL IS TESTED FOR

IMPAIRMENT
Background
Company A has three retail divisions, each of which it classifies as an operating

segment under IFRS 8 Operating Segments, for reporting purposes. All three
divisions consist of a number of individual stores that operate independently of one
another. Goodwill was recognised on the acquisition of each division. Management
does not monitor goodwill for internal management purposes.
In accordance with the requirements of IAS 36, goodwill is assessed for impairment
annually for external financial reporting purposes. Management currently only
assesses goodwill for IAS 36 impairment purposes at an operating segment level.
However, management also has the ability to allocate goodwill to each store within
each operating segment and to monitor goodwill for impairment testing at that lower
level.
Question
Given that management is capable of monitoring the impairment of goodwill at a
lower level than it is currently monitored, should management perform its IAS 36
impairment assessment for goodwill at the lower level or is its current practice
appropriate?
Answer
Management's current practice is appropriate.
IAS 36.80 requires goodwill to be assessed for impairment at the lowest level within
the entity at which the goodwill is monitored for internal management purposes, and
not be larger than an operating segment determined in accordance with IFRS 8.
Company A complies with both requirements and does not need to alter the level at
which goodwill is currently assessed for impairment.
Q&A IAS 36: 80-2 — LEVEL AT WHICH GOODWILL IS TESTED FOR

IMPAIRMENT ON ADOPTION OF IFRS 8
[Reserved 14 August 2009]
[Reissued 18 September 2009]
Background
Company A (which has only one geographical segment) has three retail divisions,
each of which it classified as a business segment under IAS 14 Segment Reporting.
All three retail divisions consist of a number of individual stores operating
independently of each other. Goodwill was recognised on the acquisition of each
store and was tested for impairment at the geographical segment level for financial
reporting purposes. Management does not monitor goodwill at a lower level for
internal management purposes. The results of each store are, however, reported
internally to Company A's chief operating decision maker.
In the current year, Company A has adopted IFRS 8 Operating Segments, and has
determined that each store within a retail division represents an operating segment
for the purposes of that Standard. IAS 36.80 (as amended) requires, for the purpose
of impairment testing, that each unit or group of units to which goodwill is allocated
should not be larger than an operating segment determined in accordance with IFRS
8.
Company A is therefore required to test goodwill for impairment at the operating

segment level (i.e. at store level), which is lower than the level at which it previously
tested goodwill for impairment under superseded IAS 36.80.
Question
Should Company A recognise the amendment to IAS 36.80 requiring goodwill to be
tested for impairment at an operating segment level retrospectively as a change in
accounting policy or prospectively as a change in accounting estimate?
Answer
The change should be accounted for retrospectively as a change in accounting policy.
When, as in the above scenario, the level at which goodwill is tested for impairment
changes because of the consequential amendments to IAS 36 as a result of the
application of IFRS 8, the change is recognised as a change in accounting policy.
IFRS 8.36 requires restatement of comparative information in the initial year of
application of IFRS 8 unless the necessary information is not available and the cost
to develop it would be excessive. In addition, in the absence of any specific
transitional provisions for the consequential amendments to IAS 36 as a result of
IFRS 8, the amendments to IAS 36.80 should be applied retrospectively in
accordance with paragraph 19(b) of IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors, subject to IAS 8.22–27.
When retrospectively performing the goodwill impairment test at the store level,
Company A should ensure that the estimates it uses are consistent with those made
for the same date under the previous accounting unless there is objective evidence
that those estimates were wrong.
Facts and circumstances should be analysed carefully in the determination of

whether a change to the level at which goodwill is tested for impairment results from
an error in the application of IAS 14 or from the different requirements of IFRS 8.
Q&A IAS 36: 80-3 — ALLOCATION OF GOODWILL BY UNLISTED

ENTITIES
Background
Group A is an unlisted entity. It is therefore not within the scope of IFRS 8 Operating
Segments; nor does it choose to apply that Standard voluntarily. Group A acquired a
subsidiary some years ago, which resulted in the recognition of goodwill.
Management generally monitors Group A's activities on a country-by-country basis.

However, goodwill has not been allocated to individual countries for internal
management purposes.
If Group A were to apply IFRS 8, each country would represent an operating

segment under that Standard.
Question
Should Group A test goodwill for impairment at the reporting entity (group) level, or
should it test for impairment at a lower operating segment (individual country) level,
ie at the level at which management generally monitors activities?
Answer
IAS 36.82 clarifies that the objective of the guidance in IAS 36 on allocating goodwill
is to ensure that goodwill is tested for impairment "at a level that reflects the way an
entity manages its operations and with which the goodwill would naturally be
associated".
In specifying the level at which goodwill should be allocated, IAS 36.80(b) requires
that the unit or group of units to which goodwill is allocated "not be larger than an
operating segment determined in accordance with IFRS 8". Note that this
requirement does not refer to the level of reported operating segments. Therefore,
irrespective of whether an entity reports segment information in respect of its
operating segments in accordance with IFRS 8, it should assess its goodwill at the
operating segment level in accordance with IAS 36.80(b).
In the circumstances described, the internal management reporting system on an

individual country basis appears to represent an appropriate operating segment level
for Group A. Therefore, goodwill should be tested for impairment at the country
level.
Q&A IAS 36: 98-1 — ASSETS THAT PROVIDE NO FUTURE BENEFIT

Question
Can an entity test, as part of a cash-generating unit, an asset that individually
provides no future economic benefit and does not contribute to the derivation of
economic benefits at the group level, but has in the past been allocated to an asset
group that continues to have positive cash flows?
Answer
No. IAS 36 is not intended to allow an entity to continue to recognize, as an asset,
an item that does not meet the definition of an asset. Where an indicator of
impairment exists, the entity must first test the individual asset for impairment, and
recognise any impairment losses. If no future benefits are expected to be gained
from holding or disposing of the asset, then it would be likely that the asset should
be written off in full in accordance with the derecognition requirements of IAS 16.67
Property, Plant and Equipment.
Furthermore, if goodwill exists in the cash-generating unit to which the asset

belonged, impairment testing would be conducted in respect of this cash-generating
unit, with the book value attributable to the written-down asset being zero.
Example
A company provides worldwide wireless communications to its customers through a
network of ten satellites. The company has determined appropriately that its satellite
business as a whole represents a "lowest level" for which identifiable cash flows
largely are independent of the cash flows of other assets and liabilities. A meteorite
destroys one satellite. However, the company can continue to provide worldwide
service with the remaining nine satellites. Although the company continues to have
positive cash flows from its satellite communications business, the company must
recognize the loss of an asset.
Q&A IAS 36: 98-2 — ASSET WITHIN CASH-GENERATING UNIT THAT

NO LONGER CONTRIBUTES TO CASH FLOWS
Question
A machine within a cash-generating unit (CGU) has become redundant and is no
longer contributing to cash flow. Its carrying amount exceeds its recoverable
amount. However, the recoverable amount of the CGU is above its carrying amount.
Should the entity recognise an impairment loss for the machine?
Answer
Yes. The entity should recognise an impairment loss for the machine, as its carrying
amount is above its recoverable amount. The general principle is that impairment
should be identified at the individual asset level, where possible. The recoverable
amount should be calculated for the smallest CGU to which the asset belongs only
where the recoverable amount for the individual asset cannot be identified. This
machine is no longer in use, and, therefore, no longer belongs to the CGU. The
smallest CGU is the machine itself — it is not that the entity is unable to determine
the future cash inflows arising from using this machine; it is that they are readily
determinable and they are nil. Therefore, the entity should determine the fair value
less costs to sell of the machine (as it is possible the machine has some scrap or
re-sale value) and recognise the impairment loss identified by this exercise.
Q&A IAS 36: 104-1 — CORPORATE ASSETS

Question
D-Packaging Ltd produces different types of packaging on the basis of paper. The
three main types of packaging materials produced for its customers are the
following:
• Tubes
• Corrugated Board
• Solid Board
Each of the three main types of packaging associated with the business is identified
as a business segment under IAS 14 Segment Reporting, and as cash generating
units under IAS 36.
Asset M is partly used for the production of tubes (T) and corrugated board (C).
The information regarding the cash-generating unit T is as follows:
• Carrying amount of machinery used exclusively in manufacturing tubes

(excluding M) = 4,500
• Carrying amount of M = 1,000
• Capacity of M used for the tubes production is equal to 60 per cent
• Recoverable amount of the tubes (with M) = 4,000
Regarding cash-generating unit C, the excess of value in use over the carrying
amount is equal to 2,000.

Should an impairment loss in respect of cash-generating unit T be recognised?
Answer
Yes. In accordance with IAS 36.102, asset M should be allocated on a reasonable
and consistent basis to unit T. The entity should compare the carrying amount of the
unit, including the portion of the carrying amount of the corporate asset allocated to
the unit with its recoverable amount. In this case, M is used at 60 per cent for the
production of the tubes; therefore, it seems reasonable to allocate 60 per cent of the
carrying amount of M to the cash-generating unit T. Therefore, the carrying amount
of the cash-generating unit T is equal to 5,100 ((1,000 × 60%) + 4,500) which is
higher than the recoverable amount (4,000) by 1,100. Therefore, an impairment loss
should be recognised and should be allocated to all assets of the cash-generating
unit T (including M) on a pro-rata basis based on the carrying amount of each asset
in the unit. However, if the entity was able to determine the fair value less costs to
sell of M, and that number was 1,000 or more, the impairment loss in respect of
cash-generating unit T would be allocated on a pro-rata basis to the other assets of T
in accordance with the requirements of IAS 36.105.
No impairment is recognised in respect of unit C because the amount of M to be

allocated (400) is less than the excess of C's value in use over C's carrying amount
(2,000).
Even though the difference between the carrying amount and the recoverable
amount (2,000) of the cash-generating unit C is higher than the impairment loss of
T, an impairment loss should be recognised. The entity cannot test for impairment at
a higher level to avoid the impairment loss.
Q&A IAS 36: 110-1 — REVERSAL OF AN IMPAIRMENT LOSS

Question
An intangible asset costing 10 million is amortised over 20 years. Two years after it
is purchased, it becomes impaired and is written down from its carrying amount of 9
million to its estimated recoverable amount of 5 million. Two years after the
recognition of that impairment loss, the recoverable amount of the intangible asset is
now estimated to be 10 million, following a change in estimates of the future cash
flows arising from this asset.
Can the entity reverse the impairment loss?
Answer
Since the impairment reversal arises from a change in the estimates used to
determine the recoverable amount, the impairment loss should be reversed.
However, the impairment loss can only be reversed to the extent that it does not
increase the carrying amount above what it would have been had the impairment
never occurred. The carrying amount, had the impairment never occurred, would be
8 million (9 million – two years depreciation @ 0.5 million per year); therefore, only
3 million of the original 4 million impairment loss can be reversed.
Q&A IAS 36: 110-EX-1 — DETERMINING WHETHER THE REVERSAL OF

AN IMPAIRMENT LOSS IS APPROPRIATE
Background
An acquired business produces bottled mineral water. Just before the year end, a
consumer group tests the water and publicises the fact that it contains dangerous
levels of a harmful chemical. Sales of the mineral water plummet.
Situation 1
Assume that there is great uncertainty about validity of the consumer group's claim,
but it is assumed to be valid and that sales of the product will recover only after the
problem has been sorted out, and the product has been re-tested and re-marketed.
The future cash-flows indicate that the recoverable amount of the intangible asset
(the brand of mineral water) is less than its carrying amount, so the asset is written
down by the entity.
However, in the next period, further tests demonstrate that the consumer group had
been wrong in its claims and it retracts them publicly. Sales of the mineral water
recover very quickly and soon are back to the previous level.
In this specific case, it is clear that an unforeseen change in the estimates of future
cash flows used in determining the recoverable amount has resulted in the
recognition of the impairment loss, and later in the reversal of that impairment loss.
The intangible asset can be written back up to the value that would have been
recognised had the impairment never occurred (refer to Q&A IAS 36: 110-1). This
write-up is recognised immediately in profit or loss.
Situation 2
Suppose this time that, by year end, the mineral water company has conducted its
own tests and satisfied both itself and independent experts that the consumer group
was wrong in its claims. So the company forecasts that, although there has been a
temporary reduction in the sales, they will soon recover as the consumer group
retracts the claims.
The temporary reduction in sales has caused a small temporary impairment in the
value of the intangible asset as measured at the balance sheet date. The intangible
asset is written down by this small amount to its recoverable amount.
In the next period, the sales increase back to their previous levels in line with
expectations and the value of the intangible recovers to its original level. But, the
(small) impairment loss cannot be reversed this time in the financial statements. Its
reversal was foreseen in the original impairment calculations and has occurred
simply because of the passing of time; therefore, the reversal does not arise from a
change in the estimates used in completing the original recoverable amount
calculation.
Q&A IAS 36: 126-1 — INCLUSION OF IMPAIRMENT LOSS WITHIN

DEPRECIATION
Question
Company G recognises an impairment loss in respect of certain intangible assets with
indefinite useful lives in the fourth quarter of 20X6 in accordance with IAS 36.
Company G has certain debt covenants that state that they must maintain a certain
multiple of EBITDA (earnings before interest, taxes, depreciation, and amortisation).
Can impairment under IAS 36 be included in depreciation expenses?
Answer
No. Impairment losses recognised in accordance with IAS 36 cannot be included
within depreciation expense. IAS 16.6 Property, Plant and Equipment, defines
depreciation as the systematic allocation of the depreciable amount of an asset over
its useful life. The recognition of an impairment loss is as a result of a valuation
exercise, rather than an allocation exercise, and should not be presented in a way
which might encourage the belief that it is part of the regular allocation, that is,
depreciation expense.
Q&A IAS 36: C4-1 — APPLICATION OF IAS 36.C4 WHEN

NON-CONTROLLING INTERESTS ARISE SUBSEQUENT TO THE
BUSINESS COMBINATION AND ARE MEASURED AT THE
PROPORTIONATE SHARE OF NET ASSETS OF THE SUBSIDIARY
Background
IAS 36.C4 requires that, when non-controlling interests (NCI) are measured under
IFRS 3(2008) Business Combinations at their proportionate share of the acquiree's
identifiable net assets, for the purpose of impairment testing the carrying amount of
the related cash-generating unit (CGU) should be grossed up to include the goodwill
attributable to the NCI.
Question
Does IAS 36.C4 apply to situations when the NCI arise from transactions or events
other than a business combination (e.g. a decrease in ownership in a subsidiary
without loss of control) and are measured at the proportionate share of a
subsidiary's net assets?
Answer
No.
The purpose of IAS 36.C4 is to ensure consistency (for the purpose of impairment
testing) between the goodwill included in the recoverable amount of a CGU and the
goodwill included in the carrying amount of that CGU. The cash flows used to
determine the recoverable amount of a CGU reflect 100 per cent of its activities; as a
result, the recoverable amount includes 100 per cent of the goodwill attributable to
the CGU. When NCI arise as a result of a business combination and are measured at
the proportionate share of the acquiree's identifiable net assets, the goodwill
recognised in the consolidated financial statements reflects only the parent's share of
the goodwill. Therefore, there is a potential mis-match for the purpose of impairment
testing, which is avoided by IAS 36.C4's requirement to gross up the goodwill
included in the carrying amount of the CGU.
However, when the parent initially purchased 100 per cent of the subsidiary, the
goodwill recognised in the consolidated financial statements represents 100 per cent
of the goodwill of the subsidiary. This remains the case after the disposal of a
non-controlling interest in the subsidiary, even when NCI recognised subsequent to
the acquisition are measured at the proportionate share of the net assets (see Q&A
IAS 27(2008): 30-1). Therefore, grossing up goodwill for the purposes of impairment
testing would not be appropriate.
Q&A IAS 36: C4-EX-1 illustrates this point.
Q&A IAS 36: C4-EX-1 — EXAMPLE OF THE APPLICATION OF IAS 36.C4

WHEN NON-CONTROLLING INTERESTS ARISE SUBSEQUENT TO THE
BUSINESS COMBINATION AND ARE MEASURED AT THE
PROPORTIONATE SHARE OF NET ASSETS OF THE SUBSIDIARY
Example
Assume that on 1 January 20X3, Parent P acquires 100 per cent of Subsidiary S for
CU1,900. At that date, the fair value of Subsidiary S's net identifiable assets is
CU1,500. Parent P recognises goodwill of CU400 in its consolidated financial
statements as a result of the business combination.
On 1 July 20X3, Parent P disposes of 20 per cent of its interest in Subsidiary S for
CU380. For simplicity, it is assumed that the fair value of Subsidiary S's net
identifiable assets on that date is still CU1,500. Parent P recognises non-controlling
interests (NCI) of CU300 (20% × CU1,500) and the difference of CU80 between this
amount and the proceeds received is recognised in equity. Because control is
retained, there is no adjustment to the carrying amount of goodwill (i.e. goodwill
remains at CU400).
At the end of 20X5, Parent P determines that the recoverable amount of Subsidiary S
is CU1,000. The carrying amount of the net assets of Subsidiary S, excluding
goodwill, is CU1,350.
Testing Subsidiary S for impairment
Because all of the goodwill attributable to Subsidiary S is included in the recoverable

amount of Subsidiary S and is also recognised in Parent P's consolidated financial
statements, no adjustment is required to gross up goodwill for the purpose of
impairment testing. In the circumstances described, an impairment loss of CU750
should be recognised and calculated as follows:
In accordance with IAS 36.104, the impairment loss of CU750 is allocated to the
assets in Subsidiary S by first reducing the carrying amount of goodwill. Therefore,
CU400 of the CU750 impairment loss is allocated to the goodwill and the remaining
impairment loss of CU350 is recognised by reducing the carrying amounts of
Subsidiary S's identifiable assets.
Q&A IAS 36: C6-1 — ALLOCATION OF GOODWILL IMPAIRMENT LOSS

WHEN NON-CONTROLLING INTERESTS ARE MEASURED AT FAIR
VALUE
Background
When non-controlling interests (NCI) are measured at fair value, paragraph B45 of
IFRS 3(2008) Business Combinations indicates that the fair values of the parent's
interest in an entity and the NCI on a per-share basis may differ (e.g. due to the
inclusion of a control premium in fair value of the parent's interest or, conversely,
the inclusion of a discount to reflect its lack of control in the fair value of the NCI). In
such circumstances, the goodwill attributable to the parent's interest is not
necessarily proportional to the goodwill attributable to the NCI.
For example, assume Entity A acquires 80 per cent of Entity B for CU1,250. Entity B
has identifiable net assets with a fair value of CU1,000 and the fair value of the NCI
is determined to be CU250.
Question
If an impairment loss arises on such goodwill, how should the impairment loss be
allocated between the parent interest and the NCI?
Answer
IAS 36.C6 states that "[i]f a subsidiary, or part of a subsidiary, with a
non-controlling interest is itself a cash-generating unit, the impairment loss is
allocated between the parent and the non-controlling interest on the same basis as
that on which profit or loss is allocated".
Accordingly, despite the fact that goodwill attributable to the parent and to the NCI
may not be proportional to the percentage of ownership held by each, any
impairment loss arising on the goodwill should be allocated to the parent and to the
NCI on the same basis as that on which profit or loss is allocated (i.e. in proportion
to their respective present ownership interests).
For example, in the circumstances described above, if an impairment loss of CU100

subsequently arises on Entity B's goodwill, it is allocated 80 per cent to Entity A
(CU80) and 20 per cent to the NCI (CU20).
Equally, if the impairment loss arising on Entity B's goodwill is CU300, CU60 (i.e. 20
per cent) is allocated to the NCI and CU240 (i.e. 80 per cent) is allocated to Entity A.
This is so even though, in this example, the goodwill impairment allocated to the NCI
exceeds the goodwill originally included in the NCI.

[Deleted 11 April 2008]
Deleted

Deleted

Reserved
Q&A IAS 37: 2-1 — LIABILITY WITH PAYMENT LINKED TO FUTURE

SALES
Background
Entity A faces a claim for an alleged infringement of intellectual property (IP) rights.
On 31 December 20X1, in settlement of the claim, Entity A agrees to pay the
claimant a fixed sum plus a variable amount calculated as 1 per cent of any revenue
generated by Entity A over the next five years from sales of a specified product.
Question
At 31 December 20X1, should Entity A recognise a liability for the obligation to pay a
variable amount on the basis of future sales?
Answer
It depends whether the variable amount to be paid based on future sales represents
a settlement for use of the IP in the past or compensation for the future use by
Entity A of the underlying IP:
• if the sales-linked feature is a mechanism for determining the amount

due for past use by Entity A of the IP (plus any compensatory or
punitive element), Entity A should recognise a liability under IAS 39
Financial Instruments: Recognition and Measurement at 31 December
20X1; and
• if the sales-linked payments relate to future use by Entity A of the IP,

the obligation arises as new sales are realised and represents an executory
contract under IAS 37. In such circumstances, Entity A should not
recognise a liability for the variable amount to be paid based on future
sales at 31 December 20X1, unless the executory contract is determined to
be onerous.
In practice, situations in which entities would recognise immediately a liability for the
variable amount to be paid on the basis of future sales are expected to be rare.

Q&A IAS 37: 3-EX-1 — ILLUSTRATION OF EXECUTORY CONTRACT —
EXAMPLE
Example
"Executory contracts are contracts under which neither party has performed any of
its obligations or both parties have partially performed their obligations to an equal
extent". [IAS 37.3] Executory contracts do not fall within the scope of IAS 37, unless
they are onerous. Examples of executory contracts include:
• employee contracts in respect of continuing employment;
• contracts for future delivery of services such as gas and electricity;
• obligations to pay local authority charges and similar levies; and
• most purchase orders.
On 1 January 20X0, Company A enters into a contract with Company B for the
manufacture and delivery of 100 units of component Q at five different dates in the
future, i.e. 500 units are to be delivered in total. Payment is due on delivery of the
units.
On 1 January 20X0, the contract between Company A and Company B is executory

because neither party has performed any of its obligations: Company B has neither
manufactured nor delivered any of the units, nor has Company A paid for any of
them.
By 1 March 20X0, Company B has produced and delivered 200 of the units and
Company A has paid in full for those 200 units. At this date, the contract between
Company A and Company B continues to be executory because both parties have
partially performed their obligations to an equal extent.
By 1 June 20X0, Company B has produced and delivered the full 500 units, but
Company A has only paid for 400 units in total. The contract between Company A
and Company B no longer meets the definition of an executory contract because the
two parties have not performed under the terms of the contract to an equal extent.
Company A is required to recognise a liability for the final 100 units of component Q
for which it has not yet paid.

Reserved

Reserved

Deleted

Deleted
Q&A IAS 37: 14-4 — LATE DELIVERY PENALTIES

Background
In some circumstances, a late delivery penalty may be incurred when goods are not
supplied by a specified delivery date. At the end of its reporting period, an entity
may know that it will not be able to meet the delivery date for goods to be supplied
in the next year.

Question
Should the entity recognise a provision for the penalty that will be payable when, as
is expected, the goods are delivered late?
Answer
No. There is no past event because the late delivery of goods has not yet occurred.
Consequently, there is neither a legal nor a construction obligation to pay the
penalty at the end of the current reporting period and no basis for recognising a
provision for the penalty.
However, if the remaining part of the contract has, as a whole, become onerous as a
result of the penalty clause, a provision should be made for any overall loss expected
to result.
These principles are illustrated in Q&A IAS 37: 14-EX-5.
Q&A IAS 37: 14-EX-5 — LATE DELIVERY PENALTIES — EXAMPLE

Example
Entity A (which has a December year end) signed a firm sales contract with one of
its major clients on 1 February 20X1. This contract specifies that 100 units of a
product must be delivered before 1 February 20X2 at a fixed price of CU10. The
costs of production are CU9 per unit. If the products are delivered more than 10
days late, the client will be given a discount of 50 per cent on each delayed product.
When Entity A signed the contract, it had the ability and the intention to produce the
100 units on time. However, at the end of 20X1, it has only been able to deliver 80
units, and expects to deliver only 10 more before 1 February 20X2 due to
manufacturing constraints. Therefore, at the end of the reporting period, Entity A
expects to deliver 10 of the remaining 20 units at the discounted price of CU5 per
unit.
Total revenue from this contract will be CU950 [(90 × 10) + (10 × 5)]. Total costs
will be CU900 (100 × 9). Therefore, the overall contract is profitable. However, the
situation at the end of the 20X1 reporting period is as follows:
• Entity A has recognised CU800 revenue and CU720 costs (i.e. profit of
CU80) in 20X1;

• Entity A expects to deliver 10 units on time at a profit of CU10 [(10 × 10)
– (10 × 9)]; and
• Entity A expects to deliver 10 units after the deadline at a loss of CU40

[(10 × 5) – (10 × 9)].
The remaining part of the contract is therefore onerous and a provision of CU30
(discounted if material) should be recognised to cover the potential loss arising from
the outstanding obligations under the contract. If Entity A is able and expects to
mitigate damages by purchasing suitable replacement products and delivering them
prior to 1 February, the provision should be adjusted to reflect the expected
economic loss anticipated to be incurred by Entity A.
If Entity A had entered into this contract knowing that it would not be able to deliver
on time, this would have been dealt with under the revenue recognition criteria of
IAS 18 Revenue. If, from the outset, Entity A expected to sell 100 units at an
average price of CU9.50 (CU950 ÷ 100) per unit, then revenue of only CU9.50 would
have been recognised for each unit sold (both in 20X1 and 20X2) and there would
have been no need to consider a separate provision.
Q&A IAS 37: 14-5 — RELOCATION COSTS

[Reissued 11 April 2008]
Question
An entity has decided to relocate one of its employees. The employee is aware of the
impending move. Should the entity recognise a provision for the relocation costs?
Answer
There is no past event until the relocation occurs. Until relocation commences, no
legal or constructive obligation exists; therefore, no provision should be recognised.
Q&A IAS 37: 14-6 — REPURCHASE AGREEMENTS — TRADE-IN RIGHT

Background

In order to facilitate vehicle sales, a motor dealer offers specified-price trade-in
arrangements on vehicles for sale that give a customer the right to trade in his or
her vehicle toward the purchase of a new vehicle. The trade-in may be exercisable
by the customer at a specified point in time or during a specified period of time.
Question
Should the dealer recognise a provision for the cost of the guaranteed vehicle
repurchases?
Answer
If the amount of trade-in credit for the new vehicle that the customer will receive
upon exercise of a specified-price trade-in right is equal to or less than the estimated
fair value of the vehicle at the trade-in date (determined on the date of the sale of
the vehicle subject to the specified-price trade-in right) and, in addition to that
credit, if the customer is required to pay a significant incremental amount for the
new vehicle at the trade-in date, then no revenue from the sale of the vehicle should
be allocated to the trade-in right and no provision should be recognised for the
trade-in right at the time of the sale.
If the motor dealer subsequently determines, however, that the trade-in

arrangement has become onerous, the motor dealer should recognise a provision for
the onerous contract. In assessing whether, and to what extent, the trade-in
arrangement has become onerous, the motor dealer should consider the net of:
• any loss that may be incurred upon the customer's exercise of the
specified-price trade-in right (i.e. the difference between the trade-in price
and the resale value at that date of the vehicle traded in); and
• any profit that may be expected on the sale of the new vehicle to the
customer at the trade-in date.
Q&A IAS 37: 14-7 — EMPLOYMENT DISPUTES

Background
An entity employs three foreign professional seamen. Maritime law prescribes that
registered professionals are paid a premium over unregistered professionals. The
entity subsequently discovers that the professionals are not registered, and
therefore, have been overpaid. The entity consequently reduces the salaries of these
professionals who then take the matter to court. One employee wins the case and is
awarded a CU70,000 retrenchment package. The other two lose on a technicality,

but will appeal the decision. Lawyers are certain that the appeal will be successful.
Question
What provision should be recognised?
Answer
A provision should be recognised for the best estimate of the costs to settle the
appeal. The past event is the underpayment of the employees (after it was thought
they were overpaid) which occurred during the year. As a result of the court
proceedings, a legal obligation to compensate the one employee exists in the current
year (for CU70,000). With regard to the other two seamen, the past event is the
constructive dismissal that occurred during the year. Because it is probable (more
likely than not) that the entity will be found liable, a present obligation exists. It is
probable that economic benefits will flow from the entity.

[Reserved 12 March 2010]
Reserved
Q&A IAS 37: 14-9 — INTERPRETATION OF 'PROBABLE' IN IAS 37

Question
What is the interpretation of the term 'probable' in IAS 37?
Answer
The term 'probable' as used in IAS 37 should be taken to mean more likely than not
to occur. This interpretation does not necessarily apply in other Standards. 'More
likely than not' means that the probability that a transfer of economic benefits will
occur is more than 50 per cent (see also IAS 37.23).
Q&A IAS 37: 14-EX-1 — BEST ESTIMATE: LARGE POPULATIONS —

EXAMPLE
Example
An entity faces 100 legal claims, each with a 40 per cent likelihood of success with
no cost and a 60 per cent likelihood of failure with the cost of each claim to be CU1
million.
Using expected value, the statistical likelihood is that 60 per cent of the claims will
result in a cost of CU1 million. Thus, the best estimate of the provision should be
calculated as 60% × 100 claims × CU1 million per claim = CU60 million.
Q&A IAS 37: 14-EX-2 — BEST ESTIMATE: SINGLE OBLIGATION —

EXAMPLE
Example
An entity faces a single legal claim, with a 40 per cent likelihood of success with no
cost, and a 60 per cent likelihood of failure with a cost of CU1 million.
Expected value is not valid in this case, because the outcome will never be a cost of
CU600,000 (60% × CU1 million). It will either be nil or CU1 million. IAS 37.40
indicates that the provision may be estimated at the individual most likely outcome.
In this example, it is more likely that the cost of CU1 million will result, and
therefore, a provision of CU1 million should be recognised.
Thus, when the provision relates to a single event, or a small number of events,
expected value is not a valid technique.
Q&A IAS 37: 14-EX-3 — BEST ESTIMATE: EXPECTED VALUE —

EXAMPLE 1
Example
An entity is required to replace a major component in an asset under a warranty.
Each replacement costs CU1 million. From experience, there is a 30 per cent chance
of a single failure, a 50 per cent chance of two failures and a 20 per cent chance of
three failures.
The most likely outcome is two failures, costing CU2 million. The expected value is
CU1.9 million [(30% × CU1 million) + (50% × CU2 million) + (20% × CU3 million)].
The expected value supports the provision for the most likely outcome of CU2
million.
Generally, when the most likely outcome is close to the expected value, it will be
appropriate to provide for the most likely outcome because the expected value
provides evidence of the probable outflow of benefits.
Q&A IAS 37: 14-EX-4 — BEST ESTIMATE: EXPECTED VALUE —

EXAMPLE 2
Example
An entity is required to replace a major component in an asset under a warranty.
Each replacement costs CU1 million. From experience, there is a 40 per cent chance
of a single failure, a 30 per cent chance of two failures and a 30 per cent chance of
three failures.
The most likely outcome is a single failure, costing CU1 million. The expected value
is CU1.9 million [(40% × CU1 million) + (30% × CU2 million) + (30% × CU3
million)]. In this case, the most likely outcome of CU1 million has only a 40 per cent
probability. There is a 60 per cent probability that the cost will be higher. The
outcome closest to the expected value is CU2 million (i.e. two failures) and,
therefore, a provision of CU2 million will be made.
When the most likely outcome and the expected value are not close together, it will
often be appropriate to provide for whichever possible outcome is nearest to the
expected value.
Q&As IAS 37: 14-10 and 14-11 — DELETED

IAS 37: 14-10

Deleted
IAS 37: 14-11
Deleted

Deleted
Q&As IAS 37: 14-13 and 14-14 — RECOGNITION OF CONSTRUCTIVE

OBLIGATIONS ASSOCIATED WITH A CONSTRUCTION CONTRACT
Background
Entity X is in the construction industry. It stores plant and machinery at its site, Site
A, and transports certain plant and machinery (e.g. cranes) to a construction site
(Site B), where it is in the process of constructing a hotel. At the end of construction,
Entity X will be required to remove the crane from Site B and transport it back to
Site A, or to a site of another contract.
IAS 37: 14-13
Question
Should a liability be recognised for the transporting of the crane back to site A?
Answer
Yes. A liability should be recognised for transporting the crane back to Site A. IAS 11
Construction Contracts does not deal specifically with this type of provision, and so it
falls within the scope of IAS 37.
It is only those obligations arising from past events existing independently

of an entity's future actions (ie the future conduct of its business) that are
recognised as provisions.
Because the crane cannot be left at Site B, Entity X has a constructive obligation to
remove the crane. Therefore, Entity X should recognise a liability for the removal of
the crane once it is installed on site B and measure that liability at the best estimate
of the cost of transporting the crane back to Site A (or the next site at which it is
required).
IAS 37: 14-14
Question
Can the liability that Entity X recognises for transporting the crane back to Site A be
added to the cost of the crane in accordance with the cost model under IAS 16
Property, Plant and Equipment?
Answer
No. The liability cannot be capitalised to the cost of the crane under the IAS 16's cost
model. In accordance with IAS 16.16(c) the cost of an item of property, plant and
equipment comprises:
[T]he initial estimate of the costs of dismantling and removing the item
and restoring the site on which it is located, the obligation for which an
entity incurs either when the item is acquired or as a consequence of
having used the item during a particular period for purposes other than to
produce inventories during that period.
The cost of the removal of the crane in this instance relates to its redeployment post
inventory production, not to restoring the site on which it was located for
construction purposes.
However, the cost may represent a contract cost under IAS 11 and, if so, would be
included in the associated construction asset.
Q&A IAS 37: 14-15 — OBLIGATION TO RESTORE LEASED PROPERTY


Background
Entity A is a lessee in a lease contract. As a condition of a lease and prior to return of

the property to the lessor, Entity A is required to:
• remove any leasehold improvements, such as additional internal walls or

partitioning made by the lessee; and/or
• repair the fabric of the building so that it is restored to its original condition
at the date of inception of the lease, i.e. to make good any dilapidations.
Question
When should Entity A recognise any provision in relation to restoration of the leased
property?
Answer
If a lease agreement requires an item to be replaced if its standard falls below a
specified level, no provision should be recognised until the point at which it is no
longer possible for the entity to avoid replacing the item.
Generally, it will not be appropriate to recognise a provision for restoring leased

property on a straight-line basis over the lease term, because typically the obligation
will not arise on a straight-line basis. For example, if a lease agreement requires
carpets to be replaced or walls to be repainted at the end of the lease period, full
provision for the associated cost will be required from the outset, because the
outflow cannot be avoided.
Typically, a provision will be recognised on a straight-line basis only when the

associated costs are directly proportional to the length of time for which the
associated asset has been used. This may be true for some elements of restoration
relating to, for example, oil wells and landfill sites, but it is less common for property
leases.
Q&A IAS 37: 14-16 — VOUCHERS ISSUED FOR NO CONSIDERATION

Background
A reporting entity may, for no consideration, distribute vouchers that can be used,
sometimes within a set period, to obtain discounts on the entity's products and/or a
third party's products. (Note: When such vouchers are issued as part of a sales
transaction, it will be necessary to consider the unbundling implications of IFRIC 13
Customer Loyalty Programmes).
Question
Should the entity recognise a provision in respect of the vouchers distributed?
Answer
Applying the recognition criteria of IAS 37, the questions to consider are as follows.
• Is there a present obligation? Generally, the answer will be yes. However,

if the reporting entity reserves the right to terminate the scheme at any
time, thus invalidating existing vouchers, then there may or may not be a
constructive obligation. In the absence of evidence that schemes have
been terminated (and existing vouchers invalidated) in the past, it should
be presumed that an obligation exists.
• Is it probable that economic benefits will be transferred? If, after vouchers

are deducted, the entity's products are still being sold at a profit, the
answer will be no — in which case no provision should be recognised. To
the extent that products will be sold at a loss, however, or that a third
party will be reimbursed for discounts, there will be a transfer of economic
benefits.
• Can a reliable estimate be made? The answer here should be presumed to

be yes, but in making the estimate the entity should consider how many
vouchers are expected to be used.
In summary, if the criteria are met, a provision should be recognised for the best
estimate of the cost to the entity (which may not be the face value of the discounts).
The entity will need to form a view as to how many vouchers are expected to be
used and should also consider whether discounting is appropriate.

Reserved
Q&A IAS 37: 17-2 — OBLIGATION FOR FUTURE COSTS — MAJOR REFIT
AND REPAIR COSTS

Question
Ships and aircraft are required to undergo major work at regular intervals due to
maritime and aviation law. Should an entity, which recognises these ships and
aircraft as assets, accrue an obligation for these future costs?
Answer
No. There is no present obligation created by the legal requirement to do the major
work until the requisite number of hours or days have been completed. The cost of
the major work is not recognised because, at the end of the reporting period, no
obligation to undergo such major work exists independently of the entity's future
actions — the entity could avoid the future expenditure by its future actions, for
example by selling the ship or aircraft.
Q&A IAS 37: 17-3 — ADJUSTMENT OF INSURANCE PREMIUMS

Background
Entity A has an insurance policy with premiums that are adjusted on the basis of
actual losses incurred in that year. For example, if losses for a specific fiscal period
exceed CU100, Entity A will have to pay the insurance company 80 per cent of the
excessive losses in the form of additional premiums in that year.
Question
How should Entity A account for its obligation to pay additional premiums?
Answer
Entity A should recognise a provision as at the end of each reporting period for the
additional premiums due as a result of losses in that year. In estimating that
provision, Entity A should consider not only known losses, but also losses incurred
but not yet reported.
Q&A IAS 37: 17-EX-1 — LEASE OF AIRCRAFT — EXAMPLE

Example
Under some operating leases, the lessee is required to incur periodic charges for
maintenance of the leased asset or to make good dilapidations or other damage
occurring during the rental period. Because the lease is a legal contract, it may give
rise to legal obligations. Accordingly, the principles of IAS 37, which generally
preclude the recognition of provisions for repairs and maintenance, do not preclude
the recognition of such liabilities in a lease once the event giving rise to the
obligation under the lease has occurred.
For example, an entity leases an aircraft under an operating lease. The aircraft has
to undergo an expensive 'C check' after every 2,400 flying hours.
The requirement to perform a 'C check' does not give rise to a present obligation at
the time the lease is signed because, until 2,400 hours have been flown, no
obligation exists independently of the entity's future actions. Even the intention to
incur the cost of a 'C check' depends on the entity deciding to continue flying the
aircraft. Therefore, no provision should be recognised for a future 'C check'. The cost
of each successive 'C check' will instead be capitalised when it is incurred and
amortised over the period to the next 'C check'.
This leaves the question of the condition in which the aircraft must be returned to
the lessor at the end of the lease and of whether this creates a present obligation,
and thus the requirement for a provision, at the time the lease is signed. The answer
depends on what the lease terms state will happen when the aircraft is returned at
the end of the lease. If no final 'C check' is required (i.e. in the final period, the client
can use the aircraft for up to 2,399 flying hours and then return it without bearing
any cost), no provision should be recognised because there is no legal obligation.
If a 'C check' is required at the end of the lease, irrespective of how many hours
have been flown, full provision for the cost should be recognised at the start of the
lease. The costs should be carried forward and written off over the shorter of the
next 2,400 flying hours and the number of flying hours to the end of the lease — and
similarly each time a 'C check' is carried out.
If, on returning the aircraft, the entity must make a payment towards the 'C check'
which is in proportion to the number of hours flown (e.g. 75 per cent of the cost of a
'C check' for 1,800 hours flown), then an obligation is created as the aircraft is used.
It will be appropriate to build up a provision based on the number of hours flown.

[Amended and Renumbered to Q&A IAS 37: 53-2 on 26 June 2009]
Renumbered

Deleted

Deleted

[Reserved 19 August 2005]
Reserved

Deleted

Q&A IAS 37: 51-EX-1 — EXPECTED DISPOSALS OF ASSETS — EXAMPLE
Example
Under IAS 37.51 and 52, gains from expected disposals of assets should not be
taken into account in measuring a provision, even if the expected disposal is closely
linked to the event giving rise to the provision. At the end of 20X1, an entity is
demonstrably committed to the closure of some facilities, having drawn up a detailed
plan and made announcements. The expected impact of the plan is as follows.
The provision required at the end of 20X1 is CU100 million (ignoring discounting).
The expected gain on the sale of the property is dealt with separately under the
derecognition criteria in IAS 16 Property, Plant and Equipment.
Q&A IAS 37: 53-1 — PROVISIONS FOR COLLATERALISED OR

GUARANTEED LOAN COMMITMENTS
Background
Entity A has issued a non-cancellable loan commitment at market terms to Entity B.

The loan commitment cannot be settled net, and Entity A has no past practice of
selling the assets resulting from its loan commitments shortly after origination.
Entity A did not designate this loan commitment at fair value through profit or loss;
therefore, in accordance with paragraphs 2(h) and 4 of IAS 39 Financial
Instruments: Recognition and Measurement, this loan commitment is scoped out of
IAS 39 and should be accounted for according to IAS 37.
Scenario 1:
The loan subject to the loan commitment is guaranteed by another party (e.g. the
parent of the borrowing entity or an insurer). That party will reimburse Entity A for
any loss incurred if Entity B fails to make payments when due (i.e. if there is a
breach of contract). The loan commitment has not been settled at the end of the
reporting period; however, Entity A assesses that Entity B will not be able to repay
the loan that Entity A has committed to grant to Entity B.
Scenario 2:
The loan subject to the loan commitment is a collateralised loan; that is, if Entity B
fails to make payments when due, Entity A will be transferred the legal ownership of
the collateral (e.g. property). The loan commitment has not been settled at the end
of the reporting period; however, Entity A assesses that Entity B will not be able to
repay the loan that Entity A has committed to grant to Entity B.
Question
How should Entity A account for the loan commitments under Scenarios 1 and 2 at
the end of the reporting period?
Answer
In general, a provision should be recognised when conditions set out in IAS 37.14
are met. That is, if Entity A has assessed at the end of the reporting period that
Entity B will not be able to repay the loan, a provision should be recognised.
Scenario 1:
The provision should be measured according to IAS 37.36 at “the best estimate of
the expenditure required to settle the present obligation at the end of the reporting
period”. In accordance with IAS 37.53, Entity A shall not take into account the
guarantee provided by the parent or insurer when assessing the amount of the
provision necessary at the end of the reporting period.
The guarantee provided by the parent or insurer is a reimbursement right because

Entity A “is able to look to another party to pay part or all of the expenditure
required to settle a provision” (IAS 37.55). The guarantee, therefore, should be
recognised as a separate asset. However, this should only be done when the
conditions required by IAS 37.53 are met, which requires that a reimbursement from
another party is recognised only when it is virtually certain that reimbursement will
be received if Entity B fails to make payment when due. The 'virtually certain' criteria
may be met once the breach of contract from Entity B has occurred (e.g. at the first
interest payment date).
If the guarantee was part of the same contractual arrangement, then it would be
bundled and an alternative treatment would be appropriate (e.g. when the loan
commitment issued to Entity B is guaranteed by the parent of Entity B, and the
guarantee is part of the same contractual arrangement (see the answer for scenario
2 below)).
Scenario 2:
Collateral held on the loan is not a reimbursement right as Entity A is not “able to
look to another party to pay part or all of the expenditure required to settle a
provision” (IAS 37.55). Accordingly, this collateral is not separate to the loan
commitment and, when accounting for the provision, it should be treated as a net
arrangement with a single counterparty (i.e. the collateral should be taken into
account when measuring the provision amount).
The provision is measured according to IAS 37.36. Although the loan commitment is
within the scope of IAS 37, in practice, a provision will be recognised at the amount
equivalent to the impairment that would have been required under IAS 39.63, which
states that “the amount of the loss is measured as the difference between the
asset's carrying amount and the present value of estimated future cash flows”.
Additionally, IAS 39.AG84 indicates that “the calculation of the present value of the
estimated future cash flows of a collateralised financial asset reflects the cash flows
that may result from foreclosure, less costs for obtaining and selling the collateral,
whether or not foreclosure is probable”. Accordingly, the provision is recognised for
the present value of the net non-recoverable amount (including the value of the
collateral, less the cost for obtaining and selling it).
Q&A IAS 37: 53-2 — RECOGNITION OF REIMBURSEMENT EXPECTED

FROM INSURANCE COMPANY
[Amended and Renumbered from IAS 37: 31-1 on 26 June 2009]
Background
An entity has a high probability of losing a lawsuit in which it is the defendant. The
entity's insurance company is expected to cover any loss incurred.
Question
What amounts, if any, should the entity recognise in its statement of financial
position in respect of the anticipated loss and reimbursement?
Answer
The outflow of resources expected on the loss of the lawsuit and the amounts
expected to be recovered from the insurance company arise from the same past
event.
When the conditions of IAS 37.14 are met, the entity should recognise a liability for
the expected outflow of resources, measured at the best estimate of the expenditure
required to settle the obligation at the end of the reporting period as stated in IAS
37.36.
In respect of the expected recovery from the insurance company, the entity should
assess the effectiveness of its insurance policy. Under IAS 37.53, it should recognise
the amount expected to be reimbursed (as a separate asset) when, and only when,
it is virtually certain that the claim will be received (i.e. unless there is doubt
regarding the insurance claim).
The amount recognised for the reimbursement should not exceed the amount of the
provision.
Q&A IAS 37: 53-3 — RECOGNITION OF REIMBURSEMENTS

Question
An entity with a present obligation may be able to seek reimbursement of part or all
of the expenditure from another party. Under what circumstances should an entity
recognise a reimbursement asset?
Answer
The basis underlying the recognition of a reimbursement is that any asset arising is
separate from the related obligation. Consequently, such a reimbursement should be
recognised only when it is virtually certain that it will be received consequent upon
the settlement of the obligation. [IAS 37.53] This treatment is also consistent with
guidance on contingent assets.
When a provision has been recognised, the occurrence of the expenditure is taken to
be certain for the purposes of assessing the probability of receiving reimbursement
and judging whether it is virtually certain.
Note that it is the existence of the reimbursement asset that must be virtually
certain, rather than its amount. An entity may be virtually certain that it has
insurance to cover a particular provision, but it may not be certain of the precise
amount that would be received from the insurer. Provided that the range of possible
recoveries is such that the entity can arrive at a reliable estimate, it will be able to
recognise this as an asset, even though the amount ultimately received may be
different.
Q&A IAS 37: 53-4 — MEASUREMENT OF REIMBURSEMENTS — IMPACT

OF THE TIME VALUE OF MONEY
Question
If an entity has a provision and a matching reimbursement, and the time value of
money is material to both, should both be discounted?
Answer
In principle, both the asset and the liability should be discounted. If there will be a
significant interval between the cash outflows and receiving the reimbursement, the
reimbursement will be more heavily discounted; in such circumstances, if the gross
inflows and outflows are the same, on initial recognition there will be a net cost. If
(presumably rarely) the reimbursement will be received first, IAS 37.53 will restrict
the discounted amount of the reimbursement so that it does not exceed the
discounted amount of the provision. In the statement of comprehensive income, the
unwinding of the discount on the reimbursement may be offset against that on the
provision.
When a reimbursement will not be received until some significant time after the
outflows to which it relates, it is possible (though perhaps rare) that it may carry
interest, or in some other way be increased, so as to reimburse the entity for the lost
time value of money. The only restriction in IAS 37 is that the asset recognised (i.e.
the discounted amount) must not exceed the provision recognised. It is, in principle,
possible for the gross amount of reimbursement used in the discounting calculation
to exceed the gross outflows expected (i.e. for the undiscounted asset to be greater
than the undiscounted liability).

Deleted
Q&A IAS 37: 59-2 — CHANGE IN THE DEGREE OF UNCERTAINTY

ASSOCIATED WITH A PROVISION
Question
When the amount payable under an obligation becomes certain, should the amount
previously recognised as a provision be reclassified?
Answer
Yes. The degree of uncertainty associated with an obligation can change over time.
In some cases, an obligation will be recognised initially as a provision due to the
uncertainty surrounding the amount payable. Subsequently, after negotiation with
the counterparty, an exact amount may be agreed upon. To the extent that the
agreed amount is not settled immediately, it no longer meets the definition of a
provision and, therefore, should be reclassified to another appropriate category
within liabilities.
Q&A IAS 37: 66-1 — RECOGNITION OF ONEROUS CONTRACTS

Background
Company A entered into a contract for the supply of goods with an estimated cost of
sales of CU100. Because of increased costs, Company A's expenditure to meet its
contractual obligations is expected to be CU120. Therefore, the contract is
considered to be onerous, and a provision should be recognised. Assume that any
compensation or penalties arising from failure to fulfil the contract are equal to the
cost of fulfilling the contract (i.e. CU120).
Question
Should the provision recognised by Company A be the full cost of fulfilling the
contract (CU120) or only the expected loss (CU20)?
Answer
Company A should recognise a provision for the onerous contract equal to the
expected loss (CU20).

IAS 37.10 defines an onerous contract as “a contract in which the unavoidable costs
of meeting the obligations under the contract exceed the economic benefits expected
to be received under it”. IAS 37.68 further states that “[t]he unavoidable costs
under a contract reflect the least net cost of exiting from the contract, which is the
lower of the cost of fulfilling it and any compensation or penalties arising from failure
to fulfil it” (emphasis added).
Because IAS 37 refers to the net cost rather than the gross cost associated with the
contract, the provision for the onerous contract should reflect the costs required to
fulfil the contract net of any income that the entity will receive as a consequence of
fulfilling the contract.
Q&A IAS 37: 66-2 — IDENTIFICATION OF ONEROUS CONTRACTS

Question
How should an onerous contract be identified?
Answer
An onerous contract is defined in IAS 37.10 as "a contract in which the unavoidable
costs of meeting the obligations under the contract exceed the economic benefits
expected to be received under it". The unavoidable costs under a contract reflect the
least net cost of exiting from the contract, i.e. the lower of (a) the cost of fulfilling
the contract and (b) any compensation or penalties arising from failure to fulfil the
contract. [IAS 37.68]
It is not appropriate to test for an onerous contract only by comparing the value of
the goods or services to be received or provided with the amount to be paid or
received. A mere fall in price does not necessarily mean that a contract is onerous.
Instead, the test of whether a contract is onerous focuses on how the goods or
services that are the subject of the contract will be used within the business.
Depending on the facts and circumstances, the contract may or may not relate to a
cash-generating unit (CGU). For example, a vacant leasehold property is not part of
any CGU of a lessee because it is not being used in the business. Therefore, the
lease contract will be onerous if the cash flows to be generated through sub-letting
are lower than those to be paid as rental. In such circumstances, a provision should
be recognised at the lower of the net rental payable (after deducting rental income
to be generated) and any penalty payable for early termination of the lease.
Conversely, a contract to buy goods or services that will be used by a CGU will not
be onerous unless the cost of those items is such that it will cause the CGU to report
a loss or will increase a loss to be reported by the CGU. However, even when this is
the case, it does not follow that a CGU reporting a loss will necessarily have an
onerous contract or contracts. Rather, it will always be necessary to consider
contracts individually in order to assess whether the unavoidable costs of meeting
the obligations under the contract exceed the economic benefits expected to be
received under it. Onerous contracts may arise when an entity prepares financial
statements on a basis other than that of a going concern. In those circumstances,
contracts that would not normally be onerous, e.g. employee contracts, may become
onerous.
Long-term contracts for the supply of goods or services when costs have risen or
current market prices have fallen may be onerous and, if so, a provision is
recognised to the extent that future supplies must be made at a loss. No provision is
recognised under a contract for the supply of goods which is profitable, but at a
reduced margin compared to other contracts, because there is no probable net
transfer of economic benefits by the reporting entity.

Deleted

Deleted
Q&A IAS 37: 72-2 — LEASE TERMINATION

Background

An entity has developed a detailed formal plan for restructuring a business, and has
announced the key features of the restructuring to all affected by it in a manner that
meets the criteria of IAS 37. As part of the restructuring, the entity has entered into
an oral agreement (i.e. a commitment has been established) with the landlord to
terminate a lease and pay a settlement fee of CU1 million to the landlord. The
settlement fee represents a direct cost resulting from the restructuring. The entity
does not expect to be able to sublet the lease; therefore, the CU1 million represents
the minimum expected obligation.
Question
Should a provision be recognised for the settlement fee to the landlord?
Answer
Yes. A provision should be recognised for the CU1 million settlement fee for the lease
because a valid expectation has been created between the lessor and lessee that the
lease will be terminated.
The entity has a constructive restructuring obligation because it has publicly

announced the plan to restructure. Such an announcement gives rise to valid
expectations in other parties (e.g. the lessor) that the entity will carry out the
restructuring, which includes the termination of the lease.
Q&A IAS 37: 72-3 — IDENTIFICATION OF EMPLOYEES TO BE

TERMINATED UNDER A RESTRUCTURING PLAN
Background
Under IAS 37.72, the two principal requirements for the recognition of a provision for
a restructuring are that the entity (a) "has a detailed formal plan" and (b) "has
raised a valid expectation in those affected [that the plan will be carried out,] by
starting to implement that plan or announcing its main features to those affected by
it".
Question
To meet the criteria for recognition as a provision, is it necessary that a plan for
restructuring specifically identify which individual employees will be terminated under
the plan?
Answer
No. IAS 37.72(a) requires that the detailed formal plan must identify the location,
function and approximate number of employees who will be compensated for
terminating their services. Generally, it is not necessary for the plan to be so detailed
that it identifies which individual employees will be leaving. However, it must be
sufficiently detailed that those employees in the employee groups affected by the
restructuring plan have a valid expectation that either they or their colleagues in the
group will be affected.
Q&A IAS 37: 72-4 — ENTITY IS DEMONSTRABLY COMMITTED TO ONLY

PART OF A RESTRUCTURING PLAN
Background
IAS 37.72 states that a constructive obligation to restructure arises only when the
entity (a) "has a detailed formal plan" and (b) "has raised a valid expectation in
those affected [that the plan will be carried out,] by starting to implement that plan
or announcing its main features to those affected by it".
Question
To meet the criteria for recognition as a provision, is it necessary that the entity be
demonstrably committed to all of the restructuring plan?
Answer
No. IAS 37.74 clarifies that, for a plan to be sufficient to give rise to a constructive
obligation when it is communicated to those affected by it, implementation of the
plan should be planned to begin as soon as possible and to be completed within a
timeframe that makes significant change to the plan unlikely. When either there is a
long delay before commencement, or execution of the plan will take an unreasonably
long time, the timeframe allows opportunities for the plan to be changed. Thus, it is
unlikely that the reporting entity has raised a valid expectation that it is sufficiently
committed to the restructuring.
However, when a restructuring plan will take quite a long time to be completed, it is
possible that the entity may be demonstrably committed to earlier actions in the plan
but not to later actions in the plan. In such circumstances, a provision should be
recognised only for those actions to which the entity is committed, i.e. the earlier
actions in the restructuring plan.
Q&A IAS 37: 72-5 — ENTITY TO HAVE RAISED A VALID EXPECTATION

IN THOSE AFFECTED BY A RESTRUCTURING PLAN AT THE END OF
THE PERIOD
Background
Under IAS 37.72, the two principal requirements for the recognition of a provision for
a restructuring are that the entity (a) "has a detailed formal plan" and (b) "has
raised a valid expectation in those affected [that the plan will be carried out,] by
starting to implement that plan or announcing its main features to those affected by
it".
Question
For the purposes of IAS 37.72(b), does the requirement for the existence of a valid
expectation in those affected relate to the situation at the end of the reporting
period?
Answer
Yes. The expectations of those affected by the plan must have been raised at or
before the end of the reporting period.
The fact that implementation has commenced by the date that the financial
statements are authorised for issue does not of itself provide evidence that a present
obligation existed at the end of the reporting period.
Q&A IAS 37: 82-1 — VACANT PROPERTY

Background
Company X entered into an operating lease over a property several years ago. The
property is now surplus to requirements and Company X has vacated it. The lease
has three years to run with an associated expense of CU10,000 per year.
Company X believes it may be able to find a tenant to take a sublease of the

property, but that it might only receive CU8,000 per year from the sublease.
Alternatively, the landlord is prepared to terminate the lease and forgive the future
rentals of CU30,000, if Company X makes a termination payment of CU5,500.

Question
What, if any, provision should Company X recognise in relation to the operating
lease?
Answer
Because the property has been vacated, and the continuing rentals are not expected
to be recoverable from subleasing the property, a provision should be recognised.
The provision should represent the best estimate of the expenditure required to
settle the obligation at the end of the reporting period. If Company X subleases the
property, it expects to pay CU30,000 in lease rentals and receive CU24,000 in
sublease rentals, which would leave a deficit of CU6,000 to be provided. However, in
this case, the amount the landlord would accept to terminate the lease is CU5,500,
which is lower. Accordingly, Entity X should recognise an onerous lease provision of
CU5,500, irrespective of whether it intends to terminate the lease or enter into a
sublease.

Deleted
Q&As IAS 38: 9-1 and 9-2 — CLASSIFICATION OF COMMISSIONS PAID

TO ACQUIRE CONTRACTS
Background
Company A pays commission to an external party, Company B, which markets its

security contracts. When a customer commits to a security contract, the customer
agrees to use Company A's security services for a minimum of two years and
Company B earns a commission of CU100. If, for any reason, the customer cancels
within those two years, it is required to pay in full for the unexpired term of the
contract at the time of cancellation. Company A has a history of enforcing these

payments in the event of cancellation.
IAS 38: 9-1
Question
Does the commission paid meet the definition of an asset?
Answer
Yes. The commission is paid to acquire an asset (i.e. the ability to obtain revenues
over a minimum two-year period). The asset is controlled by Company A as
evidenced by the enforcement of cancellation penalties, and it has arisen as a result
of past events (the signing of the contract) from which future economic benefits
(security contract revenues) are expected to flow.
IAS 38: 9-2
Question
As determined in Q&A IAS 38: 9-1 above, the CU100 paid to Company B meets the
definition of an asset and should be recognised as an asset. Should this asset be
treated as an intangible asset or as a prepayment?
Answer
The asset meets the definition of an intangible asset in IAS 38.8 because it is "an
identifiable non-monetary asset without physical substance". The amount, which
represents a right to receive future revenue from customers, is clearly identifiable. It
is non-monetary because it cannot be readily converted into cash; and it does not
have physical substance.
Q&A IAS 38: 10-1 — ACCOUNTING FOR COSTS RELATED TO

COMPLIANCE WITH REACH

Background
The Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH)

regulation requires commercial users of chemical substances in the European Union
(EU) to perform studies demonstrating the properties of each of the substances they
use or sell and to pay a one-time fee to register each of the chemical substances.
The registration process (the performance of the studies and the one-time
registration fee) is required for all chemical substances already in use and those that
will be developed. If the registration process is not followed for a substance, a
commercial user cannot market that chemical substance or the products containing
the substance.
In addition, the REACH regulation allows studies performed by one commercial user
to be sold to other users as a means of sharing costs among users.
Question
How should an entity account for the costs of the registration process?
Answer
It depends on whether the costs incurred relate to chemical substances (and
products made with such substances) already in commercial use when the REACH
regulation came into effect or to new substances (and new products made with such
substances) developed after the effective date of the REACH regulation.
Existing Chemical Substances and Existing Products Made With Chemical Substances
The preferred treatment is to recognise the REACH costs relating to existing chemical
substances and products in profit or loss as incurred because those costs do not add
value to the entity's business but rather enable the entity to continue its operations.
However, because there is no clear guidance on the issue, it would also be

acceptable to recognise an intangible asset arising from the costs incurred to comply
with the REACH regulation, provided that the recognition criteria of IAS 38 are met.
This is because the costs incurred under REACH result in an entity obtaining
identifiable rights for the commercial use of a specific substance that are necessary
to earn benefits from that substance or the product that embodies the substance.
The accounting policy adopted should be disclosed and applied consistently.
New Chemical Substances and New Products Made With Chemical Substances
The REACH costs are necessary to the development of new chemical substances (or
new products) and their commercial use. Therefore, if the recognition criteria in IAS
38 are met, an intangible asset should be recognised arising from the costs incurred
to comply with the REACH regulation.
Income From Sale of the Studies
In either case, any income received from the sale of the studies should be
recognised in profit or loss as 'other income' because it is incidental to the
development of the studies.
Note that the conclusions in this Q&A should not be applied by analogy to costs other
than those incurred to comply with the REACH regulation.
Note: In its July 2009 Update, the IFRIC announced its rejection of a request to
provide guidance on the appropriate accounting for the costs of complying with the
REACH regulation. The IFRIC noted that IAS 38 includes definitions and recognition
criteria for intangible assets that provide guidance to enable entities to account for
the costs of complying with the REACH regulation.
Q&A IAS 38: 12-1 — ACQUISITION OF AN INTANGIBLE ASSET WHICH

WILL NOT BE USED
Question
A company acquired a trademark as part of a business acquisition. The trademark
involved the logo of one of its direct competitors. When acquired, the company has
no intention of using this logo.
Can the company recognise the logo as a separate intangible asset?
Answer
Yes. The logo is separable by itself as it can be licensed and arises from legal rights.
In acquiring the logo, the entity makes sure that future economic benefits will
increase as the entity stops or reduces the business of its competitors. The criteria of
IAS 38.12 and IAS 38.21 are met, and therefore, an intangible asset should be
recognised.
However, if the entity has no intention of using the logo after the acquisition, it
should not be allocated to existing cash-generating units, but should be identified as
a cash-generating unit by itself as management intends to exclude the logo from the
operating process. The cash inflows related to the logo are nil. Immediately after
acquisition, it would appear reasonable that the fair value less costs to sell are not
significantly different from the amount recognised. Accordingly, an impairment loss
is not recognised, and the asset must be amortised over its useful life. The useful life
to the entity is the length of time that holding the logo will be effective in
discouraging competition, which would be a fairly short period, as an unexploited
logo loses value quickly. As the entity acquired the asset with the express intention
of denying others the opportunity to use the asset, it appears unlikely that the asset
will be sold in the future and, accordingly, the residual value is nil. As a result, an
amortisation charge for the full carrying amount of the asset is recognised over the
useful life (which may be as short as a single accounting period).
Q&A IAS 38: 16-1 — NON-CONTRACTUAL CUSTOMER RELATIONSHIPS

AND SIMILAR ITEMS
Background
In some industries, such as those providing mobile telephone services, one service
provider may purchase subscriber bases of existing customers from another.
Question
Do non-contractual customer relationships and similar items meet the definition of
intangible assets?
Answer
IAS 38.16 allows that customer relationships and similar items may meet the
definition of intangible assets when either:
• they are protected or otherwise controlled by legal rights; or
• the ability to control the expected benefits flowing from the relationships,
and the separability of the relationships, have been evidenced by
"exchange transactions for the same or similar non-contractual customer
relationships (other than as part of a business combination)".
An established customer base or market share is not usually controlled by the entity.
There may be an expectation that customers will continue to buy from the entity but,
usually, they are under no obligation to do so. Clearly, when the relationship is
protected by a legal right, the entity has control over the future economic benefits.
However, such control may also be evidenced when the entity has acquired a
non-contractual customer relationship in a separate exchange transaction, or when
there have been exchange transactions for similar relationships. Because these
exchange transactions also provide evidence that the customer relationships are
separable, such customer relationships meet the definition of an intangible asset.
In the circumstances described, the price paid for the subscriber bases usually
exceeds the value of the existing contracts, the difference representing the
expectation that existing subscribers will renew their contracts, although they are
under no obligation to do so. The exchange transaction may provide sufficient
evidence to enable the entity to recognise the difference between the price paid and
the value of existing contracts as a separable intangible asset in its own right, even if
the existing customers are under no obligation to renew their contracts. (However,
this should not be confused with the situation when payments are made directly to
potential customers as an incentive to enter into a contract.)
Another example of a common scenario when a non-contractual relationship may

qualify for recognition as a separate intangible in a business combination is when the
acquiree has an established customer loyalty programme to which IFRIC 13
Customer Loyalty Programmes applies.
The IFRS 3 Business Combinations Illustrative Examples address various types of

customer-related intangible assets acquired in a business combination and whether
they meet the definition of an intangible asset.
Q&A IAS 38: 51-1 — RESEARCH AND DEVELOPMENT ACTIVITIES

PERFORMED UNDER CONTRACT FOR OTHERS
Question
When an entity carries out research and development activities under a contract for
others, do such activities fall within the scope of IAS 38?
Answer
When an entity carries out research and development activities for others, the
substance of the arrangement dictates the accounting treatment of the research and
development expenditure for both entities. If the entity carrying out the research
and development activities is retaining the risks and rewards of the activities and will
control any asset that is developed, it should account for the expenditure on the
research and development activities in accordance with IAS 38 and recognise an
internally generated intangible asset when the criteria set out in that Standard are
met.
If the entity carrying out the research and development activities is not retaining the
risks and rewards of the activities and control of any asset that is developed will lie
with the other party, the entity carrying out the activities is providing a service to
that other party and should account for its activities in accordance with IAS 18
Revenue or IAS 11 Construction Contracts, as appropriate. The following factors may
indicate that the risks and rewards of the research and development activities are
retained by the entity carrying out the activities:
• the entity conducting the research and development activities will retain
full rights to any intellectual property that is developed;
• the entity conducting the research and development activities will only
receive payment from the other entity if the outcome of the research and
development activities is successful (i.e. the outcome meets criteria
specified by that other entity);
• the entity conducting the research and development activities is

contractually obliged to repay any of the funds provided by the other
entity, regardless of the outcome of the research and development
activities; or
• even though the contract does not require the entity conducting the
research and development activities to repay any of the funds provided by
the other entity, repayment could be required at the option of the other
entity or the surrounding conditions indicate that repayment is probable.
Q&A IAS 38: 57-1 — DEVELOPMENT COSTS PAID TO AN EXTERNAL

PARTY
Background
Company A pays Company B, an external party, to develop an asset that meets the
requirements of IAS 38 for recognition as an internally generated intangible asset in
Company A's financial statements. Company B is performing only development work.
All the associated research has already been performed, and the costs expensed, by
Company A.
Question
Should Company A recognise an internally generated intangible asset for these costs
under IAS 38?
Answer
Yes. Company A should recognise an internally generated intangible asset for those
development costs under IAS 38. Whether Company A incurs the costs directly via
an internal development function or outsources the development process to an
external party does not influence how Company A should account for the asset in its
Therefore, because the expenditure meets the requirements for the recognition of an
internally generated intangible asset under IAS 38, Company A should recognise the
asset as an internally generated intangible asset in its financial statements. If the
asset being developed did not meet the requirements for recognition of an internally
generated intangible asset under IAS 38, the costs would be considered research
expenditures and would be expensed as incurred. Similarly, if Company B was paid
by Company A to perform both research and development activities, the research
element would be expensed as incurred, but the development element would be
capitalised provided that it met the requirements of IAS 38.

[Added 12 May 2006]
Deleted
Q&A IAS 38: 67-1 — EVALUATING WHETHER GENERAL OVERHEADS

ARE 'DIRECTLY ATTRIBUTABLE COSTS'
Background
Company A is developing a product in premises used solely for the product's

development. The criteria in IAS 38 for the recognition of an intangible asset arising
from the development activities have been met. Company A expects to continue
using the premises after the product's development is completed.
Question
Is it acceptable for the costs of these premises to be included in the cost of the
internally generated development asset?
Answer
IAS 38.66 states that "the cost of an internally generated intangible asset comprises
all directly attributable costs necessary to create, produce and prepare the asset to
be capable of operating in the manner intended by management". Examples cited of
directly attributable costs are:
• costs of materials and services used or consumed in generating the

intangible asset;
• costs of employee benefits arising from the generation of the intangible

asset;
• fees to register a legal right; and
• amortisation of patents and licences used to generate the intangible asset.
Premises costs are more likely to fall under IAS 38.67, which states that selling,
administrative and other general overhead costs are not part of the cost of an
internally generated intangible asset "unless this expenditure can be directly
attributed to preparing the asset for use". Whether such costs can be considered
'directly attributable' will be a matter of professional judgement in the particular
circumstances. However, to qualify as 'directly attributable', it would be expected
that the costs would have been avoided had the entity not engaged in the
development activities.
Therefore, if the premises are rented, it may be possible to demonstrate that the
rental costs are directly attributable costs if they would not have been incurred had
the entity not engaged in the development activities. For example, Company A might
be able to demonstrate that:
• it did not rent the premises until commencement of the development

activities; and
• had it not engaged in the development activities, it would not have rented
the premises until a later date for use in other activities.
Alternatively, if the development activities take place in a property owned by

Company A, prior to commencing those activities, Company A would need to
demonstrate that the costs of the building (or portion of the building) in which the
development activities are carried out would have been avoided, such as in one of
the following scenarios:
• the building (or portion of the building) is separately identifiable and could
have been separately subleased if not used for the development activities;
or
• the building (or portion of the building) would have been used to house
other activities for which Company A has rented additional premises.
Q&A IAS 38: 68-1 — SELLING AND MARKETING COSTS


Entity A, a real estate developer, has incurred selling and marketing costs during the
construction of a block of units that relate to the specific real estate construction
project. These costs include:
• advertising costs for the project;
• sales commissions paid for selling the units; and
• fees paid to the bank to list the property to enable buyers to get
mortgages.
The construction of the units does not fall within the scope of IAS 11 Construction
Contracts. Following the guidance in IFRIC 15 Agreements for the Construction of
Real Estate, revenue from the construction of the units is recognised as a 'sale of
goods' in accordance with IAS 18 Revenue rather than in accordance with IAS 11.
Question
Is Entity A permitted to capitalise these selling and marketing costs?
Answer
Generally, no. However, there may be very limited circumstances in which the
capitalisation of such costs is appropriate. Although IFRIC 15 and IAS 18 are both
silent regarding the accounting for the costs of real estate projects that are not in
the scope of IAS 11, other Standards do provide guidance on the capitalisation of
costs.
The following Standards specifically prohibit the capitalisation of selling and

marketing costs:
• if the real estate units are accounted for as inventories, paragraph 16 of

IAS 2 Inventories prohibits selling costs from being included in the cost of
inventories;
• IAS 16 Property, Plant and Equipment does not permit selling costs to be
recognised as part of the cost of property, plant and equipment unless they
are directly attributable to preparing the asset for use; and
• IAS 11.20 excludes selling costs from the cost of a construction contract.
No Standard permits the capitalisation of advertising or other costs incurred in

attempting to obtain customer contracts.
However, other Standards permit some direct and incremental costs recoverable as a
result of securing a specifically identifiable contract with a customer to be capitalised

in narrow circumstances. For example, provided that specified conditions are met,
IAS 11.21 permits costs incurred in securing a contract to be included as part of
contract costs; and IAS 18.IE14(b)(iii) requires the capitalisation of the incremental
costs of securing an investment management contract. In these circumstances,
when the specified conditions are met, capitalised costs may represent an identifiable
intangible asset arising from contractual or other legal rights in accordance with IAS
38.
The appropriate accounting for selling and marketing costs is dependent on the
specific facts and circumstances. Each situation should be carefully assessed to
determine if capitalisation of such costs is appropriate.
Q&A IAS 38: 75-1 — REVALUATION OF INTERNALLY GENERATED

INTANGIBLE ASSETS
[Added 12 May 2006]
Background
Over the past two years, a group has developed various items of computer software
to be used internally and/or to be sold to prospective buyers. In accordance with IAS
38, the group capitalised the development costs incurred during the development
phase and recognised an intangible asset of CU1 million.
After the reporting date, the group began discussions with a third party for the sale
of the subsidiary that owns the software, or the sale of that subsidiary's assets. The
selling price under negotiation is much higher than the carrying amount of the
subsidiary's assets (which mainly relate to the internally generated intangible asset
and other computer equipment).
Question
Is it acceptable for the group to revalue its internally developed software?
Answer
No. The group is not permitted to revalue its internally generated intangible asset
because no active market exists (IAS 38.75). An active market is only considered to
exist when the items traded in that market are homogeneous, willing buyers and
willing sellers normally can be found at any time, and prices are available to the
public (IAS 38.8).

Although the entity has entered into a sale negotiation, this is not sufficient to
indicate an active market. If an active market, as defined, genuinely existed, the
price for which the asset could be sold would be publicly available and would not be
a matter for negotiation. Indeed, IAS 38.78 states that the fact that there is a sale
agreement between an entity and a buyer does not provide evidence of an active
market.
Q&A IAS 38: 97-1 — DATE OF COMMENCEMENT OF AMORTISATION OF

AN INTANGIBLE ASSET
[Added 12 May 2006]
Background
Operators usually are required to purchase a telecom licence prior to the provision of
services in a particular location or prior to the provision of certain types of services
(e.g. 3G services). Because telecom licences normally are granted for a specified
period of time, the cost of the licence has to be amortised over the best estimate of
its useful life. The operator generally will have to build and commission its network
before it can earn revenues from the use of its licence.
Question
Should the amortisation of the licence begin from the date of acquisition of the
licence or from the date the network assets are ready for their intended use?
Answer
The ability to receive economic benefits from the licence is linked directly to the
ability to use the network; therefore, the licence is only available for use when the
network is in place. Consequently, amortisation of the licence should commence at
the date the network is available for use (i.e. "it is in the location and condition
necessary for it to be capable of operating in the manner intended by management".
[IAS 38.97]
In some countries, the full network may not be operational in the entire targeted
areas until a certain date. However, as soon as one area (one connection) is in place
and working, the amortisation of the licence should start. In most instances, the
amortisation of the licence will begin before the full commercial launch.
Q&A IAS 38: 97-2 — AMORTISATION METHOD FOR INTANGIBLE

ASSETS IN THE ENTERTAINMENT INDUSTRY

Background
Entity A holds an exclusive three-year licence for the distribution of a film. Typically,
the volume of sales declines over the life of the licence, such that Entity A recognises
the majority of its revenue in the first two years of distribution of a new film. Entity
A typically lowers its per-unit selling price over time, in response to the declining
volume of sales.
If Entity A were to use the straight-line method of amortisation, it is likely that Entity
A would need to recognise significant impairment losses towards the end of the
distribution agreement.
Question
Is it acceptable for Entity A to use an amortisation method other than straight-line?
Answer
Yes. The amortisation method for an intangible asset should be selected, as
described in IAS 38.97, so as to "reflect the pattern in which the asset's future
economic benefits are expected to be consumed by the entity". Revenue-based
amortisation methods are not acceptable because they do not reflect the
consumption of the future economic benefits inherent in the intangible asset.
However, methods such as the unit-of-production method, whose application may
consider how revenue will be generated, may be used if they result in a pattern of
amortisation that complies with the principle established in IAS 38.97.
In the specific fact pattern described above, the film distribution licence may be
amortised using a unit-of-production method of amortisation, adjusted to take into
account the typical life cycle of the product as contemplated in IAS 38.90(b).
For example, assume that a film is expected to be in high demand in the first two
years following its launch. In the third year, the distributor estimates that it will be
able to match the volume of sales in the second year but only if it drops the price by
50 per cent. Using this data (assumed to be supported by historical data for similar
products), the distributor may appropriately conclude that the intangible asset
should be amortised 40 per cent (10/25) in Year 1, 40 per cent (10/25) in Year 2,
and 20 per cent (5/25) in Year 3.
In this example, the projected revenue as assessed at each reporting date (rather
than actual revenue) is used to establish the expected remaining consumption of the
asset such that the resulting pattern of amortisation reflects the consumption of the
benefits embodied in the exclusive distribution right.

If at the end of Year 1, actual revenue achieved is less than originally projected and
the distributor now expects to generate equal revenue in Years 2 and 3, the
amortisation recognised in Year 1 would remain at 40 per cent and would not be
revised. However, the amortisation pattern would be adjusted prospectively to reflect
the change in projected revenues. Therefore, the amortisation recognised in each of
Years 2 and 3 would represent 30 per cent of the original cost of the film distribution
licence.
Q&A IAS 38: 104-1 — REASSESSMENT OF THE USEFUL LIVES OF

INTANGIBLE ASSETS
Question
What are the requirements regarding the reassessment of the useful lives of
intangible assets?
Answer
Whether an intangible asset is determined to have a finite useful life, or an indefinite
useful life, IAS 38 requires that the initial determination be reviewed at least
annually.
The determination of useful life for each intangible asset requires a comprehensive
consideration of all pertinent factors surrounding the assets. Subsequent to the initial
determination of useful life, entities must establish sufficient procedures to identify
and evaluate appropriately those events or circumstances that, if occurring or
changed from the initial determination, may impact the remaining useful life. Some
events or circumstances will represent both discrete and readily identifiable events to
which the entity should respond (e.g. a change in regulation). Other events or
circumstances may develop more gradually over time but, nevertheless, must be
monitored and given appropriate consideration by the entity (e.g. obsolescence,
competition, demand). Given the varying nature of the intangible assets, and each
entity's unique background and circumstances, procedures employed by entities to
evaluate useful lives of intangible assets are expected to vary.
When the annual review of the amortisation period of a previously-amortised

intangible asset results in a determination that the asset has an indefinite useful life:
• it should be tested for impairment;
• it should no longer be amortised, but should be accounted for in the same

manner as other intangible assets that are not subject to amortisation; and

• previous amortisation of that asset should not be reversed.
Following the annual reassessment of the useful life of an asset previously

considered to have an indefinite useful life:
• if the intangible asset still has an indefinite useful life, it should be tested
for impairment in accordance with the requirements of IAS 38; or
• if the intangible asset is determined to have a finite useful life, it should be

tested for impairment, amortised over its estimated remaining useful life
and accounted for in the same manner as other intangible assets that are
subject to amortisation, including further impairment testing when
indicators of impairment exist.
Q&A IAS 39: 2(a)-1 — SCOPE: SUBSIDIARIES, ASSOCIATES, AND JOINT

VENTURES
[Issued 10 December 2004]
Question
Are subsidiaries, associates, and joint venture always exempt from the requirements
of IAS 39 in consolidated financial statements?
Answer
No. Interests in subsidiaries are exempt from IAS 39 if they are accounted for under
IAS 27 Consolidated and Separate Financial Statements.
Interests in associates are exempt if they are accounted for under IAS 28
Investments in Associates. The interest is excluded from the provisions of IAS 28 if
the interest is held by (a) a venture capital organisation, or (b) mutual fund, unit
trust or similar entities including investment-linked insurance funds, and the interest
is classified as held for trading in accordance with IAS 39 (IAS 28.1). As with
interests in subsidiaries described above, if an interest in an associate is acquired
and held exclusively with a view to its disposal within 12 months from acquisition,
management is actively seeking a buyer, the investment is in the scope of IAS 39.
Therefore, the investment is classified as held for trading (IAS 28.13 and IAS
28.14(a)) in the consolidated accounts.

Interests in joint ventures are exempt from IAS 39 if they are accounted for under
IAS 31 Interests in Joint Ventures. The interest is excluded from the provisions of
IAS 31 if the interest is held by (a) venture capital organisations, or (b) mutual
funds, unit trusts or similar entities including investment-linked insurance funds, and
the interest is classified as held for trading in accordance with IAS 39 (IAS 31.1).
Q&A IAS 39: 2(a)-2 — SCOPE: INTERESTS IN SUBSIDIARIES,

ASSOCIATES, AND JOINT VENTURES
Question
Are interests in subsidiaries, associates, and joint venture always exempt from the
requirements of IAS 39 in separate financial statements of the investor?
Answer
No. In accordance with IAS 27.37 Consolidated and Separate Financial Statements,
an investor may account for an interest in a subsidiary, associate or joint venture
either at cost, or in accordance with IAS 39 in the separate financial statements. An
entity, therefore, may account for the interest as either fair value through profit or
loss, held for trading or available for sale. The investor cannot account for the equity
interest as held to maturity, because interests in subsidiaries, associates and joint
ventures do not have a maturity.
Q&A IAS 39: 2(a)-3 — SCOPE: DERIVATIVES ON INTERESTS IN

SUBSIDIARIES, ASSOCIATES, AND JOINT VENTURES
Question
Are derivatives on interests in subsidiaries, associates, and joint ventures exempt
from the requirements of IAS 39 in separate financial statements of the investor?
Answer
No. In accordance with IAS 39.2(a), derivatives on interests in subsidiaries,
associates and joint ventures are within the scope of IAS 39, and therefore, should
be treated like all other instruments that meet the definition of a derivative in IAS

39.9; at fair value with gains and losses recognised in net profit or loss.
Q&A IAS 39: 2(b)-1 — SCOPE: EXCEPTION NOT APPLICABLE TO LEASES

Question
Are all leases excluded from the scope of IAS 39?
Answer
No. IAS 32 Financial Instruments: Presentation, defines financial instruments and
provides guidance on applying those definitions. IAS 39 then sets out the recognition
and measurement principles to those instruments that meet the definitions of
financial instruments in IAS 32. It is IAS 17 Leases, that determines whether a
contractual arrangement is a finance lease or an operating lease. A finance lease is
considered to be a financial instrument, whereas an operating lease is not. However,
IAS 39 specifically excludes rights and obligations under leases from its scope as IAS
17 applies, except for certain parts of IAS 39, such as derecognition. For lease
receivables and payables, the derecognition provisions of IAS 39 apply. For lease
receivables, the impairment provisions of IAS 39 also apply. Additionally, derivatives
that are embedded in leases are subject to the embedded derivative provisions of
the standard (IAS 39.2).
Q&A IAS 39: 2(d)-1 — SCOPE: CLASSIFICATION OF A COMPANY'S OWN

SHARES PURCHASED IN ORDER TO HEDGE AN INDEX TRACKER
BOND
Background
Company F is a large financial institution with its shares included in the S&P 100
index. Company F issues a bond whose principal amount varies with the movement
in a share index (referred to as an "index tracker bond"). In order to hedge
economically the equity derivative that is embedded in the bond, F may purchase a
portfolio of the shares contained in the relevant index and classify them as held for
trading.
Question
May F classify its own shares purchased in order to hedge economically the index
tracker bond as held for trading?
Answer
No. IAS 39.2(d) excludes from its scope "financial instruments issued by the entity
that meet the definition of an equity instrument in IAS 32 (including options and
warrants)". Furthermore, IAS 32.33 requires that treasury shares are presented in
the balance sheet as a deduction from equity and not as assets, and that no gain or
loss should be recognised in the income statement on such shares.
Q&A IAS 39: 2(e)-1 — FINANCIAL GUARANTEE CONTRACTS

[Added 12 May 2006]
Background
Company B has a wholly owned subsidiary, Company A. Company A obtained a third

party bank loan in September 2005 that B guaranteed. Under IAS 39, the guarantee
given by B to the third party bank meets the definition of a financial guarantee.
Question
Company B previously has not issued any financial guarantees. Should B apply IAS
39 to the financial guarantee in its separate financial statements at 31 December
2005 and 31 December 2006?
Answer
The amendment of IAS 39 and IFRS 4 Insurance Contracts, is applicable for annual
periods beginning on or after 1 January 2006, with early application encouraged.
Company B does not early adopt this amendment in its 2005 financial statements.
Consequently, B should apply IFRS 4 to the financial guarantee contract issued in its
31 December 2005 financial statements.
Company B may choose to make an explicit statement in its 31 December 2005

financial statements that it regards this financial guarantee contract as an insurance
contract and use accounting applicable to insurance contracts. If it does so, B may
elect to apply either IAS 39 or IFRS 4 to the financial guarantee in its 31 December
2006 financial statements.
Q&A IAS 39: 2(e)-2 — DEFINITION OF A FINANCIAL GUARANTEE

CONTRACT

Question
Is a contract that requires an entity to make payments when the counterparty to a
derivative contract (for example a foreign currency forward contract or an interest
rate swap) fails to make a payment when due considered a financial guarantee?
Answer
No.
IAS 39.9 defines a financial guarantee as a contract "that requires the issuer to
make specified payments to reimburse the holder for a loss it incurs because a
specified debtor fails to make payment when due in accordance with the original or
modified terms of a debt instrument". [Emphasis added] As a derivative is not a debt
instrument, the contract does not meet the definition of a financial guarantee
contract.
Q&A IAS 39: 2(e)-3 — FINANCIAL GUARANTEE CONTRACTS: PARENT'S

REPRESENTATIONS IN SUPPORT OF SUBSIDIARY'S OBLIGATIONS TO
PARTIES OUTSIDE THE GROUP
Background
In some jurisdictions, regulatory or statutory requirements state that an ultimate

parent company or subsidiary (the guarantor) must, or can elect to, make
representations that it will make payments to unspecified parties outside the group
should a subsidiary (obligor) fail to make payments under its obligations to those
parties. The guarantor will make a payment to the debtor equal to the amount that
the obligor has failed to pay. The representation is open-ended (i.e. it relates to all
currently recognised obligations as well as to all obligations that the subsidiary may
enter into in the future) and does not have a specified counterparty.
Question
Is representation by the parent to guarantee obligations of a subsidiary to a third
party a financial instrument and, if so, is it a financial guarantee contract in
accordance with IAS 39.9 in the guarantor's separate financial statements?
Answer
It depends. Before considering whether the representation meets the definition of a
financial guarantee contract in accordance with IAS 39.9, the entity must consider
whether the instrument meets the definition of a financial instrument. If it does not,
the instrument is not within the scope of IAS 39 and cannot be a financial guarantee
contract.
Representations to unspecified parties do not meet the definition of a financial

instrument because they are not a contractual arrangement between the guarantor
and a specified third party or parties. IAS 32.13 Financial Instruments: Presentation,
states that a contract is "an agreement between two or more parties that has clear
economic consequences that the parties have little, if any, discretion to avoid,
usually because the agreement is enforceable by law". A representation to meet the
subsidiary's obligations should the subsidiary fail to meet its obligations is a
representation of unspecified amounts held by unspecified parties. As such, the
representation is not a contractual arrangement and is outside the scope of IAS 32
and IAS 39. In addition, IAS 32.AG12 clarifies that "[l]iabilities or assets that are not
contractual (such as income taxes that are created as a result of statutory
requirements imposed by governments) are not financial liabilities or financial
assets". Therefore, the guarantor would apply IAS 37 Provisions, Contingent
Liabilities and Contingent Assets, and potentially provide for the amount it could be
required to pay under the arrangement if the criteria in IAS 37.14 are met.
If the representation is a contractual arrangement between the guarantor and a

specified third party over a specified amount and, therefore, does meet the definition
of a financial instrument and is within the scope of IAS 39, the entity must consider
whether the instrument meets the definition of a financial guarantee contract in IAS
39.9. A financial guarantee contract only exists when the guarantor agrees to make
specified payments to reimburse the holder for a loss it incurs because a specified
debtor fails to make payment when due in accordance with the original or modified
terms of a debt instrument. If the guarantor has not explicitly stated that it regards
financial guarantee contracts as insurance under IFRS 4 Insurance Contracts, it must
account for the contract in accordance with IAS 39, initially measuring at fair value
and subsequently measuring at the higher of (1) the amount determined in
accordance with IAS 37 or (2) the amount initially recognised less, when
appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue.
Contractual arrangements that do meet the definition of a financial instrument but

do not meet the definition of a financial guarantee contract will be measured at fair
value through profit or loss because the contractual arrangement will meet the
definition of a derivative in IAS 39.9. The contractual arrangement will meet the
following criteria: (1) the initial investment received by the guarantor is small
compared with the amount that could be required to be paid if a claim is made under
the contractual arrangement, (2) the fair value of the arrangement is driven by the
credit risk of the obligor, and (3) the arrangement will be settled either at a future
date, should the holder make a claim against the guarantor, or at its maturity since
expiration at maturity is a form of settlement [IAS 39.IG B7 "Definition of a
Derivative: Option Not Expected to Be Exercised"].

Q&A IAS 39: 2(e)-4 — FINANCIAL GUARANTEE CONTRACT WRITTEN
TO A THIRD-PARTY BANK BY A PARENT
Background
A parent writes a guarantee to a third-party bank that guarantees the performance

of the parent's subsidiary in connection with debt the subsidiary borrowed from the
bank. The parent agrees to pay the bank if, and only if, the subsidiary fails to pay
the bank in accordance with the contractual terms of the debt. Therefore, the
guarantee meets the definition of a financial guarantee contract in accordance with
IAS 39.9. The parent does not receive a premium from the bank for writing the
guarantee, but the bank agrees to lend to the subsidiary at a rate that reflects that
the bank has the guarantee from the parent. The parent does not receive any
payment from the subsidiary for providing the guarantee.
The borrowing contractual interest rate is 7 per cent. For illustrative purposes, the
fair value of the financial guarantee at inception is €1 million and the proceeds from
issuing the debt are €50 million.
Question
When the parent and the group have not explicitly stated that they consider financial
guarantee contracts to be insurance contracts, how should the financial guarantee
contract be accounted for in the financial statements of the: (1) Parent, (2)
Subsidiary, (3) Group?
Answer
Parent
In accordance with IAS 39.AG4(a), the financial guarantee contract must be

recognised initially at fair value. The fair value of a financial guarantee contract will
generally be equal to the premium received from the purchaser of the guarantee
when the arrangement is a stand-alone transaction involving a guarantee for the
debt of an unrelated party. In this instance, no premium was payable by the bank to
the parent. The parent must, therefore, determine the fair value of the guarantee at
inception (i.e., the amount that would have been received by a third party for
guaranteeing the debt of that subsidiary). Since the contract guarantees the
subsidiary's obligation, and the parent entered into the guarantee for nil
consideration, a capital contribution should be recognised.
At inception, the following entry will be required:

The parent will subsequently measure the guarantee at the higher of:
• The amount determined in accordance with IAS 37 Provisions, Contingent

Liabilities and Contingent Assets.
• The amount initially recognised (i.e., the fair value) less, when appropriate,
cumulative amortisation recognised in accordance with IAS 18 Revenue.
Subsidiary
IFRSs do not provide guidance on whether a subsidiary should recognise a capital

contribution when the subsidiary borrows from a bank and the bank acquires a
financial guarantee contract for nil consideration from the parent.
Since the parent should recognise a capital contribution to the subsidiary upon initial
recognition of the financial guarantee contract, the preferred treatment for the
subsidiary is to reflect the capital contribution received from the parent.
Alternative 1: Recognising a capital contribution (preferred treatment)
The fair value of the financial guarantee contract is recognised as a capital

contribution from the parent and considered an incremental cost that is directly
attributable to the acquisition of the financial liability. At inception, the following
entries will be recognised:

The subsidiary will normally subsequently measure the debt at amortised cost and
apply the effective interest rate, unless it has specifically designated the debt as a
financial liability at fair value through profit or loss (when all the criteria are met).
The effective interest rate, provided that the debt is not issued at a discount or
premium and is issued at market terms, will be higher than 7 per cent after the fair
value of the financial guarantee is taken into account. Application of the effective
interest rate will ensure that the carrying value of the financial liability will accrete
from €49 million to €50 million during the life of the instrument.
Alternative 2: Not recognising a capital contribution
If the subsidiary does not recognise a capital contribution, the debt will be initially
recognised at its initial proceeds less transaction costs, if any.
The subsidiary will normally elect to subsequently measure the debt at amortised
cost and apply the effective interest rate, unless it has specifically designated the
debt as a financial liability at fair value through profit or loss (when all criteria are
met). The effective interest rate in this case, provided that the debt is not issued at a
discount or premium, has no transaction costs, and is issued at market terms, will be
equal to the contractual interest of 7 per cent.
Group
The consolidated group has written a financial guarantee contract to a bank that has
lent money to a subsidiary of the group. Upon consolidation, the investment in the
subsidiary will be eliminated. The effect of the guarantee is inherent in the
contractual terms of the instrument. Since the debt was issued at market terms, the
initial proceeds received by the subsidiary from the bank will equal the fair value at
initial recognition. The financial guarantee contract will be eliminated upon
consolidation because the group cannot recognise a financial guarantee over its own
debt. The parent's guarantee forms part of the contractual terms of the debt issued
by the bank to the subsidiary, and the debt is already recognised as a financial
liability in the group's financial statements; therefore, the group has no additional
obligation to the bank.
The debt will be recognised initially at fair value (net of transaction costs).
The group will normally elect to measure the debt at amortised cost and apply the
effective interest method, unless it has specifically designated the debt as a financial
liability at fair value through profit or loss (when all the criteria could be met). The
effective interest rate in this case, provided that the debt is not issued at a discount
or premium, has no transactions costs, and is issued at market terms, will be equal
to the contractual interest of 7 per cent.
Q&A IAS 39: 2(e)-5 — FINANCIAL GUARANTEE CONTRACTS:

TREATMENT BY THE HOLDER
[Added 23 May 2008]
Background
Bank A has total outstanding loans of US$100 million from its largest customer,
Company C. Bank A is concerned about concentration of credit risk and enters into a
contract with Bank B to reduce the credit exposure without actually selling the loans.
Under the terms of the contract, Bank A pays a fee to Bank B at an annual rate of 50
basis points on the par amount of the loans outstanding. If C defaults on any
principal or interest payments, Bank B will pay Bank A for any loss incurred.
Question
How should Bank A account for its contract with Bank B?
Answer
Bank A should first determine whether the contract is (1) a derivative financial
instrument that must be classified at fair value through profit or loss or (2) a
financial guarantee contract in accordance with IAS 39.AG4. Because the contract
requires Bank B to pay Bank A only if Bank A has suffered loss on a specified debt
instrument, the contract meets the definition of a financial guarantee contract in the
financial statements of Bank B (the writer).
IAS 39 provides the writer of the guarantee, but not the holder, with guidance on
accounting for financial guarantee contracts (in this case, the holder is Bank A)1. IAS
39.IN6 states, "Financial guarantee contracts held are not within the scope of the
Standard". However the body of IAS 39 does not specifically exclude financial
guarantee contracts held from the standard's scope. At its June 2007 meeting, the
IASB discussed amending the introduction to IAS 39 to clarify why financial
guarantee contracts held are outside the scope of IAS 39. The clarification was
issued in January 2008 as an editorial change to IAS 39.IN6 only, which now states
that financial guarantee contracts for the holder are not within the scope of IAS 39
"because they are insurance contracts". The scope exclusion does not state which
standard does apply to the accounting for these arrangements.
Because financial guarantee contracts held are not within the scope of IAS 39, they
will generally be recognised as assets equal to the premium paid, with amortisation
of the assets to profit or loss over the period in which the benefit of the guarantee is
obtained. The asset should be remeasured upwards to reflect the claim in accordance
with IAS 37.33 Provisions, Contingent Liabilities and Contingent Assets, only if the
entity considers it virtually certain that its claim under the financial guarantee
contract will be successful. The contract is not accounted for in accordance with IFRS
4 Insurance Contracts, because this standard applies only to the issuer's accounting,
not the holder's.
1 The entity must apply IAS 39 unless it has previously asserted that it regards financial
guarantee contracts as insurance contracts, has used accounting applicable to insurance
contracts, and has elected to apply IFRS 4 instead of IAS 39.2(e).
Q&A IAS 39: 2(e)-EX-1 — ACTUAL CREDIT LOSS CONTRACT

[Amended and Renumbered from IAS 39: 3-EX-2 on 25 August 2006]
Example
Company X owns £100 million of single-family residential mortgage loans. Company
X is concerned that defaults may increase as a result of a recession, and purchases a
guarantee contract from Company B, a mortgage insurance entity. The contract
requires B to pay any loan deficiency to X upon a default and foreclosure by X. The
contract has a £5 million cap. Company B receives a £2 million fee from Company X
for the contract. This contract meets the definition of a financial guarantee contract
in IAS 39.9 because the contract provides for specified payments to be made to
reimburse X for a loss it incurs in the event of a failure of a specified debtor to pay
when due. From the perspective of the issuer, such a financial guarantee contract is
within the scope of IAS 39 unless the issuer has previously asserted explicitly that it
regards such contracts as insurance contracts and has used accounting applicable to
insurance contracts. In the latter case, the issuer of this contract may elect to apply
IAS 39 or IFRS 4 Insurance Contracts. The issuer may make that election contract
by contract, but the election for each contract is irrevocable.

[Renumbered to IAS 39: AG4(a)-EX-1 on 25 August 2006]
Renumbered

[Renumbered to IAS 39: 2(e)-EX-1 on 25 August 2006]
Renumbered
Q&A IAS 39: 5-1 — SCOPE OF IAS 39 — NET SETTLEMENT OF

CONTRACTS TO SELL NON-FINANCIAL ITEMS
Question
Company A is a copper manufacturer. The Company enters into forward contracts to
sell its copper cathode to its customers. The forward contracts are homogenous and
permit the Company to:
• provide physical delivery of copper at the end of the contract, or
• pay or receive a net settlement in cash based on the change in fair value of
copper.
Based on its inventory levels and its production capacity, A is able to meet the
obligation to deliver copper, in accordance with the terms of the forward contracts,
should the Company decide to provide physical delivery of copper relating to all of its
outstanding forward sales contracts.

At inception, management claims that the intention in entering into the forward sales
contracts is for the purpose of delivery of copper in accordance with its sale
requirements. Historically, A has a practice of net settling a portion of similar forward
contracts, provided the contracts are in the money. For contracts that are out of the
money, historically A has opted to physically deliver.
Are these forward contracts scoped out of IAS 39?
Answer
No. In accordance with IAS 39.6(b) and IAS 39, IG A.1, the intention of
management and any past practice of net settling similar contracts must be
considered when assessing whether the contracts are scoped out of IAS 39.
As described above, the contracts are homogenous and the fact that A has a past
practice of net settling a portion of similar forward contracts implies that the
contracts are not held for the purpose of the delivery of copper, in accordance with
the entity's expected sale requirements.
Hence, the forward contracts do not satisfy the scope exemption provided under IAS
39.5; consequently, all of the forward contracts should be accounted for as
derivatives in accordance with IAS 39 since the entire group of forward contracts
cannot be argued to be fully in accordance with the entity's expected sale
requirements.
Q&A IAS 39: 5-2 — MEANING OF DELIVERY — CONTRACTS TO SELL

REFINED GOLD
Background
Entity A is a gold producer that regularly enters into contracts with its customers to
sell refined gold at a fixed price. To supply its customers, A has to assign a gold
refiner to refine the estimated amount of gold doré (i.e. gold that is less pure than
refined gold). When refining is complete, the refiner allocates to the producer's
account an equivalent quantity of refined gold, which is then allocated to the account
of A's customer. This is an integral part of the market process. The gold producer
effectively cannot supply its gold doré directly to its customers.
Question
Can A apply to these contracts the "own use" exemption in IAS 39.5, which excludes
from the scope of IAS 39 "contracts that were entered into and continue to be held
for the purpose of the receipt or delivery of a non-financial item in accordance with
the entity's expected purchase, sale or usage requirements"?
Answer
Yes, as long as the criteria in IAS 39.5–7 are met.
Specifically, the meaning of "delivery" in the IAS 39.5 exemption is not necessarily
restricted to physical delivery of the underlying to a specific customer, because
physical delivery is not a condition of the exemption set out in that paragraph.
While the allocation of an equivalent of refined gold in return for delivery of gold doré
by the refiner cannot be seen as delivery from the producer's perspective, the
allocation to a customer's account could be regarded as delivery.
Note the IFRIC agenda decision published in the August 2005 IFRIC Update.
Q&A IAS 39: 5-3 — MEANING OF DELIVERY — GROSS POOL MARKET

Background
Entity A produces electricity in a country in which the market for electricity is a

"gross pool" market that requires producers and retailers to sell their production to a
market operator (which acts as a clearing entity) at spot price on delivery. To
manage its exposure to spot price risk resulting from the gross pool market
mechanism, A enters into contracts with customers stating that it will pay, or will
receive, the difference between the contracted price and the spot price on settlement
("contracts for difference"). That is, the contracts are settled net. The maturities
correspond with the delivery dates of A's production. The economic result of both
transactions is that A sells its production at a fixed price.
Question
Can A apply to these "contracts for difference" the "own-use" exemption in IAS 39.5,
which excludes from the scope of IAS 39 "contracts that were entered into and
continue to be held for the purpose of the receipt or delivery of a non-financial item
in accordance with the entity's expected purchase, sale or usage requirements"?
Answer
No. The synthetic arrangement that results from linking a non-deliverable contract
(i.e., the contract for difference) to a deliverable contract (i.e. the contract obligating

A to deliver electricity to the market operator) does not meet the scope exemption in
IAS 39.5 because the contracts cannot be considered to be one contract. Entity A
should evaluate both contracts separately. Therefore, the contract for difference will
be within the scope of IAS 39 and accounted for as a derivative.
Note the IFRIC agenda decision published in the August 2005 IFRIC Update.
Q&A IAS 39: 6(b)-1 — NET SETTLEMENT OF FUTURES CONTRACT

Background
Company C is in the business of milling maize as input into its production process.
Company C's procurement strategy for maize includes purchasing futures on the
Futures Exchange. Due to the significant quantity of maize needed, C must enter
into forward purchases of maize to secure the level required for running C's
business. The intention at the outset is to take physical delivery of the maize C
forward purchases.
For example, C is currently procuring maize for its 2003/2004 requirements. The
only available contracts that it can purchase for this maize terminate in July 2003. If
C requires maize for September 2003, it can not at this stage buy a forward for that
period. Throughout the period until July 2003, C will close out some of these July
2003 contracts and take out new contracts to meet its preferred delivery schedule.
For example, in April it may choose to close out some of its July 2003 forwards, and
simultaneously take out September 2003 forwards to meet its requirement for
physical delivery in September 2003; these are closed out at market value at the
time of settlement. Company C eventually will take physical delivery of the maize it
forecasts it will need for production.
Question
Does the practice of net settling the futures contract prevent Company C from using
the normal purchase and sale scope exception from IAS 39?
Answer
IAS 39.5 states the following:
This Standard shall be applied to those contracts to buy or sell a

non-financial item that can be settled net in cash or another financial
instrument, or by exchanging financial instruments, as if the contracts
were financial instruments, with the exception of contracts that were
entered into and continue to be held for the purpose of the receipt or
delivery of a non-financial item in accordance with the entity's expected
purchase, sale or usage requirements.
IAS 39.6(b) clarifies that there are various ways to settle net, including where an
"entity has a practice of settling similar contracts net in cash or another financial
instrument or by exchanging financial instruments (whether with the counterparty,
by entering into offsetting contracts or by selling the contract before its exercise or
lapse)". If offsetting contracts are entered into, then an entity cannot treat any of
the forward contracts (whether the July or the September contract, in this example)
within the entity's expected purchase, sale or usage requirements, and, accordingly,
the contract is within the scope of IAS 39. As the contract meets the definition of a
derivative, fair value gains and losses would be recognised in profit or loss unless
they qualified for, were designated as, and were effective as a cash flow hedge, for
example, as a hedge of the forecast purchase of inventory. Effectiveness could not
be presumed due to differences in the derivative's term and the timing of the
forecast transaction (a July contract for a September transaction), and would need to
be demonstrated.
Q&A IAS 39: 6(b)-EX-1 — COMMODITY-BASED FORWARD CONTRACT:

SETTLEMENT BY DELIVERY
Example
Company X enters into a fixed-price forward contract to purchase one million pounds
of copper. Copper is traded on the London Metals Exchange (LME) and is readily
convertible to cash. The contract permits X to take physical delivery of the copper at
the end of 12 months or to pay or receive a net settlement in cash, based on the
change in fair value of copper. The contract is a derivative instrument because there
is no initial net investment, the contract is based on an index, copper, and it is to be
settled at a future date.
However, the contract qualifies for the exemption and is not considered a derivative
under IAS 39 if:
• X can demonstrate that the contract was entered into and continues to be
held for the purpose of the receipt of copper in accordance with X's
expected purchase or usage requirements, and
• X does not have a practice of settling similar contracts net, or taking

physical delivery of copper and selling it within a short period after delivery
for the purposes of generating a profit from short-term fluctuations in
price.

Q&A IAS 39: 9-1 — UNDERLYING FURTHER EXPLAINED WITH
EXAMPLES
Question
What is an underlying?
Answer
An underlying is a variable that, along with either a notional amount or a payment
provision, determines the settlement of a derivative. Examples of an underlying
include:
• a security price or security price index;
• a commodity price or commodity price index;
• an interest rate or interest rate index;
• a credit rating or credit index;
• an exchange rate or exchange rate index;
• an insurance index or catastrophe loss index;
• a climatic or geological condition (e.g., temperature, earthquake severity,

or rainfall), another physical variable, or a related index;
• other variables (e.g., volume of sales).
An underlying may be any variable whose changes are observable or otherwise

objectively verifiable. The value or related cash flows of all assets and liabilities, and
purchase and sales commitments, change in response to changes in the market
factors in which they are founded. There is nothing unique in this regard about
derivatives, except that the market factor is referred to as an index, a variable or an
underlying and, in many instances, the underlying is not delivered at settlement but
is used as a basis for computing a settlement in cash or net cash.
However, IAS 39.2(h) does scope out derivative instruments where the variable is
based on climatic, geological and other physical variables. If a derivative includes a
variable that is scoped out, e.g., climatic variables, but also includes a variable that
is scoped into the standard, e.g., a financial variable such as interest rates, the part
of the instrument that relates to the financial variable must be accounted for as an
embedded derivative in accordance with the measurement requirements of the

standard.
Additionally, a derivative where the underlying is a specific commodity, for example

oil, may be scoped out of IAS 39 if the contract is considered a normal purchase,
sale or usage requirement contract in accordance with IAS 39.5. Whether the
instrument is scoped in or out of IAS 39 is dependent on the entity's normal business
requirements as well as the settlement terms of the instrument, the entity's past
practice, and whether the instrument is a written option and the underlying is readily
convertible to cash (in accordance with IAS 39.6).
Q&A IAS 39: 9-EX-1 — UNDERLYING: ORDINARY SHARES

Example
Company ABC enters into a contract with a counterparty that requires ABC to
purchase one share in company XYZ in one year for €110, the market forward price.
The current share price of shares in XYZ is €105 per share. In this example, the
share price of XYZ's ordinary shares represents the underlying variable.
Q&A IAS 39: 9-2 — INTERACTION OF NOTIONAL AMOUNT AND

UNDERLYING
Question
How do the notional amount and an underlying interact?
Answer
The settlement of a derivative instrument with a notional amount is determined by
the interaction of that notional amount with the underlying. The interaction may be
simple multiplication, or it may involve a formula with leverage factors or other
constants. A payment provision specifies a fixed payment or payment of an amount
that can change (but not proportionally with a change in the underlying) as a result
of some future event that is unrelated to a notional amount.
Q&A IAS 39: 9-EX-2 — EXAMPLE OF INTERACTION OF NOTIONAL

AMOUNT AND UNDERLYING
Example
Company XYZ enters into an interest rate swap that requires XYZ to pay a fixed rate
of interest and receive a variable rate of interest. The fixed interest rate amount is
7.50 per cent, while the variable interest rate amount is three-month LIBOR, reset
on a quarterly basis. The notional amount of the swap is $100 million.
In this example, the underlying is an interest-rate index, the difference between

7.50 per cent and three-month LIBOR. Payments are based on the multiplication of
the underlying by the $100 million notional amount.
Q&A IAS 39: 9-EX-3 — NOTIONAL AMOUNT AND UNDERLYING:

LEVERAGED INDEX
Example
Company XYZ enters into an interest rate swap that requires XYZ to pay a variable
rate of interest and receive a fixed rate of interest. The fixed interest rate amount is
7.50 per cent, while the variable interest rate amount is three-month LIBOR, reset
on a quarterly basis. The notional amount of the swap is $100 million.
The interest rate swap contains a provision that, if three-month LIBOR exceeds eight
per cent, XYZ will pay the counterparty three-month LIBOR times two. In this
example, the underlying is a leveraged interest rate index. Payments are based on
the multiplication of the underlying and the $100 million notional amount. The
leverage feature is a LIBOR-based written cap. The premium on the embedded
option is paid for by an adjustment to the pay or receive amounts on the swap. In
this instance, XYZ receives a fixed payment that is above market at the swap
inception date. However, the embedded option does not need to be separated out as
an embedded derivative as the whole contract meets the definition of a derivative,
and, therefore, is already recognised at fair value with changes in fair value
recognised in profit or loss. The payment is an adjustment to the terms of the
contract.
Q&A IAS 39: 9-EX-4 — PAYMENT PROVISION

Example
Company XYZ enters into a contract that requires XYZ to pay £10 million if ABC
stock increases by £5 per share during a six-month period; XYZ will receive £10
million if ABC stock decreases by £5 per share during the same six-month period. In
this example, the underlying is a security price, ABC stock. There is no notional
amount to determine the settlement amount. Instead, there is a payment provision
that does not move proportionally with the underlying. In this case, the absence of a
notional amount does not preclude the instrument from meeting the definition of a
derivative because there is a payment provision.
Q&A IAS 39: 9-EX-5 — INITIAL NET INVESTMENT:

DEEP-IN-THE-MONEY OPTION
Example
Company XYZ purchases a deep-in-the-money call option on ABC stock. ABC's stock
price is €100 per share. The option is an American option with a 180-day maturity.
The option has a strike price of €10 per share and XYZ pays a premium of €91. The
initial investment in the option of €91 is less than the notional amount applied to the
underlying, €100 (notional amount is one share and the underlying is €100 per
share). Although the option has a significant initial net investment, it is smaller than
the investment that would be required for other types of contracts that would be
expected to have a similar response to changes in market factors. The invested
amount of €91 does not approximate the notional amount applied to the underlying,
and, therefore, the option meets the initial net investment criterion for a derivative
instrument.
Q&A IAS 39: 9-EX-6 — INITIAL NET INVESTMENT: INTEREST RATE

SWAP
Example
Company B enters into a contract with a counterparty that requires it to pay a
LIBOR-based variable rate of interest on a notional amount of ¥10 billion while the
counterparty pays B an eight per cent fixed rate of interest. The contract is a typical
interest rate swap with a notional amount of ¥10 billion. The contract does not
require an initial net investment by either party. In some instances, the terms of the
interest rate swap may be favourable or unfavourable, and would require one of the
parties to make an upfront initial investment in the contract. If the initial investment
represents a premium or discount for market conditions, the initial net investment
normally would still be smaller than the notional on the debt instrument where the
interest rate cash flows are derived from, and, thus, the contract meets the initial
net investment criteria of a derivative.
Q&A IAS 39: 9-3 — EXECUTORY CONTRACTS

Question
Is any contract that requires settlement at a future date in which neither party has
performed a derivative?
Answer
No. Executory contracts based on agreements to perform services would not fall
under the definition of a derivative since these are settled by performance in the
normal course of business. See IAS 39.AG35(b). However, some executory contracts
are within the scope of IAS 39 with respect to measurement:
• a firm commitment to buy or sell a financial item;
• a firm commitment to buy or sell a non-financial item that is not expected

to be delivered or received in accordance with the entity's expected
purchase, sale or usage requirement contract (IAS 39.5–6);
• a firm commitment that is considered to be a normal purchase, sale or

usage requirement, but is a hedged item in a fair value hedge, or a hedged
item in a cash flow hedge of foreign currency risk only;
• regular-way purchases that require delivery of a financial asset.
Q&A IAS 39: 9-4 — LEGALLY ENFORCEABLE

Question

When is a firm commitment binding?
Answer
A commitment is binding if it is enforceable either legally or otherwise. If the
commitment is with a related party, consideration should be given as to whether in
practice the right can be enforced. To be enforceable, the agreement should provide
for remedies that are available to the parties to the contract in the event of
non-performance. For example, a penalty could be specified at a fixed amount or
equal to the change in market price of the item under the contract. Alternatively, the
penalty may not be stipulated specifically in the agreement but may be applicable
otherwise (for example, remedies under law).
Q&A IAS 39: 9-5 — COMMITMENT AT MARKET

Question
If a commitment requires delivery of a specified number of units and the price
specified is market at the time of delivery, is the commitment considered to be firm?
Answer
Yes. A firm commitment is a binding agreement for the exchange of a specified
quantity of resources at a specified price on a specified future date or dates. If the
firm commitment is a commitment to buy a specified quantity of resource at future
market value, it is still a firm commitment, even though the contract may be
expected to have little or no fair value.
If the price of the underlying item subject to the firm commitment varies, and the
fair value of the firm commitment also varies, the firm commitment may be
fair-value hedged, or with respect to hedging the foreign currency risk only, it also
may be cash-flow hedged.
Q&A IAS 39: 9-6 — MEANING OF "SIGNIFICANT"

Question

IAS 39 frequently refers to "significant" in relation to measurement. For example:
• An entity may continue to classify an asset as held-to-maturity (HTM) if it

has sold some of the asset so close to maturity that changes in the market
rate would not have a significant effect on the fair value of the asset [IAS
39.9].
• An entity should not classify any financial assets as HTM if the entity has,
during the current financial year or during the two proceeding financial
years, sold or reclassified more than an insignificant amount of HTM
investments before maturity without meeting any of the specified
exceptions [IAS 39.9].
• Objective evidence that a financial asset or group of assets is impaired

includes observable data about significant financial difficulty of the issuer
or obligator [IAS 39.59].
• An entity has retained substantially all the risks and rewards of ownership
of a financial asset if its exposure to the variability in the present value of
the future net cash flows from the financial asset does not change
significantly as a result of the transfer [IAS 39.21].
• If an investment's decline in fair value is significant or prolonged then it is

objective evidence of impairment [IAS 39.61].
What does "significant" mean in the context of IAS 39?
Answer
There are no bright-lines in determining what "significant" means. Qualitative and
quantitative factors need to be considered when determining what is "significant" for
the entity.
Q&A IAS 39: 9-7 — DETERMINING THE EFFECTIVE INTEREST RATE

FOR A DEMAND DEPOSIT THAT HAS A ZERO CONTRACTUAL
INTEREST RATE
Question
Parent A provides a $100,000 perpetual interest-free loan to Subsidiary B on at-call
terms. "At call" means that A may demand repayment at any time.
Does the fact that the loan is at call mean that the effective interest rate for the loan

is zero?
Answer
No. In accordance with IAS 39.AG64 the effective interest rate on a loan that carries
no interest is deemed to be the prevailing market rate of interest for a similar
instrument. This is not impacted by the fact that the term of the loan is effectively
zero because it is at call.
IAS 39.AG64 states that "the fair value of a long-term loan or receivable that carries
no interest can be estimated as the present value of all future cash receipts
discounted using the prevailing market rate(s) of interest for a similar instrument
(similar as to currency, term, type of interest rate and other factors) with a similar
credit rating".
When applied together with a zero term, this will result in the loan's amortised cost
being the amount payable on demand. This does not mean, however, that the
effective interest rate is zero.
The determination of an effective interest rate on a loan at call is important as this

effective interest rate affects the assessment of the rate to be applied where the
terms of a loan liability are changed to defer repayment (the substantial modification
test).
Q&A IAS 39: 9-8 — ACCOUNTING FOR "GAMING TRANSACTIONS"

Background
Generally, a gambler places a wager with an operator for consideration, either in the
form of cash or, potentially, on credit.
The placing of the wager creates an agreement between the gambler and the
operator that may be evidenced by a ticket specifying the wager and the odds, or
the agreement may be undocumented.
Once the wager has been made, the operator has an obligation to pay cash to the
gambler if the gambler's wager is a winning bet. This obligation may be legal or
constructive, and is evidenced by the fact that if the operator defaults and does not
pay the wager in the instance that the bet is a winning bet, the operator would suffer
significant economic consequences, including possible withdrawal of its gambling
license.

Depending on the nature and terms of the wager, the gambler may or may not be
allowed to trade or sell the wager contract to another person or entity.
Entities that are involved in gaming operations include:
• Bricks and mortar casinos.
• Online casinos.
• Bookmakers.
• Fixed-odds betting terminals.
• Amusement-with-prizes facilities, including slot machines.
Although operations vary significantly in terms of size, nature of wagers taken, and
involvement in the odds-setting process, the underlying transaction is generally the
same: a wager.
Question
How should an operator or gambler account for wagers?
Answer
IAS 32.13, Financial Instruments: Presentation, refers to the terms "contract" and
"contractual" as denoting an agreement between two or more parties that has clear
economic consequences that the parties have little, if any, discretion to avoid,
usually because the agreement is enforceable by law. The financial instruments may
take a variety of forms and need not be in writing.
The gaming operator has a contractual obligation that meets the definition of a
financial liability. Similarly, the gambler has a contractual right to receive cash if the
wager is a winning bet. This right to receive cash meets the definition of a financial
asset under IAS 32. In particular, IAS 32.AG8 states that the "ability to exercise a
contractual right or the requirement to satisfy a contractual obligation may be
absolute, or it may be contingent on the occurrence of a future event". Additionally,
IFRS 4.B19(d), Insurance Contracts, indicates that a gambling contract is not an
insurance contract and is outside the scope of IFRS 4.
The inability to trade or sell the wager contract to another party does not preclude
the wager from qualifying as a financial asset or financial liability. From the time the
wager is placed and until the instrument is settled, the gambler has a contractual
right to receive cash if certain events occur, and the operator has an obligation to
pay cash if certain events occur.
Most wager contracts meet the definition of a derivative in accordance with IAS 39.9,
because:
1. Their value changes in response to a variable (namely, the event that

determines whether the wager is a winning bet) that is not a non-financial
variable specific to a party of the contract (i.e., a bet that pays out only if a
specified event that occurs is a payment provision as described in IAS
39.AG9, as the instrument requires a fixed payment or payment of an
amount that can change (but not proportionally with a change in the
underlying) as a result of some future event that is unrelated to a notional
amount).
2. They require no initial net investment or one that is smaller than would be
required for other contracts with similar responses to changes in market
factors (the return on the bet is larger than the initial amount paid to place
the bet).
3. They are settled at a future date (if the wager is a winning bet, the
operator will pay the gambler).
In accordance with IAS 39.43, upon initial recognition, the financial asset (from the
gambler's perspective) and the financial liability (from the operator's perspective)
must be measured at fair value, which generally will be the price paid to enter into
the wager, assuming the operator and gambler are unrelated parties transacting at
arm's length. IAS 39.46–47 requires all derivative financial assets and liabilities to
subsequently be measured at fair value with gains or losses recognised in profit or
loss (except if designated as an effective cash flow or net investment hedge).
The fair value gains or losses relating to wagers should be recorded in the balance
sheet gross (i.e., they should not be set-off with other financial instruments unless
the criteria for offset in IAS 32.42 are met). Similarly, the gain or loss on the wager
will be recognised in profit or loss as a single amount and should not be split into
component parts, such as the initial stake and the payout.
In addition, because wagers are derivative financial instruments, the disclosure

requirements of IAS 32 (or IFRS 7, Financial Instruments: Disclosures, if adopted)
will apply.
Care should be taken when assessing the different types of operations of entities in
the gaming industry. In certain instances some operations may have contracts that
do not meet the definition of a derivative because the arrangement does not have an
underlying. A derivative must have either a notional or a payment provision (where
the amount payable is fixed or can change but does not change in proportion to a
change in the underlying).
For example, a lottery operator will issue tickets to players when the player has a
pre-determined probability of winning. As the player selects a set of numbers that, if
chosen in the lottery draw, will result in the player winning, the chance of being a
winner never changes, regardless of the number of tickets sold. Because the
underlying is the event upon which the wager is placed, in this case the chosen
numbers on the lottery ticket equalling that of the lottery draw, this is not a
derivative as the chances of the event occurring are always the same. However, the
lottery tickets issued are a financial liability of the operator and therefore the total
tickets issued should be measured at the total amount that will be required to be
paid to the winner of the lottery draw. If there is no winner in a particular draw or
time period, the operator usually rolls over the total wagers received to the next
draw and the amount carried forward, together with any additional wagers that will
then be available to the next winner. The fair value of such a liability should
therefore reflect the amount that the operator would be expected to pay if a winner
emerged. This is consistent with IAS 39.49, which states that the fair value of a
financial liability with a demand feature (e.g., a demand deposit) is not less than the
amount payable on demand, discounted from the first date that the amount could be
required to be paid.
Q&A IAS 39: 9-EX-7 — FORECAST TRANSACTIONS AND FIRM

COMMITMENTS
Example
It is important to distinguish between forecast transactions and firm commitments.
Forecast transactions are always cash flow hedged, whereas firm commitments are
always fair value hedged (except in hedges of foreign currency risk, where they may
be cash flow or fair value hedged). The following table illustrates differences between
a forecast transaction and a firm commitment:
Forecast Transaction Firm Commitment
In May 20X1, an entity forecasts An entity has signed a legally binding

the purchase of 100,000 bushels of purchase agreement to take delivery of
corn to be used in its 100,000 bushels of corn on 30
manufacturing process in October September 20X1 for $2 per bushel.
20X1.
Corporate Treasury forecasts the Corporate Treasury has signed a legally

sale of an available-for-sale debt binding agreement with a third party to
instrument at the end of the fourth sell a specific available-for-sale debt
quarter. instrument for par on 30 December
20X1

20X1.
Corporate Treasury forecasts the Corporate Treasury has entered into a

purchase of a £25 million bond on legally binding purchase agreement
23 March 20X1 from an investment with a bank to take delivery of a £25
bank. million bond for par on 23 March 20X1.
Q&A IAS 39: 9-9 — CLASSIFICATION OF FAILED LOAN SYNDICATIONS

Background
Entity A originates a loan with the intention of syndication. Subsequently, Entity A

fails to find sufficient commitments from other participants and attempts to sell the
surplus loan amount to other parties in the near term, rather than holding it for the
foreseeable future.
Question
Should the loan amount resulting from the failed loan syndication that Entity A
intends to sell in the near term be classified as held for trading?
Answer
Yes. IAS 39.9(a)(i) requires a financial asset or financial liability that is acquired or
incurred principally for the purpose of selling or repurchasing in the near term to be
classified as held for trading. The definition of loans and receivables also explicitly
requires a loan (or portion of a loan) that is intended to be sold immediately or in the
near term to be classified as held for trading on initial recognition.
IAS 39.AG14 describes characteristics that generally apply to financial instruments

classified as held for trading. However, these general characteristics are not a
prerequisite for all instruments the Standard requires to be classified as held for
trading.
If, subsequently, Entity A changes its intention to sell the surplus loan, it is
permitted in accordance with IAS 39.50D to reclassify the surplus loan amount that
it no longer intends to sell (that would have met the definition of loans and
receivables if it had not been required to be classified as held for trading at initial
recognition) to the loans and receivables category if it has the intention and ability to
hold the financial asset for the foreseeable future or until maturity.

Q&A IAS 39: 10-1 — ASSESSING "CLOSELY RELATED" BY ANALOGY

Question
How does an entity determine whether an embedded derivative is closely related to
the host contract?
Answer
Often, considerable judgment is required to make this determination since there is
no definition of "closely related" in IAS 39. Most of the guidance provided is in the
form of examples. Absent fact patterns that specifically are identified in the
examples in IAS 39, the determination is based on analogy to such examples.
Q&A IAS 39: 10-2 — DETERMINING THE HOST INSTRUMENT

Question
If a hybrid contract has both equity and debt features, when is the host contract an
equity instrument?
Answer
From the perspective of the holder of the contract, if a host contract has no stated or
predetermined maturity and represents a residual interest in the net assets of an
entity, then its economic characteristics and risks are those of an equity instrument,
and an embedded derivative would need to possess equity characteristics related to
the same entity to be regarded as closely related. If the host contract is not an
equity instrument and meets the definition of a financial instrument, then its
economic characteristics and risks are those of a debt instrument (IAS 39.AG27).
A financial instrument host contract commonly will not embody a claim to the
residual interest in an entity and, thus, the economic characteristics and risks of the
host contract should be considered that of a debt instrument. For example, even
though the overall hybrid instrument that provides for repayment of principal may
include a return based on the market price (the underlying as defined by the
Standard) of XYZ Corporation common stock, the host contract does not involve any
existing or potential residual interest rights (i.e. rights of ownership) and, thus,
would not be an equity instrument. The host contract, instead, would be considered
a debt instrument, and the embedded derivative that incorporates the equity-based
return would not be closely related to the host contract.
Q&A IAS 39: 10-3 — EMBEDDED DERIVATIVES: TERMS OF AN

EMBEDDED FOREIGN EXCHANGE FORWARD CONTRACT
Question
How should the terms of a foreign exchange forward contract that is embedded in a
non-financial host contract (e.g. a sales contract that offers the customer credit) be
determined?
Answer
The maturity of the embedded derivative must be equal to the billing date of the
sale, and not when the resulting receivable is expected to be settled. The forward
rate in the forward contract, therefore, is equivalent to the forward rate that would
be achieved for an on-market forward contract with a zero fair value at inception
which expires on the date the sale is billed. It is the sale that is the host contract,
and not the receivable that results from the sale. The receivable is a monetary item
that will be translated into the functional currency of the entity in accordance with
IAS 21 The Effects of Changes in Foreign Exchange Rates.
Q&A IAS 39: 11(a)-1 — MEANING OF "ECONOMIC ENVIRONMENT" IN

THE CONTEXT OF A COMMONLY USED CURRENCY
Question
IAS 39.AG33(d)(iii) states that an embedded foreign currency derivative is
considered to be closely related to the host contract if it requires payments in a
currency that is commonly used in contracts in the economic environment of the
transaction.
Is an economic environment interpreted as the country or the industry in which it

operates?

Answer
The currency that is commonly used in contracts in the economic environment in
which the transaction takes place normally will be viewed as the currency of that
country. Hence, IAS 39.AG33(d)(iii) should be applied consistently to entire
countries, not specific individual industries within countries. [IAS 39.AG33(d)(iii) was
included as a change to the prior version of IAS 39, as described in the Basis of
Conclusions (IAS 39, BC39), where it states that the requirement is relevant "for
entities that operate in economies in which business contracts denominated in a
foreign currency are common".]
However, it may be the case that within a country more than one currency is
commonly used. For example, the analysis of IAS 39.AG33(d)(iii) may have to be
performed separately with respect to internal transactions and external trade. The
wording of IAS 39.AG33(d)(iii) itself suggests that this may be appropriate: "e.g., a
relatively stable and liquid currency that is commonly used in local business
transactions or external trade".
Looking only at local transactions or only external trade, the application of IAS
39.AG33(d)(iii) may lead, in some instances, to a situation where a country has
more than one currency that is "commonly used to purchase or sell non-financial
items". For instance, at a certain point in time, import and export transactions in and
out of a small country (with counterparties in other small countries) may be
commonly denominated in a range of internationally liquid, stable currencies (such
as the euro, the yen and the U.S. dollar) rather than just one internationally liquid,
stable currency. In such a case, if there is a significant level of transactions in each
of the currencies, it may be possible that more than one currency is commonly used
in the economic environment of external trade pertaining to that country.
Similarly, at some point in time, it may be possible that in certain hyperinflationary

economies more than one foreign currency could be used in local business
transactions (because large sections of the general population view amounts in
terms of one foreign currency and significant other sections of the population view
amounts in another foreign currency). Also, it may be the case that a particular
industry which forms a very significant part of the economy commonly uses a foreign
currency in local business transactions whilst the entirety of the remaining part of
the economy uses the local currency. In this case, again, it may be possible that two
currencies are commonly used in the economic environment of local business
transactions in the country in which the transactions are taking place.
In any case, the judgement will depend on how significant the use of a particular
currency is with respect to the local or external trade transactions of the country as a
whole.
Q&A IAS 39: 11(a)-2 — DETERMINATION OF COMMON CURRENCY

Question
IAS 39.AG33(d)(iii) states that an embedded foreign currency derivative is
considered to be closely related to the host contract if it requires payments in a
currency that is commonly used in contracts in the economic environment in which
the transaction takes place (e.g., a relatively stable and liquid currency that is
commonly used in local business transactions or external trade).
A significant portion of imports and exports in Country A are denominated in U.S.

dollars. A considerable number of these transactions are with entities located in the
U.S. The majority of local business transactions in Country A are conducted in euros.
Should trade with U.S. entities be considered when assessing whether the U.S. dollar
is a commonly used currency according to IAS 39.AG33(d)(iii)? Furthermore, how
does the reference to internal or external transactions affect the determination of
common currency?
Answer
Yes, transactions with U.S.-based companies must be included when determining
whether a currency is commonly used in Country A's economic environment.
An entity should assess whether U.S. dollars are commonly used in Country A. IAS
39.AG33(d)(iii) allows the "as commonly used" classification to be based on either
local business or external trade. Therefore, both internal and external business
transactions should be considered when determining whether a currency is
commonly used. As the U.S. dollar is commonly used in external trade in Country A,
it may be considered a commonly used currency for all transactions by companies in
that country (regardless of the location of the counterparty). Accordingly, local
transactions in Country A denominated in U.S. dollars would not require separate
recognition of an embedded derivative because U.S. dollars are commonly used in
external trade.
Q&A IAS 39: 11(a)-3 — ACCOUNTING FOR CASH FLOW CREDIT

DEFAULT OBLIGATIONS
[Added 4 May 2007]
Question
Entity A has established a special-purpose entity (SPE) that issues notes to
investors. The notes pay the performance of specific named corporate debt. The SPE
holds the debt instruments of the named entities. The notes are not designated as
fair value through profit or loss.
The SPE has issued 200 currency units (CU200) of notes — CU140 are AA rated,
CU50 are B rated, and CU10 are C rated. The different ratings arise because the
notes have different exposures to the underlying pool of assets. Each type of note
will pay a rate of interest commensurate with the risk assumed by the investor. The
interest received on the corporate bonds, if paid by the issuer of the bonds, is
distributed by the SPE across the various classes of notes.
If there is a default on one of the bonds (commonly referred to as "first-to-default"),

then the lowest rated note holders will suffer from the default first. The extent of
loss for the note holders depends on their seniority. If the SPE does not receive the
cash flows from the corporate bonds (i.e., in the event of credit default), the SPE is
not required to make payments to its note holders.
Do the notes issued by the SPE contain embedded credit derivatives that should be
separately accounted for?
Answer
No. The economic characteristics and risks of the embedded derivative are closely
related to the economic characteristics and risks of the host contract.
The SPE is similar in nature to a fund with a unit-linking feature as described in IAS
39.AG33(g) and is, therefore, akin to an instrument specified by the standard as not
having an embedded derivative that should be separately accounted for. In addition,
the instrument is similar to a debt instrument with an embedded purchased financial
guarantee contract because the SPE purchases credit protection on its investment in
the corporate bond portfolio by issuing the notes to third party investors.
Since the embedded derivative does not need to be separately accounted for, the
issued notes will be measured at amortised cost with the effective interest rate
applied. The effective interest rate will be calculated by discounting all expected cash
payments and will be updated to reflect changes in expectations of cash flows,
excluding future credit losses. Cash flows are only revised for credit losses at the
point at which an actual default occurs.
This conclusion only applies to cash flow credit default obligations, i.e., when the SPE
actually holds the debt securities of the corporate entities to which the return on the
notes issued by the SPE is linked. When the SPE holds derivatives over the corporate
entities' debt securities, as opposed to investments in the debt securities
themselves, the conclusion in this Q&A will not apply.

Q&A IAS 39: 11-1 — EMBEDDED TERMS HAVING CASH SETTLEMENTS
Question
If a debt instrument provides for an adjustment of interest that is a multiple of the
market rate, is that adjustment closely related to the debt instrument since it is
based on interest?
Answer
Generally, no, since the adjustment is a leveraging feature that is not closely related
to interest. However, if the adjustment does not result in the holder being exposed
to loss on substantially all of its investment, or in the issuer having to pay more than
twice the market rate, the adjustment is considered closely related to risks of the
host instrument as per IAS 39.AG33(a). Also, an adjustment that results from and is
related to the additional risk from credit deterioration, would be considered closely
related to the debt host.
Q&A IAS 39: 11-EX-1 — PERPETUAL PREFERRED SHARES:

CONDITIONAL CASH RETURN
Example
Company A issues $100 million of perpetual preferred shares that pays a
discretionary dividend of eight per cent to Company B. Embedded in the shares is a
provision that states if LIBOR increases beyond 12 per cent, the holders additionally
will receive the difference between LIBOR and 200 basis points, in addition to the
eight per cent dividend. If an additional amount is paid with respect to the interest
rate feature, the dividend on the perpetual preferred shares remain discretionary for
that period and future periods.
Company B classifies the shares as available for sale. Because A has the discretion
whether to pay the dividend, part of the instrument that A has issued is equity, and
part is a liability relating to obligation inherent in the interest rate feature. For B, the
host contract has equity characteristics, and, therefore, any embedded derivative
would be considered closely related to the host contract only if it also shared equity
characteristics. As the embedded derivative's value is derived from movements in
interest rates, which are considered debt, not equity characteristics, the embedded

derivative is not closely related to the host contract.
Q&A IAS 39: 11-2 — EMBEDDED DERIVATIVES: CREDIT ADJUSTMENTS

TO DEBT INSTRUMENTS
Question
Are adjustments to the terms of a debt instrument as a result of defaults, changes in
credit ratings and in a debtor's creditworthiness considered to be derivative features
embedded in a debt instrument?
Answer
IAS 39 specifically does not address adjustments to the terms of a debt instrument
as a result of defaults, changes in credit ratings and in a debtor's creditworthiness.
IAS 39 does state that adjustment to the terms of a debt instrument that relate to a
third party's credit risk are not considered to be closely related. However, if the
terms of a debt instrument protect the investor or compensate the investor for credit
risks related to the issuer, then these are considered closely related to debt
instruments (except if these adjustments are leveraged).
Q&A IAS 39: 11-EX-2 — INDEXED-CREDIT SENSITIVE PAYMENT

Example
Company X issues bonds with a AA rating. At the date of issue, the yield on AA rated
bonds is the equivalent maturity treasury rate plus a credit spread. The bonds have
a provision that requires the interest rate to reset in the event that a competitor of X
receives a credit downgrade.
The embedded credit related provision would be accounted for separately because
the credit of a competitor is not considered to be closely related to the host debt
instrument.
Q&A IAS 39: 11-3 — EMBEDDED DERIVATIVES: ONE OF TWO

VARIABLES EXEMPT

Question
How is a contract accounted for if it contains two or more variables and one of them
qualifies for the exception for climatic, geological or other physical variables?
Answer
The component that does not qualify for the exemption for physical variables is
required to be bifurcated and accounted for as a derivative if on a stand-alone basis
it meets the definition of a derivative. See IAS 39.10–11.
Q&A IAS 39: 11-EX-3 — MULTIPLE UNDERLYINGS, INCLUDING A

PHYSICAL UNDERLYING
Example
Entity X enters into a forward contract to purchase one million shares of Entity B, a
public company that owns and manages holiday resorts in A Land. The forward
contract is priced at market value and has a conditional underlying that is based on
the number of sunny days in A Land in June. If there are less than ten days of
sunshine in A Land in June, the forward contract is terminated for nil consideration.
The forward contract has two underlyings: (1) Entity's B's equity price, and (2) the
number of days of sunshine in A Land in June.
IAS 39.AG1 states that derivatives based on climatic, geological, or other physical
variables are in the scope of IAS 39 unless they meet the definition of an insurance
contract in IFRS 4 Insurance Contracts. In the scenario described above, the weather
feature does not qualify as an insurance contract. [An insurance contract requires
the issuer to accept significant insurance risk from the policyholder by agreeing to
compensate the policyholder if a specified uncertain future event adversely affects
the policyholder.] Therefore, the instrument is wholly a derivative within the scope of
IAS 39 and should be accounted for at fair value through profit or loss.
Q&A IAS 39: 11-EX-4 — EQUITY OPTION DEPENDENT ON INTEREST

RATE CHANGES
Example
Company A issues €100 million of perpetual preferred shares that pays at the
issuer's discretion only, a fixed dividend rate of 10 per cent. Embedded in the shares
is a provision that states if interest rates increase 200 basis points, the holders will
receive 100,000 ordinary shares in A. Assume that the holder classifies the shares as
available for sale with changes in the fair value recognised in equity.
Provided that the fixed dividend of 10 per cent is not a contractual liability, i.e., the
dividend is paid entirely at the discretion of the issuer, the embedded derivative
would not be accounted for separately by the holder since both components of the
instrument are equity of the issuer.
The embedded derivative would not be separated by the issuer because it and the
host instrument are both equity instruments of the issuer. Although the derivative is
triggered by a change in rates, it is indexed to the change in value of the shares and
settled in a fixed number of the issuer's shares.
Q&A IAS 39: 11-EX-5 — PUT OPTION EMBEDDED IN AN EQUITY

SECURITY
Example
Company A issues common stock to investors that is puttable to the Company at the
end of three years at an amount equal to a proportionate share of the net asset
value of A. The put option can be settled in net cash or shares at the option of the
investors. Assume that the investors classify such securities as available for sale with
changes in the fair value recognised directly in equity.
From the perspective of the issuer, a financial instrument that gives the investor the
right to put the instrument back to the issuer for cash, or another financial asset, is
a financial liability. These are referred to as "puttable instruments". The issuer will
recognise the instrument as a debt host contract with an embedded derivative
(equity total return swap) that is not closely related unless the instrument is
measured at fair value with changes in fair value recognised in profit or loss (for
instance, because the issuer applies the option to designate the instrument at fair
value through profit or loss). Similarly, the investor also will treat the instrument as
a debt host contract with an embedded derivative (equity total return swap) that is
not closely related. In both cases, the embedded derivative will be fair valued with
gains and losses recognised in profit or loss.
Q&A IAS 39: 11-EX-6 — CONVERTIBLE PREFERRED SHARES

Example
Company X issues perpetual preferred shares where the remuneration is entirely at
the discretion of the issuer, which are convertible into a fixed number of ordinary
shares at the option of the holder. The conversion feature represents an embedded
call option on X's ordinary shares that meets the definition of equity in accordance
with IAS 32. Company X would not account for the embedded option separately
because on a free-standing basis, the option would be an equity instrument of X.
Similarly, the investor would determine that the host contract has equity
characteristics, and, therefore, because the embedded option also has equity
characteristics, the embedded derivative is considered to be closely related to the
equity-based host contract.
Q&A IAS 39: 11-EX-7 — CONVERTIBLE DEBT: ISSUER VERSUS HOLDER

Example
Company X issues debt that is convertible into a fixed number of its common stock
in five years. The conversion feature represents an embedded written call option on
the stock of X, settled in a fixed number of shares.
For X, the convertible debt is a compound instrument that should be split into its
liability and equity components. Company X would not account for the written call
option as an embedded derivative separately because, on a free-standing basis, the
option would be an equity instrument of X. Equity instruments of the issuer are
exempted from the scope of IAS 39 as they fall within the scope of IAS 32. The
investor would, however, have to account for the embedded purchased option
separately as an embedded derivative under IAS 39.
Q&A IAS 39: 11-EX-8 — PUTTABLE DEBT

Example
Company X issues 10-year bonds with a par value of €1 million for proceeds of
€800,000. The bonds have a coupon of eight per cent. Embedded in the bonds is a
provision that allows the investors to put the bonds back to X for €900,000 in the
event interest rates increase by 500 basis points.
The embedded put option would be accounted for separately because the put's
exercise price is not approximately equal to the debt instrument's amortised cost on
each exercise date.
Q&A IAS 39: 11-EX-9 — SUBSEQUENTLY EMBEDDED PUT BONDS

Example
Company X issues 10-year bonds with a six per cent coupon to a banker and
receives proceeds of €103. The debt is puttable by the holder at the end of three
years. Three-year debt rates for non-puttable/callable debt are six per cent. The
banker attaches a call option and sells the bonds to an investor for a €3 premium.
A party other than the issuer has attached the call option to the debt instrument.
Thus, the investor would not be able to consider the call option as an embedded
derivative. The holder of the call option would have a free-standing derivative that
would be recognised at fair value with fair value changes reported in profit or loss.
In addition, X does not have to consider the accounting for the call option because X
is not a party to the option.
Q&A IAS 39: 11-EX-10 — CONTINGENT EMBEDDED DERIVATIVE:

EXCEPTION FOR PUT OPTIONS
Example
Company X issues $10 million in debt with an eight per cent coupon and a maturity
of eight years. However, if LIBOR increases by 200 basis points within any one year,
the debt is puttable at the end of year five at par. In this example, it is reasonably
possible that LIBOR could increase by 200 basis points.
The embedded contingent put option in this instance would not be automatically
accounted for separately because, as noted in IAS 39.AG30(g), a put option
embedded in a debt instrument that is indexed to interest rates is considered to be
closely related, assuming the put's exercise price is approximately equal to the debt
instrument's amortised cost on each exercise date.
Q&A IAS 39: 11-4 — HIGHLY CORRELATED INDEXED CREDIT

Question
If a credit derivative is embedded in a debt instrument and is indexed to debt
instruments of competitors of the entity in the same industry, and general credit
spreads can be shown to be highly correlated in the industry, is the credit derivative
required to be separated?
Answer
Yes. IAS 39.AG30(h) states that if a credit derivative embedded in a host contract
transfers the credit risk of a particular reference asset (in this case, the competitors
credit risk) to another party the embedded derivative is not closely related to the
host debt instrument.
Q&A IAS 39: 11-EX-11 — EMBEDDED INTEREST RATE CAP

Example
Company X issues $1 million variable-rate debt with a five-year maturity. The
variable rate is indexed to LIBOR, which is 4.5 per cent at the date of issue.
Embedded in the debt is a provision that caps the variable rate at 10 per cent.
The cap would not be accounted for separately because the cap is both related to
interest rates and above the market rate when the debt is issued, and there is no
leverage effect. Thus, the cap is considered to be closely related to the host
instrument.

Q&A IAS 39: 11-5 — A "SUBSTANTIAL PARTY" TO A CONTRACT
Question
What is a "substantial party" to a contract for purposes of evaluating whether there
is an embedded foreign currency derivative in the contract?
Answer
A "substantial party" to the contract is a party acting as in substance principal to the
contract. The criterion for a "substantial party" would not be satisfied if the party is
an agent that is being engaged by the entity solely to comply with the requirement
that payments be denominated in the functional currency of any substantial party to
the contract.
Q&A IAS 39: 11-6 — LIMITATIONS ON CURRENCY OF PRIMARY

ECONOMIC ENVIRONMENT
Question
If payment under a contract that is not a financial instrument is in a foreign currency
that is the currency of the primary economic environment in which a substantial
party to the contract operates, is the foreign currency component always considered
to be closely related to the host contract?
Answer
Generally, yes. However, the exemption applies only to the extent that all other
aspects of the contract are considered to be closely related. Hence, for example, a
leveraged embedded foreign currency forward would be required to be separated
from a foreign-currency-based goods or services contract.
Q&A IAS 39: 11-7 — SALES CONTRACT INDEXED TO AN UNRELATED

CURRENCY

Question
Two Norwegian kroner functional entities have entered into a construction contract
whose price is fixed at the inception in euros. Progress billings under the contract will
be invoiced and paid in Norwegian kroner in two equal installments. Thus, the
amount of kroner payable/receivable will vary based on changes in the euro/kroner
exchange rate at each payment date.
There is no hedge of the foreign currency risk in the contract and the euro is the
currency commonly used in contracts in the economic environment in which the
transaction took place. Does the contract have an embedded derivative?
Answer
The contract contains an embedded derivative because the payment terms in euro
are equivalent to entering into the contract in Norwegian kroner and then entering
into a euro/Norwegian kroner foreign currency derivative. However, the embedded
derivative is considered to be closely related, and, therefore, does not need to be
accounted for separately as a derivative in accordance with IAS 39.AG33(d)(iii)
because the euro is a currency that is commonly used in construction contracts in
the economic environment.
Q&A IAS 39: 11-EX-12 — EMBEDDED FOREIGN CURRENCY PROVISION:

NON-QUALIFYING CURRENCY
Example
Company X, a New Zealand company, leases property under an operating lease from
Company Y, an Australian company. The lease payments are denominated in U.S.
dollars (US$). The functional currency of X is the New Zealand dollar ($NZ) and the
functional currency of Y is the Australian dollar ($A).
The provision to pay in US$ would require separate accounting because it is not the
functional currency of any substantial party to the contract, and the price of this
asset is not denominated routinely in that currency in international commerce, and
US$ is not the currency that is commonly used in the economic environment in
which the transaction took place.
If the property was leased under a finance lease, the embedded derivative would be
considered closely related because:

• a finance lease payable/receivable is a monetary item, and
• IAS 21 requires foreign currency gains and losses on monetary items to be

recognised in profit or loss, so the movement between US$ and the
functional currency will have been already recognised in profit or loss.
Q&A IAS 39: 11-EX-13 — EMBEDDED FOREIGN CURRENCY PROVISION:

INVOLVEMENT OF A THIRD PARTY
Example
Company X would like to lease property from Company Y under an operating lease
and have the payments denominated in U.S. dollars. The functional currency of both
companies is the euro. To accomplish a U.S. dollar-denominated lease, Y leases the
property to an investment bank whose functional currency is U.S. dollars. The
investment banker then subleases the property to X. The sublease agreement
requires X to pay U.S. dollars. If the investment bank was acting solely as an agent
for X to the transaction, and, accordingly, was not at risk, (i.e., the investment bank
would be indemnified for any losses incurred due to a default by X), the parties
would look through the investment bank to X to assess whether the U.S. dollar was
the functional currency of any substantial party to the contract or whether other
exemptions were available.
If the investment bank is a principal to each lease and cannot offset the lease
transactions, the provision to pay in U.S. dollars would not require separate
accounting because the U.S. dollar is the functional currency of the investment bank
who is acting as a principal. That is, the party that is subject to the risk of loss.
Q&A IAS 39: 11-EX-14 — INFLATION-INDEXED PAYMENTS: DOMESTIC

ENVIRONMENT
Example
Company X leases property with a lease term of 10 years. The functional currency of
X is the euro. Lease payments, also, are to be made in euros. Embedded in the lease
is a provision that requires the lease payment to be adjusted every two years for the
change in the euro-land consumer price index. The provision does not have any
additional unusual features.

The embedded inflation indexed payment would not be accounted for separately
because the rate of inflation is not leveraged and is in the same economic
environment of the entity.
Q&A IAS 39: 11-EX-15 — INFLATION-INDEXED PAYMENTS: FOREIGN

ENVIRONMENT
Example
X is the euro. Lease payments are made in euros. Embedded in the lease is a
provision that requires the lease payment to be adjusted every two years for the
change in the UK consumer price index which is not the index of the economic
environment of X.
The embedded inflation indexed payment would be accounted for separately

because, although the rate of inflation is not leveraged, the inflation index is in a
different economic environment than the entity's.
Q&A IAS 39: 11-EX-16 — INFLATION-INDEXED PAYMENTS:

LEVERAGED
Example
X is the Hong Kong dollar. Lease payments, also, are to be made in Hong Kong
dollars. Embedded in the lease is a provision that requires the lease payment to be
adjusted every two years for two times the change in the consumer price index.
The embedded inflation indexed payment would be accounted for separately as an

embedded derivative that is not closely related to the host contract because the rate
of inflation is leveraged.
Q&A IAS 39: 11-8 — SUBSTANTIALLY ALL TEST-BASED ON CONTRACT,

NOT PARTIES

Question
If a holder accounts for a contract as a derivative because it could lose substantially
all of its investment or obtain a rate more than twice the market rate at inception, is
the issuer also required to account for the contract as a derivative?
Answer
Yes. The test is based on the contract provisions, and, therefore, the determination
is made for both parties to the contract based on the return or loss to the investor.
Q&A IAS 39: 11-9 — VARIABLE RATE INSTRUMENTS

Question
Does a variable rate instrument contain an embedded derivative, since the issuer
could "pay a rate more than twice the market rate at inception"?
Answer
No. A rate that is always equal to the current market rate is not an embedded
feature.
Q&A IAS 39: 11-EX-17 — ISSUER'S RATE DOUBLES

Example
Company A issues 30-year zero coupon debt with principal of €10 million due at
maturity. The bonds are issued to yield 5 per cent, excluding the impact of a written
option, embedded in the debt. The option is a five-year written cap with a notional
amount of €460 million and a strike of 10 per cent indexed to six-month LIBOR. The
debt holder receives payments, if any, from the cap component during the first five
years. For example, if rates go to 12 per cent the holder receives two per cent of
€460 million.

The embedded cap would be accounted for separately because it could result in a
rate of return on the host contract that is at least double the issuer's initial rate on
the host contract and could result in a rate of return that is at least twice what the
market return would be for a contract with the same terms as the host contract.
Q&A IAS 39: 11-EX-18 — ISSUER'S RATE DOUBLES

Example
Company A issues £10 million in debt with a coupon of eight per cent and a term of
10 years. Company A's market rate for 10-year debt is 8.25 per cent. Embedded in
the debt is an interest rate adjustment that resets the interest rate to 16.50 per cent
if three-month LIBOR increases to 7 per cent or greater during the first three years
of the debt.
The adjustment feature is a written cap that would be accounted for separately
because it could result in a rate of return on the host contract that is, at least,
double the issuer's initial rate on the host contract and could result in a rate of
return that is, at least, twice what the market return would be for a contract with the
same terms as the host contract.

PROBABILITY ASSESSMENT
Example
Company X issues $10 million in debt with an eight per cent coupon. However, if
LIBOR increases by 500 basis points within any one year, the bonds mature and the
holder receives $8 million in total.
An embedded derivative exists and should be separately accounted for because there
is a payment provision that may cause the holder not to recover substantially all of
its recognised investment if LIBOR increases by 500 basis points.

ISSUER'S RATE DOUBLES
Example
Company X issues $10 million in debt with a variable coupon rate that is factored at
1.99 multiplied by the change in LIBOR. There is a floor such that the investor could
not lose its principal investment. In addition, if LIBOR falls below 3 per cent, no
interest is paid in the period. At inception, LIBOR is 5 per cent.
The leveraged interest rate feature is an embedded derivative that would be

accounted for separately because although the investor would not lose its
investment, and the purchased floor is out of the money at inception, interest rates
could change such that the issuer may pay more than twice the market rate at
inception and a rate of return more than double the market return for a contract with
the same terms as the host contract. For example, if rates increase by 260 basis
points, the issuer would pay 10.17 per cent which is more than double the initial
market rate.
Q&A IAS 39: 11-EX-21 — EMBEDDED DERIVATIVES: EXAMPLES OF

CLOSELY RELATED
Example
The table below provides a summary of examples illustrating the application of the
closely related criteria to derivative instruments embedded in hybrid instruments.
Specifically, each example (1) provides a brief discussion of the terms of an
instrument that contains an embedded derivative, and (2) analyses the instrument
(as of the date of inception) to determine whether the embedded derivative is closely
related to the host contract. Unless otherwise stated, the examples are based on the
following assumptions:
• if the embedded derivative and host portions of the contract are not closely
related, a separate instrument with the same terms as the embedded
derivative would meet the scope requirements, and
• the contract is not a financial asset or financial liability at fair value through
profit or loss.
Type of Economic Characteristics Embedded Derivative Close

Instrument
Instrument
Inverse Floater Bond: Coupon = 5.25 per cent Fixed-for-floating rate No. IA
for three months to July 1999; interest rate swap
thereafter, at 8.75 per cent
six-month LIBOR to January
2000. Stepping option allows
for spread and caps to step
semi-annually to maturity.
Levered Bond: Accrues interest at six Leveraged interest rate No. IA

Inverse Floater per cent to June 2000; swap
thereafter, at 14.55 per cent –
(2.5 × 3-month LIBOR).
Deleveraged Bond: Coupon = (0.5 × 10-year Deleveraged interest Yes. IA

Floater constant maturity treasuries rate swap from floating
(CMT)) + 1.25 per cent. to fixed
Range Floater Bond: The investor receives 5.5 Two written conditional Yes. IA
per cent annualised on each exchange option
day that 3-month LIBOR is contracts with notional
between three per cent and amounts equal to the
four per cent, with the upper par value of the
limit increasing annually after a fixed-rate instrument
specified date. The coupon will
be equal to zero per cent for
each day that three-month
LIBOR is outside the range.
Ratchet Floater Bond: Coupon = three-month Combinations of Yes. IA

LIBOR + 50 basis points. In purchased and written
addition to having a lifetime cap options that create
of 7.25 per cent, the coupon changing caps and
will be collared each period floors
between the previous coupon
and the previous coupon plus
25 basis points.
Indexed A bond that repays principal Conditional exchange Yes. IA

Amortising based on a predetermined option that requires
Note amortisation schedule or target partial or early payment
value. The amortisation is of the note
linked to changes in a specific
mortgage-backed security index
or interest rate index. The
maturity of the bond changes
as the related index changes

as the related index changes.
Equity-Indexed A bond for which the return of Forward exchange No. IA

Note interest, principal, or both is contracts or option
tied to a specified equity contracts
security not of the issuer or
index (e.g., the Standard and
Poor's 500 [S&P 500] index).
This instrument may contain a
fixed or varying coupon rate
and may place all, or a portion,
of principal at risk.

Instrument
Variable Bond: A supplemental principal Purchased option No. IA

Principal payment will be paid to the
Redemption investor, at maturity, if the final
Bond S&P 500 closing value
(determined at a specified date)
is less than its initial value at
date of issuance and the
10-year CMT is greater than
two per cent as of a specified
date. In all cases, the minimum
principal redemption will be 100
per cent of face amount.
Crude Oil A bond that has a one per cent Option contracts No. IA
Knock-in Note coupon and guarantees
repayment of principal with
upside potential based on the
strength of the oil market.
Gold-Linked A bond that has a fixed three Option contracts No. IA

Bull Note per cent coupon and
guarantees repayment of
principal with upside potential if
the price of gold increases

the price of gold increases.
Step-up Bond A bond that provides an Call option Yes. IA

introductory above-market yield
that is less than twice the
market rate at inception and
steps up to a new coupon,
which will be below
then-current market rates or,
alternatively, the bond may be
called in lieu of the step-up in
the coupon rate.
Credit-Sensitive A bond that has a coupon rate Conditional exchange Yes. IA

Bond of interest that resets based on contract or option
changes in the issuer's credit
rating.
Inflation Bond A bond with a contractual Conditional exchange Yes. IA

principal amount that is indexed contract or option
to the non-leveraged inflation
rate, but cannot decrease below
par; the coupon rate typically is
below that of traditional bonds
of similar maturity.

Instrument
Specific A bond that pays a coupon Series of forward No. IA

Equity-Linked slightly below that of traditional contracts or option
Bond bonds of similar maturity; contracts
however, the principal amount
is linked to the stock market
performance of an equity
investee of the issuer

investee of the issuer.
Dual Currency A bond providing for repayment Foreign currency Yes. IA

Bond of principal in one currency forward
(e.g., euro) and periodic
interest payments denominated
in a different currency (e.g.,
yen). In this example, an entity
with the euro as its functional
currency is borrowing funds
from an independent party with
those repayment terms as
described.
Short-Term A U.S. lender issues a loan at an Foreign currency option No. IA

Loan with a above-market interest rate. The
Foreign loan is made in U.S. dollars, the
Currency borrower's functional currency,
Option and the borrower has the
option to repay the loan in U.S.
dollars or in a fixed amount of a
specified foreign currency.
Lease Payment A U.S. company's operating Foreign currency swap Yes. IA

in Foreign lease with a Japanese lessor is
Currency payable in yen. The functional
currency of the U.S. company is
the U.S. dollar, and the
functional currency of the lessor
is yen.
Certain A U.S. company enters into a Foreign currency swap No. IA

Purchases in a contract to purchase corn from
Foreign a local American supplier in six
Currency months for yen; the yen is the
functional currency of neither
party to the transaction.
Additionally, yen is not the
currency in which corn is
routinely denominated in
commercial transactions. The
corn is expected to be delivered
and used over a reasonable
period in the normal course of
business

business.
Participating A mortgage in which the Call option No. IA

Mortgage investor receives a
below-market interest rate and
is entitled to participate in the
appreciation in the market
value of the project that is
financed by the mortgage upon
sale of the project, at a deemed
sale date, or at the maturity or
refinancing of the loan. The
mortgagor must continue to
own the project over the term
of the mortgage.
Q&A IAS 39: 11-10 — EMBEDDED DERIVATIVES: PREPAYMENT OPTION

IN INTEREST-ONLY MORTGAGE
Question
A pool of floating rate mortgages can be split into an interest-only (IO) and
principal-only (PO) strip, with entities acquiring one of these parts.
Under most mortgage terms, a borrower has an option to prepay the mortgage at
amortised cost prior to the contractual maturity of the mortgage.
If an entity purchases an IO strip from a pool of mortgages with a floating rate, is

the prepayment option in the IO strip a closely related embedded derivative if the
floating rate IO strip has the same terms as the floating rate on the original
instrument?
Answer
The prepayment option in the IO mortgage does meet the definition of an embedded
derivative. However, the prepayment risk evident in the IO strip should not be split
out separately from the IO strip because the embedded prepayment option in an
interest-only or principal-only strip is closely related to the host contract, if (1) the
embedded derivative initially resulted from separating the right to receive
contractual cash flows of a financial instrument that, in and of itself, did not contain
an embedded derivative requiring separation, and (2) does not contain any terms

not present in the original host debt contract [IAS 39.AG33(e)].
Q&As IAS 39: 11-11 and 11-12 — REASSESSMENT OF EMBEDDED

DERIVATIVES
Background
On 1 January 2005, Company Y issued convertible bonds with an aggregate principal

sum of CU30 million; the functional currency of Y is CU. The bonds will mature on
the third anniversary of the date of issue. The bonds are convertible into ordinary
shares two years from the date of issue up until the maturity date (1 January 2007
to 31 December 2007). The conversion price is the lower of CU1.50 and 90 per cent
of Y's average closing price, determined based on the last 10 trading days
immediately before 1 January 2007.
At initial recognition, the conversion option does not provide a fixed amount of cash
for a fixed number of shares settlement and hence does not meet the definition of
equity. The conversion option is considered as not closely related to the host debt
contract (the bonds) and accounted for as a derivative under IAS 39.
IAS 39: 11-11
Question
Should the classification of the conversion option be reassessed when a fixed
conversion price is determined (i.e., when Y's average closing price is determined on
1 January 2007)?
Answer
IFRIC 9, Reassessment of Embedded Derivatives, provides the assessment as to
whether an embedded derivative is required to be separated should be made when
the entity first becomes a party to the contract. Subsequent reassessment is
prohibited unless there is a change in the terms of the contract that significantly
modifies the cash flows. However, subsequent determination of conversion price
does not constitute a change in the terms of the contract; thus, the conversion
option should continue to be accounted for as a derivative, with changes in fair value
dealt with in profit or loss.
IAS 39: 11-12

Question
How should the convertible bond be accounted for on conversion/redemption?
Answer
When the holder exercises the conversion option, the fair value of the conversion
option derivative (determined immediately before the conversion) and the carrying
value of the bond are classified to equity. If no conversion takes place and the bonds
are redeemed, the difference between the redemption amount and the carrying
amount of the bonds, and the conversion option derivative, should be recognised in
the income statement.
Q&A IAS 39: 11-13 — INFLATION-LINKED EMBEDDED DERIVATIVES

Question
As part of its capital expansion, Company Q, a transportation company that uses the
South African rand as its functional currency, has entered into a contract to acquire
specialised vehicles over time from Company B. Company Q will pay B in B's
functional currency, British pounds sterling.
The vehicles will be manufactured in Britain. Since the manufacturing will occur over
an extended period, the supplier's costs will be exposed to British inflation.
Therefore, the purchase price of the vehicles will constitute a base cost that will be
increased by a British inflation index relevant to the manufacturer's industry. The
inflation index will not include any leverage.
If the inflation escalation is not leveraged, is the embedded derivative closely related
to the host contract?
Answer
Since the contract is being paid in B's functional currency and B is a substantial party
to the contract, the foreign currency component is considered to be closely related to
the host contract.
The inflation index in the contract is the rate of inflation in the economic
environment for the currency in which the purchase is denominated. Application of
the inflation index effectively compensates B for fluctuations in the value of
nonfinancial items used in manufacturing the vehicles. Because the inflation index
(1) is linked to the economic environment in which the vehicles are manufactured,
(2) is not leveraged, and (3) therefore is associated with the costs of manufacturing,
the inflation feature is considered to be closely related to the host contract.
Currency and inflation embedded derivatives are closely related. Therefore, Q should
not separately recognise any embedded derivative.
Q&A IAS 39: 11-14 — APPLICATION OF THE "DOUBLE DOUBLE" TEST

IN IAS 39.AG33(a)
Question
When evaluating whether an embedded derivative whose underlying is an interest
rate or interest rate index is closely related to its interest-bearing host, how should
an entity apply the "double double" test established by IAS 39.AG33(a)?
Answer
The double double test is performed when the hybrid instrument is acquired (or
incurred) by the reporting entity. The double double test consists of two separate
tests.
In the first test, the entity must determine whether there is a possible future interest
rate scenario, no matter how remote, in which the embedded derivative would at
least double the investor's initial return on the host contract. In making this
assessment, the entity must differentiate the return on the host contract from the
return on the hybrid contract. The host contract's terms are identical to those of the
hybrid contract being tested, except that the host contract does not contain the
embedded derivative. IAS 39.AG33(a) describes this test as requiring that "the
embedded derivative could at least double the holder's initial rate of return on the
host contract". An embedded derivative that does not pass this test would be
considered closely related to its host. If the embedded derivative does pass this test,
a second test must be performed to determine whether it is closely related to the
host contract.
In the second test, the entity must review each interest rate scenario identified in
the first test for which the investor's initial rate of return on the host contract would
be doubled, and determine whether, for any of the scenarios, the embedded
derivative would simultaneously result in a rate of return that is at least twice what
otherwise would be the then-current market return for a contract that has the same
terms as the host contract and that involves a debtor with a credit quality similar to
the issuer's credit quality at inception. If the embedded derivative also passes this
test, it would not be considered closely related to its host contract.

If neither test is passed, the embedded derivative whose underlying is an interest
rate or interest rate index would be considered closely related to the host contract.
Example
On January 1, 20X1, an investor purchases a bond at par that pays LIBOR. The bond
also incorporates an interest rate cap provision whereby if LIBOR equals or exceeds
8 per cent as of any interest rate reset date, the investor will receive a return of 10
per cent. When the investor purchases the bond, it also could purchase at par a
variable-rate bond not containing a cap that pays LIBOR minus 1 per cent from a
debtor that has the same credit quality as the issuer of the investor's bond. As of
January 1, 20X1, LIBOR is 5 per cent. The bond cannot be contractually settled such
that the investor would not recover substantially all of its initial recorded investment
in the bond.
To perform the first test in paragraph AG33(a), the investor must determine whether
there is any interest rate scenario, no matter how remote, under which the
embedded derivative (the cap) would at least double the investor's initial rate of
return on the host contract. This analysis is summarized in the following table:
A B C D
Interest Return Initial rate Initial rate Is the

rate change reflecting of return on of return on double
the effect of host (LIBOR host double test
cap - 1%) doubled met (i.e., is
A > D)?
0-7.99% 0-7.99% 4% 8% No
8% and up 10% 4% 8% Yes
Since the first test is met, the investor must perform the second test described in
paragraph AG33(a) to determine whether the embedded cap is closely related to its
bond host. For each interest rate scenario identified above for which the investor's
initial rate of return on the host contract would be doubled, the investor must
determine whether the embedded cap would simultaneously result in a rate of return
that is at least twice what otherwise would be the then-current market return for a
contract that has the same terms as the host contract and that involves a debtor
with a credit quality similar to the issuer's credit quality at inception. The investor's
analysis for this test can be summarized as follows:

A B C
Interest rate Return Current market Is the double

scenario reflecting the rate of return double test met
identified in the effect of the cap for the host (i.e., is B at
first test above under the contract under least twice C for
for which the interest rate the interest any scenario)?
cap would at scenario in A rate scenario in
least double the A (LIBOR - 1%)
investor's initial
rate of return
on the host
contract
8% and up 10% 7% and up No
Since the first test in paragraph AG33(a) is met, but the second test is not, the
embedded cap is considered closely related to the bond host.
Q&As IAS 39: 11-15, IAS 39: 11-EX-17, and IAS 39: 11-EX-18 provide additional
illustrations of how to perform the double double test.
Q&A IAS 39: 11-15 — INTEREST RATE INDEX EMBEDDED IN A DEBT

HOST
Question
Under what circumstances would a derivative embedded in a debt host, for which the
underlying is an interest rate or interest rate index, not be considered closely
related?
Answer
Generally, interest rates are considered to be closely related to a debt host. An
interest rate or interest rate index that alters net interest payments that otherwise
would be paid or received on an interest-bearing host contract is not considered to
be closely related to the host contract if either (a) or (b) is true:

a. The hybrid instrument can be settled in such a way that the holder
(investor) would not recover substantially all of its recognised investment.
For example, Company X (X) invests in a $10 million 10-year bond that
pays a fixed rate of 6 per cent for the first two years and then pays a
variable rate calculated as 14 per cent minus the product of 2.5 times
three-month LIBOR, without a floor, for the remaining term of the bond. If
three-month LIBOR were to increase significantly, the bond might result in
a negative return, which would effectively erode the bond's principal. In
that case, X may not recover substantially all of its initial investment.
Company X and the bond issuer should, therefore, separately account for
the embedded interest rate derivative unless the election in IAS 39.11A
has been made to measure the entire hybrid financial instrument at fair
value with changes in fair value recognised in profit or loss.
b. The embedded derivative meets both of the following conditions:
1. There is a possible future interest rate scenario (even though it may

be remote) under which the embedded derivative would at least
double the investor's initial rate of return on the host contract.
2. For any of the possible interest rate scenarios under which the
investor's initial rate of return on the host contract would be doubled
(as discussed in 1 above), there is a scenario in which the embedded
derivative would simultaneously result in a rate of return that is at
least twice what otherwise would be the then-current market return
(under each of those future interest rate scenarios) for a contract that
has the same terms as the host contract and that involves a debtor
with a credit quality similar to the issuer's credit quality at inception.
For example, Company A invests in 30-year variable-rate debt issued by Company B.

The debt is indexed to the three-month LIBOR (3M LIBOR) rate plus 4 per cent. As of
the date of issuance, the 3M LIBOR rate was 2 per cent. The debt's terms also
specify that if the 3M LIBOR rate increases to 5 per cent, the debt issuer is required
to pay 23 per cent for the remaining term of the bonds.
Note that in accordance with (b)(1) above, if B were to issue 30-year variable-rate
debt without any embedded derivatives (i.e., the interest rate reset feature), it
would pay a coupon of 3M LIBOR plus 6 per cent. Consequently, the initial rate of
return on the host contract is 8 per cent (3M LIBOR of 2 per cent plus 6 per cent).
An entity must determine whether the embedded derivative could at least double the
investor's initial rate of return on the host contract, which was 8 per cent as of the
date of issuance, in any of the possible interest rate environments. Therefore, when
3M LIBOR increases to 5 per cent, the 23 per cent interest rate feature more than
doubles the initial rate of return of 8 per cent on the host contract.
In applying (b)(2) above, an entity should determine whether the embedded

derivative results in a rate of return that is at least twice what otherwise would be
the then-current market rate of return for a host contract when 3M LIBOR is at 5 per
cent. When 3M LIBOR increases to 5 per cent, the rate of return on the host contract
would be 11 per cent (3M LIBOR of 5 per cent plus 6 per cent) for a bond of similar
credit quality that does not contain any embedded derivatives. Therefore, when 3M
LIBOR increases to 5 per cent, the 23 per cent interest rate feature is more than
twice the then-current market rate of return of the host contract of 11 per cent (3M
LIBOR of 5 per cent plus 6 per cent.)
Companies A and B would both be required to account for the embedded derivative
separately unless the election in IAS 39.11A has been made to measure the entire
hybrid financial instrument at fair value with changes in fair value recognised in
profit or loss.
While conditions (a) and (b) focus on the investor's rate of return and the investor's
recovery of its investment, if either of those conditions exists, the embedded
derivative instrument would not be considered closely related to the host contract by
both parties to the hybrid instrument. Furthermore, any one of the conditions
discussed above is considered satisfied if there is any possibility that it will be met.
Therefore, in the above example, the probability that the 3M LIBOR rate will increase
to 5 per cent is not relevant to the analysis of whether the condition is met.
However, such probability should be considered when valuing the embedded
derivative.
Q&A IAS 39: 11A-1 — INTERACTION OF IFRIC 9 AND THE FAIR VALUE
OPTION
Question
An entity has a hybrid financial instrument that contains an embedded derivative
that is considered to be closely related to the host contract at inception and,
therefore, is not separately recognised. Subsequent to the entity becoming party to
the hybrid financial instrument, there is a change to the embedded feature that is
considered to be significant in accordance with IFRIC Interpretation 9, Reassessment
of Embedded Derivatives.
Can the entity apply the fair value option (IAS 39.9(b) or IAS 39.11A) to the hybrid
financial instrument at the date of the contractual change when the embedded
derivative is recognised separately for the first time?
Answer
It depends. An entity may only designate a financial instrument as being at fair value
through profit or loss on initial recognition. If the change in terms of the hybrid
financial instrument meets the requirements of derecognition of a financial asset
(IAS 39.15–35) or derecognition of a financial liability (IAS 39.39–42), then the
original hybrid financial instrument is derecognised and the amended hybrid financial
instrument is recognised for the first time. In this instance only, the entity may apply
the fair value option on the date of the change in the terms since this date coincides
with the initial recognition of a new financial instrument. In all other instances, the
change in the terms will be considered a remeasurement of the original instrument
and, therefore, the fair value option cannot be applied.
Q&A IAS 39: 11A-2 — APPLYING THE FAIR VALUE OPTION FOR
NON-FINANCIAL CONTRACTS
[Added 4 May 2007]
Question
IAS 39.11A states:
[I]f a contract contains one or more embedded derivatives, an entity may

designate the entire hybrid (combined) contract as a financial asset or
financial liability at fair value through profit or loss unless:
(a) the embedded derivative does not significantly modify the cash flows
that otherwise would be required by the contract; or
(b) it is clear with little or no analysis when a similar hybrid (combined)

instrument is first considered that separation of the embedded derivative(s)
is prohibited, such as a prepayment option embedded in a loan that permits
the holder to prepay the loan for approximately its amortised cost.
Under IAS 39.11A, may an entity apply the fair value option (FVO) to a hybrid
contract that has a non-financial host contract?
Answer
No. IAS 39.11A should be read in the context of the scope paragraphs, IAS 39.2–7.
IAS 39.11A states that when a contract is designated under the FVO, the contract is
a financial asset or a financial liability. This can only be applied if the host contract is
already a financial instrument. Therefore, for an entity to apply the provisions of IAS
39.11A, the hybrid contract in its entirety must be within the scope of IAS 39, i.e.,
the host contract must be financial. The FVO does not override the recognition and
measurement guidance for a host contract that is clearly outside the scope of IAS
39.
Q&A IAS 39: 16-1 — ACCOUNTING FOR LOANS SUBJECT TO

PARTICIPATION
Background
A bank (the 'lead' bank) advances CU100 million to a borrower for a fixed term, with
the intention of sub-participating the loan (due to the risk profile of the borrower).
The lead bank already has an arrangement with other banks through which other
specific participations (not related to the new CU100 million loan) have been
arranged. The lead bank subsequently enters into a participation agreement with
three other banks (the 'participant' banks), under which the participant banks
purchase parts of the CU100 million loan. The participant banks pay the lead bank
cash for a proportionate share of the loan. In return, the lead bank pays the
participating banks a proportionate share of the interest and principal cash flows
received from the borrower. The lead bank retains a proportionate share of the loan.
The parts of the loan that have been acquired by the participating banks are
specifically linked to a portion of the original loan.
Question
How should the lead bank classify the loan to the borrower in terms of IAS 39, both
at initial recognition and subsequently when parts of the loan are sold?
Answer
At inception

The lead bank's intention to sub-participate only part of the loan is not considered
for the purposes of initial classification. Under IAS 39, contractual rights and
obligations that arise from a single contract constitute a single financial instrument.
IAS 39 requires that financial instruments be classified into one of the appropriate
financial instrument categories and does not permit parts of a single financial
instrument to be separately classified, other than in the cases of embedded
derivatives and hedge accounting.
The classification of financial instruments that do not contain embedded derivatives

is based on the holder's intention in acquiring and holding the instrument. Where the
holder of a financial asset has different intentions for different parts of the asset, the
entire asset should be classified according to the entity's principal intention for the
asset. Therefore, at inception, the loan to the borrower would generally be classified
in its entirety into the 'loans and receivables' category. Classification as
available-for-sale or designation as at fair value through profit or loss would also be
possible provided that the applicable requirements of IAS 39 were met.
Subsequently
IAS 39.16(a) permits derecognition of a part of a financial asset. In the above

example, IAS 39.16(a)(ii) applies because the participant banks have contracted on
the basis of a fully proportionate share of the cash flows on the original loan.
Provided that the parts of the loan subject to the participation agreements meet the
transfer requirements in IAS 39.18(b) and IAS 39.19, those parts of the loan should
be derecognised by the lead bank.
Q&A IAS 39: 17-1 — DERECOGNITION OF FINANCIAL ASSETS: EXPIRED

CONTRACTUAL RIGHTS TO CASH FLOWS
Question
A financial asset shall be derecognised by an entity if its contractual rights to the
cash flows from the financial asset expire [IAS 39.17(a)].
Does it mean that the contractual rights should expire for the holder or for the
underlying asset itself? For example, following the transfer of an asset that has not
yet reached its maturity, the holder no longer has the contractual right to receive
cash flows.
Answer
IAS 39.17(a) is only relevant to the expiration of the financial asset itself. If a
financial asset that has been subject to a transfer has not yet expired, IAS 39.17(a)
is not relevant in determining derecognition.
The entity should consider whether derecognition under IAS 39.17(b) is appropriate.
Q&A IAS 39: 18-1 — RETENTION OF SERVICING RIGHTS

[Added 12 May 2006]
Background
An entity enters into an arrangement with a third party to transfer the contractual
rights to receive the cash flows of a financial asset, but agrees to continue to act as
an agent to administer collection and distribution of cash flows to the recipient (i.e. it
retains servicing rights on the cash flows).
Question
Would this arrangement fail to meet the derecognition criteria set out in IAS
39.18(a)?
Answer
No. IAS 39.18(a) focuses on whether an entity transfers the contractual rights to
receive the cash flows from a financial asset. The determination of whether the
contractual rights to cash flows have been transferred is not affected by the
transferor retaining the role of an agent to administer collection and distribution of
cash flows. Retention of servicing rights by the entity transferring the financial asset
does not, in itself, cause the transfer to fail to meet the requirements in IAS
39.18(a).
However, careful judgement must be applied to determine whether the entity

providing servicing effectively has transferred all risks and rewards of the financial
asset, and if the entity is acting solely as an agent for the owner of the financial
asset.
Q&A IAS 39: 19-1 — DERECOGNITION OF A FINANCIAL ASSET:

REMITTANCE OF CASH FLOWS WITHOUT MATERIAL DELAY

Question
An entity can derecognise a financial asset in situations when it retains contractual
rights to cash flows, but, at the same time, assumes obligations to pay these cash
flows to third parties when all of the three conditions listed below are met:
a. The entity has no obligation to pay amounts to the eventual recipients

unless it collects equivalent amounts from the original asset. Short-term
advances by the entity with the right of full recovery of the amount lent,
plus accrued interest at market rates, do not violate this condition.
b. The entity is prohibited by the terms of the transfer contract from selling or
pledging the original asset other than as security to the eventual recipients
for the obligation to pay them cash flows.
c. The entity has an obligation to remit any cash flows it collects on behalf of
the eventual recipients without material delay. In addition, the entity is not
entitled to reinvest such cash flows, except for investments in cash, or
cash equivalents (as defined in IAS 7 Cash Flow Statements) during the
short settlement period from the collection date to the date of required
remittance to the eventual recipients, and interest earned on such
investments is passed to the eventual recipients. [IAS 39.19]
What does "material delay" mean?
Answer
Judgement must be applied. Without material delay does not mean instantaneously,
nor does it imply a significant length of time. The contractual arrangement will need
to be considered in full in order to make an assessment as to the whether the
timeframe between the collection of cash flows on the underlying assets, and the
point at which they are passed on to the eventual recipients, is material in the
context of the contractual arrangements of the transfer.
It may be reasonable to assume that a delay in delivering cash flows to the note
holders is acceptable if the delay is equivalent to the next coupon payment date on
the notes when the coupon payments occur weekly, monthly or quarterly. This
conclusion is not applicable if the interest on the notes are paid annually, or they are
zero-coupon notes and all interest is paid at maturity.
Q&A IAS 39: 19-2 — DERECOGNITION OF FINANCIAL ASSETS:

PASS-THROUGH ARRANGEMENTS WITH CREDIT ENHANCEMENT

Question
In a pass-through arrangement an entity acts as an agent of the eventual recipients
of the cash flows that derive from the asset and passes the cash flows to the
eventual recipient.
Will the entity fail the pass-through test in IAS 39.19 if the entity also provides credit
enhancements to the arrangement so that the entity incurs the first losses up to a
specified amount of the assets?
Answer
If the three pass-through tests are applied and are met, the entity must consider the
extent to which the risks and rewards of the asset are transferred in line with IAS
39.20. An entity may meet the pass-through tests as described in IAS 39.19, even
when providing a credit enhancement, because (1) the entity will pay all cash flows
received from the assets onto the eventual recipients, (2) the entity is prohibited
from selling or pledging the original asset, and (3) the entity must remit any cash
flows it collects on behalf of the eventual recipient without material delay. However,
the existence of credit enhancement may result in failed derecognition when the
credit enhancement results in the entity not transferring substantially all the risks
and rewards of ownership.
Q&A IAS 39: 19-3 — REVOLVING STRUCTURES

[Added 12 May 2006]
Background
In a revolving structure an entity collects cash flows on behalf of eventual recipients

and uses the amounts collected to purchase new financial assets instead of remitting
the cash directly to the eventual recipients. On maturity, the financial assets
invested in the principal amount are remitted to the eventual recipients from the
cash flows arising from the reinvested assets.
Question
Does the revolving structure meet the pass-through requirements in IAS 39.19(c)?
Answer
No. In order to meet the pass-through arrangement requirements in IAS 39.19(c),
an entity is required to remit any cash flows it collects on behalf of eventual
recipients, without material delay. In addition, this paragraph limits permissible
reinvestments to items that qualify as cash or cash equivalents. Most revolving
arrangements involve a material delay before the original collection of cash is
remitted to the eventual recipients. Furthermore, the nature of the new assets
typically acquired implies that most revolving arrangements entail reinvestment in
assets that would not qualify as cash or cash equivalents.
Q&A IAS 39: 20(c)-1 — TRANSFEREE ACCOUNTING WHEN THE

TRANSFEROR HAS CONTINUING INVOLVEMENT IN A TRANSFERRED
FINANCIAL ASSET
Background
Bank S owns a 16 per cent equity stake in a thinly traded company. The investment
is classified by S as an available-for-sale financial asset. Bank S enters into an
agreement with Entity K. Entity K pays €102 to S in return for:
1. The 16 per cent equity interest in the thinly traded company, and
2. A purchased put option that allows K to put the shares back to S for a price
of €96 at a pre-specified date.
On the date of the transfer, the fair value of the shares is €97 and the time value of
the put option is €5 (€102 minus €97); i.e. the option is out of the money.
Bank S, the transferor, will apply continuing involvement accounting in accordance

with IAS 39.20(c); i.e., it is considered to control the shares as it has neither
transferred nor retained substantially all the risks and rewards of the shares and K
does not have the practical ability to sell the shares since it is a significant holding in
an entity that is thinly traded.
As the arrangement involves a written put option by the transferor on an asset that
is measured at fair value, the extent of the continuing involvement of S is limited to
the lower of the fair value of the shares and the option exercise price in accordance
with IAS 39.30(b) and IAS 39.AG48.
At the transaction date, the following entries will be required:

These entries ensure that the continuing involvement is measured at €96, which is
the lower of the fair value of the shares and strike price of the option.
The shares continue to be recognised by Bank S and measured as an

available-for-sale financial asset, though changes in their value above the strike
price of €96 are not recognised.
Question
How should the transferee, K, measure its involvement in the above arrangement?
Answer
Entity K has paid cash of €102 in return for a right to receive cash of €96 (through
exercise of its purchased put option) and rights to all the upside on the shares above
€96 (i.e. by not exercising its put and physically retaining the transferred shares).
Entity K economically has an investment in shares with no downside risk (below
€96).
Entity K should recognise its interest in the arrangement as an available-for-sale

financial asset, but not recognise any changes in fair value below the strike price of
€96, as K has no exposure to fair value movements below this amount. This is the
"mirror image" of the accounting by the transferor, S (that recognises an
available-for-sale asset, but does not recognise any changes in fair value above the
strike price of €96).
At the transaction date, the following entries will be required:

Q&A IAS 39: 37-1 — REPOSSESSION OF PROPERTY HEDGED AS
COLLATERAL
Background
Entity A, a financial institution, provides mortgage loans to individuals or corporate

entities to finance the acquisition of properties. The terms of these mortgage loans
require the property to be pledged as collateral for the loan. If a counterparty
defaults under the terms of a mortgage loan, Entity A repossesses the property and
is entitled to receive the rental income from the property while it is held.
Question
How should Entity A account for the rentals received on the property?
Answer
If the derecognition criteria in IAS 39.17 are met as a result of repossessing the
property, Entity A derecognises the loan receivable. In accordance with IAS 39.37,
Entity A recognises the property as its asset, initially measured at fair value (see
Q&A IAS 40: 5-1 for subsequent accounting). Any rentals received should be
recognised as rental income in profit or loss.
However, if the derecognition criteria in IAS 39.17 are not met, Entity A continues to
recognise the loan receivable in its statement of financial position. Any rentals
received should be treated as a reduction in the carrying amount of the loan
receivable. This would be the case if Entity A merely administers the property on
behalf of the previous owner and is only entitled to retain rent in settlement of
amounts due from the owner.

Q&A IAS 39: 38-EX-1 — REGULAR-WAY PURCHASE OF PUBLICLY
TRADED SECURITIES
Example
A contract to purchase or sell a publicly traded equity security in the United States
customarily requires settlement within three business days ("T + 3"). If a contract
for purchase of this type of security requires settlement in three business days, the
regular-way exception applies; however, if the contract requires settlement in a
period greater than three business days, the regular-way exception does not apply.
Trades of financial instruments with settlement terms outside those prescribed by
normal market convention typically do not qualify for the regular-way exception and
are considered derivative instruments if the other criteria are satisfied.
Q&A IAS 39: 39-1 — DERECOGNITION OF FINANCIAL LIABILITIES

WHEN FUTURE OUTFLOW OF ECONOMIC BENEFITS IS UNLIKELY
Background
Situations may arise where a liability is considered unlikely to result in an outflow of

economic resources.
Three scenarios are considered below.
Scenario 1: Unredeemed Travellers Cheques
Company A is in the business of issuing travellers cheques to customers. Historical

statistical analysis indicates that five percent of travellers cheques (travellers
cheques do not have an expiry date) will never be redeemed.
Scenario 2: Goods Received but Not Invoiced
Company B is a media buying company that purchases advertising space in

newspapers, television and radio on behalf of its customers, thereby incurring a
liability to pay for that advertising space. Historical analysis shows that invoices have
never been received by B in respect of five percent of the advertising space
purchased. The jurisdiction of B contains a "statute of limitations", which means that
the counterparty will no longer be able to legally enforce payment if it does not claim
payment from B within a period of six years from the date the goods or services are
provided.
Scenario 3: Dormant Bank Accounts
Company C is a bank where a customer with a balance in his bank account cannot be
located (e.g. a customer moves from his/her home without notifying the bank),
his/her legal representatives (including executors of estates) have the right to claim
these amounts indefinitely. Historically, five percent of dormant accounts held with
the bank have never been reclaimed.
Question
At what point, if at all, should the liabilities that are described above be
derecognised?
Answer
Each of the amounts that are described above is a financial liability in accordance
with IAS 32 Financial Instruments: Presentation, as each result from a contractual
relationship between the entity and the counterparties.
In accordance with IAS 39.39, an entity should only derecognise a financial liability
when it is extinguished. This is explained by IAS 39.AG 57(b) which states, in part,
that:
A financial liability (or part of it) is extinguished when the debtor is legally
released from primary responsibility for the liability (or part of it) either by
process of law or by the creditor.
Scenario 1
Depending on the legal requirements of each jurisdiction, the derecognition criteria

may never be met (i.e. subject to statutory limitation). Travellers cheques do not
have an expiry date, therefore, as the entity is obliged to honour the redemption of
travellers cheques, on demand, and depending on the jurisdiction, this obligation
may carry on indefinitely into the future.
Scenario 2
The derecognition criteria are met when the statute of limitations expires in respect
of a particular transaction. In this case at the end of six years after the transaction,
if the counterparty has not made a claim to B by the end of that period for payment
for the advertising services received. Until such time, B is legally obligated to pay if

the counterparty makes a claim.
Scenario 3
Where there is no statute of limitation in C's jurisdiction in relation to dormant

accounts, the derecognition criteria are never met, hence the entity is obligated to
provide the funds on demand and it is never released from the obligation.
Note that in some jurisdictions, obligations relating to dormant accounts may be

taken over by a government organisation after a certain number of years. The
derecognition criteria are met when the obligation in respect of the dormant
accounts is transferred to a third party, in this case the government organisation.
In determining the appropriate accounting treatment on issues similar to the above

scenarios, full consideration of the legislation in the relevant jurisdiction, together
with all other relevant facts, is required.
Q&A IAS 39: 40-1 — RECOGNITION OF GAIN/LOSS ON MODIFICATION

OF AN ISSUED DEBT LIABILITY
[Added 7 July 2006]
Company A borrowed £1 million on 1 January 20X0, at a fixed rate of 9 per cent per
annum for 10 years. Company A incurred issue costs of £100,000. Interest on the
loan is payable annually in arrears. During 20X5, A approached the lender for a
modification of the terms of the debt (this modification could have been as a result
of a deteriorating financial condition of the borrower or because of a fall in interest
rates). The following modified terms were agreed with effect from 1 January 20X6:
• Interest rate will be reduced to 7.5 per cent payable yearly in arrears.
• The original amount, payable on maturity, remains unchanged but the

maturity of the loan is extended by two years to 31 December 20Y1.
• No fees for renegotiating the finance are payable.
Calculation of the effective interest rate of the original debt (EIR is 10.6749 per cent)

Calculation of present value of modified debt at the original effective interest rate
Question
How should the difference between the amortised cost of the original debt and the
present value of the new debt, discounted at the original effective interest rate, be
treated at the date of modification?
Answer
Firstly, the entity must determine, in accordance with IAS 39.AG62, whether the
modification is considered to be an extinguishment of the original debt. As the
difference between the amortised cost of the debt instrument at the date of
modification and the present value of the new debt instrument discounted by the
original effective interest rate is less than 10 per cent, the modification is not
considered an extinguishment of the original debt. The difference in this case is
£83,257, which is 8.8 per cent of the amortised cost of the original debt.
The difference of £83,257 will not be recognised in profit or loss immediately at the
date of modification as derecognition of the original debt has not been achieved. A
revised effective interest rate is determined at the date of the modification, which
reflects the new cash flows the issuer is required to pay under the modified terms.
The difference of £83,257, therefore, will impact profit or loss in the future periods
through recognition of a revised effective interest rate.
The revised effective interest rate that is determined at the date of modification is
required in order to recognise the appropriate effective interest for future periods
that reflects the modified terms of the debt instrument. For the avoidance of doubt,
at the date of modification only, the issuer should not apply IAS 39.AG8, as this will
result in an immediate gain/loss in profit or loss on modification, which is contrary to
the issuer not achieving derecognition. IAS 39.AG8 requires an entity to revise its
estimates of cash flows and discount them by the original effective interest rate. Any
difference between this amount and the current carrying value is recognised in profit
or loss. The issuer will only apply IAS 39.AG8 following the date of modification if the
estimates of future cash flow change. The "original" discount rate to be used in the
IAS 39.AG8 calculation after the modification date is the revised effective interest
rate that was determined at the date of modification.
Q&A IAS 39: 40-2 — DETERMINING THE AMORTISED COST OF AN

INTEREST-FREE INTERCOMPANY LOAN INITIALLY AT CALL AND
SUBSEQUENTLY DEFERRED
Question
Parent A provides a $100,000 loan to Subsidiary B on "at-call" terms. At reporting
date 31 December 20X0, no principal repayments had been made on the loan, and A
contractually modifies the terms of the loan such that the terms do not call for
repayment of the loan during the next 12 months.
How should this modification be accounted for in A's and B's financial reports at 31
December 20X0?
Answer
Accounting by Parent A at 31 December 20X0

By agreeing to defer repayment on the loan, A has modified the terms of the loan
such that the amortised cost on the loan during the period of the deferral is no
longer the nominal amount of the loan. Parent A adjusts the carrying amount of the
loan receivable to reflect its new amortised cost, calculated using the original
effective interest rate (refer to Q&A IAS 39: 9-7) and the contracted 12 month term.
As this is a transaction between parent and subsidiary, in accordance with the IASB
Framework, the adjustment to the carrying amount of the loan receivable represents
an equity contribution by the parent as an equity participant and is therefore
recognised as an additional investment in the subsidiary. Interest revenue is
recognised in profit and loss over the contracted term of the receivable.
Note: The adjustment arising on deferral of the intercompany loan may not be an
equity contribution depending on an entity's accounting policy regarding common
control transactions. Furthermore, depending on the reason for granting the deferral
there may be an indicator that the investment is impaired.
Accounting by Subsidiary B
By agreeing to defer repayment on the loan, A has modified the terms of the original
loan. Subsidiary B is required to assess whether or not the modification results in
derecognition of the existing borrowing and a replacement with a new borrowing.
This occurs where it is considered to be "a substantial modification of the terms of an
existing financial liability" (IAS 39.40). When assessing if the terms are substantially
different, IAS 39.AG62 states that "the terms are substantially different if the
discounted present value of the cash flows under the new terms, including any fees
paid net of any fees received and discounted using the original effective interest
rate, is at least 10 per cent different from the discounted present value of the
remaining cash flows of the original financial liability". In performing this calculation,
B should discount the remaining cash flows of the original loan using the original
effective interest rate (refer to Q&A IAS 39: 9-7) over the new term and compare
that to the existing loan.
Deferral Represents a Substantial Modification of the Terms
Subsidiary B treats the loan liability as though it were a new financial liability. That
is, the fair value of the "new" loan is estimated using the prevailing interest rate for
a similar loan if obtained from an independent third party based on the entity's credit
rating and the contracted 12-month term. Interest expense is recognised over the
contracted term of the loan (being twelve months in this case).
Any difference between the carrying amount of the original loan and the carrying
amount of the new loan, net of any costs or fees incurred on deferral, are recognised
as part of the gain or loss on the extinguishment. However, as the transaction is
between parent and subsidiary, in accordance with the IASB Framework the
gain/loss on extinguishment would generally be accounted for as a contribution from
an equity participant and should be recognised as such (i.e. for a gain on
extinguishment: DR Loan, CR Equity), but alternative accounting policies for
common control transactions may exist.
Deferral Does Not Represent a Substantial Modification of the Terms
Subsidiary B adjusts the carrying amount of the loan liability down to its new
amortised cost, calculated using the original effective interest rate and the
contracted 12-month term (refer to Q&A IAS 39: 9-7). Interest expense is
recognised over the contracted term of the loan (being twelve months in this case).
Any costs or fees incurred are netted against the carrying amount of the liability and
are amortised over the remaining term of the modified liability.
IAS 39.AG8 states, "If an entity revises its estimates of payments or receipts, the
entity shall adjust the carrying amount of the financial asset or financial liability (or
group of financial instruments) to reflect actual and revised estimated cash flows.
The entity recalculates the carrying amount by computing the present value of
estimated future cash flows at the financial instrument's original effective interest
rate. The adjustment is recognised as income or expense in profit or loss". As
discussed above, as this is a transaction between owner and subsidiary, the
adjustment would generally be recognised as an equity contribution from or
distribution to an equity participant (i.e., for a gain on extinguishment: DR Loan, CR
Equity), but alternative accounting policies for common control transactions may
exist.
Q&A IAS 39: 40-3 — APPLICATION OF THE 'SUBSTANTIAL

MODIFICATION OF A FINANCIAL LIABILITY 10 PER CENT TEST' TO A
FLOATING-RATE INSTRUMENT EXCHANGED FOR A FIXED-RATE
INSTRUMENT
Background
Entity A (GBP functional currency) has a floating-rate GBP borrowing ('the original
debt') with the following features:
• the borrowing was issued at par with nil transaction costs;
• the remaining term of the borrowing is five years;
• interest is payable at a floating rate of LIBOR + 100bps; and

• £100 million repayable.
Entity A renegotiates the terms of the original debt with the original lender such that
the original debt is modified, resulting in the same GBP nominal value of £100 million
being due in five years but with a fixed interest rate of 10 per cent.
At the date of renegotiation, the spot LIBOR rate is 5 per cent with forecasts
indicating that LIBOR will increase to 9 per cent over the five-year term of the
modified debt.
IAS 39.40 specifies the accounting treatment required when there has been a
“substantial modification” in the terms of an existing financial liability. Under IAS
39.AG62, a quantitative '10 per cent test' is required to determine whether a
renegotiation has resulted in a liability with terms that are “substantially different”.
The terms are considered to be substantially different if “the discounted present
value of the cash flows under the new terms, including any fees paid net of any fees
received and discounted using the original effective interest rate, is at least 10 per
cent different from the discounted present value of the remaining cash flows of the
original financial liability”.
Question
In applying the 10 per cent test under IAS 39.AG62, what rate of LIBOR (i.e. spot
rate or forecast rate at the date of renegotiation) should be used when forecasting
the remaining cash flows of the original debt?
Answer
In the case of a floating-rate financial liability, IAS 39 does not specify whether a
spot or forecast rate for LIBOR should be used to discount future contractual cash
flows when applying the 10 per cent test. An entity should select one methodology
and apply it, as an accounting policy, consistently for all modifications or exchanges
involving financial liabilities with floating interest rates.
Q&A IAS 39: 47-1 — DETERMINING THE AMORTISED COST AND

CLASSIFICATION OF AN INTEREST-FREE INTERCOMPANY LOAN
PROVIDED WITHOUT ANY STATED REPAYMENT TERMS
Question
Parent A provides a $100,000 loan to Subsidiary B at the start of 20X0. The loan was
provided without any stated repayment terms (that is, effectively "at call").

At reporting date 31 December 20X0, what is the amortised cost of the loan in A and
B's financial reports, and should the loan be classified as a current or non-current
financial asset/liability?
Answer
The amortised cost of the loan at 31 December 20X0 to both A and B is the amount
repayable on demand; that is, $100,000 (IAS 39.49), subject to an impairment test
on the loan receivable by A.
Parent A classifies the loan receivable as current or non-current, depending on when

it expects to realise the loan (IAS 1.57(c)).
Subsidiary B classifies the loan payable as a current financial liability, as it does not
have an unconditional right to defer settlement of the liability for at least 12 months
after the reporting date (IAS 1.60(d)).
Q&A IAS 39: 48-1 — FAIR VALUE MEASUREMENT OF FINANCIAL

INSTRUMENTS WITH OFFSETTING RISKS
Question
An investment fund holds financial assets and puttable financial liabilities linked to
the performance of the assets. The assets are classified as fair value through profit
or loss (FVTPL) and the liability is separated with a debt host contract and an
embedded derivative in accordance with IAS 39.AG28.
Which quoted market prices (i.e. bid, ask, or mid-market) should be used to
measure the fair value of these instruments?
Answer
IAS 39.AG72 indicates that when an entity has assets and embedded derivatives
that are liabilities with offsetting market risks, it may use mid-market prices as a
basis for establishing fair values for the offsetting risk positions. As appropriate, the
entity should use the relevant bid or asking price to the net open position.
As the asset and liability have offsetting market risks, (i.e. the market risk of the
assets is offset by the market risk of the liability, and both instruments are subject
to fair value measurement), it is permitted to apply mid-market prices for both. In
this case, as the liability is linked to the performance of all invested assets, there will

be no open net position.
Q&A IAS 39: 48A-1 — MEASUREMENT OF DERIVATIVES AT

MID-MARKET PRICES
[Added 4 May 2007]
Question
Can a derivative that is designated in a qualifying cash flow hedge relationship of a
forecast transaction that has yet to be recognised on the balance sheet be
recognised at its mid-market price (i.e. the mid price between the bid and offer
price)?
Answer
No. IAS 39.AG72 states that a financial instrument quoted in an active market may
only be recognised at the mid-market price if an entity has assets and liabilities with
offsetting risks. If an entity designates a derivative in a qualifying cash flow hedge of
a forecast transaction that is not recognised on the balance sheet, e.g. a forecast
sale or purchase, the entity cannot measure the derivative at its mid-market price
because the hedged item is not a recognised asset or liability that has a quoted price
in an active market.
An entity may measure a derivative at its mid-market price only if it is an offset of

the risks of a recognised asset or liability. Both the derivative and the recognised
asset or liability will be measured at mid-market prices to the extent their risks
offset, with the bid or offer price being applied to the net open position. The
recognised asset or liability may be a derivative financial instrument or a
non-derivative financial instrument and does not necessarily need to be designated
in a qualifying hedge relationship.
Q&A IAS 39: 50D-1 — RECLASSIFICATIONS: DATE OF ASSESSMENT

REGARDING DEFINITION OF 'LOANS AND RECEIVABLES'
Background
An entity may reclassify a financial asset classified as held for trading (i.e. part of the
'fair value through profit or loss' classification) or classified as available-for-sale to
loans and receivables under IAS 39.50D and IAS 39.50E respectively if the asset

meets the definition of 'loans and receivables'.1
Question
At which date should the entity make the assessment as to whether the financial
asset meets the definition of 'loans and receivables'?
Answer
IAS 39 does not state explicitly at what date an entity should make the assessment
for the purpose of determining whether the conditions for reclassification are met.
Two interpretations are acceptable, i.e. make the assessment at either:
• the date of initial recognition of the financial asset; or
• the date of reclassification of the financial asset. This is particularly

relevant for financial assets that would not have met the definition of loans
and receivables at initial recognition (e.g. because the instruments were
traded in an active market), but that meet the definition at the date of
reclassification.
An entity should decide on the appropriate interpretation and apply it, as an

accounting policy choice, consistently to all reclassification assessments that require
an assessment of whether the 'loans and receivables' definition is met. If the
accounting policy is considered relevant for the understanding of the financial
statements it should be disclosed in accordance with paragraph 117 of IAS 1(2007)
Presentation of Financial Statements.
1 If the financial asset does not meet the definition of 'loan and receivables', the entity may
instead choose to reclassify the asset from held for trading to available-for-sale.
Q&A IAS 39: 50F-1 — RECOGNITION OF IMPAIRMENT OF EQUITY

INSTRUMENTS RECLASSIFIED FROM FVTPL TO AFS
Question
For an equity instrument reclassified from fair value through profit or loss (FVTPL) to
available-for-sale (AFS) in accordance with IAS 39.50(c) and IAS 39.50B, should the
recognition of an impairment loss in periods subsequent to the reclassification be
determined with reference to events occurring since the acquisition date of the

instrument or since the reclassification date?
In particular, is the criterion regarding “[a] significant or prolonged decline in the fair
value of an investment in an equity instrument below its cost” in IAS 39.61 to be
assessed since the acquisition date or since the date of reclassification?
Answer
The assessment of impairment should be made with reference to events since the
date of reclassification.
In the period between its acquisition date and the date of reclassification, the asset
is not FVTPL. The fair value of the financial asset on the date of reclassification
becomes its new cost in accordance with IAS 39.50C, rendering the acquisition cost
(and the period from acquisition to reclassification) referred to in IAS 39.68
irrelevant for the assessment of impairment. The assessment under IAS 39.61 as to
whether the decline in fair value represents “[a] significant or prolonged decline in
the fair value of an investment in an equity instrument below its cost” is assessed
with reference to the new deemed cost established on the basis of the fair value at
the date of reclassification and the period since the reclassification date.
If there is objective evidence of impairment after the reclassification date, the

amount of the cumulative loss reclassified from equity to profit or loss is the
difference between the fair value at the date of reclassification and current fair value,
less any impairment loss on the financial asset previously recognised in profit or loss
since the date of reclassification.
Q&A IAS 39: 50F-2 — RECOGNITION OF IMPAIRMENT ON AFS DEBT

INSTRUMENTS RECLASSIFIED FROM FVTPL TO AFS
Background
On 1 January 20X0, Entity X acquires a debt instrument for its fair value of CU100
that it classifies as held for trading (within the fair value through profit or loss
(FVTPL) category) in accordance with IAS 39.9. In the year ended 31 December
20X0, the fair value of the instrument decreases from CU100 to CU60. At 31
December 20X0, there is objective evidence of impairment; however, Entity X is not
required to perform an impairment assessment in accordance with IAS 39.58
because the asset is classified as at FVTPL.
On 1 January 20X1, Entity X elects to reclassify the asset from FVTPL to

available-for-sale (AFS) in accordance with IAS 39.50(c) and IAS 39.50B. In the year
ended 31 December 20X1, the fair value of the asset declines further, resulting in a
fair value loss of CU10 recognised in other comprehensive income. The fair value loss
arises as a result of an increase in market rates of interest only (i.e. the expected
recoverability of cash flows remains the same as at 31 December 20X0).
Question
How should Entity X account for the fair value loss of CU10 in the year ended 31
December 20X1?
Answer
The fair value loss of CU10 should be retained in other comprehensive income.
Up until the date of reclassification, the asset is not subject to the impairment
requirements of IAS 39.58 because it is classified as at FVTPL. The fair value of the
financial asset on the date of reclassification becomes its amortised cost in
accordance with IAS 39.50C and, therefore, it is from this date that the asset is
subject to the impairment requirements of IAS 39.58. Therefore, only reductions in
recoverability of cash flows after the date of reclassification accompanied by a net
fair value loss in equity (i.e. there is an overall debit balance in equity in respect of
the financial asset) would result in the reclassification of that fair value loss to profit
or loss as an impairment loss.
Because there has been no reduction in the recoverability of cash flows since the
date of reclassification, the asset is not considered to be impaired at 31 December
20X1. The asset is therefore not subject to the requirements of IAS 39.67 (which
require that a fair value loss arising on an impaired AFS debt instrument be
recognised in profit or loss) in that period. Instead, the fair value loss of CU10 should
remain in equity. However, if in a subsequent period there is a reduction in the
recoverable cash flows, any cumulative fair value loss accumulated in equity should
be reclassified to profit or loss in accordance with IAS 39.67.
Q&A IAS 39: 58-1 — EVIDENCE OF IMPAIRMENT: CHANGES IN

INTEREST RATES
Question
Is an increase in interest rates objective evidence of impairment of fixed rate debt
investments?
Answer
Changes in the fair value of a fixed rate debt investment due to movements in the
risk-free interest rate would not be objective evidence of impairment.
Changes in the fair value of a fixed rate debt investment due to movements in
market interest rates generally will not be indicative of impairment as movements in
market interest rates are not specific to the credit quality of the investment that is
held.
However, it is possible that a fall in fair value due to an increase in the borrower's
specific interest rate (i.e. due to an increase in the credit spread of the borrower)
could be indicative of impairment when considered with other evidence supporting
that a loss has been incurred [IAS 39.AG22(a)].
Q&A IAS 39: 58-2 — DECLINE IN FAIR VALUE OF AN IMPAIRED AFS

DEBT INSTRUMENT
Background
Entity A reclassifies a fair value loss from equity (investments revaluation reserve) to
profit or loss as an impairment loss on a fixed-rate available-for-sale (AFS) debt
instrument in accordance with IAS 39.67 in year ended 31 December 20X0. In the
next financial year (year ended 31 December 20X1), the fair value of the AFS debt
instrument falls further, resulting in a fair value loss. The fair value loss is due solely
to an increase in the risk-free market interest rate. There has been no reduction in
the recoverable cash flows since 31 December 20X0.
Question
How should the fair value loss on the AFS debt instrument be recognised in the
financial statements for the year ended 31 December 20X1?
Answer
Fair value losses on impaired AFS debt instruments should be recognised in profit or
loss as a remeasurement of impairment regardless of the reason for the fair value
loss.
At 31 December 20X1, there is objective evidence that the asset is impaired (IAS
39.58) due to the impairment recognised at 31 December 20X0 and, therefore, the
requirements of IAS 39.67 and IAS 39.68 apply.
IAS 39.68 states that the fair value loss reclassified “from equity to profit or loss [is]
the difference between the acquisition cost (net of any principal repayment and
amortisation) and current fair value”. The fair value loss in the reporting period
ended 31 December 20X1 is a remeasurement of the impairment loss on the AFS
asset that continues to be impaired. This treatment is consistent with the treatment
of non-monetary AFS assets in IAS 39.IG E.4.9, which requires that if an asset is
impaired in a previous period, any subsequent losses (including the portion
attributable to foreign exchange losses) are also recognised in profit or loss until the
asset is derecognised.
Note: In accordance with IAS 39.70, if the outcome in the year ended 31 December
20X1 was a fair value gain, rather than a fair value loss, this fair value gain would
not be recognised in profit or loss unless it could be objectively related to a credit
event occurring after the date of impairment that represents either a full or partial
reversal of the 20X0 impairment loss.
See Q&A IAS 39: 50F-2 for guidance on a debt instrument that is reclassified from
fair value through profit or loss to AFS debt where the fair value declines after the
reclassification date.
Q&A IAS 39: 61-1 — SIGNIFICANT OR PROLONGED DECLINE IN FAIR

VALUE OF AN EQUITY INSTRUMENT
[Added 12 May 2006]
Question
An equity instrument that has been classified as available for sale has a carrying
amount below its original cost as a result of a previously recognised impairment loss.
How should the requirement for "a significant or prolonged decline" in the fair value
in IAS 39.61, be applied when assessing the equity instrument for impairment?
Answer
As IAS 39 refers to original cost on initial recognition, a prior impairment is not
considered as having established a new cost basis for the investment.
Consequently, for an equity instrument for which a prior impairment loss has been
recognised, "significant" should be evaluated against the original cost at initial
recognition, and "prolonged" should be evaluated against the period in which the fair
value of the investment has been below original cost at initial recognition.
IAS 39 Implementation Guidance, Section E.4.9 states that further declines in value,
after an impairment loss is recognised in profit or loss, are also recognised in profit
or loss.
Q&A IAS 39: 61-2 — SIGNIFICANT OR PROLONGED DECLINE IN FAIR

VALUE OF AN EQUITY INTEREST
Question
How should the requirement in IAS 39.61 for "a significant or prolonged decline" in
fair value be applied when assessing available-for-sale equity instruments for
impairment?
Answer
The determination of what constitutes a 'significant or prolonged' decline in fair value
is a matter of fact that requires the application of judgement. This is true even
though an entity may develop internal guidance to assist in the consistent application
of that judgement.
In accordance with the requirements of IAS 1(2007) Presentation of Financial

Statements (paragraphs 122–123) and IFRS 7 Financial Instruments: Disclosures
(paragraph 20), an entity should provide disclosures regarding the judgements it has
made in determining the existence of objective evidence of impairment and the
amounts of impairment losses.
In July 2009, the IFRIC considered the diversity that has emerged in the application
of IAS 39.61 and noted some applications in particular that are not in accordance
with the requirements of IAS 39. The IFRIC concluded the following in respect of
specific practices that had developed. (These are examples only and this is not an
exhaustive list of all the inconsistencies with the Standard that might exist in
practice.)
• The Standard cannot be read to require the decline in value to be both

significant and prolonged. Thus, either a significant or a prolonged decline
is sufficient to require the recognition of an impairment loss. The IFRIC
noted that in finalising the 2003 amendments to IAS 39, the IASB
deliberately changed the word from 'and' to 'or'.
• IAS 39.67 requires the recognition of an impairment loss on

available-for-sale equity instruments if there is objective evidence of
impairment. IAS 39.61 states conclusively that a significant or prolonged
decline in the fair value of an investment in an equity instrument below its
cost is objective evidence of impairment. Consequently, when such a
decline exists, recognition of an impairment loss is required.
• The fact that the decline in the value of an investment is in line with the
overall level of decline in the relevant market does not mean that an entity
can conclude that the investment is not impaired.
• The existence of a significant or prolonged decline cannot be overcome by

forecasts of an expected recovery of market values, regardless of their
expected timing. Consequently, an anticipated market recovery is not
relevant to the assessment of 'significant or prolonged'.
• IAS 39.AG83 and IAS 39.IG Q&A E.4.9 Impairment of non-monetary

available-for-sale financial asset both discuss the recognition of financial
instruments denominated in foreign currencies. It is inappropriate to
assess 'significant or prolonged' in the foreign currency in which the equity
investment is denominated. That assessment must be made in the
functional currency of the entity holding the instrument because that is
how any impairment loss is determined.
Note: IFRIC agenda decision published in the July 2009 IFRIC Update.
Q&A IAS 39: 67-1 — DETERMINING THE EFFECTIVE INTEREST RATE

FOR AFS DEBT INSTRUMENTS AT THE DATE OF IMPAIRMENT
Question
When an available-for-sale (AFS) debt instrument is impaired and fair value losses
have been reclassified from other comprehensive income to profit or loss in
accordance with IAS 39.67, what is the effective interest rate that is applied
immediately after impairment?
Answer
A revised effective interest rate determined at the date of the impairment is applied
immediately after impairment.
IAS 39.67 requires the impairment loss previously recognised in other

comprehensive income and accumulated in equity to be reclassified to profit or loss
when the asset is impaired. This impairment loss is determined by the fair value of
the asset at the date of impairment. IAS 39.AG93 requires that following the
recognition of an impairment loss, interest income is “recognised using the rate of
interest used to discount the future cash flows for the purpose of measuring the
impairment loss”. The revised effective interest rate is the internal rate of return that

discounts the expected cash flows (including the effect of the impairment) to the fair
value at the date of the impairment, which in turn is used to measure the
impairment loss.
In determining interest to be recognised in profit or loss in the periods following

impairment, this revised effective interest rate is applied to the fair value at the date
of impairment.
A revision of the effective interest rate will also be necessary at the date of any
further fair value losses reclassified to profit or loss as impairment losses in
accordance with IAS 39.67 or fair value gains recognised in profit or loss in
accordance with IAS 39.70 as a reversal of previous impairment losses.
Q&A IAS 39: 67-2 — RECLASSIFICATION TO PROFIT OR LOSS OF GAINS

OR LOSSES WHEN A DEBT INSTRUMENT PREVIOUSLY RECLASSIFIED
FROM AVAILABLE-FOR-SALE TO HELD-TO-MATURITY OR LOANS AND
RECEIVABLES IS DETERMINED TO BE IMPAIRED
[Added 7 May 2010]
Background
On 1 January 20X7, an entity invests in a zero coupon bond with a four year term.
The initial consideration for the bond is CU68.3 and the final redemption amount on
31 December 2010 is CU100, giving an effective interest rate (EIR) of 10 per cent.
The entity initially classifies the bond as an available-for-sale (AFS) financial asset.
On 31 December 20X7, the bond's amortised cost (for the purposes of recognising
interest income on an EIR basis) is CU75.1 (CU68.3 × 110%). Due to an increase in
market rates of interest, the fair value of the bond on 31 December 20X7 is CU60.
The fair value loss of CU15.1 is recognised in other comprehensive income (OCI).
On 1 January 20X8, the entity reclassifies the bond to held to maturity (HTM)
investments (or loans and receivables (L&R)) in accordance with IAS 39.50E. Its fair
value on this date, CU60, becomes its new amortised cost in accordance with IAS
39.54; a new EIR of 18.6 per cent is calculated to discount the redemption amount
of CU100 on 31 December 2010 to CU60 at 1 January 20X8. IAS 39.54(a) requires
that the loss of CU15.1 accumulated in equity prior to reclassification be amortised to
profit or loss over the remaining life of the investment using the EIR method.
On 31 December 20X8, the bond is determined to be impaired and the revised

expected redemption amount at maturity is CU90. The amortised cost immediately
before impairment is CU71.1 (CU60 × 118.6%). The impairment loss is calculated as
CU7.1, which is the difference between the carrying amount of CU71.1 and CU64.0
(CU90 discounted by 18.6 per cent over the remaining two years).
Question
When the bond is determined to be impaired, how much of the loss previously
accumulated in equity should be reclassified to profit or loss?
Answer
When the impairment loss is recognised, all of the loss previously accumulated in
equity (i.e. CU15.1) should be reclassified to profit or loss.
This treatment is based on IAS 39.54(a), which states that “[i]f the financial asset is
subsequently impaired, any gain or loss that has been recognised in other
comprehensive income is reclassified from equity to profit or loss in accordance with
[IAS 39.67]” (emphasis added). The words 'any gain or loss' require the total
amount relating to the reclassified asset previously accumulated in equity to be
reclassified to profit or loss. This is further confirmed by IAS 39.67 which states that
“[w]hen a decline in the fair value of an available-for-sale financial asset has been
recognised in other comprehensive income and there is objective evidence that the
asset is impaired (see paragraph 59), the cumulative loss that had been recognised
in other comprehensive income shall be reclassified from equity to profit or loss as a
reclassification adjustment even though the financial asset has not been
derecognised” (emphasis added).
Q&A IAS 39: 70-1 — REVERSAL OF IMPAIRMENT LOSSES ON AN AFS

DEBT INSTRUMENT
Background
On 1 January 20X0, Entity A acquires a fixed-rate interest bearing debt instrument

for its fair value and par of CU100. The debt instrument is classified as
available-for-sale (AFS). In the year ended 31 December 20X0, the fair value of the
instrument decreases from CU100 to CU70, of which CU20 is attributed to the
declining creditworthiness of the issuer and CU10 to increases in the risk-free market
interest rate. Entity A identifies objective evidence that the instrument is impaired in
accordance with IAS 39.58, and the entire CU30 fair value loss is reclassified from
equity to profit or loss as an impairment loss in accordance with IAS 39.67.
In the year ended 31 December 20X1, the fair value of the debt instrument
increases to CU92, of which CU15 relates to an improvement in the creditworthiness
of the issuer (which gives rise to increased expectations of estimated recoverable

cash flows) and CU7 to decreases in the risk-free market interest rate.
The improvement in the creditworthiness of the issuer is considered an objective

'event' in accordance with IAS 39.70.
Question
How should Entity A account for the increase in fair value of CU22 in the year ended
31 December 20X1?
Answer
The entire fair value gain of CU22 should be recognised in profit or loss as a reversal
of the previous impairment loss. IAS 39.70 requires that if the increase in fair value
can be objectively related to an event occurring after the previous impairment loss
was recognised in profit or loss, the impairment loss should be reversed or partly
reversed, with the amount of the reversal recognised in profit or loss.
In the example under consideration, the event in question is the improvement in the
creditworthiness of the issuer (which gives rise to increased expectations of
estimated recoverable cash flows). Entity A should recognise the entire amount
(CU22 gain) in profit or loss, not just the portion of the fair value that relates to the
improvement in the creditworthiness of the issuer (CU15 gain).
The gain of CU22 is a partial reversal of the original impairment loss of CU30
recognised in the period ended 31 December 20X0.
Q&A IAS 39: 71-1 — RISK REDUCTION AND HEDGE ACCOUNTING

Question
For a hedge relationship to qualify for hedge accounting, must the hedge relationship
reduce risk for the entity?
Answer
No.
Consider the following example:
An entity has a fixed rate asset and a fixed rate liability, each having the
same principal amount. The entity receives interest of 10 per cent on the
asset and pays interest of 8 per cent on the liability. Because payments
and receipts occur in the same period, the entity always has a net cash
inflow of 2 per cent.
The entity enters into a receive-floating, pay-fixed interest rate swap on a
notional amount equal to the principal of the asset and designates the
interest rate swap as a fair value hedge of the fixed rate asset. The entity
qualifies for hedge accounting, even though the swap creates an exposure
to variability in interest rate changes that did not previously exist. The
asset being hedged has a fair value exposure to interest rate movements
that is offset by the interest rate swap.
Q&A IAS 39: 72-EX-1 — HEDGING WITH NON-DERIVATIVES

Example
On 1 January 20X4, Company B has a firm commitment to purchase equipment (a
nonfinancial asset) from Company M, a French company, whose functional currency
is €. Company B's functional currency is pound sterling. The firm commitment
requires B to pay €30 million in exchange for delivery of the equipment on 1 January
20X5. Company B has a 31 March year end.
Company B currently has €30 million on deposit with a bank, maturing on 1 January
20X5, on which it currently recognises in profit or loss foreign exchange gains and
losses at each reporting date. Company B would like to use its euro deposit balance
as a hedge of its commitment to purchase the equipment.
Company B can designate the cash deposit as a hedging instrument in either a cash
flow or a fair value hedge of the spot foreign currency risk of the firm commitment.
The spot foreign exchange rates are as follows:

The entries below do not consider the accounting for the deposit before 1 January
20X4. Up to this date, the monetary asset will have been retranslated at the spot
rate on each reporting date, with exchange gains and losses reported in profit or
loss. In addition, interest on the deposit has been ignored for illustrative purposes
only.
B designates the hedge as a fair value hedge.

1 January 20X4
There are no entries. The firm commitment has a fair value of zero.
31 March 20X4
1 January 20X5

B designates the hedge as a cash flow hedge.

1 January 20X4
There are no entries.
31 March 20X4
1 January 20X5

If B has an accounting policy not to apply basis adjustments to nonfinancial items,
the amount in equity will be retained in equity at the acquisition date of the
equipment and will be recycled in profit and loss in future periods when the
depreciation of the equipment will affect profit or loss. In this case, the carrying
value of the equipment would be £20,673,971.
Q&A IAS 39: 72-EX-2 — HEDGING WITH A WRITTEN OPTION

Example
Company A owns shares in Company XYZ, an unrelated company. Company A
classifies these shares as available-for-sale. Company A purchased the shares when
the share price was £10. The share price is currently £15. Company A writes a call
option over its shares in XYZ, allowing the purchaser of the option to acquire the
shares for £17; for this, A receives a premium of £0.50.
Company A cannot designate the option as a hedge of its shares in XYZ because it is
a written option.
Q&A IAS 39: 72-EX-3 — ASSESSING WRITTEN OPTIONS IN

INSTRUMENTS
Example
Company A issues 20-year, fixed rate debt. To hedge its fair value exposure to
interest rate risk, it enters into a receive-fixed, pay-floating interest rate swap, such
that all the terms of the swap match the debt. Owing to the long-term nature of the
swap, the counterparty to the swap, the bank, inserts a break clause that gives it
the option to terminate the swap after 10 years, so that on termination no cash will
be exchanged. No cash is exchanged at the start of the transaction.
Company A has effectively allowed the bank to terminate the swap after 10 years.
While no cash was exchanged up front, A will receive a favourable rate on one of the
legs of the swap in recompense for giving the bank this option.
The swap cannot be designated as a hedge of the issued debt, since it contains a
written option (i.e. it is a net written option). The written option cannot be split out
of the swap contract (leaving a vanilla, 20-year interest swap) since a derivative
must be designated as a hedging instrument in its entirety.
If the terms of the break clause resulted in termination of the swap at fair value at
the time of termination, and fair value excluded any compensation in excess of the
interest rate swap payable or receivable to either party, the swap would still contain
a written option but the value of the option would be zero. The legs of the swap
would be no different from a swap without a break clause. In this case, the swap
could be used as a hedging instrument since it is not a net written option.
Q&A IAS 39: 72-EX-4 — HEDGE ACCOUNTING WITH A PURCHASED

OPTION
Example
On 4 January 20X0, Company X issued a five-year, $100 million variable rate bond.
The bond pays interest based on LIBOR plus a spread of 200 basis points annually,
reset on 31 December. Company X wants to hedge against increases in interest rates
by capping the maximum interest rate at 9 per cent (LIBOR of 7 per cent plus a 2
per cent spread). Company X purchased an interest rate cap that is indexed to
LIBOR with a $100 million notional amount. The cap pays X the difference between 7
per cent and LIBOR, if LIBOR rises above 7 per cent. The interest rate cap (intrinsic
value only) is designated as a cash flow hedge of the variable rate debt. The terms
of the cap are as follows:
Notional amount $100 million
Trade date 4 January 20X0
Start date 4 January 20X0

Expiration date 31 December 20X4
Strike price 7.00 per cent
Index 12 month LIBOR
Initial LIBOR 5.56 per cent
Premium $1.44 million
Caplet expirations 31 December 20X0,

20X1, 20X2, and 20X3
The payments on each caplet are made 12 months after the expiration. For example,
the caplet that expires on 31 December 20X0 will be paid, if applicable, on 31
December 20X1. The fair value of the cap throughout the term of the cap is
summarised below:
The following entries are required:
4 January 20X0

31 December 20X0

31 December 20X1
31 December 20X2

31 December 20X3

31 December 20X4

Q&A IAS 39: 74-1 — SPLITTING A FINANCIAL ELEMENT OF A
NON-OPTIONAL DERIVATIVE
Question
Is it possible to exclude the financing element of a non-optional derivative (e.g. a
forward contract) from designation in a hedging relationship?
Answer
No. IAS 39.74 permits only the following two exceptions to the rule that a hedging
relationship is designated by an entity for a hedging instrument in its entirety:
• Separating the intrinsic value and time value of an option contract and
designating only the change in intrinsic value as the hedging instrument,
thereby excluding the change in time value.
• Separating the interest element and the spot price of a forward contract
and designating only the changes in the spot element as the hedging
instrument.
Therefore, it is not possible to split the embedded financing from a non-optional

derivative that has a fair value other than zero at the time of designation and to
account for it as a separate amortising loan while designating the zero fair value
derivative as the hedging instrument.
If a non-optional derivative, such as a forward contract or swap, has a fair value

other than zero at inception of the hedge, future changes in its fair value are
affected by that starting value. The derivative includes an embedded financing
element, which contributes to its fair value movements and will cause these
movements to differ from the changes in fair value of the hedged item when the
hedged item does not have an equal and opposite financing element.
IAS 39 does not prohibit the designation of non-zero, fair value non-optional
derivatives as hedging instruments in their entirety, as long as the hedging
instrument is expected to be highly effective. In fact, IAS 39 allows hedging
instruments to be designated part of the way through their lives; it is quite common,
therefore, for a derivative's designated starting value to be other than zero. If the
derivative can pass the prospective and retrospective assessment of hedge
effectiveness, the non-zero element of the derivative at initial designation will cause
ineffectiveness that will be recognised in profit or loss over the term of the hedge.
The ineffectiveness arises because the embedded financing element is economically

similar to a fixed rate amortising loan embedded in the derivative and this "loan" will
change in fair value as interest rates move.
Q&A IAS 39: 74-2 — DESIGNATING THE TIME VALUE OF AN OPTION IN

AN EFFECTIVE HEDGING RELATIONSHIP
Background
Entity P, which has a euro functional currency, has a highly probable forecast
external sale in six months in U.S. dollars. Entity P hedges its exposure to a fall of
the U.S.$ against the € by buying a € call/U.S.$ put option with a maturity and
notional exactly matching those of the exposure. The strike price of the option is
€1/U.S.$1.
Entity P's management wishes to treat the purchased option as a cash flow hedge of
its forecast U.S.$ sale. It designates the hedged risk as "the risk that, when the sale
takes place (being the maturity of the option), the US$/€ rate will be below
US$1/€1".
Question

Can the full fair value of the option (i.e. both time value and intrinsic value) in the
above scenario be treated as a 100 per cent effective component of the cash flow
hedge relationship if the designated risk has been defined in the way described
above — that is, only the downside risk is hedged beyond a specified level?
Answer
No. IAS 39.105 states that hedge effectiveness is assessed by comparing the
changes in fair values or cash flows of a hedged item with changes in fair values or
cash flows of a hedging instrument. In the above scenario, the hedged item (highly
probable forecast U.S.$ external sales) is not subject to changes in time value. The
change in cash flows of the hedged item for the hedged risk in this case will be
driven solely by the extent to which U.S.$/€ rates move below €1 on the date when
P recognises revenue on the highly probable external U.S.$ sales, and will not be
affected by changes in time value.
IAS 39.74 permits an entity to exclude the time value of an option from the hedging
relationship and, thus, from assessment of effectiveness. In such a case, the
changes in time value would be recognised in profit or loss outside of the hedging
relationship. This allowance may be particularly beneficial in a cash flow hedging
relationship, such as the one described above in which a purchased option is used to
hedge a non-optional hedged item. To the extent that changes in time value are not
excluded from the hedging relationship, only the effective portion of the change in
the total fair value of the option will be recognised in equity, in accordance with IAS
39.95(a). However, because the non-optional exposure (in this case the risk that
when the sale takes place, U.S.$/€ rates have fallen below U.S.$1/€1) is not subject
to changes in time value, if this latter designation is applied, the hedge is likely to be
highly ineffective.
Q&A IAS 39: 74-EX-1 — HEDGING A PORTION OF FAIR VALUE

Example
Company A has an investment in shares of Company XYZ, which it has classified as
an available-for-sale (AFS) financial asset. To protect itself against a decrease in the
share price, A purchases a put option over those shares. Company A designates the
intrinsic value of the put as a hedging instrument in a fair value hedge of the XYZ
shares.
The put has a strike price of £50 per share (i.e. it allows A to sell the shares at £50
to the counterparty to the put). When A purchased the put, XYZ shares were trading
at £55 per share. The put option will be fully effective in offsetting any price
decrease below £50, since A is designating only the intrinsic value. Any change in
price above £50 is not hedged.
Changes in the fair value of XYZ shares are recognised in equity as the investment is
AFS. To the extent that the shares are hedged, changes in the fair value attributable
to the hedged risk are recognised in profit or loss and offset with the gains and
losses on the hedging instrument (i.e. the gains or losses on the hedged item below
£50 will be recognised in profit or loss and offset by the gains or losses on the
hedging instrument, with the increases in fair value above £50 recognised in equity).
Changes in the fair value of the option that relate to time value will be recognised in
profit or loss since this is not part of the hedge designation.
Q&A IAS 39: 75-EX-1 — DESIGNATING A HEDGING RELATIONSHIP FOR

ONLY A PORTION OF THE PERIOD DURING WHICH THE HEDGING
INSTRUMENT REMAINS OUTSTANDING
Example
IAS 39.75 is clear that a hedging relationship may not be designated for only a
portion of the period during which the hedging instrument remains outstanding.
Company A has a pay-fixed, receive-variable interest rate swap that it wishes to

designate as hedging its variable rate issued debt. The swap has a 10-year term,
and the debt has a seven-year term. Company A may not designate seven of the 10
years of the swap as the hedging instrument.
The inability to designate a hedging instrument for only a portion of the period
during which the hedging instrument remains outstanding is an extension of the rule
in IAS 39.74 that a hedging instrument must be designated in a hedging relationship
in its entirety subject to some limited exceptions. An entity is not permitted to
designate part of a derivative that is not a proportion of the derivative as a whole,
unless the part of the derivative excluded from the hedge relationship is the time
value of an option or forward points in a forward as permitted by IAS 39.74.
The prohibition above should not be confused with the ability to designate a hedging
instrument for only part of its life, if for that part of its life the hedge is expected to
be highly effective. For example, it is possible to hedge a 10-year debt instrument
using a 10-year interest rate swap but to apply hedge accounting for only one year.
Hedge accounting is permitted, as long as the relationship is highly effective, for as
long as the designation is applied. An entity may choose to de-designate any hedge
relationship at any time because hedge accounting is always voluntary.
Note that in the first scenario, rather than designating seven of the 10 years of the
swap as the hedging instrument, the entity is permitted to designate as the hedging
instrument the entire 10 years of the swap, even if the hedged item has the shorter
maturity of seven years. In such designations, however, ineffectiveness will arise.
If, in the above example, the terms of the debt and swap were reversed (the debt
having a life of 10 years and swap maturing in seven years), it would be possible to
hedge the debt for the first seven years in which it remains outstanding. This is in
accordance with IAS 39.IG F2.17, which specifically states that the principle
contained in IAS 39.81 (that a financial instrument may be a hedged item for only a
portion of its cash flows or fair value if effectiveness can be measured) allows for
partial term hedging of financial instruments. In this case, the derivative is
designated as hedging only a portion of the period to maturity of a hedged item.
Q&A IAS 39: 76-1 — DESIGNATING A HEDGING INSTRUMENT AS

HEDGING MORE THAN ONE RISK
Background
Company A, a pound sterling functional currency entity, issues variable U.S. dollar
debt. To hedge its exposure to foreign currency exchange rates and to interest rate
risk, it enters into a cross-currency interest rate swap. The terms of the swap match
those of the debt. Under the swap, A receives floating U.S.$ and pays fixed £.
Company B, also a pound sterling functional currency entity, issues fixed U.S. dollar
debt, and uses a cross-currency interest rate swap (again on matching terms) to
convert the position into variable £ debt and thereby hedge its exposure to U.S.$
interest rates and foreign exchange rates. Under the swap, B receives fixed U.S.$
and pays floating £.
Question
Can A and B designate their respective swaps in hedging relationships, even though
in each case the entity is hedging more than one risk?
Answer
Yes. IAS 39.76 permits a single hedging instrument to be designated as a hedge of
more than one type of risk as long as the following three conditions are met:
1. The risks can be identified clearly.
2. The effectiveness of the hedge can be demonstrated.

3. The hedging instrument and different risk positions can be specifically
designated.
Therefore, under the above criteria, A can, in accordance with IAS 39.76, designate
the single swap as a cash flow hedge of U.S.$ interest rate risk, and either a cash
flow hedge or fair value hedge of the U.S.$:£ foreign currency risk. Similarly, B can,
subject to meeting the criteria of IAS 39.76, designate its single swap as either a fair
value hedge of the U.S.$ interest rate risk and U.S.$:£ foreign exchange risk or a
fair value hedge of the U.S.$ interest rate risk and a fair value or cash flow hedge of
the U.S.$:£ foreign exchange risk.
If a single hedging instrument is designated as a hedge of more than one risk, the
hedge accounting criteria must be satisfied with respect to all the designated hedged
risks. If the hedge effectiveness criteria are not met with respect to one of the risks
being hedged, no hedge accounting treatment is allowed for both designations for
the period. If one of the risks designated fails to meet the effectiveness test,
continuing hedge accounting would result in a hedging relationship that does not
encompass the entirety of the hedging instrument and would not be permitted by
IAS 39.74. Thus, in the case of B, if the fair value hedge of U.S.$ interest rates fails
to satisfy the hedge effectiveness tests, no hedge accounting would be permitted for
the hedge of either the interest rate risk or the foreign currency risk.
Q&A IAS 39: 77-1 — ABILITY TO DESIGNATE A COMBINATION OF A

DERIVATIVE AND A NON-DERIVATIVE WHEN HEDGING FOREIGN
CURRENCY RISK
Question
Parent A (pound sterling functional currency) and Group A (pound sterling
presentation currency) have an investment in a yen functional-currency foreign
operation. Parent A has US$100 million floating issued debt. Parent A also has a
cross-currency swap to receive US. dollars floating over a notional of US$100 million,
pay yen floating over a fixed notional of yen (equivalent to US$100 million on the
trade date of the swap). Both the U.S. dollar debt and the cross-currency swap have
the same period to reach maturity.
Can Group A designate the U.S. dollar-denominated debt and U.S. dollars/yen
cross-currency swap as a hedging instrument in hedging the yen risk of its net
investment in its yen foreign operation?
Answer
Yes. IAS 39.77 permits a derivative and a non-derivative to be designated in
combination as a hedging instrument when hedging foreign currency risk. IAS 39.77
also specifies that a combination of derivatives can be designated even where those
derivatives have offsetting risks. For example, an entity could designate, in
combination, an offsetting receive yen/pay U.S. dollars swap, which has a long
yen/short U.S. dollars risk, together with a receive U.S. dollars/pay yen swap, which
has a long U.S. dollars/short yen risk. The ability to designate items with offsetting
risks is not explicitly limited only to combinations of derivatives; rather, the
combination of derivatives is an illustration of the principle that can be extended to a
combination of a derivative and a non-derivative in a hedge of foreign currency risk.
The combination of the U.S. dollars debt and the cross-currency swap from U.S.
dollars to yen, is, therefore, a qualifying hedging instrument and can be used as a
hedge of the foreign currency risk of the net investment in the Japanese foreign
operation. The U.S. dollars risk on the debt can be offset by the U.S. dollars risk on
the cross-currency swap.
Q&A IAS 39: 77-2 — DESIGNATING A COMBINATION OF DERIVATIVES

INCLUDING A WRITTEN OPTION
Background
Company A enters into a foreign currency purchased option and foreign currency
written option at the same time. The entity is considering the appropriateness of
jointly designating the two options as a hedging instrument.
Question
What factors should A consider in determining whether the two options should be
seen as separate instruments or as a single arrangement?
Answer
IAS 39.77 only permits an entity to jointly designate two or more derivatives, or
proportions of them, as the hedging instrument if none of them is a written option or
net written option. Therefore, A must determine whether, in substance, the two
options constitute separate instruments or a single arrangement. In making its
determination, A should consider the guidance in IAS 39.IG B.6.
Factors indicating that is the options constitute a single arrangement include:
• They are entered into at the same time and are contemplated together.
• They have the same counterparty.

• They relate to the same risk.
• There is no apparent economic need or substantive business purpose for

structuring separate transactions that could not also have been
accomplished in a single transaction.
If the combination of options is not considered to be one arrangement, then because

one of the instruments is a written option, A is not permitted to designate the
combination of options as a hedging instrument.
If, on the other hand, the two options are determined to constitute a single
arrangement, A should consider whether the single arrangement is a net written
option on the basis of the guidance in IAS 39.IG F.1.3. If the single arrangement is
determined to be a net written option, then, in line with IAS 39.AG94, it could not be
designated as a hedging instrument unless it is designated as an offset to a
purchased option (including one that is embedded in another financial instrument).
Q&A IAS 39: 77-EX-1 — HEDGING WITH MULTIPLE DERIVATIVES

Example
Company A has a forecast purchase of copper. To hedge the price risk associated
with the forecast purchase, A enters into a futures contract to buy copper. However,
the grade of copper in futures contracts is lower than that required by A. Therefore,
A also enters into a basis swap, which swaps the different grades of copper between
the futures contracts and the forecast purchase. As long as the other hedge
accounting criteria are satisfied, A may jointly designate the futures and the basis
swap as hedging its forecast purchase of copper.
Q&A IAS 39: 77-EX-2 — DESIGNATING A COMBINATION OF

DERIVATIVES AS THE HEDGING INSTRUMENT
Example
Company M, a pound sterling functional currency entity, issues € denominated fixed
rate debt. At the date of issue, M also enters into two derivative instruments (swap 1
and swap 2). Under swap 1, M receives fixed € (matching the fixed payments on the
debt) and pays floating £. Under swap 2, M receives floating £ and pays £ fixed.

Neither swap 1 nor swap 2 is a written option or a net written option.
In accordance with IAS 39.77, M may jointly designate the combination of two or
more derivatives or proportions of them as a hedging instrument even if the
derivatives have an offsetting risk (like the floating £ legs on both swaps in the
above scenario). Thus, M could designate the combination of swap 1 and swap 2 as
the hedging instrument in a cash flow or fair value hedge of foreign exchange risk
arising from the issued € debt.
When a combination of derivatives (or non-derivative instruments with respect to

hedges of foreign currency risk only) is used as a hedging instrument, the hedge
effectiveness of this relationship is based on the whole combination.
Q&A IAS 39: 77-EX-3 — ASSESSING NET WRITTEN OPTIONS

Example
Company A issues £100 million of variable rate debt. To hedge against interest rate
increases, it purchases an interest rate collar at the date of the debt's issuance that
hedges interest rates above 8 per cent and below 4 per cent. Current fixed interest
rates for the same term as the debt are 6 per cent. The collar costs £0.5 million;
forward rates indicate that interest rates are expected to rise over the term of the
debt; therefore, the purchased cap will more likely be in the money than will the
written floor. The purchased cap and written floor included in the collar have the
same notional of £100 million.
Company A may designate the collar as a cash flow hedge of the variable rate debt,
since no net premium is received (there is a net premium payable of £0.5 million)
and the notional on the floor does not exceed that on the cap.
If a premium was received on the collar, it could not have been designated as a
hedging instrument, for it would be considered a net written option. Likewise, if the
notional on the floor was greater than £100 million, the collar could not have been
designated as a hedging instrument.
Q&As IAS 39: 78-EX-1 and 78-EX-2 — HEDGE ACCOUNTING: FIRM

COMMITMENTS
IAS 39: 78-EX-1

Example
Company B, a pound sterling functional currency entity, sells machinery at fixed
prices in many jurisdictions. Company B enters into a contract with Company D, a
euro functional currency entity, to sell machinery for delivery in six months at a fixed
price in euros that is determined today. Company B has entered into a firm
commitment with D.
Company B simultaneously enters into a foreign currency forward contract to hedge

its future exposure to the euro arising from its firm commitment. This foreign
currency forward contract can be designated as a hedging instrument in either a fair
value hedge or a cash flow hedge, since Company B is hedging the foreign currency
risk of a firm commitment.
IAS 39: 78-EX-2
Example
Company E, a discount grocery chain with more than 400 stores in the United
States, enters into forward contracts to purchase various inventory items for its
stores. On 1 June 20X0, E enters into a forward contract to purchase 300,000
bushels of wheat — for use in its bakery operations — from a wheat producer for a
fixed price of $1.40 per bushel on 1 August 20X0. Company E intends to take
physical delivery of the wheat in accordance with its expected purchase
requirements. If E failed to take delivery of the wheat, it would be required to pay
for any decrease in the value of the wheat and legal remedies would be available to
the wheat producer.
The transaction is a firm commitment because it is a binding agreement for the

exchange of a specified quantity of wheat at a specified price on a specified future
date. The forward contract is not accounted for as a derivative because E intends to
take physical delivery of the wheat and has no past practice of settling similar
contracts on a net basis. Company E could enter into a fair value hedge to hedge the
fair value exposure of the firm commitment due to the change in the price of wheat
between 1 June 20X0 and 1 August 20X0 by entering into a forward contract to sell
wheat for a fixed price on 1 August that qualifies as a hedging instrument. Since E is
hedging all risks of the firm commitment over a nonfinancial item, it is a qualifying
hedged item in accordance with IAS 39.82.
Q&A IAS 39: 79-EX-1 — HEDGING FORECAST INTEREST RECEIPTS ON

DEBT INSTRUMENTS RESULTING FROM THE REINVESTMENT OF
INTEREST RECEIPTS FROM A HELD-TO-MATURITY ASSET
Example
Company XYZ owns a variable rate asset that it has classified as held-to-maturity
(HTM). The variable interest rate receipts are reinvested in debt instruments.
Company XYZ enters into a derivative to lock in the current interest rate on the
reinvestment of the future variable cash flows and designates the derivative as a
cash flow hedge of the forecast future interest receipts on debt instruments.
Company XYZ qualifies for hedge accounting, even though the interest payments
that are being reinvested derive from an HTM asset. Although an HTM asset itself
cannot be hedged with respect to interest rate risk, it is possible to designate the
derivative as hedging cash flow variability from debt instruments that were
purchased using the interest receipts from the HTM asset. The source of the funds
used to purchase the debt instruments in the future is not relevant. The key
determinant is whether the forecast transaction is highly probable, as long as all
other hedge accounting criteria are met.
The same would be true if XYZ had fixed HTM assets instead of variable rate HTM
assets.
Q&A IAS 39: 80-1 — CASH FLOW HEDGE ACCOUNTING OF FORECAST

INTRAGROUP TRANSACTIONS
Background
Scenario 1

Company B incurs production costs in £ towards goods it manufactures and sells in £
to a fellow subsidiary, Company C. This creates a foreign currency risk in Company C
to the £/US$ exchange rate with regard to its forecast intragroup transaction with
Company B (purchase of goods in £). Company C also intends to sell the goods
externally outside of the group in US$. In order to hedge the exposure associated
with the forecast purchase from Company B, Company C enters into a forward
contract with a third party bank (buy £ / sell US$). The group wishes to designate
the forward contract as hedging the foreign currency risk of the forecast intragroup
purchase by Company C in a cash flow hedging relationship in accordance with IAS
39 in the consolidated financial statements.
Scenario 2

Scenario 2 presents a fact pattern similar to Scenario 1 above, except that the sale
of goods from Company B to Company C is denominated in US$ and therefore there
is foreign currency risk for Company B on the sale of goods to Company C. Company
B enters into a forward contract with a third-party bank to mitigate its functional
currency risk of the forecast sale to Company C in US$ (buy £ / sell US$). The group
wishes to designate the forward contract as hedging the foreign currency risk of the
forecast intragroup sale by Company B in a cash flow hedging relationship in
accordance with IAS 39 in the consolidated financial statements.
Question
Can the above scenarios qualify for cash flow hedge accounting of the forecast
intragroup transaction in the consolidated financial statements of a group that has
two subsidiaries that have different functional currencies (Company B — Pound
Sterling (£) functional currency and Company C — US Dollar (US$) functional
currency)?
Answer
IAS 39.80 states that "the foreign currency risk of a highly probable forecast
intragroup transaction may qualify as a hedged item in consolidated financial
statements provided that the transaction is denominated in a currency other than
the functional currency of the entity entering into that transaction and the foreign
currency risk will affect consolidated profit or loss."
In both scenarios, the transaction being designated is denominated in a currency

other than the functional currency of the entity entering into it. In the case of
Scenario 1, the forecast intragroup purchase by Company C (functional currency of
US$) is denominated in £. In Scenario 2 the forecast intragroup sale by Company B
(functional currency £) is denominated in US$. Also, in both cases the onward sale of
the goods by Company C will affect consolidated profit or loss. Thus, in both cases
the forecast intragroup transaction could be designated as the hedged item in a cash
flow hedge of foreign currency risk within the consolidated financial statements. In
order for hedge accounting treatment to be applied, all relevant conditions within IAS
39.88 also must be satisfied.
In both scenarios above, the effective gains or losses from the derivative initially
recognised in equity under cash flow hedge accounting are reclassified to profit or
loss in the same period that the foreign currency risk of the hedged transaction
affects consolidated profit or loss in accordance with IAS 39.AG99B. This impact on
consolidated profit or loss will occur when the onward external sale outside the group
occurs and not when the intragroup sale from B to C occurs. In the event that hedge
accounting is discontinued, the gains and losses in equity will be subject to the
requirements of IAS 39.101.
It should also be noted that IAS 39 does not require a company exposed to the
hedged risk within a group to be party to the hedging instrument if hedge accounting
is applied at the consolidated level as noted in IAS 39.IG F.2.14. Thus, in both of the
above scenarios, the hedging instrument (foreign currency forward contract) could
be held by a different entity within the group.
Q&A IAS 39: 80-2 — INTRA GROUP CASH FLOW HEDGING

Background
A Swedish entity, Company A, sells goods to a fellow Brazilian subsidiary, Company

B. The functional currency of A is SEK and the functional currency of B is BRL; the
internal sales are denominated and settled in USD. The two companies are part of a
group with an SEK presentation currency. Company A's cost base is denominated in
SEK, and, thus, has a currency exposure to USD in respect of the sale of goods to B
(as it has a right to receive USD in the future). Company B sells the goods externally
in its functional currency, BRL, and, thus, has a currency exposure to USD in respect
of its purchase of goods from A (as it has an obligation to pay USD in the future).
The Group is economically left with a net exposure of SEK/BRL in respect of external
purchases and sales as the two internal USD exposures will offset.
The following figure illustrates the transaction flow and currency exposure within the
Group.

Question
Does the intra-group transaction (intercompany sale and/or purchase denominated
in USD) qualify as a hedged item in an intra-group cash flow hedge in the group's
consolidated financial statements? Assume that all other hedge criteria have been
met (e.g. all hedge documentation has been completed, the transactions are highly
probable, and effectiveness can be assessed and measured).
Answer
No.
The amendment to IAS 39 Cash Flow Hedge Accounting of Forecast Intragroup

Transactions, was introduced to cover situations where one of the parties to the
internal transaction passes their foreign currency risk to the other (i.e. where the
internal transaction is in the functional currency of either A or B). This is the
currency risk that cannot be avoided because the two parties have different
functional currencies; however in this example, each of the parties to the internal
transaction are taking on an additional foreign currency risk, and, therefore, the
amendment cannot be applied.
If A entered into an SEK/USD forward, assuming all the other hedge criteria were
met, the derivative would qualify as a hedging instrument of its USD/SEK exposure.
Similarly, if B entered into a USD/BRL forward, this derivative would qualify as a
hedging instrument of its BRL/USD exposure, and both hedge designations would
qualify for hedge accounting in the respective separate company financial statements
of A and B. However, in the consolidated financial statements, these would not
qualify as a hedge of the group's exposures as even though the sum of the two
derivatives results in a net SEK/BRL forward, both the external purchase and the
external sale are in the functional currency of A and B, respectively, and hence the
group does not have an exposure to variable cash flows.
If the internal transaction had been denominated in BRL, A could have designated in
the consolidated financial statements an SEK/BRL forward as a hedging instrument
of the foreign currency risk of its forecast sale with B, assuming all of the other
conditions for hedge accounting were met. Similarly, if the internal transaction had
been denominated in SEK, B could have designated in the consolidated financial
statements an SEK/BRL forward as a hedging instrument of the foreign currency risk
of its forecast purchase from A, assuming all of the other conditions for hedge
accounting were met.
Q&As IAS 39: 80-EX-1 and 80-EX-2 — CASH FLOW HEDGE

ACCOUNTING OF FORECAST INTRAGROUP TRANSACTIONS
IAS 39: 80-EX-1
Example
Company A, a pound sterling functional currency entity, is expecting to purchase a
machine from Company B, a euro functional currency entity, for €10 million in 1
year. The purchase is highly probable. Companies A and B are part of the same
group, and A will use the machine in its production process to make goods for
external sale. The cost of the machine will be capitalised and depreciated over its
useful economic life in both A's financial statements and the consolidated financial
statements (including both A and B). Company A enters into a
buy-euro-sell-pound-sterling forward contract to hedge the expected foreign
currency risk on the forecast purchase.
The forecast intragroup purchase will qualify as a hedged item in the consolidated
financial statements in a cash flow hedge of the foreign currency risk for the
following three reasons:
• The purchase is highly probable.
• The purchase is denominated in a currency (euro) other than A's functional

currency (pound sterling).
• The depreciation of the machine will result in the foreign currency risk of
the forecast transaction affecting consolidated profit or loss. The
euro/pound sterling exchange rate at the date of purchase will affect the
amount initially recognised for the machinery since it will initially be
recognised at spot currency rates. Thus, the foreign currency exchange
rate will affect the amount of depreciation charged in future periods.
In accordance with IAS 39.99, A and B may or may not have an accounting policy
that "basis adjusts" nonfinancial items with the effective amount of the hedging
instrument recognised in equity at the date of acquisition of the non-financial item.
IAS 39: 80-EX-2
Example
Company E, a pound sterling functional currency entity, has a wholly owned
subsidiary, Company F, a yen functional currency entity. Company F generates
substantial profits and regularly pays yen dividends on its ordinary shares to its sole
shareholder and parent, E. To hedge the yen exposure associated with the dividend
income, E enters into a series of sell-yen-buy-pound-sterling forward foreign
currency contracts. Company E also expects to pay dividends on its own ordinary
shares (classified as equity in accordance with IAS 32 Financial Instruments:
Presentation) using the proceeds from the dividends received from its shareholding
in F.
The forecast intragroup transaction (the dividend income in the hands of E) will not
qualify as a hedged item in the consolidated financial statements of the group in a
cash flow hedge of the currency risk since the foreign currency risk will not affect
consolidated profit or loss. Even though E may expect to make an onward
declaration and payment of dividends on its own shares, IAS 32 requires that
distributions to holders of an equity instrument be debited by the entity directly to
equity. Thus, a gain or loss in consolidated profit or loss will not arise, and the
transaction cannot be hedged.
Q&A IAS 39: 81-1 — HEDGED RISK: EUROPEAN CENTRAL BANK

INTEREST RATE
Question
Entity C has issued debt with a floating interest rate based on the European Central
Bank (ECB) rate.

Can a Receive Fixed Pay LIBOR interest rate swap be designated as a hedge of the
portion of the ECB cash flows that are due to changes in LIBOR?
Answer
No. There is no LIBOR component in the ECB cash flows. The interest rate risk that
can be designated as the hedged risk is the ECB rate. It is not possible to argue that
the LIBOR rate is a portion of the ECB rate in accordance with IAS 39.81.
Additionally, because of the basis difference between ECB and LIBOR, hedging the
variability of the ECB floating interest rate with a LIBOR swap is unlikely to be a
highly effective hedging instrument if the notional of the two swaps are the same.
Changes in the cash flows of the floating interest rate will not be offset by the cash
flows of the LIBOR swap.
It may be possible to continually adjust the number of LIBOR swaps to be equivalent

to the variability in cash flows generated by variability in the ECB rate in order to
achieve a highly effective hedge relationship. If a sufficiently high correlation can be
demonstrated between LIBOR and ECB rates then this statistical relationship could
be used as a basis to adjust the hedge ratio in order to demonstrate a highly
effective hedge. Such a hedge designation is applying the principles described in IAS
39.AG100.
Q&A IAS 39: 81-2 — HEDGING FOREIGN CURRENCY RISK OF

DUAL-LISTED PUBLICLY TRADED SHARES
[Added 7 July 2006]
Background
Group A is a group headed by a Japanese resident parent whose shares are publicly
traded on the Tokyo Stock Exchange (TSE). Group A has a secondary listing on the
New York Stock Exchange (NYSE) where the Parent's shares are listed as American
Deposit Receipts (ADRs). Trading on the NYSE is comparatively low compared to
trading on the TSE as A has a small number of U.S. investors. The prices on the
NYSE are simply the prices of the shares on the TSE multiplied by the current foreign
exchange rate between Japanese yen and U.S. dollars.
Question
IAS 39.IG F.2.19 prohibits an investor from hedging the foreign currency risk of an
investment in a share if the share is listed on more than one stock exchange and the
price of the shares is denominated in multiple currencies where one of the currencies
is the functional currency of the investor. Can a US dollar functional currency
investor hedge the Japanese yen foreign currency risk in respect of a holding of the
Parent's shares acquired on the TSE when the trading volume on the NYSE is low?
Answer
No.
Even though the trading volume on the NYSE is low compared to its primary listing
on the TSE, the Parent's shares remain dual listed. As the investor is a US dollar
functional currency investor, and the shares are denominated in US dollars on a
stock exchange, the investor cannot hedge their foreign currency risk in respect of
the shares acquired from the TSE that are denominated in Japanese yen.
Q&A IAS 39: 81-3 — OPTIONS AVAILABLE FOR FAIR VALUE HEDGING
A FINANCIAL INSTRUMENT
Background
Company B has a five-year fixed rate bond asset. Company B wishes to hedge part,
or all, of the bond. The instrument is not classified as held-to-maturity.
Question
What options are available to B in designating the bond in a qualifying fair value
hedge relationship?
Answer
To designate the bond in a qualifying hedge relationship, B could choose one of the
following options:
• Hedge the full fair value of the cash flows on the debt (all contractual cash
flows).
• Hedge the fair value on a proportion of debt — e.g. fair value of 50 per
cent of the debt (proportion of all the contractual cash flows).
• Hedge the fair value on all cash flows due to impact of a specific risk only
(rather than all risks) — e.g. hedge all interest and all principal for interest
rate risk only.
• Hedge part of the cash flows due to a specific risk — e.g. designate the
impact of movements in interest rates on 50 per cent of the cash flows
(hedge a specific risk on a proportion of all cash flows).

• Hedge an isolated set of cash flows due to all risks — e.g. hedge the fair
value movement on the principal only (hedge a portion of cash flows).
• Hedge an isolated set of cash flows due to a specific risk — e.g. hedge the
fair value movement due to interest rate risk on the principal only (hedge a
specific risk only on a portion of cash flows).
• Hedge the full fair value beyond or below a range — e.g. hedge fair value
decreases below a specified amount (hedge a part of the fair value).
Q&A IAS 39: 81-4 — HEDGING INTEREST RISK PORTION OF CHANGES

IN FAIR VALUE OF FIXED RATE DEBT IN A FAIR VALUE HEDGE SOME
TIME AFTER ISSUE OF DEBT
Question
Is it possible to hedge the benchmark interest rate risk portion of a fixed rate loan
some time after its issue and achieve a highly effective hedge relationship?
Answer
Yes. However, this may require careful designation in line with the principles of IAS
39.AG99B.
For example, Entity A issues a fixed rate bond at par that will redeem at par and
pays semiannual coupons of 7 per cent. The coupons comprise an interest rate
(six-month LIBOR) component of 6 per cent and the entity's own credit spread of
100 basis points. Some time after issuance, the entity enters into an interest rate
swap (receive-fixed, pay six-month LIBOR) to hedge its exposure to changes in the
fair value of the liability attributable to the benchmark interest rate (six-month
LIBOR). The swap has an initial fair value of zero. Interest rates have fallen since the
bond was issued; hence, the coupons on the bond (of 6 per cent) will be higher than
the contracted fixed receipts on the interest rate swap (which may, for example, be
4 per cent). Because the fixed receipts on the swap are lower than the contractual
fixed rate coupons on the bond, the entity can designate as the hedged item a
portion of each coupon cash flow equal to the fixed receipts of the swap. The fixed
receipts of the swap and the cash flows on the designated portion of the bond will
match, and the hedge is likely to be highly effective. This is in line with the
requirements of IAS 39.AG99A, which states that if a portion of the cash flows of a
financial asset or financial liability is designated as the hedged item, that designated
portion must be less than the total cash flows of the asset or liability.
In contrast, if interest rates have risen since the bond was issued, the coupons on
the bond may be lower than the contractual fixed receipts on the interest rate swap.
For instance, assume the terms of the bond are the same as described above, but as
a result of a rise in interest rates, when the entity enters into a receive-fixed, pay
six-month LIBOR swap some time after issue of the debt, the contractual fixed
receipts on the swap are 8 per cent. At this point, the fair value of the bond that
reflects movements in the benchmark interest rate (i.e. excluding fair value
movements in the entity's credit spread) has decreased to £90.
In accordance with IAS 39.AG99B, the entity can designate the bond as a hedged
item for the benchmark interest rate (six-month LIBOR in this case) portion of its fair
value interest rate risk in such a scenario, provided that the benchmark rate is lower
than the effective interest rate calculated on the assumption that A purchased the
instrument on the day of designation without taking into account credit risk (in the
above case calculated to be 8 per cent). This is achieved by designating a LIBOR
potion that comprises both the contractual coupon payments of 6 per cent and an
amount of discount, which is the difference between the current fair value due to
interest rates of the bond (£90) and the amount repayable at maturity (£100). A
hedge designated in this way is likely to exhibit some ineffectiveness because the
fixed cash flows on the swap will have a different profile than the fixed cash flows of
the hedged item. The fixed cash flows of the swap are composed of equal cash
payments, while the hedged cash flows on the bond comprise lower contractual cash
payments and a discount to par. The different cash flow profiles will result in
different changes in fair value in response to changes in interest rates.
To minimise ineffectiveness, an entity may need to enter into a swap with a fixed leg
rate equal to or lower than the contractual coupons on the bond. Such a swap does
not have a zero fair value at inception because it is not entered into at market
interest rates. When the up-front payment on the swap is structured to be
equivalent to the discount on the bond, the swap will be more effective at hedging
the bond for the benchmark interest rate risk.
Q&A IAS 39: 81-EX-1 — DESIGNATING THE INTEREST RATE RISK

PORTION OF CHANGES IN FAIR VALUE OF FIXED RATE DEBT IN A
FAIR VALUE HEDGE
Example
Company Z has a credit rating of BBB. It issues fixed rate debt at 7 per cent, which
includes a credit spread of 200 basis points (i.e. the rate comprises a LIBOR rate of 5
per cent and a credit spread of 2 per cent). To hedge its exposure to changes in
interest rate movements, it enters into a receive-fixed, pay-floating interest rate
swap.
Company Z may designate the hedged risk as changes in fair value of the debt
associated with changes in the interest rate risk portion only (i.e. it may exclude
from the designation its own credit spread and designate only the LIBOR element of
its debt as the hedged item). Excluding the credit spread from the designation will
increase the effectiveness of the hedge relationship since the equivalent credit risk
inherent in the debt is not reflected in the terms of the interest rate swap.
Instead of entering into a swap in which the pay leg exactly matches the equivalent
of LIBOR (i.e. receive 5 per cent, pay LIBOR), Z enters into a swap in which the fixed
leg exactly matches its debt. Because the receive leg is 7 per cent, the pay leg is
increased correspondingly, to LIBOR plus 200 basis points. Moreover, since the fair
value of the swap is derived from its net settlements, the receive 5 per cent, pay
LIBOR swap and the receive 7 per cent, pay LIBOR plus 200 basis points will have
the same fair value for a given movement in interest rates. Therefore, Z may still
designate the swap as a hedge of the LIBOR portion of its debt.
Q&A IAS 39: 81-EX-2 — HEDGE ACCOUNTING ON AN INSTRUMENT

SUBJECT TO PREPAYMENT
Example
Company A purchases a perpetual debt instrument, which pays a market rate of
interest of 5 per cent on par. The issuer of the debt instrument has the option of
prepaying the perpetual debt at an amount equal to the instrument's par amount
after five years.
Because the debt instrument is not quoted in an active market, A classifies the
instrument as a loan and receivable and determines that the embedded prepayment
option is closely related to the host contract, since the option's exercise price is
roughly equal to the debt instrument's amortised cost on the exercise date of the
option (i.e. par). Company A enters into a non-prepayable swap with Bank B to pay
a fixed 5 per cent rate and to receive LIBOR for 20 years. The interest rate swap is
designated as a partial-term fair value hedge of the LIBOR portion of the perpetual
debt instrument for 20 years. Apart from the issuer call prepayment option, all terms
and conditions of the swap match those of the hedged item.
Company A must compare the changes in fair value of the interest rate swap to the
changes in the fair value of the perpetual debt instrument with respect to the
designated portion of cash flows, where the latter includes both the change in fair
value of the contractual cash flows until year 20 and the change in fair value of the
prepayment option at year five. Hedge ineffectiveness will arise since the hedged
item is prepayable while the hedging instrument is not. Hedge ineffectiveness is
likely to be so significant that it will be difficult to demonstrate prospective hedge
effectiveness. If, five years after the issue, the perpetual debt has not been called by
the issuer, A may be able to designate the interest rate swap as a partial-term hedge
of the LIBOR portion of the perpetual debt for the next 15 years. However, to the
extent that at the date of designation the swap is off-market (i.e. has a positive or
negative present value), ineffectiveness will arise, which may be significant enough
to prevent hedge accounting. One should not exclude the prepayment risk when
designating the hedging relationship, since prepayment risk and interest rate risk are
closely interrelated.
Q&A IAS 39: 81A-EX-1 — HEDGING A PORTION AFTER INITIAL

RECOGNITION
Background
Company FGH originated a four-year, 5 per cent fixed rate loan of £10,000 on 1
January 20X2, with a maturity date of 31 December 20X5. Of the 5 per cent coupon,
0.4 per cent represents credit spread (i.e. the market rate of interest, being LIBOR,
was 4.6 per cent). Interest is receivable annually. The effective interest rate of FGH's
loan at inception is 5 per cent.
Scenario 1: Interest Rates Fall Between 1 January 20X2 and 31 December 20X2
One year after FGH originated the loan, interest rates have fallen. On 31 December
20X2, the loan has a fair value of £10,251. FGH wishes to protect its loan asset
against a further decline in interest rates by entering into a fair value hedge of
interest rate risk. The current market rate of interest is 3.5 per cent instead of 4.6
per cent, and the entity's credit risk remains unchanged.
Company FGH enters into a receive-variable, pay-fixed rate of 3.5 per cent interest
rate swap on 31 December 20X2, with a maturity date of 31 December 20X5, to
hedge its fair value interest rate exposure. The swap is on-market (i.e., it has a fair
value of zero at inception).
If FGH had originated the loan when the hedging swap was entered into, it would not
have originated the loan at 5 per cent but at 3.9 per cent, the benchmark interest
market rate plus the appropriate margin given the counterparty's credit rating (3.5
per cent plus 0.4 per cent). In this case, the effective interest rate of the loan would
have been 3.9 per cent, not 5 per cent. The benchmark interest rate of 3.5 per cent
is lower than the effective interest rate of this "hypothetical loan"; hence, FGH is
permitted to designate as the hedged item a portion equal to the benchmark rate
(e.g. LIBOR).
Scenario 2: Interest Rates Increase Between 1 January 20X2 and 31 December 20X2

One year after FGH originated the loan, interest rates have increased. On 31
December 20X2, the loan has a fair value of £9,081. FGH wishes to protect its loan
asset against a further increase in interest rates by entering into a fair value hedge
of the interest rate risk. The current market rate of interest is 6 per cent instead of
4.6 per cent, and the entity's credit risk remains unchanged.
Entity FGH enters into a receive-variable, pay-fixed rate of 6 per cent interest rate
swap on 31 December 20X2, with a maturity of 31 December 20X5, to hedge its fair
value interest rate exposure. The swap is on-market (i.e. it has a fair value of zero at
inception).
If FGH had originated the loan when the hedging swap was entered into, it would not
have originated the loan at 5 per cent but at 6.4 per cent, the benchmark interest
market rate plus the appropriate margin given the counterparty's credit rating (6 per
cent plus 0.4 per cent). In this case, the effective interest rate of the loan would
have been 6.4 per cent, not 5 per cent. The benchmark interest rate of 6 per cent is
lower than the effective interest rate of this "hypothetical loan"; hence, FGH is
permitted to designate as the hedged item a portion equal to the benchmark rate
(e.g. LIBOR) that is higher than the contractual fixed rate received on the asset.
Q&A IAS 39: 82-1 — HEDGING NON-FINANCIAL ITEMS —

TRANSPORTATION COSTS
[Added 7 July 2006]
Background
Company C acquires commodities for use in its business. Company C acquires the
commodities at spot prices on the date C requires the commodity for use in its
business. The amount C pays for the commodity from the supplier is an amount
referenced to the London Metal Exchange (LME), plus an amount for transportation
of the commodity from the supplier to the company.
Question
If C wishes to cash flow hedge the variability of its future purchases of commodities,
is C obligated to include variable transportation costs in determining the future cost
of the non-financial item that will be hedged?
Answer
Yes.
IAS 39.82 states that if an entity designates a non-financial item as a hedged item it
must be designated as a hedged item (a) for foreign currency risk only, or (b) in its
entirety.
If C is hedging the cash flow price variability of its future commodity purchases (i.e.,
not foreign currency risk only), the company must include the costs it will incur in
bringing the non-financial item to its current location. If costs of transportation are
variable, this cash flow variability also must be included in the price of the
non-financial item that is designated in the hedge relationship.
If C enters into the hedging instrument to hedge the variability in the LME price only,
yet the transportation costs also are variable, C may choose to adjust the hedge
ratio in accordance with IAS 39.AG100, to reduce the amount of hedge
ineffectiveness that may result from changes in the transportation costs.
Q&As IAS 39: 82-2 and 82-3 — COMMODITY PRICE RISK HEDGING
IAS 39: 82-2
Question
Entity B purchases bronze for its inventory of raw materials used in manufacturing
its products. Entity B enters into a forward contract indexed to copper and wishes to
designate it as a hedge of the copper component in the cash flow variability of highly
probable forecasted purchases of bronze.
Can a non-financial item, such as bronze, be a hedged item with respect to a

separate price risk component (in this case copper) when the hedging instrument
relating to that component is traded on an efficient, liquid, and regulated commodity
exchange?
Answer
No. IAS 39.82 states, "If the hedged item is a non-financial asset or non-financial
liability, it shall be designated as a hedged item (a) for foreign currency risks, or (b)
in its entirety for all risks".
The price of copper is only a portion of the exposure to changes in the price of
bronze. Entity B cannot designate as the hedged item variability in cash flows on a
separate price risk component, such as copper.
Note: IFRIC agenda decision published in the October 2004 IFRIC Update.

IAS 39: 82-3
Question
Entity B purchases bronze for its inventory of raw materials used in manufacturing
its products. Entity B enters into a forward contract indexed to copper (which is a
component in bronze) and wishes to designate it as a hedge of the cash flow
variability of highly probable forecasted purchases of bronze. The forward contract is
an instrument traded on an efficient, liquid, and regulated commodity exchange.
Can a non-financial item, such as bronze, be a hedged item with respect to price risk
in its entirety when the hedging instrument is only related to a component of the
non-financial item?
Answer
IAS 39.82 states, "If the hedged item is a non-financial asset or non-financial
liability, it shall be designated as a hedged item (a) for foreign currency risks or (b)
in its entirety for all risks".
Although the price of copper is only a portion of the exposure to changes in the price
of bronze, if B is able to demonstrate that the hedging instrument is expected to be
highly effective in hedging the variability in the cash flows on forecasted purchases
of bronze in its entirety, it may be able to designate the forward contract as a
hedging instrument.
Any hedge ineffectiveness that arises from the hedging relationship must be reported
in profit or loss.
Q&A IAS 39: 82-4 — HEDGING ALL RISKS EXCEPT FOREIGN

CURRENCY RISK OF NON-FINANCIAL ITEMS
Background
Company O expects to purchase 1,000 barrels of oil in six months. The purchase
price will be the market price at the date of purchase and will be in U.S. dollars.
Company O's functional currency is the Australian dollar.
Company O purchases oil futures on 500 barrels of oil to fix the price at U.S.$60 for
the first 500 barrels of oil it forecasts to buy. The purchases are considered highly
probable. The duration and other terms of the forecast transaction and the futures
contracts match. Company O therefore believes that the hedge will be highly
effective over the life of the hedging relationship.
Company O's two risk exposures are foreign currency and U.S. dollar oil price.
The oil futures purchase hedges the U.S. dollar price risk only. Company O does not
coterminously hedge its exposure to the U.S. dollar on the purchase contract.
Question
Does IAS 39 permit a non-financial item to be designated as the hedged item for all
risks except foreign currency risk, such that O can designate just the U.S. dollar
price risk of its purchase of 500 barrels of oil in six months?
Answer
Yes. IAS 39.82 is clear that a non-financial item can be designated as the hedged
item in its entirety for all risks or just for foreign currency risk. With respect to
non-financial items, therefore, it is possible to hedge all risks except foreign currency
risk, as long as all other hedge accounting criteria are met. However, an entity is not
permitted to designate a portion of all risk (except the portion attributable to foreign
currency risk).
IAS 39, IG E.3.4, which discusses the interaction between IAS 39 and IAS 21, The
Effects of Changes in Foreign Exchange Rates, further supports this understanding of
IAS 39.82. For financial instruments, fair value is first determined in the currency in
which the contract is denominated and translation of the contract into the functional
currency of the entity is secondary. If the exposure to fair value of the non-financial
instrument excluding foreign currency translation risk can be identified and
measured, and hedged for all risks except foreign currency risk, such exposure is a
permissible hedging designation.
Therefore, O can designate the oil futures as a hedge of the forecast purchase of 500
barrels of oil (provided that the other hedge accounting criteria are satisfied). A
forward purchase of oil (a non-financial asset) does not have inherent foreign
exchange risk. The foreign exchange risk arises because of the reporting entity's
functional currency, which is not the U.S. dollar, not because of the market price risk
inherent in a forward purchase of oil. Thus, the exposure to cash flow risk for all
risks except foreign currency risk can be identified and measured.
Q&A IAS 39: 82-5 — PRICE OF SEPARATE BASE METALS AS HEDGED

ITEM IN SALES OF METAL CONCENTRATE

Background
Entity A is a mining entity that owns and operates a copper mine. Entity A mines the
ore from the mine and processes it into metal concentrate, which contains copper as
well as other base metals. Entity A sells the metal concentrate to Entity B. The sales
price for the metal concentrate is based on the actual base metal composition of the
metal concentrate, which may be established through analysis of a sample of the
metal concentrate.
Question
Given the guidance in IAS 39.82, is it acceptable for Entity A to designate the price
risk of a specific base metal within the metal concentrate (e.g. copper) as the
hedged item?
Answer
It depends. If the process of extracting the base metals from the metal concentrate
is merely a process of disaggregating the different base metals, the metal
concentrate in effect represents a collection of different non-financial items for the
purposes of IAS 39.82 and, therefore, a specific base metal could be designated as a
hedged item. In contrast, if the process of extracting the base metals from the metal
concentrate is a process of transformation, the metal concentrate represents a single
non-financial item for the purposes of IAS 39.82.
In assessing whether a specific base metal contained within the metal concentrate
represents a separate non-financial item, careful judgement and industry knowledge
is required. The assessment should include a careful analysis of the following:
• whether the process of extracting the base metals contained within the
metal concentrate is a simple process of disaggregation rather than one of
transformation;
• whether the quantity of the base metal within the metal concentrate is
known with a high degree of certainty;
• whether the pricing of the metal concentrate is based on the actual content
of the base metals extracted, rather than on estimated content or a fixed
amount price per volume/quantity of the metal concentrate;
• whether the individual base metal components contained within the metal
concentrate constitute separate “units of account” for revenue recognition
purposes from the point of view of the seller; and
• whether there are any terms in the sale contract for the metal concentrate
that would suggest that the distinct non-financial items cannot be identified
easily for the purposes of IAS 39.82; such terms may include any
significant element of the pricing of the metal concentrate that cannot be
related back to the individual base metals contained within the metal
concentrate.
An example of circumstances in which it would not be appropriate to conclude that a

single physical item contains different non-financial items for the purposes of IAS
39.82 is set out in Q&A IAS 39: 82-EX-1.
Q&A IAS 39: 82-EX-1 — HEDGING COMMODITIES

Example
Company B purchases bronze for its inventory of raw materials used in
manufacturing its products. Company B enters into a forward contract indexed to
copper and wishes to designate it as a hedge of the copper component in forecast
purchases of bronze.
The price of copper is only a portion of the exposure to changes in the price of
bronze. Company B cannot designate as the hedged item changes in the value of the
future purchase of bronze due to changes in the price of copper. However, if B can
demonstrate that the hedging instrument will be highly effective in hedging the price
of bronze, B may be able to designate the forward contract as a hedging instrument
in hedging the price of bronze. Any hedge ineffectiveness that arises from the hedge
relationship must be reported in profit or loss.
Q&A IAS 39: 82-EX-2 — HEDGE ACCOUNTING OF FUTURE LEASE

RECEIPTS
Example
Company A is a leasing company that rents out machinery in both operating and
finance lease arrangements. Company A may wish to hedge future lease receipts.
The ability to hedge these future receipts depends on whether the lease arrangement
is a finance lease or an operating lease. An operating lease is an executory contract
requiring the lessor to provide the use of an asset in future periods in exchange for
cash receipts. Because the lease is a nonfinancial item (see IAS 32.AG9,
"Definitions"), A would need either to hedge-account all the risks of the future lease
payments or to hedge account foreign currency risk only. This is different from a
finance lease, since a finance lease is a financial instrument that gives A greater

flexibility in designating the hedged item in a qualifying hedge relationship.
Q&A IAS 39: 84-EX-1 — HEDGING A NET POSITION

Example
IAS 39.84 is clear that because an entity assesses hedge effectiveness by comparing
the change in the fair value or cash flow of a hedging instrument (or group of similar
hedging instruments) and a hedged item (or group of hedged items), comparing a
hedging instrument with an overall net position, rather than with a specific hedged
item, does not qualify for hedge accounting. However, in many instances, the
hedging instrument in question can be designated against an appropriate gross
position, which will achieve a similar result to a hedge of a "net" position, as the
following examples illustrate:
• Company A (A), a pound sterling functional currency entity, has payables

of $100 and receivables of $80. Instead of entering into two separate
derivatives, it wishes to hedge the net $20 position for foreign currency
risk. Although the standard does not allow it to designate the net position
as the hedged item, A can instead designate $20 of payables as the
hedged item.
• Company B has £500 of fixed rate assets and £350 of fixed rate liabilities
and enters into a derivative, economically hedging the net position of
£150. While such a designation is not permitted, B could designate £150 of
the fixed rate assets as a hedged item in a fair value hedge of interest rate
risk.
• Company C, a UK company, has highly probable forecast sales of $100 and

highly probable forecast purchases of $80. Company C enters into a single
foreign currency forward contract to economically hedge the net exposure
of $20. Company C can designate that derivative as hedging the first $20
of sales.
• Company D (D) is a pound sterling functional currency entity. One-fifth of

A's profits is generated in U.S. dollars; this exposes the company's net
profit to foreign currency risk. The U.S. dollar sales are expected to be
$100 million per month and have a relatively stable net profit margin of 15
per cent. Company D wishes to hedge the exposure of its net profit to
changes in U.S.$/£ currency rate. Although D cannot hedge a net amount
and therefore cannot hedge the net profit, D could instead choose to
designate foreign currency forward contracts that mature each month as a
cash flow hedge of the first $15 million of U.S.$ sales per month, as long
as it believes the amount of U.S. dollar sales to be highly probable. This
designation will economically hedge the expected profit margin of $15
million per month, but it will be accounted for and presented as a hedge of
the first $15 million of U.S. dollar sales.
Q&A IAS 39: 88(d)-1 — QUALIFYING HEDGING INSTRUMENT

Question
Can any financial instrument that meets the definition of a derivative, and is not
considered a written option, be a qualifying hedging instrument, even though the
valuation of the derivative may include non-observable data?
Answer
It depends. IAS 39.88 describes several conditions that must be met for a hedge
relationship to qualify. One condition is that hedge effectiveness can be reliably
measured. A derivative that cannot be reliably measured cannot be a qualifying
hedging instrument. However, IAS 39 is clear that all derivatives can be measured
reliably at fair value, even if the valuation includes non-observable data, except for
those specifically measured at cost in accordance with IAS 39.AG80 and IAS
39.AG81. The only type of derivative that cannot be a qualifying hedging instrument
is a derivative that is linked to and must be settled by delivery of an unquoted equity
instrument where the range of reasonable fair value estimates is significant and the
probabilities of the various estimates cannot be reasonably assessed.
If an entity designates a derivative that has non-observable data included in its

valuation, significant judgement will need to be exercised in assessing hedge
effectiveness. Furthermore, judgment will need to be applied when (1) determining
the gain/loss attributed to the hedged risk for the hedged item in a fair value hedge
(pursuant to IAS 39.89(b)) or (2) determining, for a cash flow hedge, the cumulative
change in fair value of the expected future cash flow on the hedged item from
inception of the hedge (pursuant to IAS 39.96(b)), as these, most likely, will also
include non-observable data.
Q&A IAS 39: 88-1 — HEDGE EFFECTIVENESS: DOLLAR OFFSET

Question
If the dollar offset test is used as a method of retrospective hedge assessment, and
the dollar offset test fails to be highly effective for the period (i.e. it is outside the
80-125 per cent range as described in IAS 39.AG105(b)), can hedge accounting still
be applied if the movements in the hedging instrument and hedged item are small?
Answer
IAS Framework.29 states that the application of IAS only relates to material items.
Therefore, if the fair value of the hedging instrument and the hedged risk is
immaterial both in qualitative and quantitative, then the fact that the dollar offset
test has failed in a particular period is irrelevant.
Q&A IAS 39: 88-2 — REDESIGNATION OF A HEDGED ITEM AND

HEDGING INSTRUMENT IN A HEDGE WHICH HAS PREVIOUSLY
FAILED THE EFFECTIVENESS TEST
[Added 12 May 2006]
Background
An entity has designated a hedging instrument in a hedge relationship. The hedge

relationship fails the retrospective effectiveness test in IAS 39.88(e) when assessing
whether the hedge has been highly effective.
Question
Can the hedging instrument be redesignated in a hedge of the same financial asset
or liability where the hedge has proven to be effective, and qualify for hedge
accounting in a subsequent period?
Answer
Yes. IAS 39 does not preclude the entity from redesignating the hedging instrument
in a hedge of the same financial asset or liability in a subsequent period, provided
the hedge relationship meets the hedge accounting requirements.
Q&A IAS 39: 88-3 — HEDGING CASH-SETTLED SHARE-BASED

PAYMENTS
Question
A company has a cash-settled share-based payment scheme in which employees
participating in the scheme are entitled to receive a cash payment equal to the listed
trading price of the company's shares at the maturity date less the share price at
inception of the scheme. This is, however, subject to a vesting condition stating that
employees must remain employed by the company for three years to become
entitled to the payment.
The company is consequently negatively exposed to favourable movements in its

own share price. The more the share increases in value, the greater the share-based
payment liability that must be carried on the balance sheet in accordance with IFRS
2 Share-based Payment, and the greater the ultimate cash payout will be at the
maturity of the scheme, subject to the fulfillment of various vesting conditions. To
hedge this risk exposure, the company has entered into a derivative contract with a
financial institution. The derivative is a net cash-settled purchased call option over its
own shares that helps protect the company if the share price increases above a
certain level; as a result, the company's cash flows will offset the cash flows of the
share-based payment.
Can a cash-settled share-based payment be hedged under paragraph 88(c) of IAS

39?
Answer
Under IAS 39.88(c), for an item to qualify for cash flow hedge accounting, the
"transaction" (not the "cash flow") must be highly probable and must present an
exposure to variations in cash flows that could ultimately affect profit or loss. In the
scenario described above, the transaction is the award of a cash-settled share right
to employees for services rendered. The cash-settled share-based payment (the
transaction) presents an exposure to cash flows that could ultimately affect profit or
loss because the company's liability under the scheme moves with the share price.
The transaction must be highly probable for at least a portion of the employee
population. That is, a portion of the employees must be expected to remain in
employment for three years to exercise their cash-settled share right. For example,
the hedge designation can be the first 70 of 100 cash-settled share rights granted
that are expected to be exercised. The designation therefore depends on the number
of options ultimately expected to vest and to be exercised. Designating multiple
share options will only be possible when the population is homogenous (i.e. the
options have the same maturity and the same strike price, and therefore result in
the same cash payment at maturity).
To ensure hedge effectiveness, the time value of the hedging instrument will
generally be excluded from the hedge designation. The effectiveness of the hedge
will also be influenced by the number of options hedged, versus the number that is
expected to, and ultimately does, vest. The effective portion of the gain and loss on
the hedging instrument is recognised directly in equity and is subsequently recycled
and included in profit or loss in the same period during which the hedged item
affects profit or loss. The period in which the granted share option will affect profit or
loss is that in which the share-based payment transaction is recognised in profit or
loss upon rendering of services. The ineffective portion of the gain or loss on the
derivative must be recognised in profit or loss immediately.
IAS 39.IG F.2.1 does not permit a derivative to be a hedged item unless it is a
purchased option in a fair value hedge. This transaction does not breach the
prohibition in the implementation guidance, since a cash-settled share-based
payment falls within the scope of IFRS 2 and is therefore not a derivative under IAS
39.
This Q&A only applies to hedges that are share-based payments and that are
exclusively cash-settled.
See Q&A IAS 39: 88-EX-1.
Q&A IAS 39: 88-4 — "CHANGE IN VARIABLE CASH FLOWS" METHOD

OF ASSESSING EFFECTIVENESS IN A CASH FLOW HEDGE
Question
In a cash flow hedging relationship, may the entity assess effectiveness solely by
comparing the change in the hedged variable cash flows on the hedged item with the
change in the variable leg of the derivative hedging instrument?
Answer
No. In using the change in variable cash flows method, an entity is comparing the
change in the floating rate cash flows of the hedged item with the change in the
floating rates cash flows on the derivative. For example, if an entity was assessing
hedge effectiveness for a variable rate financial asset or liability, the entity would
compare the present value of the cumulative changes in the expected future cash
flows on the variable leg of an interest rate swap with the present value of the
cumulative change in expected future interest cash flows on the hedged item. The
fixed rate leg of the interest rate swap is excluded from the analysis under the
assumption that the derivative's fair value that is attributable to the fixed rate leg is
not relevant to the variability of the variable cash flows on the hedged item.
IAS 39.IG F.5.5, specifically states that it would be inappropriate to compare only
the variable cash flows on a hedging instrument with the variable cash flows on the
hedged item. Using such a method would contravene IAS 39.74, which does not

permit such bifurcation of a derivative in assessing effectiveness.
However, if the derivative has a fair value of zero at inception of the hedging
relationship, the variable cash flow method should be comparable to other
acceptable methods of assessing hedge effectiveness in a cash flow hedge.
Q&A IAS 39: 88-EX-1 — HEDGING CASH-SETTLED SHARE-BASED

PAYMENTS
This example should be read in conjunction with Q&A IAS 39: 88-3.
Example
On 1 January 20X1, Company A (A) awarded its employees exclusively cash-settled
share appreciation rights (SARs) that vest and can be exercised at 31 December
20X3, if the employees are still working for the company on that date. Each of the
100 employees is granted one SAR with a strike price of €10. Therefore, each right
provides for a cash payment equal to the amount by which the share price of A
exceeds the strike price on the exercise date. No payment will be made if A's share
price is at or below €10; A's share price on 1 January 20X1 is €10. Company A
estimates that 85 per cent of employees granted a SAR will be employed at 31
December 20X3 (if five employees leave the company each year).
Company A estimates that the first 70 SARs are highly probable to vest, and
therefore purchases a net cash-settled call option for €70 with a strike price of €10
that can only be settled at maturity on 31 December 20X3. Company A excludes the
time value from the hedge designation to demonstrate prospectively that the
relationship is expected to be highly effective. Company A designates the whole of
the derivative as hedging the cash flow variability of 70 employees' SARs and their
profit or loss impact recognised as an IFRS 2 Share-based Payment, charge. At any
given period, the IFRS 2 liability and corresponding cumulative profit or loss charge
will be equal to the degree to which the derivative is "in-the-money" apportioned for
the period from the grant date to the vesting date.
1 January 20X1

31 December 20X1
Company A's share price is €13, and three employees have left the company in the
period. The company changes its estimate of the number of employees expected to
be employed at 31 December 20X3 to 91. The fair value of the derivative asset is
€250.
The share-based payment charge and liability is €91 [((€13 – €10) × 91) × 1/3 =
€91].
The period-end cash flow hedge reserve must be equal to the intrinsic value of 70
employee SARs that are still considered to be highly probable and that have not yet
affected profit and loss (P&L) through the IFRS 2 charge. Because the scheme is
one-third through its life, the cash flow hedge reserve at the end of the period is
€140 [((€13 – €10) × 70) × 2/3 = €140]. The hedge was highly effective for the
period since 70 employees are still expected to be employed at 31 December 20X3,
and the hedging instrument provides a perfect offset to the cash flow variability of
the liability for the payments to these employees.

31 December 20X2
Company A's share price is €14, and four employees have left the company in the
period. The company revises its estimates of the number of employees expected to
be employed at 31 December 20X3 to 89. The fair value of the derivative asset is
€300.
The share-based payment liability is €237 [((€14 – €10) × 89) × 2/3 = €237].
The period-end cash flow hedge reserve must be equal to the intrinsic value of 70
employee SARs that are still considered to be highly probable and that have not yet
affected P&L through the IFRS 2 charge. Because the scheme is two-thirds through
its life, the cash flow hedge reserve at the end of the period is €93 [((€14 – €10) ×
70) × 1/3 = €93]. The hedge was highly effective for the period since 70 employees
are still expected to be employed at 31 December 20X3, and the hedging instrument
provides a perfect offset to the cash flow variability of the liability for the payments
to these employees.
31 December 20X3
Company A's share price is €12, and five employees have left the company in the
period. In all, 12 employees have left over the three-year period [three in 20X1, four
in 20X2, and five in 20X3]. The fair value of the derivative asset is €140 [(€12 –
€10) × 70]. (This represents only intrinsic value, since all time value has been
eroded.)
The share-based payment liability is €176 [((€12 – €10) × 88) × 3/3 = €176].
Since the 70 SARs vested at the period end, no amount should be left in the cash
flow hedge reserve. Because the scheme is at the end of its life, the cash flow hedge
reserve at the end of the period is €0. The hedge was highly effective for the period
since 70 employees were employed at 31 December 20X3, and the hedging
instrument provided a perfect offset to the cash flow variability of the liability for the
payments to these employees.
Summary of entries

The net cash impact of hedging the cash-settled share-based payments is the total
share-based payments of €176, plus the up-front premium spent to acquire the
hedging instrument of €70, less the cash received on settlement of the hedging
instrument of €140 as the SAR was in the money at maturity. The P&L impact of
€106 is also the cumulative P&L impact of the IFRS 2 accounting for the share-based
payment and the gain from hedge accounting those payments.
The net income in each period is not fully offset for the following reasons:
• Company A did not hedge all its expected cash-settled share-based

payment transactions. The company hedged the first 70 share-based

payment transactions, even though it expected at 1 January 20X1 that 85
of 100 employees would still be employed at 31 December 20X3.
• The time value of the SAR is not designated as part of the hedge
relationship, which results in net income volatility in all periods.
The time value and intrinsic value of the hedging instrument are summarised below:
The detailed cash flow recycling entries would be as follows:

Q&A IAS 39: 88-EX-2 — HEDGING ON AN AFTER-TAX BASIS
Example
Company T (T), a pound sterling functional currency entity, has an investment in a
wholly owned subsidiary, Company U (U), a euro functional currency entity. The
consolidated financial statements, which include both T (parent) and U (subsidiary),
are presented in pounds sterling. Company T's interest in its foreign operation (U) is
equal to €840,000 of net assets as of 1 January 20X1. Assume that the amount of
net assets of U will not attract any taxation. On 1 January 20X1, T enters into a
forward contract to sell €1,200,000 and buy pounds sterling at a rate of €1.5:£1 on
31 December 20X2. The gain or loss arising on retranslation of the forward contract
at spot rates is subject to current tax at 30 per cent.
The forward and the spot €/£ translation rates are as follows:
Translating €1,200,000 at the above rates gives the following pound sterling
amounts:
Therefore, the fair value of the forward is:1

Translating €840,000 at the above spot rates gives the following pound sterling
amounts:
The forward contract is designated as the hedging instrument in an after-tax hedge

of the spot retranslation risk on the first €840,000 net assets of the investment in
the foreign operation in the consolidated financial statements. The notional of the
forward contract is purposefully greater than the amount of net assets being
designated as a hedged item to compensate for the fact that foreign currency
movements on the hedged item (net assets) are not taxable while those on the
hedging instrument (forward contract) are taxable. The notional of the derivative of
€1,200,000 equals the net assets grossed up for the tax rate (€840,000/[1 – 0.30
tax rate]).
Movements in the fair value due to the forward points will not give rise to hedge
ineffectiveness, since the designated hedged risk is movements in spot rate only (on
an after-tax basis) — i.e. these movements do not form part of the hedging
relationship and will be recognised directly in profit or loss.
In accordance with the requirements of IAS 12 Income Taxes, the current tax
relating to the gain or loss retranslation of the forward contract at spot rates will be
recognised in equity since the gain or loss itself is recognised directly in equity.
The required entries are as follows:
31 December 20X1

31 December 20X2

1 For illustrative purposes only, the fair value of the forward contract ignores the time value
of money.
Q&A IAS 39: 88-EX-3 — MINIMISING INEFFECTIVENESS:

DESIGNATION INCLUDES THE FORWARD POINTS
Example
Company X (X) has a euro functional currency. Company X makes sales to U.S.
customers in U.S. dollars. Company X wishes to hedge its exposure to U.S.$ by
entering into a forward contract to sell U.S.$ and buy € at a fixed rate on a specified
delivery date that coincides with the timing of the sales.
Company X can choose to designate the hedged risk as movements in either the
spot U.S.$/€ rate or the forward U.S.$/€ that terminates when the sale occurs and
the hedging instrument matures.
If X chooses to hedge the spot rate, then movements in the fair value of the forward
contract due to movements in spot rate from period to period are recognised in
equity (to the extent that this is effective). The fair value movements in the forward
contract due to the fair value of the forward points will be recognised immediately in
profit or loss throughout the hedge relationship.
If the company chooses to hedge the forward rate, then the full movement in the fair
value of the forward contract is recognised in equity (to the extent this is effective).
Compared with designation at the spot rate only, the fair value changes of the
forward points are recognised in equity (instead of profit or loss) throughout the
hedge relationship. If the hedge was perfectly effective over its life, then the fair
value of the forward points would never be recognised in profit or loss. (At maturity
of the hedge relationship, the fair value of the forward points will be zero since there
will be no more forward points left to be fair valued.) The fair value of the forward
contract at maturity will be equivalent to the difference between the spot rate at
maturity and the contracted rate.
Q&A IAS 39: 88-EX-4 — MINIMISING INEFFECTIVENESS:

DESIGNATION EXCLUDES TIME VALUE

Example
Company X (X) owns 1,000 shares of Company A (A), worth £50 each. Company X
classifies these securities as available-for-sale and recognises changes in their fair
value directly in equity. Because X would like to hedge its downside equity price risk,
it purchases an at-the-money put option (i.e. the put option has a strike price of
£50) on the shares, which expires in three years. The premium paid for the option is
£9,000.
Company X designates the intrinsic value of the put option as a fair value hedge of
its investment in A. The hedge strategy is consistent with X's established risk
management strategies. Company X measures effectiveness by comparing decreases
in fair value of the investment below the £50 strike price with changes in the intrinsic
value of the option on a quarterly basis. The time value of the option is not included
in the assessment of effectiveness.
Because the hedging instrument and the hedged item are based on the same
number of shares, increases in the intrinsic value of the option are expected to be
fully effective in offsetting decreases in the fair value of the investment.
In this example, the entire £9,000 premium is time value because the option
purchased was at-the-money. This time value and subsequent changes in time value
are recognised directly in profit or loss. The effectiveness of the hedge depends on
the option's intrinsic value instead of its fair value. To the extent that changes in the
fair value of the option are caused by other variables, such as volatility and the
risk-free rate, X calculates the fair value of the option and then deducts the intrinsic
value to arrive at the "time" value component. In other words, the time value
component reflects the effect of all variables on the option's price other than the
intrinsic value. In accordance with X's designation of effectiveness, the time value
component is not part of the hedge relationship and is, therefore, recognised directly
in profit or loss.
When the fair value of the shares falls below the strike price of the option (i.e. £50),
the entity will recognise fair value movements on the hedged item below this amount
in profit or loss (instead of equity), which will offset the intrinsic value on the
hedging instrument that will be recognised in profit or loss in the same period.
Q&A IAS 39: 89-EX-1 — FAIR VALUE HEDGE ACCOUNTING: FIXED

RATE DEBT

Example
On 1 January 20X0, Company C (C) issued £100 million of five-year, 8 per cent fixed
rate debt. Company C has a BBB credit rating at the issuance date. The fixed interest
rate on the debt is 150 basis points higher than the five-year swap rate. Interest on
the debt is payable annually. Company C's interest rate risk policy requires that all
debt be at variable rates, which is achieved either by issuing variable rate debt or by
issuing fixed rate debt and swapping it into variable rates.
To maintain compliance with this policy, C entered into an interest rate swap on 1
January 20X0 to swap the debt from fixed rate to variable rate. Company C also
designated the swap as a fair value hedge of interest rate risk on the fixed rate debt
(the credit spread portion is purposely not part of the hedge relationship). The swap
is a five-year, pay LIBOR, receive 6.50 per cent fixed interest rate swap.
Company C satisfies the hedge accounting criteria:
• The fair value of C's issued fixed rate debt will vary with changes in market
interest rates. Such changes could affect profit or loss if the debt is
extinguished early. Hence, the debt is a qualifying hedged item in a fair
value hedge accounting relationship (it is not a non-qualifying exposure).
• Company C has formally documented the hedging relationship from

inception, identifying all critical terms.
• The hedge is consistent with C's risk management policy for that hedging
relationship.
• Company C expects its hedge to be highly effective and has documented

this assessment — the primary potential source of ineffectiveness in a fair
value hedge of fixed rate debt is credit risk. Company C is using an interest
rate swap to hedge interest rate risk only. Hence, changes in credit
spreads between C's BBB rate and swap rates will not generate hedge
ineffectiveness.
Note that the critical terms of the hedged item and the hedging instrument match.
IAS 39 recognises that if the principal terms of the hedging instrument and the
hedged item are the same, then the changes in fair value attributable to the risk
being hedged are likely to offset each other fully, both at inception and afterwards.
Company C is required, however, to assess effectiveness on an ongoing basis.
The fair value of the swap and the carrying amount of the debt after the adjustment
for changes in fair value attributable to the hedged risk are as follows:

The required entries are as follows (£):
1 January 20X0
30 June 20X0
31 December 20X0

Note that the carrying amount of the debt on the balance sheet will not represent its
full fair value but will be a hybrid of amortised cost and an element of its fair value
resulting from movements in interest rates. Because the entity's credit spread was
purposely not hedged, the hedged item is not adjusted for movements in that risk.
However, IFRS 7.25 Financial Instruments: Disclosures, requires disclosure of the full
fair value of the debt (i.e. including credit spread) in the notes to the financial
statements.
Q&A IAS 39: 95-1 — CASH FLOW HEDGING: RECYCLING FROM EQUITY
AFTER A BUSINESS COMBINATION
Background
Company A (A) acquires Company B (B) in a business combination. Until the date of
the business combination, B had been applying cash flow hedge accounting to the
foreign currency risks of a highly probable forecast purchase of a machine in 12
months. The fair value movements on the derivative used to hedge the forecast
purchase had been recognised in equity in B's separate financial statements in
Question
In the consolidated accounts that include B, can A continue to apply hedge
accounting and recycle the amounts recognised in equity in the consolidated profit
and loss account once the forecast transaction occurs?
Answer
No. After a business combination in which B has applied cash flow hedging and
deferred gains or losses in equity before the acquisition, A will not be able to recycle
those gains and losses in the consolidated profit or loss account. Because the
pre-acquisition reserves of B do not exist in the consolidated financial statements of
its new parent, any amounts initially taken to equity of B before the business
combination cannot be recycled. Thus, in the consolidated accounts, the group can
only hedge-account for the specific relationship that B has prospectively from the
date of acquisition, with only post-acquisition amounts in equity being recycled to
consolidated profit or loss in accordance with IAS 39.95.
Q&A IAS 39: 95-EX-1 — CASH FLOW HEDGE OF VARIABLE RATE DEBT
WITH AN INTEREST RATE SWAP
Example
Company X (X) issued $100 million of five-year, variable rate debt on 1 January
20X0. The variable rate on the debt is LIBOR plus a spread of 200 basis points.
Initial LIBOR is 5 per cent. The debt pays interest annually, and the swap resets
annually on 31 December.
On 1 January 20X0, X entered into a five-year, pay-fixed, receive LIBOR interest rate
swap with a notional amount of $100 million. The swap is designated as a cash flow
hedge of the forecast interest payments on the LIBOR portion of the debt. The
interest rate swap is on-market at inception and has a fair value of zero.
The terms of the interest rate swap are as follows:
Notional amount $100 million
Trade date 1 January 20X0
Maturity date 31 December 20X4
Company X pays 5.50 per cent
Company X receives LIBOR
Pay and receive dates Annually on the debt payment

dates
dates
Variable reset Annually (on 31 December)
Initial LIBOR 5.00 per cent
First pay/receive date 31 December 20X0
Last pay/receive date 31 December 20X4
The interest rate swap is considered highly effective because the principal terms of
the debt and the swap match. Hedge effectiveness will be assessed and measured,
at a minimum, at each reporting date. For illustration purposes only, this hedge
relationship is deemed fully effective.
Company X accrues its interest expense at LIBOR plus 200 basis points on the debt
and accrues the swap payments or receipts at each reporting date as an adjustment
to interest expense. The effect of the debt and swap accruals is a 7.50 per cent fixed
rate. The fair value of the swap is recognised as an asset or liability with an
offsetting amount in equity to the extent that the hedge relationship is effective. Any
ineffectiveness is immediately recognised in net profit or loss.
1 January 20X0

No entries are required for the interest rate swap since it has a fair value of zero at
inception.
Interest rates increased during the period ended 31 December 20X0, resulting in a
fair value of the interest rate swap of $4,068,000. Hedge ineffectiveness is assessed
and measured at the reporting date (deemed to be zero), so the total change in fair
value of the swap is recorded in equity. Company X paid $500,000 in net cash
settlements on the swap at 31 December 20X0. The LIBOR rate for the next period is
6.57 per cent.
31 December 20X0

31 December 20X1
Interest rates increased further during the period ended 31 December 20X1,
resulting in a fair value of the interest rate swap of $5,793,000. Hedge
ineffectiveness is assessed and measured at the reporting date (deemed to be zero),
so the total change in fair value of the swap is recorded in equity. Company X
received $1,070,000 in net cash settlements on the swap at 31 December 20X1. The
LIBOR rate for the next period is 7.70 per cent.

Interest rates decreased during the period ended 31 December 20X2, resulting in a
fair value of the interest rate swap of $2,303,000. Hedge ineffectiveness is assessed
value of the swap is recorded in equity. Company X received $2,200,000 in net cash
6.79 per cent.
31 December 20X2

Interest rates decreased during the period ended 31 December 20X3, resulting in a
fair value of the interest rate swap of $241,000. Hedge ineffectiveness is assessed
value of the swap is recorded in equity. Company X received $1,290,000 in net cash
5.76 per cent.
31 December 20X3

The swap matured at 31 December 20X4. Company X received $260,000 in net cash
settlements on the swap at 31 December 20X4.
31 December 20X4

Q&A IAS 39: 95-EX-2 — CASH FLOW HEDGE OF THE FOREIGN
CURRENCY RISK OF ISSUED FLOATING RATE DEBT, WITH A
CROSS-CURRENCY SWAP RECEIVING FLOATING FOREIGN
CURRENCY AND PAYING FLOATING FUNCTIONAL CURRENCY
Example
On 1 January 20X2, Company A (A), a pound sterling functional currency entity,
issues a U.S.$ LIBOR plus 100 basis points (bp) floating rate debt instrument
denominated in U.S. dollars with a notional amount of U.S.$100,000, which will
mature on 31 December 20X6 at par. On 1 January 20X2, the spot rate on the
U.S.$/£ is 1.75/1, so the notional of U.S.$100,000 is equivalent to £57,143. In
addition, A enters into a cross-currency swap (CCS) on 1 January 20X2 to exchange
interest payments and principal at redemption on the same terms as the above debt
and designates the CCS as a hedge of the variability of the £ functional currency
equivalent cash flows on the debt. According to the terms, on each interest payment
date (assume that interest is paid annually on 31 December for both the debt and
the CCS), A will receive U.S.$ LIBOR plus 100 bp on a notional of U.S.$100,000, and
pay £ LIBOR plus 106 bp on the basis of a notional of £57,143. Because the
currency, notional, coupons, and interest payment dates match on the CCS and the
debt, A expects the hedge relationship to be highly effective.

Company A's documentation of the hedge is as follows:
Risk management Cash flow hedge of the variability in functional currency e

objective and nature of associated with the foreign currency debt due to changes
risk being hedged
Date of designation 1 January 20X2.
Hedging instrument CCS to exchange $100,000 at maturity and receive U.S.$

and pay £ LIBOR plus 106 bp interest annually over the t
instrument.
Hedged item The CCS is designated as a hedge of the changes in the c

the changes in foreign currency spot rates related to the
annual interest payments.
Assessment of hedge The critical terms of the derivative match (exchange of p

effectiveness and annual interest payment). Accordingly, high effective
The company will assess counterparty credit risk and pro
flows under the swap occurring every period.
Measurement of hedge Hypothetical derivative method. The actual hedging instru

effectiveness as the hypothetical CCS with exactly matching terms; th
ineffectiveness is expected
ineffectiveness is expected.
The following table illustrates the accounting entries for the transaction during its life
in £ (Dr or (Cr) as indicated).

Key
A: The remaining value on the CCS is the difference between the debt retranslated
at U.S.$1.75/£ (original rate) and the U.S.$1.70/£ (spot rate at date of repayment of
the notional). Hence, the total balance sheet is (debt £58,824 – CCS £1,681) =
£57,143 at 31 December 20X6, immediately before final settlement of the debt and
the CCS.
B: Nets to zero, reflecting that all amounts in the cash flow hedge reserve in equity
have been recycled to profit and loss to offset retranslation of the debt to spot each
period and the recognition of interest.
C: Reflects the total interest expense from U.S.$ debt and CCS. This amount equals
the total interest expense that would have been incurred had A actually issued £
debt at inception (£57,143 × [LIBOR + 106 bp]) × 5 years = £20,676.
Entries in the consolidated financial statements for 20X2 for illustrative purposes
1 January 20X2
No entry required for CCS since fair value is nil at inception.
31 December 20X2

Similar entries would be recorded for the remaining term of the hedging relationship
(20X3–20X6).
Interest expense totalling £20,676 is recognised over the term of the hedging
instrument, and net profit and loss impact is as if A had issued £ LIBOR plus 106 bp
debt at inception. The CCS is fair valued at each reporting date (after interest
payments have been made, since all interest payments are deemed to have taken
place on the last day of the year, which is also the reset date for swap), with
amounts initially taken to the cash flow hedge reserve in equity. The amount of the
CCS is recycled to profit and loss at each reporting period to offset the amount
recorded for retranslation of the U.S.$ debt to £ spot rates and, finally, to offset the
translation loss on repayment of principal at maturity of the debt.
If there was no margin on the legs of the CCS, the CCS would reset at par each reset
date (i.e. 31 December). In this case, the net balance sheet figure (debt and CCS)
would be the same as if A had issued £ debt at inception and, therefore, no amount
would be taken to equity at each reporting date since the value of the CCS would be
fully offset by the retranslation of the debt for spot rates. If there are margins on the
legs of the swap, the changing yield curves result in fair value movements with
respect to those margins and, therefore, the CCS will not offset the retranslation of
the debt notional for spot rates. Hence, where there is a margin, the fair value with
respect to those amounts is initially recognised in the cash flow hedge reserve, to
the extent it is effective, and recycled to profit or loss when interest on the debt is
paid. Thus, by the maturity of the debt and hedge relationship, the cash flow hedge
reserve will be fully recycled to profit or loss.
Q&A IAS 39: 95-EX-3 — CASH FLOW HEDGE OF THE FOREIGN

CURRENCY RISK OF ISSUED FIXED RATE DEBT, WITH A
CROSS-CURRENCY SWAP RECEIVING FIXED FOREIGN CURRENCY
AND PAYING FIXED FUNCTIONAL CURRENCY
Example
issues a 4 per cent annual fixed coupon debt instrument denominated in U.S. dollars
with a notional amount of U.S.$100,000, which will mature on 31 December 20X6 at
par; therefore, the effective interest rate is 4 per cent. On 1 January 20X2, the spot
rate on the U.S.$/£ is 1.75/1, so the notional of U.S.$100,000 is equivalent to
£57,143. In addition, A enters into a cross-currency swap (CCS) on 1 January 20X2
to exchange interest payments and principal at redemption on the same terms as
the above debt and designates the CCS as a hedge of the variability of the £
functional currency equivalent cash flows on the debt. According to the terms, on
each interest payment date (assume that interest is paid annually on 31 December
for both the debt and the CCS), A will receive 4 per cent on a notional of
U.S.$100,000 and pay 6 per cent on the basis of a notional of £57,143. Because the
currency, notional, coupons, and interest payment dates match on the CCS and the
debt, A expects the hedge relationship to be highly effective.

Risk management Cash flow hedge of the variability in functional currency e

objective and nature of associated with the foreign currency debt due to changes
risk being hedged
Hedging instrument CCS to receive U.S.$ 4 per cent, pay £ 6 per cent interes
basis of notional of hedging instrument U.S.$100,000 ov
instrument and exchange U.S.$100,000 at maturity.
Hedged item The CCS is designated as a hedge of the changes in the c

the changes in foreign currency spot rates related to the
annual interest payments.
Assessment of hedge The critical terms of the derivative match (exchange of p

effectiveness and annual interest payments). Accordingly, high effectiv
Measurement of hedge Hypothetical derivative method. The actual hedging instru

effectiveness as the hypothetical CCS with exactly matching terms; th
ineffectiveness is expected
ineffectiveness is expected.
in £ (Dr or (Cr) as indicated).

Key
A: The remaining value on the CCS is the difference between the debt retranslated
at U.S.$1.75/£ (original rate) and the U.S.$1.70/£ (spot rate at date of repayment of
the notional). Hence, the total balance sheet is (debt £58,824 – CCS £1,681) =
£57,143 before the final settlement of the swap for cash on 31 December 20X6.
B: Nets to zero, reflecting that all amounts in the cash flow hedge reserve in equity
have been recycled to profit and loss.
C: Reflects the total interest expense from U.S.$ debt and CCS. Equals the total
interest expense that would have been incurred had A actually issued £ debt at
inception (£57,143 × 6%) × 5 years = £17,143.
1 January 20X2
No entry required for CCS since fair value is nil at inception.
31 December 20X2

(20X3–20X6).
Interest expense totalling £17,143 is recognised over the term of the hedging
instrument. This is equivalent to the issuance by A of £ 6 per cent debt at inception.
The CCS is fair valued at each reporting date (after interest payments have been

made, since all interest payments are deemed to have taken place on the last day of
the year, which is the reset date for the swap), with amounts initially taken to the
cash flow hedge reserve in equity. The amount of the CCS is recycled to profit and
loss at each reporting period to offset the amount recorded for retranslation of the
U.S.$ debt to £ spot rates.
Q&A IAS 39: 96-1 — DESIGNATING LAYERS OF FORECAST

TRANSACTIONS IN A CASH FLOW HEDGE
Background
Entity A, whose functional currency is the euro (€), exports goods to the United
States with US$ receipts from sales of goods. Entity A is exposed to variability of its
future revenue from the export sales as a result of fluctuations in currency rates
between the US$ and the €.
Entity A reports under IFRSs semi-annually as at 30 June and 31 December. At 1

January 20X0, Entity A estimates that it will have US$ sales of US$10 million on 30
June 20X1, which are considered to be 'highly probable'. In order to hedge its
exposure to changes in the US$:€ forward exchange rate, Entity A enters into a
forward contract to sell US$10 million and buy € on 30 June 20X1. Entity A
designates and documents the forward contract as a hedging instrument in a cash
flow hedge of the US$:€ forward risk on a designated amount of highly probable US$
revenue.
Question
Will the amount of the gain or loss on the forward contract that is recognised in
other comprehensive income under the cash flow hedging relationship be affected by
whether Entity A designates and documents the forecast sales in multiple layers or a
single layer?
Answer
Yes. To illustrate, the impact on profit or loss and other comprehensive income under
two alternative methods of designation is discussed below.
The fair value of the forward contract at the dates under consideration, and
movements in the intervening periods, are as follows.

At 31 December 20X0, Entity A revises its estimates of the US$ sales expected on 30
June 20X1 — it now considers that only US$7.5 million of sales are highly probable.
Entity A is unable to identify a single event or change in circumstances (as
contemplated in IAS 39.AG113) that causes this change in estimate. In addition, a
further US$0.5 million of sales are expected to occur (but are not considered to be
highly probable).
Designation A
Entity A specifies as part of its hedge documentation put in place on 1 January 20X0
that it is designating two hedging relationships as follows.
• H1: a 75 per cent proportion of the US$10 million forward contract is

designated as hedging the first US$7.5 million of sales on 30 June 20X1
that are considered highly probable.
• H2: a 25 per cent proportion of the US$10 million forward contract is

designated as hedging the remaining US$2.5 million of sales on 30 June
20X1 that are considered highly probable.
Six months to 30 June 20X0
The entire US$10 million of sales remain highly probable and, therefore, the total fair
value movement of €0.5 million is recognised in other comprehensive income under
H1 and H2 (both being highly effective hedging relationships).

Being the effective amount of the derivative recognised in other comprehensive
income
Six months to 31 December 20X0
Entity A must consider the following two questions:
1. Should any of the amounts recognised in other comprehensive income at

30 June 20X0 be reclassified to profit or loss because some of the US$
sales are no longer expected to occur (see IAS 39.101(c))? Because US$2
million of sales are no longer expected to occur (US$8 million sales are still
expected to occur, of which US$7.5 million are highly probable), 20 per
cent of the fair value movement previously recognised in other
comprehensive income should be reclassified from equity to profit or loss.
Being the reclassification to profit or loss of 20 per cent of amounts

previously recognised in other comprehensive income because 20 per
cent of previously designated forecast transactions are no longer
expected to occur
2. Have the two hedging relationships (H1 and H2) been highly effective for
the six months to 31 December 20X0? Based of the revised estimates at
31 December 20X0, only US$7.5 million of sales are highly probable. The
H1 designation is considered highly effective because the total fair value
movement in the designated proportion of the derivative is €1.5 million (75
per cent of the total movement of €2.0 million), and the change in the fair
value of the hedged cash flows (sales revenue of US$7.5 million) is €1.5
million. Therefore, H1 is 100 per cent hedge effective (€1.5 million ÷ €1.5
million = 100%).
All of the fair value movement of designation H2 (€0.5 million, which is 25

per cent of the total movement of €2.0 million) is recognised in profit or
loss because the hedge relationship is not highly effective as a result of the
decrease in highly probable sales. Because the amount of forecast sales
between US$7.5 million and US$10 million is now nil, the hedge
relationship is 0 per cent effective.

Being the recognition of the derivative gain in respect of H1 (which is 100 per cent
effective) in other comprehensive income and the gain in respect of H2 (which is 0
per cent effective and therefore does not meet the conditions to continue hedge
accounting) in profit or loss.
Designation B
Entity A does not designate in layers, but instead designates 100 per cent of the
forward contract as hedging the first US$10 million of highly probable sales
anticipated on 30 June 20X1 as a single hedging relationship.
Six months to 30 June 20X0
The same entries as in Designation A above apply. All designated forecast

transactions remain highly probable.
Six months to 31 December 20X0
The same entries as in item (1) of Designation A above apply because only 80 per
cent of the amount recognised in other comprehensive income on 30 June 20X0 is
still expected to occur.
The entries for recognising the fair value movement in the hedging instrument for
the six months to 31 December 20X0 differ to those under Designation A. At 31
December 20X0, only US$7.5 million of the sales anticipated on 30 June 20X1 are
considered highly probable. The hedging relationship is only 75 per cent effective
because the total fair value movement in the derivative is €2.0 million and the
movement in the fair value of the hedged cash flows is €1.5 million (€1.5 million ÷
€2.0 million = 75%). Because the degree of offset between the changes in cash
flows of the hedging instrument and the remaining highly probable hedged items is
outside the range of 80-125 per cent, the entire fair value movement of €2 million
will be recognised in profit or loss.

Q&A IAS 39: 98-EX-1 — CASH FLOW HEDGING OF A NON-FINANCIAL
ITEM: NO BASIS ADJUSTMENT
Example
On 4 January 20X2, Company D (D) has a forecast sale of €4 million of confectionary
on or about 31 December 20X2 to a German retail outlet, Company AG (AG).
Company D has a pound sterling functional currency, and AG has a euro functional
currency. On 4 January 20X2, D designates the cash flow of the forecast sale as a
hedged item and enters into a currency forward to sell €4 million on the basis of the
forecast receipt. The forward contract locks in the value of the euros to be received
at a rate of €1.5:£. At inception of the hedge, the derivative is on-market (i.e. the
fair value is zero). The terms of the currency forward and the forecast sale match.
The company designates the forward foreign exchange risk as the hedged risk.
Potential sources of ineffectiveness include non-occurrence of the forecast

transaction and changes in the date of sale. Any ineffectiveness will be recognised in
profit or loss. On 30 June 20X2, the fair value of the currency forward is negative
£100,000 because the forward rate has changed, reflecting the strengthening of the
euro against the pound sterling.
On 31 December 20X2, the transaction occurred as expected. The fair value of the
forward is negative £111,111 since the euro continued to strengthen against the
pound sterling. The required entries are as follows:
4 January 20X2
No entries are required, since the forward was entered into "on-market" and
therefore had a fair value of zero at inception. Normally, margin associated with
trading on a currency exchange would need to be posted, but this has been ignored
for illustration purposes. There may also be fees if the foreign exchange contract is
an over-the-counter transaction.
30 June 20X2

31 December 20X2

The net effect of releasing the amount from equity when the sale occurred is
equivalent to recognising in profit or loss the sale translated at the contracted rate
inherent in the forward (i.e. €4,000,000/€1.5:£).
Note: For illustration purposes only, the forward contract has not been discounted.
If the spot foreign currency rate was the designated hedged risk, then the fair value
attributable to the forward points would be recognised immediately in profit or loss,
as opposed to being deferred in equity and released to profit or loss when the sale
occurs.
Note: Whether to apply basis adjustments when hedging nonfinancial items is an

accounting policy choice and must, therefore, be applied consistently for all hedges

(IAS 39.99).
Q&A IAS 39: 98-EX-2 — CASH FLOW HEDGING OF A NON-FINANCIAL

ITEM WITH BASIS ADJUSTMENT
Example
On 4 January 20X2, Company D (D) has a forecast purchase in U.S. dollars of
100,000 kg of cocoa on or about 31 December 20X2 from a Brazilian supplier,
Company B (B). Company D has a pound sterling functional currency, and B has a
U.S. dollar functional currency. On 4 January 20X2, D designates the cash flow of
the forecast purchase as a hedged item and enters into a currency forward to buy
U.S.$180,000 on the basis of the forecast payment (100,000 kg at U.S.$1.80 per
kilogram). The forward contract locks in the value of the U.S.$ amount to be paid at
a rate of U.S.$1.80:£1. At inception of the hedge, the derivative is on-market (i.e.
the fair value is zero). The terms of the currency forward and the forecast purchase
match, and the company designates the forward foreign exchange risk as the
hedged risk.
Potential sources of ineffectiveness include non-occurrence of the forecast

transaction and changes in the date of purchase. Any ineffectiveness will be
On 30 June 20X2, the fair value of the currency forward is positive £10,000 because
the forward rate has changed, reflecting the strengthening of the U.S. dollar against
the pound sterling.
On 31 December 20X2, the transaction occurred as expected. The fair value of the
forward is positive £12,500, since the U.S. dollar continued to strengthen against the
pound sterling.
4 January 20X2
No entries are required since the forward was entered into "on-market" and
therefore had a fair value of zero at inception. Normally, margin associated with
trading on a currency exchange would need to be posted, but this has been ignored
for illustration purposes. There may also be fees if the foreign exchange contract is
an over-the-counter transaction.

30 June 20X2
31 December 20X2

The net effect of releasing the amount from equity and including it in the carrying
amount of the stock is equivalent to recognising the stock at the contracted rate
inherent in the forward (i.e. U.S.$180,000/U.S.$1.8:£1)
Note: For illustration purposes only, the forward contract has not been discounted.
Alternatively, if D had elected not to basis adjust the stock and had followed IAS
39.98(a), the cumulative portion of the hedging instrument included in equity would
have been released only when the forecast transaction (the stock purchase) affects
profit or loss (such as in the period in which the stock is sold and recognised in cost
of sales or written down in value).
If the spot foreign currency rate was the designated hedged risk, then the fair value
attributable to the forward points would be recognised immediately in profit or loss,
as opposed to being deferred in equity and released to profit or loss when the
purchase occurs.
Note: Choosing whether to apply basis adjustments when hedging nonfinancial

items is an accounting policy choice and must, therefore, be applied consistently for
all hedges (IAS 39.99).

Q&A IAS 39: 101-1 — NOVATION OF A DERIVATIVE INSTRUMENT —
IMPACT ON EXISTING HEDGE RELATIONSHIP
[Added 12 May 2006]
Background
Company A (A) and Company B (B) are independent companies. Company B

executes a derivative with A; the derivative is designated by B as an effective
hedging instrument in a fair value hedge.
As a part of a restructuring of A (due to an acquisition), the ISDA agreement is

renegotiated between A and B. Company A requests and B agrees to the novation of
the derivative from A to Company A1 (A1) (A1 is a fellow subsidiary of A). The
renegotiation of the derivative is such that the identity of a party to the contract has
changed to A1 and A is released from its obligations. The intent and effect of the
novation is to retain the terms and conditions of the instrument and to treat the
party to which the agreement will be novated (A1), as if they had always been a
party to the agreement. The novation also results in B being in exactly the same
financial position before and after the novation. There is no cash settlement as a
result of the renegotiation. At the date of the transfer, the credit risks of A and A1
are the same. The parties do not commercially view the novation as a termination;
the novation of a derivative is not considered to be treated as a termination of the
contract in the entity's documented hedging strategy.
Question
Does the novation of the derivative instrument, which has been designated into a
hedge relationship, cause the existing hedge relationship in B to be terminated?
Answer
No. Company A and A1 have the same credit risk. In addition, the terms and
conditions of the instrument have not changed following the novation. Consequently,
in substance, the novation is a transfer from A to A1 that does not expose B to any
change in risk. Novation, in these circumstances, does not result in the expiration or
exercise of the hedging instrument. Commercially, and in the entity's documented
hedging strategy, it is not considered to be a sale or termination of the instrument
and to terminate the hedging relationship. In substance, the hedge relationship in B
before and after the novation is identical.
Q&A IAS 39: 101-2 — CASH FLOW HEDGING: TIMING OF RELEASE

FROM EQUITY
Background
Company D (D), a euro functional currency entity, intends to issue

euro-denominated debt in six months, with a maturity of five years, that will pay
fixed interest semi-annually. The transaction is highly probable, and therefore
involves a stream of 10 highly probable semi-annual interest payments. To hedge its
future profit and loss exposure as a result of the fixed interest payments on the debt
due to changes in the six-month LIBOR rate between now and the issuance of the
debt (in six months), D enters into a forward-starting, receive-six-month LIBOR,
pay-fixed interest rate swap with terms matching the critical terms of the forecast
debt issuance, such as start date, maturity, notional, and payment dates. The swap
will receive six-month LIBOR pay that is fixed where the fixed rate is determined
today, but cash flows on the swap will not start for six months. The entity designates
the swap as a cash flow hedge of the profit and loss exposure arising from the series
of semi-annual interest payments on the forecast issuance of debt. As long as all
conditions necessary for hedge accounting under IAS 39 are satisfied, the effective
portion of the gain and loss on the swap will be deferred in equity.
Question
To what extent should amounts from equity be recycled if, on the forecast issuance
date, D issues seven-year euro-denominated fixed rate debt, rather than debt with a
five-year term as previously expected? (Assume D closes out the swap on the date
of issuance of the debt.)
Answer
Ten forecast highly probable interest payments are still likely to occur, even though
they will now be interest payments on debt with a seven-year maturity. The gain or
loss deferred in equity will be removed from equity and included in profit or loss
when the individual interest payments for the first five years of the debt affect profit
or loss. An allocation of the amount deferred in equity when the debt is issued will be
required to determine the amount of the swap that relates to the individual interest
payments that were forecast and that are still expected to occur. Because the fair
value of the swap recognised in equity consists of the present value of 10 future
fixed cash flows, this present value amount is allocated specifically to those 10 future
interest periods and, accordingly, is released in profit or loss in those future periods.
Q&A IAS 39: 101-EX-1 — CASH FLOW HEDGING: FORECAST

TRANSACTION NO LONGER EXPECTED TO OCCUR

Example
Company D (D), an entity with a credit rating of BB, is hedging the forecast issuance
of £100 million of 10-year, fixed rate debt using a rate lock agreement (a derivative)
that D designates as a hedge of the variability in the total cash flows arising on the
forecast debt issuance. Company D expects to issue the debt in the second quarter
of 20X0. In the first quarter of 20X0, the spreads between government and
corporate bond rates widen significantly. As a result, D does not expect to issue its
bonds in the second quarter. Because D's advisers believe that the markets may
stabilise in the first quarter of 20X1, D immediately decides on what type of funding
to use in the first quarter of 20X1 and closes out its rate lock agreement. At the time
of closure, the fair value of the lock agreement is negative.
Company D should recognise the entire loss in income because the forecast debt
issuance is not expected to occur.
Q&As IAS 39: 102-1 and 102-2 — ACCOUNTING FOR A HEDGE OF A

GROUP OF NET INVESTMENTS IN FOREIGN OPERATIONS
Background
£ Parent (£ functional and £ presentational currency) has US$400 foreign

denominated issued debt. £ Parent wishes to designate the debt as a hedging
instrument of foreign exchange risk between US$ and £ of a net investment in a US$
foreign operation(s) in its consolidated accounts in accordance with IAS 39.102. [£
Parent has investments in other foreign operations and has other foreign
denominated debt and hence is not US$ functional.]
IAS 39: 102-1

Question
Are the following hedge accounting designations permitted by IAS?
Designation 1
Designate all the US$400 debt as a hedging instrument in a net investment hedge of
a foreign operation of all of the net assets in Subsidiary A, i.e., US$400.
Designation 2
Designate a portion of the US$ debt as a hedging instrument in a net investment in a

foreign operation of Subsidiary A, Subsidiary B, and Subsidiary C individually, in
accordance with IAS 39.78. The Group will, therefore, designate 1/4 of the US$ debt
as a hedging instrument of the investment in Subsidiary B, and 1/8th of the US$
debt as a hedging instrument of the investment in Subsidiary C, 5/8th as a hedging
instrument in the investment in Subsidiary A (the investment in Subsidiary A

excluding Subsidiary A's interest in Subsidiary B and Subsidiary C).
Answer
Both designations are possible under IAS.
IAS 21.8, The Effects of Changes in Foreign Exchange Rates, states that a net
investment in a foreign operation "is the amount of the reporting entity's interest in
the net assets of that operation" [emphasis added]. The reporting entity is the
Parent, and "that operation" can be considered to be either all the net assets of
Subsidiary A, or the net assets of Subsidiary A (excluding Subsidiary A's interest in
Subsidiary B and Subsidiary C), Subsidiary B, and Subsidiary C individually.
In accordance with IAS 39.88(b) the strategy applied for hedge accounting will be
consistent with the Group's documented risk management strategy for that
particular hedging relationship.
Designation 1 would be indicative of a Group that manages foreign currency risk by

managing the risk that the Parent has with respect to its interest in the immediate
holding company. The holding company may enter into separate hedge relationships
to hedge its interest in its investment in foreign operations.
Designation 2 would be indicative of a Group that manages foreign currency risk by

managing the risk that the Parent indirectly has in an individual foreign operation
within the group.
The Group should apply each one of the hedge designations consistently throughout
the whole group. Alternatively, a group may use Designation 1 for part of the group,
and Designation 2 for the rest of the group, consistently from period to period, only
if those designations reflect how the group manages the foreign currency risk within
those parts of the group.
IAS 39: 102-2
Question
If the Group chooses to designate all the US$ debt as a hedge of the net investments
of Subsidiary A, Subsidiary B, and Subsidiary C, can the Group designate all the US$
net investment as a group of foreign operations in accordance with IAS 39.78? If so,
then on what basis will hedge effectiveness be assessed and measured?
Answer
There must be an expectation that prospectively the Group considers the hedge
relationship to be highly effective in accordance with IAS 39.88. As the Group is
hedging a group of net investments in foreign operations, it must have a high
expectation that in accordance with IAS 39.83, each individual item in the portfolio
will change in fair value approximately proportionally to the overall change in the fair
value of the attributable hedged risk of the portfolio (in this case, US$:£ foreign
exchange risk).
If the net asset values of each foreign operation that forms part of the portfolio are
expected to move by an amount that is not approximately proportional to the
portfolio as a whole, then hedge accounting cannot prospectively be achieved. This is
likely to be the case where a group is hedging an amount of net assets of the foreign
operation equal to, or close to, the total net assets of that operation, as potential
significant ineffectiveness will arise if the net assets of one of the foreign operations
within the portfolio falls below its designated amount.
It may be possible to have a high expectation of the items moving approximately

proportionally to the portfolio as a whole if the group is hedging the first X of net
assets of each foreign operation, and there is a large excess of net assets above the
designated amount that is subject to the hedge (this provides the group with
capacity for the net assets of each operation to fall without incurring
ineffectiveness).
If an entity can demonstrate a high expectation of effectiveness for the portfolio, the
group must assess and measure hedge effectiveness based on the individual foreign
operations within the portfolio. Therefore, to the extent that the net assets of one of
the foreign operations fall below the designated net asset amount, or is sold,
ineffectiveness will arise.
It should be noted that the level of ineffectiveness that will be recognised by

applying a hedge of a group of net investments as described above is the same level
of ineffectiveness that would have been recognized by designating each of the
foreign operations individually and using a proportion of the US$ debt against each
of the individual foreign operations in accordance with IAS 39.75. The only
comparative advantage of the two methods is that hedging a group of net
investments reduces the amount of hedging documentation required as there is only
one designation by the Group.
Q&A IAS 39: 102-3 — NET INVESTMENT HEDGING: HEDGING THE

SPOT OR FORWARD RATE
Question

When applying net investment hedge accounting with forward contracts, is it
possible to hedge either the spot rate or the forward rate?
Answer
Either is acceptable. When hedging net investments with forward contracts, it is
important to specify what risk is being hedged (i.e., the forward rate or the spot
rate). If the forward rate is hedged, the full change in fair value of the forward is
taken to equity if it is fully effective; if the spot rate is hedged, the spot element of
the forward is taken to equity and the remainder (the fair value of the forward
points) is recognised in profit or loss. In accordance with IAS 39.102, the effective
amount of the derivative taken to equity is recycled out of equity when the
underlying net investment is sold.
Q&A IAS 39: 102-4 — NET INVESTMENT HEDGING: IDENTIFYING THE

SPOT ELEMENT OF A FORWARD CONTRACT
Question
When assessing and measuring effectiveness in net investment hedging, is it
possible to identify the spot element of a forward contract as the undiscounted spot?
Answer
Yes. This is because the risk being hedged is the risk of the retranslation of the net
assets of the net investment in accordance with IAS 21, The Effects of Changes in
Foreign Exchange Rates, which is calculated on an undiscounted basis. This is
equally true when an entity designates foreign-currency-denominated debt as a
hedge of a net investment in a foreign operation. In this case, both the hedged item
and hedging instrument are retranslated to undiscounted spot in accordance with
IAS 21 and, therefore, the hedged risk is the undiscounted spot.
Q&A IAS 39: 102-5 — NET INVESTMENT HEDGING WITH CURRENCY

SWAPS
Question

Can an entity use currency swaps to hedge its net investment in a foreign operation?
Answer
Yes. When the currency swap is fixed-to-fixed or float-to-float, the derivative may
qualify as a hedge of a net investment in a foreign operation. Hedging instruments
such as floating-to-floating currency swaps respond closely to movements in spot
rates. Thus, if the notional of such an instrument does not exceed the net
investment, it is likely to be an effective hedging instrument for a hedge of the spot
risk associated with the net investment.
Fixed-to-fixed currency swaps may be used as hedging instruments in a hedge of

either the forward or spot risk associated with the net investment. There are two
ways of designating such an instrument. One way would be to hedge an amount of
net assets that is equal to the present value of the foreign currency interest and
principal. This is in line with viewing the cross-currency swap as comprising a
combination of a loan payable in foreign currency and a loan receivable in the other
currency. In this case, an amount of net assets equal to the foreign currency
principal of the swap should be designated as the hedged item. Another way would
be to designate as the hedged item an amount of net assets equal to the sum of the
undiscounted foreign currency principal and undiscounted foreign currency interest
payments. This is in line with viewing the fixed-for-fixed swap as a combination of
forwards with respect to interest payments and final principal exchange at maturity.
Note that a greater amount of net assets would have to be available for the second
method to be effective.
A cross-currency interest rate swap (i.e., a swap that converts fixed foreign currency
to floating presentation currency) is unlikely to be an effective hedging instrument
for a hedge of foreign exchange risk of a net investment in a foreign operation
because the instrument also includes the fair value of both interest rate risk (i.e., the
swapping of fixed rates to floating rates or vice versa) and foreign currency risk.
Because interest rate risk is not an identifiable and measurable risk of the hedged
item, the hedging instrument is unlikely to be effective.
See Q&A IAS 39: 102-EX-6 when hedging a net investment in a foreign operation
using a float-to-float currency swap.
See Q&A IAS 39: 102-EX-7 when hedging a net investment in a foreign operation
using a fixed-to-fixed currency swap.
Q&A IAS 39: 102-6 — NET INVESTMENT HEDGING AT A

SUB-CONSOLIDATION LEVEL

Background
As shown in Q&As IAS 39: 102-1 and 102-2, an entity may perform a
sub-consolidation at an intermediate parent company level before the ultimate
parent company performs its consolidation. The consolidation process may affect the
ability to apply net investment hedging when the intermediate parent has a different
functional currency than the ultimate parent and enters into hedging instruments.
Question
Can an entity apply net investment hedging at a sub-consolidation level, and will this
be preserved in ultimate consolidation?
Answer
It depends. As the following example illustrates, the consolidation process may affect
the ability to apply net investment hedging when the intermediate parent has a
different functional currency than the ultimate parent and enters into hedging
instruments:
Company A (A), a pound sterling functional currency entity, has a 100 per cent
interest in Subsidiary B (B), a Norwegian kroner (NOK) functional currency entity.
Subsidiary B has a 100 per cent interest in Subsidiary C (C), a Danish kroner (DKK)
functional currency entity. Subsidiary B enters into a forward exchange contract to
sell DKK and buy NOK in order to hedge the net investment of C. The transaction is
illustrated below:

The strategy applied for hedge accounting should be consistent with the group's
documented risk management strategy for that particular hedging relationship (IAS
39.88(b)). If the group manages its foreign currency risk at each subgroup level
(i.e., B hedges its foreign currency risk with respect to its net investment in C, and A
manages its foreign currency risk with respect to its net investment in a subgroup
headed by B), then B is permitted to apply net investment hedging for its net
investment in C. The impact of this hedge will be recognised in the consolidated
financial statements of A when it performs its consolidation. This scenario is
indicative of a group that performs a sub-consolidation at the intermediate holding
company level (i.e., B, which manages its foreign currency risk for its group). In
addition, A may apply net investment hedging for its interest in the consolidated
foreign operation of B if it has entered into a foreign currency forward to sell NOK
and buy £ with a party external to the group.
If the group manages its foreign currency risk on a group basis (i.e., by A hedging
its direct and indirect investment in its subsidiaries), the forward contract that B has
entered into is not an effective net investment hedging instrument. In this case, the
consolidated group headed by A would need to enter into two foreign currency
forward contracts, one to sell NOK and buy £, and one to sell DKK and buy £.

Q&A IAS 39: 102-7 — COMPONENTS OF A NET INVESTMENT IN A
FOREIGN OPERATION
[Added 4 May 2007]
Question
Entity A (A), which has a pound sterling functional currency, has an investment in a
foreign operation, its wholly owned subsidiary, Entity B (B), which has a U.S. dollar
functional currency. The investment was made on 1 January 20X0 when A acquired
100 per cent of the share capital of B for US$100 million, paid in cash. On that date,
the fair value of the identifiable net assets of B is equal to US$70 million, with no
contingent liabilities present. Therefore, in applying purchase accounting under IFRS
3, Business Combinations, US$30 million of goodwill was recognised in A's
consolidated financial statements. Also on 1 January 20X0, A extended a loan of £10
million to B. Ten million pounds converted at the spot rate of exchange ruling on 1
January 20X0 is equal to US$20 million. Settlement of this loan is neither planned
nor likely to occur in the foreseeable future.
On the acquisition date, A wishes to enter into a hedge of its net investment in B, in
the consolidated financial statements. Of the net assets that represent the net
investment in B, what is the maximum amount that can be designated as a hedged
item in a net investment hedge under IAS 39?
Answer
In accordance with IAS 21.8, The Effects of Changes in Foreign Exchange Rates, a
net investment in a foreign operation is defined as "the amount of the reporting
entity's interest in the net assets of that operation". In accordance with IAS 21.47,
any goodwill and any fair value adjustments arising on acquisition of a foreign
operation are treated as assets and liabilities of the foreign operation, expressed in
the foreign currency, and translated at the closing rate. IAS 21.15 states that a
monetary item that is receivable from or payable to a foreign operation "for which
settlement is neither planned nor likely to occur in the foreseeable future is, in
substance, a part of the entity's net investment in that foreign operation". In
addition, IAS 39.102 describes hedges of a net investment in a foreign operation as
including a hedge of a monetary item that is accounted for as part of the net
investment in accordance with IAS 21.
Therefore, in A's consolidated financial statements, the net investment in the foreign
operation comprises a total of US$120 million of net assets. This comprises three
elements:
• US$70 million of the identifiable net assets of the foreign operation

acquired upon acquisition.
• US$30 million of goodwill that forms part of the net assets of the foreign
operation.
• US$20 million of additional net assets as a result of the loan extended by A

to B, a monetary item for which settlement is neither planned nor likely to
occur in the foreseeable future. Thus, the item forms part of the net
investment in B.
Note that if the loan extended to B was expected to be settled in the foreseeable
future, the net investment in the foreign operation would comprise net assets of only
US$100 million since, under IAS 21.15, the loan would not form part of the net
investment in B.
Q&A IAS 39: 102-EX-1 — NET INVESTMENT HEDGING: LOAN IS LESS

THAN OR EQUAL TO NET ASSETS OF SUBSIDIARY
Example
Company A (A), a UK company, has a U.S. subsidiary, Company B (B). To finance
this subsidiary, A has a U.S.$50 million loan with a third-party bank. Both A and B
have a 31 December year end, and the net assets of B at 31 December 20X1 and 31
December 20X2 were $70 million.
The loan is designated as a hedging instrument of B's first $50 million of net assets.
The designation is spot retranslation risk only. The hedge is determined to be highly
effective. The $/£ spot rate is 1.6 on 31 December 20X1 and 1.7 on 31 December
20X2.
On December 31 20X2, the entries are as follows:

The entire exchange difference on retranslating the net assets of the foreign
operation is taken to equity in accordance with IAS 21, The Effects of Changes in
Foreign Exchange Rates. The application of hedge accounting results in the
retranslation of the loan being recognised in equity, as opposed to profit or loss. No
hedge ineffectiveness has been recognised. Hedge ineffectiveness would have arisen
if the net assets of the foreign operation fell below $50 million at the period end.
Q&A IAS 39: 102-EX-2 — NET INVESTMENT HEDGING: LOAN EXCEEDS

THE NET ASSETS OF SUBSIDIARY
Example
The same scenario applies as in IAS 39: 102-EX-1, except the loan is $100 million.
The entity designates $70 million of the loan as a hedging instrument of B's first $70
million of net assets. The designation is spot retranslation risk only. The hedge is
determined to be highly effective. The $/£ spot rate is 1.6 on 31 December 20X1 and
1.7 on 31 December 20X2.
On 31 December 20X2, the entries are as follows:

The entire loan must be retranslated at the closing rate, giving rise to an exchange
gain. The exchange gain that relates to the designated and effective hedging
instrument (i.e., $70 million of the loan) is reported in equity. The remainder is
reported in the income statement.
Q&A IAS 39: 102-EX-3 — NET INVESTMENT HEDGING: NET ASSETS OF

FOREIGN OPERATION CHANGE
Example
Company A (A), a UK company, has a U.S. subsidiary, Company B (B). To finance
this subsidiary, A has a U.S.$80 million loan with a third-party bank. The year end of
both A and B is 31 December. On 31 December 20X1, the net assets of B were $90
million and were expected to remain at about this level. Thus, the entire loan was
designated as hedging the spot retranslation risk associated with the first $80 million
of B's net assets.
On 31 December 20X2, the net assets of B were $75 million. The $/£ spot rate is 1.6
on 31 December 20X2 and 1.7 on 31 December 20X2.

Hedge ineffectiveness arises because $80 million of net assets is no longer being
hedged. The effectiveness can be measured as 75/80 (93.75 per cent) or 80/75
(106.67 per cent). In either case, the effectiveness is between 80 and 125 per cent,
thereby permitting hedge accounting for the period. Hedge ineffectiveness must be
reported immediately in profit or loss.
The foreign exchange gain that relates to the designated and effective hedging
instrument is reported in equity (i.e., the exchange gain on $75 million), while the
ineffective portion is reported in profit or loss.
On 31 December 20X2, the group may choose to redesignate the hedging instrument
prospectively as only $75 million of the loan.
Q&A IAS 39: 102-EX-4 — NET INVESTMENT HEDGING: HEDGING THE

SPOT RATE
Example
On 1 November 20X1, Company XYZ (XYZ), an entity with a 31 December year end
and a pound sterling presentation currency, enters into a forward contract to sell
U.S.$1 million and buy pounds sterling at a fixed rate of U.S.$1.57:£1 on 30 January
20X2. Company XYZ enters into this contract to hedge the foreign exchange
translation risk associated with movements in the spot rate relating to XYZ's
investment in its U.S. subsidiary, Company ABC (ABC), which has net assets of
U.S.$1 million in XYZ's consolidated group accounts. The initial cost of investment in
ABC was also U.S.$1 million.
The forward and spot U.S.$/£ translation rates are as follows:

On 30 January 20X2, XYZ closes out the forward contract and sells ABC for U.S.$1.2
million, which is equal to £745,342 translated at U.S.$1.61:£1.
Translating U.S.$1 million at the above rates gives the following pound sterling
amounts:
Therefore, the value of the derivative, ignoring the time value of money, is:
Movements in the fair value of the premium (or discount) implicit in the fair value of
the forward contract will not give rise to hedge ineffectiveness, since the designated
hedged risk is movements in spot rate only. However, movements in the fair value of
these forward points will give rise to volatility in profit or loss.
The entries are as follows:
31 December 20X1

30 January 20X2

Q&A IAS 39: 102-EX-5 — NET INVESTMENT HEDGING: HEDGING THE
FORWARD RATE
Example
The same scenario applies as in IAS 39: 102-EX-4, except the forward rate is being
hedged instead of the spot rate.
Movements in the premium (or discount) implicit in the forward contract will now be
recognised in equity (rather than in profit or loss) and will, therefore, give rise to
equity volatility. These amounts will be recycled out of equity when the subsidiary is
sold.
31 December 20X1

30 January 20X2

Q&A IAS 39: 102-EX-6 — NET INVESTMENT HEDGING WITH
CROSS-CURRENCY SWAPS: FLOAT-TO-FLOAT
Example
Hedging a net investment in a foreign operation with a cross-currency swap (CCS)
that receives floating presentation currency pays floating foreign currency.

acquires a U.S. dollar functional currency subsidiary, which has net assets of
U.S.$150,000. Group A's presentation currency is also pound sterling. Company A
will be subject to foreign currency risk (between the U.S.$ and £) on retranslation of
the net investment in the consolidated financial statements. Therefore, A wants to
achieve hedge accounting for a specific level (U.S.$100,000) of the net assets in the
foreign operation. Company A wishes to designate the first U.S.$100,000 of net
assets as the hedged item in a net investment in a foreign operation. On 1 January
20X2, the spot rate on the U.S.$/£ is 1.75/1, so the notional of U.S.$100,000 is
equivalent to £57,143. On the same date, A enters into a CCS to exchange interest
payments and principal at redemption with a notional equal to the designated
amount of net assets, and designates the CCS as a hedge of the variability of the £
equivalent of U.S.$100,000 of the net assets of the foreign operation. According to
the terms, on each interest payment date (assume that interest is paid annually on
31 December for the CCS), A will pay U.S.$ LIBOR plus 100 basis points (bp) on a
notional of U.S.$100,000 and receive £ LIBOR plus 106 bp on the basis of a notional
of £57,143. Because the currency and notional on the swap match the net
investment, and the swap is on-market at inception, A expects that the hedging
relationship will be highly effective.
Risk management Net investment hedge of the foreign currency exposure (

objective and nature of spot rate) to changes in the reporting entity's interest in
risk being hedged U.S.$100,000 of net assets in the foreign operation.
Hedging instrument CCS to exchange U.S.$100,000 at maturity and pay U.S.

bp and receive £ LIBOR plus 106 bp interest annually ove
instrument

instrument.
Hedged item The first U.S.$100,000 of net assets in the foreign operat
Assessment of hedge The critical terms of the derivative (currency, notional) m

effectiveness net investment. Although there are no interest payments
investment, the cross-currency float-to-float swap respon
movements in undiscounted spot rates since the interest
made on the reporting date. Accordingly, high effectiven
Measurement of hedge The period-to-period retranslation on the first U.S.$100,0

effectiveness the foreign operation using undiscounted spot rates com
value movement on the CCS.
Period-to-period assessment of hedge effectiveness using the dollar offset test:
The hedging relationship is deemed highly effective (80 per cent to 125 per cent)
throughout each period and, therefore, hedge accounting is permitted. Any
ineffectiveness, which is the difference between fair value movement of the CCS and
the retranslation of the first U.S. $100,000 of net assets using undiscounted spot
rates, will be recognised in profit and loss in the period.
in £ (Dr or (Cr) as indicated). For illustrative purposes only, the entries have
recognised the translation on only U.S. $100,000 of net assets and not actual net
assets. IAS 21, The Effects of Changes in Foreign Exchange Rates, would require
translation of all net assets of the foreign operation to the cumulative translation
reserve. Because the total net assets never fall below U.S.$100,000 at a period end,
the journal entry for "Consolidated net assets" is always the retranslation of U.S.
$100,000.
Key
A: The remaining value on the CCS is the difference between the net assets
retranslated at U.S.$1.75/£ (original rate) and the U.S.$1.70/£ (spot rate at date
termination of swap). Hence, the total balance sheet before final settlement of CCS
is (net assets £58,824–CCS £1,681) = £57,143 on 31 December 20X6, which is
equivalent to the original U.S.$100,000 net assets at the original spot rate of
U.S.$1.75/£.
B: Nets to zero, since all amounts have been taken to profit and loss account as
ineffectiveness.
C: Because at least U.S.$100,000 of net assets existed at each reporting period

throughout the relationship, the hedge relationship was fully effective in hedging the
first U.S.$100,000 of net assets.
Entries in the consolidated financial statements for 20X2 for illustrative purposes.
1 January 20X2
No entry required by CCS since fair value is nil at inception.
31 December 20X2

(20X3–20X6). The amount in cumulative translation reserve will be recognised in
profit or loss on disposal of the foreign operation.
Interest income totalling £7,050 is recognised over the term of the hedging
instrument in profit and loss since the interest receipts represent the net financing
on the swap. The swap is not 100 per cent effective in hedging undiscounted spot
because the fair value of the swap is the present value of all future cash flows on the
swap, including some fixed cash flows. Because both legs on the swap have fixed
margins, the present value of these fixed margins will result in some hedge
ineffectiveness. In the above example, the amount of ineffectiveness is not sufficient
for the hedge relationship to fail the hedge effectiveness requirements of hedge
accounting.
Q&A IAS 39: 102-EX-7 — NET INVESTMENT HEDGING WITH

CROSS-CURRENCY SWAPS: FIXED-TO-FIXED
Example
Hedging a net investment in a foreign operation with a cross-currency swap (CCS)
that receives fixed presentation currency pays fixed foreign currency.

acquires a U.S. dollar functional currency subsidiary, which has net assets of
U.S.$150,000. Group A's presentation currency is also pound sterling. Company A
will be subject to foreign currency risk (between the U.S.$ and £) on retranslation of
the net investment in the consolidated financial statements. Therefore, A wants to
achieve hedge accounting for a specific level (U.S.$100,000) of the net assets in the
foreign operation. Company A wishes to designate the first U.S.$100,000 of net
assets as the hedged item in a net investment in a foreign operation. On 1 January
20X2, the spot rate on the U.S.$/£ is 1.75/1, so the notional of U.S.$100,000 is
equivalent to £57,143. On the same date, A enters into a CCS to exchange interest
payments and principal at redemption with a notional equal to the designated
amount of net assets, and designates the CCS as a hedge of the variability of the £
equivalent of U.S.$100,000 of the net assets of the foreign operation. According to
the terms, on each interest payment date (assume that interest is paid annually on
31 December for the CCS), A will pay U.S.$ 4 per cent on a notional of U.S.$100,000
and receive £ 6 per cent on a notional of £57,143. Because the currency and
notional on the swap match the net investment, and the swap is on-market at
inception, A expects that the hedging relationship will be highly effective.
Risk management Net investment hedge of the foreign currency exposure (

objective and nature of forward rates) to changes in the reporting entity's intere
risk being hedged U.S.$100,000 of net assets in the foreign operation.
Hedging instrument CCS to exchange U.S.$100,000 at maturity and pay U.S.

receive £ 6 per cent interest annually over the term of th
Hedged item The first U S $100 000 of net assets in the foreign operat
Hedged item The first U.S.$100,000 of net assets in the foreign operat
Assessment of hedge The critical terms of the derivative (currency, notional) m

effectiveness net investment. High effectiveness is expected. The com
counterparty credit risk and probability of cash flows und
occurring every period.
Measurement of hedge Comparison of the fair value movement of the CCS and t
effectiveness CCS that would have nil ineffectiveness.
in £ (Dr or (Cr) as indicated). For illustrative purposes only, the entries have
recognised the translation on only U.S.$100,000 of net assets and not actual net
assets. IAS 21, The Effects of Changes in Foreign Exchange Rates, would require
translation of all net assets of the foreign operation to the cumulative translation
reserve. Because the total net assets never fall below U.S.$100,000 at a period end,
the journal entry for "Consolidated net assets" is always the retranslation of
U.S.$100,000.
For illustrative purposes, the hedge relationship is deemed fully effective throughout
its life.

Key
A: The remaining value on the CCS is the difference between the net assets
retranslated at U.S.$1.75/£ (original rate) and the U.S.$1.70/£ (spot rate at date
termination of swap). Hence, the total balance sheet before final settlement of CCS
is (net assets £58,824 – CCS £1,681) = £57,143 on 31 December 20X6, which is
equivalent to the original U.S.$100,000 net assets at the original spot rate of
U.S.$1.75/£.
B: Totals to zero, since the hedge relationship was fully effective.

C: Because at least U.S.$100,000 of net assets existed at each reporting period
throughout the relationship, the hedge relationship was fully effective in hedging the
first U.S.$100,000 of net assets.
1 January 20X2
No entry required by CCS, since fair value is nil at inception.
31 December 20X2
(20X3–20X6). The amount in cumulative translation reserve will be recognised in
profit or loss on disposal of the foreign operation.
Interest income totalling £5,109 is recognised over the term of the hedging
instrument in profit and loss since the interest payments represent the net financing
on the swap.
Q&A IAS 39: AG4(a)-EX-1 — CREDIT RATING CONTRACT

[Renumbered from IAS 39: 3-EX-1 on 25 August 2006]
Example
Company C (C) owns £100 million of Company X (X) bonds that mature in twenty
years. Company X is rated BBB by the rating agencies. Company C is concerned that
X may be downgraded and the value of bonds would decline. To protect against such
a decline, C enters into a contract with a banker that will pay C for any decline in the
fair value of the X bonds related to a credit downgrade to B, or below. The contract
is for a five-year period. Company C pays £2 million for the credit contract. Since the
contract pays C in the event of a downgrade, and not in the event of a failure by X to
pay, it is a derivative instrument.
Q&A IAS 39: AG71-1— VALUATION OF RESTRICTED SECURITIES

Question
Entity A holds a security that is quoted in an active market; there is a legally
enforceable restriction on this security that prevents its sale for a specified period.
Should Entity A discount the quoted market price of the security when determining
its fair value?
Answer
It depends on whether the restriction is an attribute of the security or of Entity A
(i.e. the entity holding the security). Entity-specific restrictions that do not transfer
to market participants should not be considered in determining the fair value of the
security. Entity A should only consider the effect of the restriction on the sale of the
asset if market participants would consider the effect of the restriction in pricing the
asset.

A security with an entity-specific restriction is identical to a security that is traded in
an active market. According to IAS 39.AG71, “[t]he existence of published price
quotations in an active market is the best evidence of fair value” and, when such
price quotations are available, they should be used to measure the fair value of the
security.
However, a legal or contractual restriction on the sale of a security that transfers to

market participants should be incorporated into the measurement of the security's
fair value, because such a restriction is an attribute of the security (i.e. the
restriction is instrument-specific). The effect of such a restriction on the fair value
measurement is the amount that a market participant would demand because of the
inability to access a public market for the security for the specified period. That
amount will vary according to the nature and duration of the restriction, the extent
to which buyers are limited by the restriction, and factors specific to both the
security and the issuer.
The following are examples of entity-specific restrictions.
• Restriction on sale of security by directors during a 'closed' period

— Assume that Entity A has an equity investment in Entity B and is
represented on Entity B's board of directors. Because officers of Entity A
are directors of Entity B, Entity A is restricted from selling any of its equity
shares in Entity B during a specified 'closed' period (e.g. the period
surrounding Entity B's periodic release of earnings). Other market
participants, not being directors, would not face this restriction. Because
the restriction is entity-specific and would not transfer with the security,
Entity A should not adjust the measurement of the fair value of its
investment in Entity B for the effect of the restriction.
• Assets pledged as collateral — An entity may enter into a borrowing

arrangement that requires assets to be pledged as collateral. The
borrowing arrangement may restrict the entity from selling or transferring
the assets during the term of the arrangement. Other market participants,
however, would not face this restriction. Because this restriction is
entity-specific and would not transfer with the assets, it should not be
considered in the fair value measurement of the pledged assets.
The following is an example of a security-specific restriction.
• Legal restrictions on the sale of securities that apply to all market

participants — If the legal framework governing the sale of securities in a
particular jurisdiction restricts the sale of certain securities to buyers that
meet specified criteria, such a restriction is an attribute of the security and
would transfer to market participants. Therefore, the measurement of the
fair value of the security should incorporate this instrument-specific
restriction.
In some circumstances, it is clear that a particular restriction is an attribute of the

security and would transfer to market participants (i.e. that it is instrument-specific).
In other circumstances, significant judgment may be required to make that
determination (e.g. if the restriction is a precondition for holding the security and
prevents the entity from transferring it to a market participant). In such cases, it
may be appropriate to involve a legal specialist.
Guidance on implementing IAS 39 Financial

Instruments: Recognition and Measurement
Guidance on implementing IAS 39 Financial Instruments:

Recognition and Measurement
This guidance accompanies, but is not part of, IAS 39.
Section A Scope
A.1 Practice of settling net: forward contract to purchase a commodity
Entity XYZ enters into a fixed price forward contract to purchase one million
kilograms of copper in accordance with its expected usage requirements. The
contract permits XYZ to take physical delivery of the copper at the end of twelve
months or to pay or receive a net settlement in cash, based on the change in fair
value of copper. Is the contract accounted for as a derivative?
While such a contract meets the definition of a derivative, it is not necessarily accounted for
as a derivative. The contract is a derivative instrument because there is no initial net
investment, the contract is based on the price of copper, and it is to be settled at a future
date. However, if XYZ intends to settle the contract by taking delivery and has no history for
similar contracts of settling net in cash or of taking delivery of the copper and selling it
within a short period after delivery for the purpose of generating a profit from short-term
fluctuations in price or dealer's margin, the contract is not accounted for as a derivative
under IAS 39. Instead, it is accounted for as an executory contract.
A.2 Option to put a non-financial asset
Entity XYZ owns an office building. XYZ enters into a put option with an investor
that permits XYZ to put the building to the investor for CU150 million. The current
value of the building is CU1751million. The option expires in five years. The
option, if exercised, may be settled through physical delivery or net cash, at XYZ's
option. How do both XYZ and the investor account for the option?
XYZ's accounting depends on XYZ's intention and past practice for settlement. Although the
contract meets the definition of a derivative, XYZ does not account for it as a derivative if
XYZ intends to settle the contract by delivering the building if XYZ exercises its option and
there is no past practice of settling net (IAS 39.5 and IAS 39.AG10).
The investor, however, cannot conclude that the option was entered into to meet the
investor's expected purchase, sale or usage requirements because the investor does not
have the ability to require delivery (IAS 39.7). In addition, the option may be settled net in
cash. Therefore, the investor has to account for the contract as a derivative. Regardless of
past practices, the investor's intention does not affect whether settlement is by delivery or
in cash. The investor has written an option, and a written option in which the holder has a
choice of physical settlement or net cash settlement can never satisfy the normal delivery
requirement for the exemption from IAS 39 because the option writer does not have the
ability to require delivery.
However, if the contract were a forward contract rather than an option, and if the contract
required physical delivery and the reporting entity had no past practice of settling net in
cash or of taking delivery of the building and selling it within a short period after delivery for
the purpose of generating a profit from short-term fluctuations in price or dealer's margin,
the contract would not be accounted for as a derivative.
Section B Definitions
B.1 Definition of a financial instrument: gold bullion
Is gold bullion a financial instrument (like cash) or is it a commodity?
It is a commodity. Although bullion is highly liquid, there is no contractual right to receive

cash or another financial asset inherent in bullion.
B.2 Definition of a derivative: examples of derivatives and underlyings
What are examples of common derivative contracts and the identified underlying?
IAS 39 defines a derivative as follows:
A derivative is a financial instrument or other contract within the scope of this

Standard with all three of the following characteristics:
a. its value changes in response to the change in a specified interest

rate, financial instrument price, commodity price, foreign exchange
rate, index of prices or rates, credit rating or credit index, or other
variable, provided in the case of a non-financial variable that the
variable is not specific to a party to the contract (sometimes called
the 'underlying');
b. it requires no initial net investment or an initial net investment that is

smaller than would be required for other types of contracts that
would be expected to have a similar response to changes in market
factors; and
c. it is settled at a future date.
Type of contract Main pricing-settlement

variable (underlying variable)
Interest rate swap Interest rates
Currency swap (foreign exchange Currency rates
swap)
Commodity swap Commodity prices
Equity swap Equity prices (equity of another
entity)
Credit swap Credit rating, credit index or credit
price
Total return swap Total fair value of the reference
asset and interest rates
Purchased or written treasury bond Interest rates
option (call or put)
Purchased or written currency Currency rates
Purchased or written commodity Commodity prices
Purchased or written stock option Equity prices (equity of another
(call or put) entity)
Interest rate futures linked to Interest rates
government debt (treasury futures)
Currency futures Currency rates
Commodity futures Commodity prices
Interest rate forward linked to Interest rates
government debt (treasury
forward)
Currency forward Currency rates
Commodity forward Commodity prices
Equity forward Equity prices (equity of another
entity)

The above list provides examples of contracts that normally qualify as derivatives under
IAS 39. The list is not exhaustive. Any contract that has an underlying may be a derivative.
Moreover, even if an instrument meets the definition of a derivative contract, special
provisions of IAS 39 may apply, for example, if it is a weather derivative (see IAS 39.AG1),
a contract to buy or sell a non-financial item such as commodity (see IAS 39.5 and
IAS 39.AG10) or a contract settled in an entity's own shares (see IAS 32.21–IAS 32.24).
Therefore, an entity must evaluate the contract to determine whether the other
characteristics of a derivative are present and whether special provisions apply.
B.3 Definition of a derivative: settlement at a future date, interest rate swap with
net or gross settlement
For the purpose of determining whether an interest rate swap is a derivative

financial instrument under IAS 39, does it make a difference whether the parties
pay the interest payments to each other (gross settlement) or settle on a net
basis?
No. The definition of a derivative does not depend on gross or net settlement.
To illustrate: Entity ABC enters into an interest rate swap with a counterparty (XYZ) that
requires ABC to pay a fixed rate of 8 per cent and receive a variable amount based on
three-month LIBOR, reset on a quarterly basis. The fixed and variable amounts are
determined based on a CU100 million notional amount. ABC and XYZ do not exchange the
notional amount. ABC pays or receives a net cash amount each quarter based on the
difference between 8 per cent and three-month LIBOR. Alternatively, settlement may be on
a gross basis.
The contract meets the definition of a derivative regardless of whether there is net or gross
settlement because its value changes in response to changes in an underlying variable
(LIBOR), there is no initial net investment, and settlements occur at future dates.
B.4 Definition of a derivative: prepaid interest rate swap (fixed rate payment
obligation prepaid at inception or subsequently)
If a party prepays its obligation under a pay-fixed, receive-variable interest rate

swap at inception, is the swap a derivative financial instrument?
Yes.
To illustrate: Entity S enters into a CU100 million notional amount five-year pay-fixed,
receive-variable interest rate swap with Counterparty C. The interest rate of the variable
part of the swap is reset on a quarterly basis to three-month LIBOR. The interest rate of the
fixed part of the swap is 10 per cent per year. Entity S prepays its fixed obligation under the
swap of CU50 million (CU100 million × 10 per cent × 5 years) at inception, discounted
using market interest rates, while retaining the right to receive interest payments on the
CU100 million reset quarterly based on three-month LIBOR over the life of the swap.
The initial net investment in the interest rate swap is significantly less than the notional
amount on which the variable payments under the variable leg will be calculated. The
contract requires an initial net investment that is smaller than would be required for other
types of contracts that would be expected to have a similar response to changes in market
factors, such as a variable rate bond. Therefore, the contract fulfils the 'no initial net
investment or an initial net investment that is smaller than would be required for other
types of contracts that would be expected to have a similar response to changes in market
factors' provision of IAS 39. Even though Entity S has no future performance obligation, the
ultimate settlement of the contract is at a future date and the value of the contract changes
in response to changes in the LIBOR index. Accordingly, the contract is regarded as a
derivative contract.
Would the answer change if the fixed rate payment obligation is prepaid
subsequent to initial recognition?
If the fixed leg is prepaid during the term, that would be regarded as a termination of the
old swap and an origination of a new instrument that is evaluated under IAS 39 and IFRS 9.
B.5 Definition of a derivative: prepaid pay-variable, receive-fixed interest rate

swap
If a party prepays its obligation under a pay-variable, receive-fixed interest rate

swap at inception of the contract or subsequently, is the swap a derivative
financial instrument?
No. A prepaid pay-variable, receive-fixed interest rate swap is not a derivative if it is

prepaid at inception and it is no longer a derivative if it is prepaid after inception because it
provides a return on the prepaid (invested) amount comparable to the return on a debt
instrument with fixed cash flows. The prepaid amount fails the 'no initial net investment or
an initial net investment that is smaller than would be required for other types of contracts
that would be expected to have a similar response to changes in market factors' criterion of
a derivative.
To illustrate: Entity S enters into a CU100 million notional amount five-year pay-variable,
receive-fixed interest rate swap with Counterparty C. The variable leg of the swap is reset
on a quarterly basis to three-month LIBOR. The fixed interest payments under the swap are
calculated as 10 per cent times the swap's notional amount, ie CU10 million per year. Entity
S prepays its obligation under the variable leg of the swap at inception at current market
rates, while retaining the right to receive fixed interest payments of 10 per cent on CU100
million per year.
The cash inflows under the contract are equivalent to those of a financial instrument with a
fixed annuity stream since Entity S knows it will receive CU10 million per year over the life
of the swap. Therefore, all else being equal, the initial investment in the contract should
equal that of other financial instruments that consist of fixed annuities. Thus, the initial net
investment in the pay-variable, receive-fixed interest rate swap is equal to the investment
required in a non-derivative contract that has a similar response to changes in market
conditions. For this reason, the instrument fails the 'no initial net investment or an initial net
investment that is smaller than would be required for other types of contracts that would be
expected to have a similar response to changes in market factors' criterion of IAS 39.
Therefore, the contract is not accounted for as a derivative under IAS 39 or IFRS 9.
By discharging the obligation to pay variable interest rate payments, Entity S in effect
provides a loan to Counterparty C.
B.6 Definition of a derivative: offsetting loans
Entity A makes a five-year fixed rate loan to Entity B, while B at the same time
makes a five-year variable rate loan for the same amount to A. There are no
transfers of principal at inception of the two loans, since A and B have a netting
agreement. Is this a derivative under IAS 39?
Yes. This meets the definition of a derivative (that is to say, there is an underlying variable,
no initial net investment or an initial net investment that is smaller than would be required
for other types of contracts that would be expected to have a similar response to changes in
market factors, and future settlement). The contractual effect of the loans is the equivalent
of an interest rate swap arrangement with no initial net investment. Non-derivative
transactions are aggregated and treated as a derivative when the transactions result, in
substance, in a derivative. Indicators of this would include:
• they are entered into at the same time and in contemplation of one another
• they have the same counterparty
• they relate to the same risk
• there is no apparent economic need or substantive business purpose for

structuring the transactions separately that could not also have been
accomplished in a single transaction.
The same answer would apply if Entity A and Entity B did not have a netting agreement,
because the definition of a derivative instrument in IAS 39.9 does not require net
settlement.
B.7 Definition of a derivative: option not expected to be exercised
The definition of a derivative in IAS 39.9 requires that the instrument 'is settled at
a future date'. Is this criterion met even if an option is expected not to be
exercised, for example, because it is out of the money?
Yes. An option is settled upon exercise or at its maturity. Expiry at maturity is a form of
settlement even though there is no additional exchange of consideration.
B.8 Definition of a derivative: foreign currency contract based on sales volume
Entity XYZ, whose functional currency is the US dollar, sells products in France
denominated in euro. XYZ enters into a contract with an investment bank to
convert euro to US dollars at a fixed exchange rate. The contract requires XYZ to
remit euro based on its sales volume in France in exchange for US dollars at a
fixed exchange rate of 6.00. Is that contract a derivative?
Yes. The contract has two underlying variables (the foreign exchange rate and the volume
of sales), no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to
changes in market factors, and a payment provision. IAS 39 does not exclude from its
scope derivatives that are based on sales volume.
B.9 Definition of a derivative: prepaid forward
An entity enters into a forward contract to purchase shares of stock in one year at
the forward price. It prepays at inception based on the current price of the shares.
Is the forward contract a derivative?
No. The forward contract fails the 'no initial net investment or an initial net investment that
is smaller than would be required for other types of contracts that would be expected to
have a similar response to changes in market factors' test for a derivative.
To illustrate: Entity XYZ enters into a forward contract to purchase one million T ordinary
shares in one year. The current market price of T is CU50 per share; the one-year forward
price of T is CU55 per share. XYZ is required to prepay the forward contract at inception
with a CU50 million payment. The initial investment in the forward contract of CU50 million
is less than the notional amount applied to the underlying, one million shares at the forward
price of CU55 per share, ie CU55 million. However, the initial net investment approximates
the investment that would be required for other types of contracts that would be expected
to have a similar response to changes in market factors because T's shares could be
purchased at inception for the same price of CU50. Accordingly, the prepaid forward
contract does not meet the initial net investment criterion of a derivative instrument.
B.10 Definition of a derivative: initial net investment
Many derivative instruments, such as futures contracts and exchange traded

written options, require margin accounts. Is the margin account part of the initial
net investment?
No. The margin account is not part of the initial net investment in a derivative instrument.
Margin accounts are a form of collateral for the counterparty or clearing house and may
take the form of cash, securities or other specified assets, typically liquid assets. Margin
accounts are separate assets that are accounted for separately.
B.11 Definition of held for trading: portfolio with a recent actual pattern of
short-term profit-taking
The definition of a financial asset or financial liability held for trading states that
'a financial asset or financial liability is classified as held for trading if it is … part
of a portfolio of identified financial instruments that are managed together and for
which there is evidence of a recent actual pattern of short-term profit-taking'.
What is a 'portfolio' for the purposes of applying this definition?
Although the term 'portfolio' is not explicitly defined in IAS 39, the context in which it is
used suggests that a portfolio is a group of financial assets or financial liabilities that are
managed as part of that group (IAS 39.9). If there is evidence of a recent actual pattern of
short-term profit-taking on financial instruments included in such a portfolio, those financial
instruments qualify as held for trading even though an individual financial instrument may
in fact be held for a longer period of time.
B.12–B.23
[Deleted]
B.24 Definition of amortised cost: perpetual debt instruments with fixed or

market-based variable rate
Sometimes entities purchase or issue debt instruments that are required to be

measured at amortised cost and in respect of which the issuer has no obligation to
repay the principal amount. Interest may be paid either at a fixed rate or at a
variable rate. Would the difference between the initial amount paid or received
and zero ('the maturity amount') be amortised immediately on initial recognition
for the purpose of determining amortised cost if the rate of interest is fixed or
specified as a market-based variable rate?
No. Since there are no repayments of principal, there is no amortisation of the difference
between the initial amount and the maturity amount if the rate of interest is fixed or
specified as a market-based variable rate. Because interest payments are fixed or
market-based and will be paid in perpetuity, the amortised cost (the present value of the
stream of future cash payments discounted at the effective interest rate) equals the
principal amount in each period (IAS 39.9).
B.25 Definition of amortised cost: perpetual debt instruments with decreasing

interest rate
If the stated rate of interest on a perpetual debt instrument decreases over time,
would amortised cost equal the principal amount in each period?
No. From an economic perspective, some or all of the interest payments are repayments of
the principal amount. For example, the interest rate may be stated as 16 per cent for the
first ten years and as zero per cent in subsequent periods. In that case, the initial amount is
amortised to zero over the first ten years using the effective interest method, since a
portion of the interest payments represents repayments of the principal amount.
The amortised cost is zero after year 10 because the present value of the stream of future
cash payments in subsequent periods is zero (there are no further cash payments of either
principal or interest in subsequent periods).
B.26 Example of calculating amortised cost: financial asset
How is amortised cost calculated for financial assets measured at amortised cost
in accordance with IFRS 9?
Under IAS 39, amortised cost is calculated using the effective interest method. The effective
interest rate inherent in a financial instrument is the rate that exactly discounts the
estimated cash flows associated with the financial instrument through the expected life of
the instrument or, where appropriate, a shorter period to the net carrying amount at initial
recognition. The computation includes all fees and points paid or received that are an
integral part of the effective interest rate, directly attributable transaction costs and all
other premiums or discounts.
The following example illustrates how amortised cost is calculated using the effective
interest method. Entity A purchases a debt instrument with five years remaining to maturity
for its fair value of CU1,000 (including transaction costs). The instrument has a principal
amount of CU1,250 and carries fixed interest of 4.7 per cent that is paid annually (CU1,250
× 4.7 per cent = CU59 per year). The contract also specifies that the borrower has an
option to prepay the instrument and that no penalty will be charged for prepayment.
At inception, the entity expects the borrower not to prepay.
It can be shown that in order to allocate interest receipts and the initial discount over the
term of the debt instrument at a constant rate on the carrying amount, they must be
accrued at the rate of 10 per cent annually. The table below provides information about the
amortised cost, interest income and cash flows of the debt instrument in each reporting
period.
On the first day of 20X2 the entity revises its estimate of cash flows. It now expects that
50 per cent of the principal will be prepaid at the end of 20X2 and the remaining 50
per cent at the end of 20X4. In accordance with IAS 39.AG8, the opening balance of the
debt instrument in 20X2 is adjusted. The adjusted amount is calculated by discounting the
amount the entity expects to receive in 20X2 and subsequent years using the original
effective interest rate (10 per cent). This results in the new opening balance in 20X2 of
CU1138. The adjustment of CU52 (CU1,138 – CU1,086) is recorded in profit or loss in 20X2.
The table below provides information about the amortised cost, interest income and cash
flows as they would be adjusted taking into account the change in estimate.
If the debt instrument becomes impaired, say, at the end of 20X3, the impairment loss is
calculated as the difference between the carrying amount (CU595) and the present value of
estimated future cash flows discounted at the original effective interest rate (10 per cent).
B.27 Example of calculating amortised cost: debt instruments with stepped

interest payments
Sometimes entities purchase or issue debt instruments with a predetermined rate

of interest that increases or decreases progressively ('stepped interest') over the
term of the debt instrument. If a debt instrument with stepped interest and no
embedded derivative is issued at CU1,250 and has a maturity amount of CU1,250,
would the amortised cost equal CU1,250 in each reporting period over the term of
the debt instrument?
No. Although there is no difference between the initial amount and maturity amount, an
entity uses the effective interest method to allocate interest payments over the term of the
debt instrument to achieve a constant rate on the carrying amount (IAS 39.9).
The following example illustrates how amortised cost is calculated using the effective
interest method for an instrument with a predetermined rate of interest that increases or
decreases over the term of the debt instrument ('stepped interest').
On 1 January 2000, Entity A issues a debt instrument for a price of CU1,250. The principal
amount is CU1,250 and the debt instrument is repayable on 31 December 2004. The rate of
interest is specified in the debt agreement as a percentage of the principal amount as
follows: 6.0 per cent in 2000 (CU75), 8.0 per cent in 2001 (CU100), 10.0 per cent in 2002
(CU125), 12.0 per cent in 2003 (CU150), and 16.4 per cent in 2004 (CU205). In this case,
the interest rate that exactly discounts the stream of future cash payments through
maturity is 10 per cent. Therefore, cash interest payments are reallocated over the term of
the debt instrument for the purposes of determining amortised cost in each period. In each
period, the amortised cost at the beginning of the period is multiplied by the effective
interest rate of 10 per cent and added to the amortised cost. Any cash payments in the
period are deducted from the resulting number. Accordingly, the amortised cost in each
period is as follows:
B.28 Regular way contracts: no established market
Can a contract to purchase a financial asset be a regular way contract if there is

no established market for trading such a contract?
Yes. IAS 39.9 refers to terms that require delivery of the asset within the time frame
established generally by regulation or convention in the marketplace concerned.
Marketplace, as that term is used in IAS 39.9, is not limited to a formal stock exchange or
organised over-the-counter market. Rather, it means the environment in which the financial
asset is customarily exchanged. An acceptable time frame would be the period reasonably
and customarily required for the parties to complete the transaction and prepare and
execute closing documents.
For example, a market for private issue financial instruments can be a marketplace.
B.29 Regular way contracts: forward contract
Entity ABC enters into a forward contract to purchase one million of M's ordinary
shares in two months for CU10 per share. The contract is with an individual and is
not an exchange-traded contract. The contract requires ABC to take physical
delivery of the shares and pay the counterparty CU10 million in cash. M's shares
trade in an active public market at an average of 100,000 shares a day. Regular
way delivery is three days. Is the forward contract regarded as a regular way
contract?
No. The contract must be accounted for as a derivative because it is not settled in the way
established by regulation or convention in the marketplace concerned.
B.30 Regular way contracts: which customary settlement provisions apply?

If an entity's financial instruments trade in more than one active market, and the
settlement provisions differ in the various active markets, which provisions apply
in assessing whether a contract to purchase those financial instruments is a
regular way contract?
The provisions that apply are those in the market in which the purchase actually takes
place.
To illustrate: Entity XYZ purchases one million shares of Entity ABC on a US stock
exchange, for example, through a broker. The settlement date of the contract is six
business days later. Trades for equity shares on US exchanges customarily settle in three
business days. Because the trade settles in six business days, it does not meet the
exemption as a regular way trade.
However, if XYZ did the same transaction on a foreign exchange that has a customary
settlement period of six business days, the contract would meet the exemption for a regular
way trade.
B.31 Regular way contracts: share purchase by call option
Entity A purchases a call option in a public market permitting it to purchase

100 shares of Entity XYZ at any time over the next three months at a price of
CU100 per share. If Entity A exercises its option, it has 14 days to settle the
transaction according to regulation or convention in the options market. XYZ
shares are traded in an active public market that requires three-day settlement. Is
the purchase of shares by exercising the option a regular way purchase of shares?
Yes. The settlement of an option is governed by regulation or convention in the marketplace

for options and, therefore, upon exercise of the option it is no longer accounted for as a
derivative because settlement by delivery of the shares within 14 days is a regular way
transaction.
B.32 Recognition and derecognition of financial liabilities using trade date or

settlement date accounting
IAS 39 has special rules about recognition and derecognition of financial assets
using trade date or settlement date accounting. Do these rules apply to
transactions in financial instruments that are classified as financial liabilities, such
as transactions in deposit liabilities and trading liabilities?
No. IAS 39 does not contain any specific requirements about trade date accounting and
settlement date accounting in the case of transactions in financial instruments that are
classified as financial liabilities. Therefore, the general recognition and derecognition
requirements in IAS 39.14 and IAS 39.39 apply. IAS 39.14 states that financial liabilities are
recognised on the date the entity 'becomes a party to the contractual provisions of the
instrument'. Such contracts generally are not recognised unless one of the parties has
performed or the contract is a derivative contract not exempted from the scope of IAS 39.
IAS 39.39 specifies that financial liabilities are derecognised only when they are
extinguished, ie when the obligation specified in the contract is discharged or cancelled or
expires.
Section C Embedded derivatives
C.1 Embedded derivatives: separation of host debt instrument
If an embedded non-option derivative is required to be separated from a host debt

instrument, how are the terms of the host debt instrument and the embedded
derivative identified? For example, would the host debt instrument be a fixed rate
instrument, a variable rate instrument or a zero coupon instrument?
The terms of the host debt instrument reflect the stated or implied substantive terms of the
hybrid contract. In the absence of implied or stated terms, the entity makes its own
judgement of the terms. However, an entity may not identify a component that is not
specified or may not establish terms of the host debt instrument in a manner that would
result in the separation of an embedded derivative that is not already clearly present in the
hybrid contract, that is to say, it cannot create a cash flow that does not exist. For example,
if a five-year debt instrument has fixed interest payments of CU40,000 annually and a
principal payment at maturity of CU1,000,000 multiplied by the change in an equity price
index, it would be inappropriate to identify a floating rate host contract and an embedded
equity swap that has an offsetting floating rate leg in lieu of identifying a fixed rate host. In
that example, the host contract is a fixed rate debt instrument that pays CU40,000 annually
because there are no floating interest rate cash flows in the hybrid contract.
In addition, the terms of an embedded non-option derivative, such as a forward or swap,

must be determined so as to result in the embedded derivative having a fair value of zero at
the inception of the hybrid contract. If it were permitted to separate embedded non-option
derivatives on other terms, a single hybrid contract could be decomposed into an infinite
variety of combinations of host debt instruments and embedded derivatives, for example,
by separating embedded derivatives with terms that create leverage, asymmetry or some
other risk exposure not already present in the hybrid contract. Therefore, it is inappropriate
to separate an embedded non-option derivative on terms that result in a fair value other
than zero at the inception of the hybrid contract. The determination of the terms of the
embedded derivative is based on the conditions existing when the financial instrument was
issued.
C.2 Embedded derivatives: separation of embedded option
The response to Question C.1 states that the terms of an embedded non-option
derivative should be determined so as to result in the embedded derivative having a fair
value of zero at the initial recognition of the hybrid contract. When an embedded
option-based derivative is separated, must the terms of the embedded option be
determined so as to result in the embedded derivative having either a fair value of zero or
an intrinsic value of zero (that is to say, be at the money) at the inception of the hybrid
contract?
No. The economic behaviour of a hybrid contract with an option-based embedded derivative
depends critically on the strike price (or strike rate) specified for the option feature in the
hybrid contract, as discussed below. Therefore, the separation of an option-based
embedded derivative (including any embedded put, call, cap, floor, caption, floortion or
swaption feature in a hybrid contract) should be based on the stated terms of the option
feature documented in the hybrid contract. As a result, the embedded derivative would not
necessarily have a fair value or intrinsic value equal to zero at the initial recognition of the
hybrid contract.
If an entity were required to identify the terms of an embedded option-based derivative so

as to achieve a fair value of the embedded derivative of zero, the strike price (or strike rate)
generally would have to be determined so as to result in the option being infinitely out of
the money. This would imply a zero probability of the option feature being exercised.
However, since the probability of the option feature in a hybrid contract being exercised
generally is not zero, it would be inconsistent with the likely economic behaviour of the
hybrid contract to assume an initial fair value of zero. Similarly, if an entity were required to
identify the terms of an embedded option-based derivative so as to achieve an intrinsic
value of zero for the embedded derivative, the strike price (or strike rate) would have to be
assumed to equal the price (or rate) of the underlying variable at the initial recognition of
the hybrid contract. In this case, the fair value of the option would consist only of time
value. However, such an assumption would not be consistent with the likely economic
behaviour of the hybrid contract, including the probability of the option feature being
exercised, unless the agreed strike price was indeed equal to the price (or rate) of the
underlying variable at the initial recognition of the hybrid contract.
The economic nature of an option-based embedded derivative is fundamentally different

from a forward-based embedded derivative (including forwards and swaps), because the
terms of a forward are such that a payment based on the difference between the price of
the underlying and the forward price will occur at a specified date, while the terms of an
option are such that a payment based on the difference between the price of the underlying
and the strike price of the option may or may not occur depending on the relationship
between the agreed strike price and the price of the underlying at a specified date or dates
in the future. Adjusting the strike price of an option-based embedded derivative, therefore,
alters the nature of the hybrid contract. On the other hand, if the terms of a non-option
embedded derivative in a host debt instrument were determined so as to result in a fair
value of any amount other than zero at the inception of the hybrid contract, that amount
would essentially represent a borrowing or lending. Accordingly, as discussed in the answer
to Question C.1, it is not appropriate to separate a non-option embedded derivative in a
host debt instrument on terms that result in a fair value other than zero at the initial
recognition of the hybrid contract.
C.3
[Deleted]
C.4 Embedded derivatives: equity kicker

In some instances, venture capital entities providing subordinated loans agree
that if and when the borrower lists its shares on a stock exchange, the venture
capital entity is entitled to receive shares of the borrowing entity free of charge or
at a very low price (an 'equity kicker') in addition to interest and repayment of
principal. As a result of the equity kicker feature, the interest on the subordinated
loan is lower than it would otherwise be. Assuming that the subordinated loan is
not measured at fair value with changes in fair value recognised in profit or loss
(IAS 39.11(c)), does the equity kicker feature meet the definition of an embedded
derivative even though it is contingent upon the future listing of the borrower?
Yes. The economic characteristics and risks of an equity return are not closely related to the
economic characteristics and risks of a host debt instrument (IAS 39.11(a)). The equity
kicker meets the definition of a derivative because it has a value that changes in response
to the change in the price of the shares of the borrower, it requires no initial net investment
or an initial net investment that is smaller than would be required for other types of
contracts that would be expected to have a similar response to changes in market factors,
and it is settled at a future date (IAS 39.11(b) and IAS 39.9(a)). The equity kicker feature
meets the definition of a derivative even though the right to receive shares is contingent
upon the future listing of the borrower. IAS 39.AG9 states that a derivative could require a
payment as a result of some future event that is unrelated to a notional amount. An equity
kicker feature is similar to such a derivative except that it does not give a right to a fixed
payment, but an option right, if the future event occurs.
C.5
[Deleted]
C.6 Embedded derivatives: synthetic instruments
Entity A issues a five-year floating rate debt instrument. At the same time, it
enters into a five-year pay-fixed, receive-variable interest rate swap with Entity B.
Entity A regards the combination of the debt instrument and swap as a synthetic
fixed rate instrument . Entity A contends that separate accounting for the swap is
inappropriate since IAS 39.AG33(a) requires an embedded derivative to be classified
together with its host instrument if the derivative is linked to an interest rate that can
change the amount of interest that would otherwise be paid or received on the host debt
contract. Is the entity's analysis correct?
No. Embedded derivative instruments are terms and conditions that are included in
non-derivative host contracts. It is generally inappropriate to treat two or more separate
financial instruments as a single combined instrument ('synthetic instrument' accounting)
for the purpose of applying IAS 39 or IFRS 9. Each of the financial instruments has its own
terms and conditions and each may be transferred or settled separately. Therefore, the debt
instrument and the swap are classified separately. The transactions described here differ
from the transactions discussed in Question B.6, which had no substance apart from the
resulting interest rate swap.

C.7 Embedded derivatives: purchases and sales contracts in foreign currency
instruments
A supply contract provides for payment in a currency other than (a) the functional
currency of either party to the contract, (b) the currency in which the product is
routinely denominated in commercial transactions around the world and (c) the
currency that is commonly used in contracts to purchase or sell non-financial
items in the economic environment in which the transaction takes place. Is there
an embedded derivative that should be separated under IAS 39?
Yes. To illustrate: a Norwegian entity agrees to sell oil to an entity in France. The oil
contract is denominated in Swiss francs, although oil contracts are routinely denominated in
US dollars in commercial transactions around the world, and Norwegian krone are
commonly used in contracts to purchase or sell non-financial items in Norway. Neither
entity carries out any significant activities in Swiss francs. In this case, the Norwegian entity
regards the supply contract as a host contract with an embedded foreign currency forward
to purchase Swiss francs. The French entity regards the supply contact as a host contract
with an embedded foreign currency forward to sell Swiss francs. Each entity includes fair
value changes on the currency forward in profit or loss unless the reporting entity
designates it as a cash flow hedging instrument, if appropriate.
C.8 Embedded foreign currency derivatives: unrelated foreign currency provision
Entity A, which measures items in its financial statements on the basis of the euro
(its functional currency), enters into a contract with Entity B, which has the
Norwegian krone as its functional currency, to purchase oil in six months for 1,000
US dollars. The host oil contract is not within the scope of IAS 39 because it was
entered into and continues to be for the purpose of delivery of a non-financial
item in accordance with the entity's expected purchase, sale or usage
requirements (IAS 39.5 and IAS 39.AG10). The oil contract includes a leveraged foreign
exchange provision that states that the parties, in addition to the provision of, and payment
for, oil will exchange an amount equal to the fluctuation in the exchange rate of the
US dollar and Norwegian krone applied to a notional amount of 100,000 US dollars. Under
IAS 39.11, is that embedded derivative (the leveraged foreign exchange provision)
regarded as closely related to the host oil contract?
No, that leveraged foreign exchange provision is separated from the host oil contract
because it is not closely related to the host oil contract (IAS 39.AG33(d)).
The payment provision under the host oil contract of 1,000 US dollars can be viewed as a
foreign currency derivative because the US dollar is neither Entity A's nor Entity B's
functional currency. This foreign currency derivative would not be separated because it
follows from IAS 39.AG33(d) that a crude oil contract that requires payment in US dollars is
not regarded as a host contract with a foreign currency derivative.
The leveraged foreign exchange provision that states that the parties will exchange an
amount equal to the fluctuation in the exchange rate of the US dollar and Norwegian krone
applied to a notional amount of 100,000 US dollars is in addition to the required payment
for the oil transaction. It is unrelated to the host oil contract and therefore separated from
the host oil contract and accounted for as an embedded derivative under IAS 39.11.
C.9 Embedded foreign currency derivatives: currency of international commerce
IAS 39.AG33(d) refers to the currency in which the price of the related goods or services
is routinely denominated in commercial transactions around the world. Could it be a
currency that is used for a certain product or service in commercial transactions within the
local area of one of the substantial parties to the contract?
No. The currency in which the price of the related goods or services is routinely
denominated in commercial transactions around the world is only a currency that is used for
similar transactions all around the world, not just in one local area. For example, if
cross-border transactions in natural gas in North America are routinely denominated in
US dollars and such transactions are routinely denominated in euro in Europe, neither the
US dollar nor the euro is a currency in which the goods or services are routinely
denominated in commercial transactions around the world.
C.10 Embedded derivatives: holder permitted, but not required, to settle without
recovering substantially all of its recognised investment
If the terms of a combined contract permit, but do not require, the holder to settle
the combined contract in a manner that causes it not to recover substantially all of
its recognised investment and the issuer does not have such a right (for example,
a puttable debt instrument), does the contract satisfy the condition in
IAS 39.AG33(a) that the holder would not recover substantially all of its recognised
investment?
No. The condition that 'the holder would not recover substantially all of its recognised
investment' is not satisfied if the terms of the combined contract permit, but do not require,
the investor to settle the combined contract in a manner that causes it not to recover
substantially all of its recognised investment and the issuer has no such right. Accordingly,
an interest-bearing host contract with an embedded interest rate derivative with such terms
is regarded as closely related to the host contract. The condition that 'the holder would not
recover substantially all of its recognised investment' applies to situations in which the
holder can be forced to accept settlement at an amount that causes the holder not to
recover substantially all of its recognised investment.
C.11
[Deleted]
Section D Recognition and derecognition
D.1 Initial recognition

D.1.1 Recognition: cash collateral
Entity B transfers cash to Entity A as collateral for another transaction with Entity
A (for example, a securities borrowing transaction). The cash is not legally
segregated from Entity A's assets. Should Entity A recognise the cash collateral it
has received as an asset?
Yes. The ultimate realisation of a financial asset is its conversion into cash and, therefore,
no further transformation is required before the economic benefits of the cash transferred
by Entity B can be realised by Entity A. Therefore, Entity A recognises the cash as an asset
and a payable to Entity B while Entity B derecognises the cash and recognises a receivable
from Entity A.
D.2 Regular way purchase or sale of a financial asset
D.2.1 Trade date vs settlement date: amounts to be recorded for a

purchase
How are the trade date and settlement date accounting principles in the Standard
applied to a purchase of a financial asset?
The following example illustrates the application of the trade date and settlement date
accounting principles in the Standard for a purchase of a financial asset. On 29 December
20X1, an entity commits itself to purchase a financial asset for CU1,000, which is its fair
value on commitment (trade) date. Transaction costs are immaterial. On 31 December 20X1
(financial year-end) and on 4 January 20X2 (settlement date) the fair value of the asset is
CU1,002 and CU1,003, respectively. The amounts to be recorded for the asset will depend
on how it is classified and whether trade date or settlement date accounting is used, as
shown in the two tables below.

D.2.2 Trade date vs settlement date: amounts to be recorded for a sale
How are the trade date and settlement date accounting principles in the Standard
applied to a sale of a financial asset?
The following example illustrates the application of the trade date and settlement date
accounting principles in the Standard for a sale of a financial asset. On 29 December 20X2
(trade date) an entity enters into a contract to sell a financial asset for its current fair value
of CU1,010. The asset was acquired one year earlier for CU1,000 and its amortised cost is
CU1,000. On 31 December 20X2 (financial year-end), the fair value of the asset is CU1,012.
On 4 January 20X3 (settlement date), the fair value is CU1,013. The amounts to be
recorded will depend on how the asset is classified and whether trade date or settlement
date accounting is used as shown in the two tables below (any interest that might have
accrued on the asset is disregarded).
A change in the fair value of a financial asset that is sold on a regular way basis is not
recorded in the financial statements between trade date and settlement date even if the
entity applies settlement date accounting because the seller's right to changes in the fair
value ceases on the trade date.

D.2.3 Settlement date accounting: exchange of non-cash financial
assets
If an entity recognises sales of financial assets using settlement date accounting,

would a change in the fair value of a financial asset to be received in exchange for
the non-cash financial asset that is sold be recognised in accordance with
IAS 39.57?
It depends. Any change in the fair value of the financial asset to be received would be
accounted for under IAS 39.57 if the entity applies settlement date accounting for that
category of financial assets. However, if the entity classifies the financial asset to be
received in a category for which it applies trade date accounting, the asset to be received is
recognised on the trade date as described in IAS 39.AG55. In that case, the entity
recognises a liability of an amount equal to the carrying amount of the financial asset to be
delivered on settlement date.
To illustrate: on 29 December 20X2 (trade date) Entity A enters into a contract to sell Note
Receivable A, which is measured at amortised cost, in exchange for Bond B, which meets
the definition of held for trading and is measured at fair value. Both assets have a fair value
of CU1,010 on 29 December, while the amortised cost of Note Receivable A is CU1,000.
Entity A uses settlement date accounting for financial assets measured at amortised cost
and trade date accounting for assets that meet the definition of held for trading. On 31
December 20X2 (financial year-end), the fair value of Note Receivable A is CU1,012 and the
fair value of Bond B is CU1,009. On 4 January 20X3, the fair value of Note Receivable A is
CU1,013 and the fair value of Bond B is CU1,007. The following entries are made:
29 December 20X2
Dr Bond B CU1,010
Cr Payable CU1,010
31 December 20X2
Dr Trading loss CU1
Cr Bond B CU1
4 January 20X3
Dr Payable CU1,010
Dr Trading loss CU2
Cr Note Receivable A CU1,000
Cr Bond B CU2
Cr Realisation gain CU10
Section E Measurement
E.1 Initial measurement of financial assets and financial liabilities
E.1.1 Initial measurement: transaction costs
Transaction costs should be included in the initial measurement of financial assets

and financial liabilities other than those at fair value through profit or loss. How
should this requirement be applied in practice?
For financial assets not measured at fair value through profit or loss, transaction costs are
added to the fair value at initial recognition. For financial liabilities, transaction costs are
deducted from the fair value at initial recognition.
For financial instruments that are measured at amortised cost, transaction costs are
subsequently included in the calculation of amortised cost using the effective interest
method and, in effect, amortised through profit or loss over the life of the instrument.
Transaction costs expected to be incurred on transfer or disposal of a financial instrument

are not included in the measurement of the financial instrument.
E.2 Fair value measurement considerations
E.2.1 Fair value measurement considerations for investment funds
IAS 39.AG72 states that the current bid price is usually the appropriate price to be used in
measuring the fair value of an asset held. The rules applicable to some investment funds
require net asset values to be reported to investors on the basis of mid-market prices. In
these circumstances, would it be appropriate for an investment fund to measure its assets
on the basis of mid-market prices?
No. The existence of regulations that require a different measurement for specific purposes
does not justify a departure from the general requirement in IAS 39.AG72 to use the
current bid price in the absence of a matching liability position. In its financial statements,
an investment fund measures its assets at current bid prices. In reporting its net asset
value to investors, an investment fund may wish to provide a reconciliation between the fair
values recognised in its statement of financial position and the prices used for the net asset
value calculation.
E.2.2 Fair value measurement: large holding
Entity A holds 15 per cent of the share capital in Entity B. The shares are publicly
traded in an active market. The currently quoted price is CU100. Daily trading
volume is 0.1 per cent of outstanding shares. Because Entity A believes that the
fair value of the Entity B shares it owns, if sold as a block, is greater than the
quoted market price, Entity A obtains several independent estimates of the price it
would obtain if it sells its holding. These estimates indicate that Entity A would be
able to obtain a price of CU105, ie a 5 per cent premium above the quoted price.
Which figure should Entity A use for measuring its holding at fair value?
Under IAS 39.AG71, a published price quotation in an active market is the best estimate of
fair value. Therefore, Entity A uses the published price quotation (CU100). Entity A cannot
depart from the quoted market price solely because independent estimates indicate that
Entity A would obtain a higher (or lower) price by selling the holding as a block.
E.3 Gains and losses
E.3.1—E.3.2
[Deleted]
E.3.3 IFRS 9, IAS 39 and IAS 21 Exchange differences arising on

translation of foreign entities: other comprehensive income or profit or
loss?
IAS 21.32 and IAS 21.48 states that all exchange differences resulting from translating
the financial statements of a foreign operation should be recognised in other comprehensive
income until disposal of the net investment. This would include exchange differences arising
from financial instruments carried at fair value, which would include financial assets
measured at fair value through profit or loss in accordance with IFRS 9 Financial
Instruments.
If the foreign operation is a subsidiary whose financial statements are

consolidated with those of its parent, in the consolidated financial statements how
are IFRS 9 and IAS 21.39 applied?
IFRS 9 applies in the accounting for financial instruments in the financial statements of a
foreign operation and IAS 21 applies in translating the financial statements of a foreign
operation for incorporation in the financial statements of the reporting entity.
To illustrate: Entity A is domiciled in Country X and its functional currency and presentation
currency are the local currency of Country X (LCX). A has a foreign subsidiary (Entity B) in
Country Y whose functional currency is the local currency of Country Y (LCY). B is the owner
of a debt instrument, which meets the definition of held for trading and is therefore
measured at fair value.
In B's financial statements for year 20X0, the fair value and carrying amount of the debt
instrument is LCY100 in the local currency of Country Y. In A's consolidated financial
statements, the asset is translated into the local currency of Country X at the spot exchange
rate applicable at the end of the reporting period (2.00). Thus, the carrying amount is
LCX200 (= LCY100 × 2.00) in the consolidated financial statements.
At the end of year 20X1, the fair value of the debt instrument has increased to LCY110 in
the local currency of Country Y. B recognises the trading asset at LCY110 in its statement of
financial position and recognises a fair value gain of LCY10 in its profit or loss. During the
year, the spot exchange rate has increased from 2.00 to 3.00 resulting in an increase in the
fair value of the instrument from LCX200 to LCX330 (= LCY110 × 3.00) in the currency of
Country X. Therefore, Entity A recognises the trading asset at LCX330 in its consolidated
Entity A translates the statement of comprehensive income of B 'at the exchange rates at
the dates of the transactions' (IAS 21.39(b)). Since the fair value gain has accrued through
the year, A uses the average rate as a practical approximation ([3.00 + 2.00] / 2 = 2.50, in
accordance with IAS 21.22). Therefore, while the fair value of the trading asset has
increased by LCX130 (= LCX330 – LCX200), Entity A recognises only LCX25 (= LCY10 ×
2.5) of this increase in consolidated profit or loss to comply with IAS 21.39(b). The resulting
exchange difference, ie the remaining increase in the fair value of the debt instrument
(LCX130 – LCX25 = LCX105), is accumulated in equity until the disposal of the net
investment in the foreign operation in accordance with IAS 21.48.
E.3.4 IFRS 9, IAS 39 and IAS 21 Interaction between IFRS 9, IAS 39 and
IAS 21
IFRS 9 and IAS 39 include requirements about the measurement of financial assets and
financial liabilities and the recognition of gains and losses on remeasurement in profit or
loss. IAS 21 includes rules about the reporting of foreign currency items and the
recognition of exchange differences in profit or loss. In what order are IAS 21, IFRS 9 and
IAS 39 applied?
Statement of financial position
Generally, the measurement of a financial asset or financial liability at fair value, cost or
amortised cost is first determined in the foreign currency in which the item is denominated
in accordance with IFRS 9 and IAS 39. Then, the foreign currency amount is translated into
the functional currency using the closing rate or a historical rate in accordance with IAS 21
(IAS 39.AG83). For example, if a monetary financial asset (such as a debt instrument) is
measured at amortised cost in accordance with IFRS 9, amortised cost is calculated in the
currency of denomination of that financial asset. Then, the foreign currency amount is
recognised using the closing rate in the entity's financial statements (IAS 21.23). That
applies regardless of whether a monetary item is measured at cost, amortised cost or fair
value in the foreign currency (IAS 21.24). A non-monetary financial asset (such as an
investment in an equity instrument) is translated using the closing rate if it is measured at
fair value in the foreign currency (IAS 21.23(c)).
As an exception, if the financial asset or financial liability is designated as a hedged item in

a fair value hedge of the exposure to changes in foreign currency rates under IAS 39, the
hedged item is remeasured for changes in foreign currency rates even if it would otherwise
have been recognised using a historical rate under IAS 21 (IAS 39.89), ie the foreign
currency amount is recognised using the closing rate. This exception applies to
non-monetary items that are carried in terms of historical cost in the foreign currency and
are hedged against exposure to foreign currency rates (IAS 21.23(b)).
Profit or loss
The recognition of a change in the carrying amount of a financial asset or financial liability in
profit or loss depends on a number of factors, including whether it is an exchange difference
or other change in carrying amount, whether it arises on a monetary item (for example,
most debt instruments) or non-monetary item (such as most equity investments), whether
the associated asset or liability is designated as a cash flow hedge of an exposure to
changes in foreign currency rates, and whether it results from translating the financial
statements of a foreign operation. The issue of recognising changes in the carrying amount
of a financial asset or financial liability held by a foreign operation is addressed in a separate
question (see Question E.3.3).
Any exchange difference arising on recognising a monetary item at a rate different from
that at which it was initially recognised during the period, or recognised in previous financial
statements, is recognised in profit or loss or in other comprehensive income in accordance
with IAS 21 (IAS 39.AG83, IAS 21.28 and IAS 21.32), unless the monetary item is
designated as a cash flow hedge of a highly probable forecast transaction in foreign
currency, in which case the requirements for recognition of gains and losses on cash flow
hedges in IAS 39 apply (IAS 39.95). Differences arising from recognising a monetary item
at a foreign currency amount different from that at which it was previously recognised are
accounted for in a similar manner, since all changes in the carrying amount relating to
foreign currency movements should be treated consistently. All other changes in the
statement of financial position measurement of a monetary item are recognised in profit or
loss or in other comprehensive income in accordance with IFRS 9 or IAS 39.
Any changes in the carrying amount of a non-monetary item are recognised in profit or loss
or in other comprehensive income in accordance with IFRS 9 or IAS 39 (IAS 39.AG83). If
the non-monetary item is designated as a cash flow hedge of an unrecognised firm
commitment or a highly probable forecast transaction in foreign currency, the requirements
for recognition of gains and losses on cash flow hedges in IAS 39 apply (IAS 39.95).
When some portion of the change in carrying amount is recognised in other comprehensive
income and some portion is recognised in profit or loss, an entity cannot offset those two
components for the purposes of determining gains or losses that should be recognised in
profit or loss or in other comprehensive income.
E.4 Impairment and uncollectibility of financial assets
E.4.1 Objective evidence of impairment
Does IAS 39 require that an entity be able to identify a single, distinct past
causative event to conclude that it is probable that an impairment loss on a
financial asset has been incurred?
No. IAS 39.59 states 'It may not be possible to identify a single, discrete event that caused
the impairment. Rather the combined effect of several events may have caused the
impairment.' Also, IAS 39.60 states that 'a downgrade of an entity's credit rating is not, of
itself, evidence of impairment, although it may be evidence of impairment when considered
with other available information'. Other factors that an entity considers in determining
whether it has objective evidence that an impairment loss has been incurred include
information about the debtors' or issuers' liquidity, solvency and business and financial risk
exposures, levels of and trends in delinquencies for similar financial assets, national and
local economic trends and conditions, and the fair value of collateral and guarantees. These
and other factors may, either individually or taken together, provide sufficient objective
evidence that an impairment loss has been incurred in a financial asset or group of financial
assets.
E.4.2 Impairment: future losses
Does IAS 39 permit the recognition of an impairment loss through the

establishment of an allowance for future losses when a loan is given? For
example, if Entity A lends CU1,000 to Customer B, can it recognise an immediate
impairment loss of CU10 if Entity A, based on historical experience, expects that 1
per cent of the principal amount of loans given will not be collected?
No. Paragraph 5.1 of IFRS 9 requires a financial asset to be initially measured at fair value.
For a loan asset, the fair value is the amount of cash lent adjusted for any fees and costs
(unless a portion of the amount lent is compensation for other stated or implied rights or
privileges). In addition, paragraph 5.2.2 of IFRS 9 requires an entity to apply the
impairment requirements in IAS 39. IAS 39.58 requires that an impairment loss is
recognised only if there is objective evidence of impairment as a result of a past event that
occurred after initial recognition. Accordingly, it is inconsistent with paragraph 5.1 of IFRS 9
and IAS 39.58 to reduce the carrying amount of a loan asset on initial recognition through
the recognition of an immediate impairment loss.
E.4.3 Assessment of impairment: principal and interest
Because of Customer B's financial difficulties, Entity A is concerned that Customer

B will not be able to make all principal and interest payments due on a loan in a
timely manner. It negotiates a restructuring of the loan. Entity A expects that
Customer B will be able to meet its obligations under the restructured terms.
Would Entity A recognise an impairment loss if the restructured terms are as
reflected in any of the following cases?
a. Customer B will pay the full principal amount of the original loan five
years after the original due date, but none of the interest due under
the original terms.
b. Customer B will pay the full principal amount of the original loan on
the original due date, but none of the interest due under the original
terms.
c. Customer B will pay the full principal amount of the original loan on
the original due date with interest only at a lower interest rate than
the interest rate inherent in the original loan.
d. Customer B will pay the full principal amount of the original loan five
years after the original due date and all interest accrued during the
original loan term, but no interest for the extended term.
e. Customer B will pay the full principal amount of the original loan five
years after the original due date and all interest, including interest
for both the original term of the loan and the extended term.
IAS 39.58 indicates that an impairment loss has been incurred if there is objective evidence
of impairment. The amount of the impairment loss for a loan measured at amortised cost is
the difference between the carrying amount of the loan and the present value of future
principal and interest payments discounted at the loan's original effective interest rate.
In cases (a)–(d) above, the present value of the future principal and interest payments
discounted at the loan's original effective interest rate will be lower than the carrying
amount of the loan. Therefore, an impairment loss is recognised in those cases.
In case (e), even though the timing of payments has changed, the lender will receive
interest on interest, and the present value of the future principal and interest payments
discounted at the loan's original effective interest rate will equal the carrying amount of the
loan. Therefore, there is no impairment loss. However, this fact pattern is unlikely given
Customer B's financial difficulties.
E.4.4 Assessment of impairment: fair value hedge
A loan with fixed interest rate payments is hedged against the exposure to
interest rate risk by a receive-variable, pay-fixed interest rate swap. The hedge
relationship qualifies for fair value hedge accounting and is reported as a fair
value hedge. Thus, the carrying amount of the loan includes an adjustment for fair
value changes attributable to movements in interest rates. Should an assessment
of impairment in the loan take into account the fair value adjustment for interest
rate risk?
Yes. The loan's original effective interest rate before the hedge becomes irrelevant once the
carrying amount of the loan is adjusted for any changes in its fair value attributable to
interest rate movements. Therefore, the original effective interest rate and amortised cost
of the loan are adjusted to take into account recognised fair value changes. The adjusted
effective interest rate is calculated using the adjusted carrying amount of the loan.
An impairment loss on the hedged loan is calculated as the difference between its carrying
amount after adjustment for fair value changes attributable to the risk being hedged and
the estimated future cash flows of the loan discounted at the adjusted effective interest
rate. When a loan is included in a portfolio hedge of interest rate risk, the entity should
allocate the change in the fair value of the hedged portfolio to the loans (or groups of
similar loans) being assessed for impairment on a systematic and rational basis.
E.4.5 Impairment: provision matrix
A financial institution calculates impairment in the unsecured portion of financial

assets measured at amortised cost on the basis of a provision matrix that
specifies fixed provision rates for the number of days a financial asset has been
classified as non-performing (zero per cent if less than 90 days, 20 per cent if
90–180 days, 50 per cent if 181–365 days and 100 per cent if more than 365
days). Can the results be considered to be appropriate for the purpose of
calculating the impairment loss on the financial assets measured at amortised
cost under IAS 39.63?
Not necessarily. IAS 39.63 requires impairment or bad debt losses to be calculated as the
difference between the asset's carrying amount and the present value of estimated future
cash flows discounted at the financial instrument's original effective interest rate.
E.4.6 Impairment: excess losses
Does IAS 39 permit an entity to recognise impairment or bad debt losses in excess
of impairment losses that are determined on the basis of objective evidence about
impairment in identified individual financial assets or identified groups of similar
financial assets?

No. IAS 39 does not permit an entity to recognise impairment or bad debt losses in addition
to those that can be attributed to individually identified financial assets or identified groups
of financial assets with similar credit risk characteristics (IAS 39.64) on the basis of
objective evidence about the existence of impairment in those assets (IAS 39.58). Amounts
that an entity might want to set aside for additional possible impairment in financial assets,
such as reserves that cannot be supported by objective evidence about impairment, are not
recognised as impairment or bad debt losses under IAS 39. However, if an entity
determines that no objective evidence of impairment exists for an individually assessed
financial asset, whether significant or not, it includes the asset in a group of financial assets
with similar credit risk characteristics (IAS 39.64).
E.4.7 Recognition of impairment on a portfolio basis
IAS 39.63 requires that impairment be recognised for financial assets carried at amortised
cost. IAS 39.64 states that impairment may be measured and recognised individually or on
a portfolio basis for a group of similar financial assets. If one asset in the group is impaired
but the fair value of another asset in the group is above its amortised cost, does IAS 39
allow non-recognition of the impairment of the first asset?
No. If an entity knows that an individual financial asset carried at amortised cost is
impaired, IAS 39.63 requires that the impairment of that asset should be recognised.
It states: 'the amount of the loss is measured as the difference between the asset's carrying
amount and the present value of estimated future cash flows (excluding future credit losses
that have not been incurred) discounted at the financial asset's original effective interest
rate' (emphasis added). Measurement of impairment on a portfolio basis under IAS 39.64
may be applied to groups of small balance items and to financial assets that are individually
assessed and found not to be impaired when there is indication of impairment in a group of
similar assets and impairment cannot be identified with an individual asset in that group.
E.4.8 Impairment: recognition of collateral
If an impaired financial asset is secured by collateral that does not meet the
recognition criteria for assets in other Standards, is the collateral recognised as an
asset separate from the impaired financial asset?
No. The measurement of the impaired financial asset reflects the fair value of the collateral.
The collateral is not recognised as an asset separate from the impaired financial asset
unless it meets the recognition criteria for an asset in another Standard.
E.4.9–E.4.10
[Deleted]
Section F Hedging
F.1 Hedging instruments

F.1.1
[Deleted]
F.1.2 Hedging with a non-derivative financial asset or liability
Entity J's functional currency is the Japanese yen. It has issued a fixed rate debt
instrument with semi-annual interest payments that matures in two years with
principal due at maturity of 5 million US dollars. It has also entered into a fixed
price sales commitment for 5 million US dollars that matures in two years and is
not accounted for as a derivative because it meets the exemption for normal sales
in paragraph 5. Can Entity J designate its US dollar liability as a fair value hedge of the
entire fair value exposure of its fixed price sales commitment and qualify for hedge
accounting?
No. IAS 39.72 permits a non-derivative asset or liability to be used as a hedging instrument
only for a hedge of a foreign currency risk.
Alternatively, can Entity J designate its US dollar liability as a cash flow hedge of
the foreign currency exposure associated with the future receipt of US dollars on
the fixed price sales commitment?
Yes. IAS 39 permits the designation of a non-derivative asset or liability as a hedging

instrument in either a cash flow hedge or a fair value hedge of the exposure to changes in
foreign exchange rates of a firm commitment (IAS 39.87). Any gain or loss on the
non-derivative hedging instrument that is recognised in other comprehensive income during
the period preceding the future sale is reclassified from equity to profit or loss as a
reclassification adjustment when the sale takes place (IAS 39.95).
Alternatively, can Entity J designate the sales commitment as the hedging

instrument instead of the hedged item?
No. Only a derivative instrument or a non-derivative financial asset or liability can be

designated as a hedging instrument in a hedge of a foreign currency risk. A firm
commitment cannot be designated as a hedging instrument. However, if the foreign
currency component of the sales commitment is required to be separated as an embedded
derivative under IAS 39.11 and IAS 39.AG33(d), it could be designated as a hedging
instrument in a hedge of the exposure to changes in the fair value of the maturity amount
of the debt attributable to foreign currency risk.
F.1.3 Hedge accounting: use of written options in combined hedging

instruments
Issue (a) – Does IAS 39.AG94 preclude the use of an interest rate collar or other
derivative instrument that combines a written option component and a purchased option
component as a hedging instrument?

It depends. An interest rate collar or other derivative instrument that includes a written
option cannot be designated as a hedging instrument if it is a net written option, because
IAS 39.AG94 precludes the use of a written option as a hedging instrument unless it is
designated as an offset to a purchased option. An interest rate collar or other derivative
instrument that includes a written option may be designated as a hedging instrument,
however, if the combination is a net purchased option or zero cost collar.
Issue (b) – What factors indicate that an interest rate collar or other derivative
instrument that combines a written option component and a purchased option
component is not a net written option?
The following factors taken together suggest that an interest rate collar or other derivative
instrument that includes a written option is not a net written option.
a. No net premium is received either at inception or over the life of the

combination of options. The distinguishing feature of a written option is the
receipt of a premium to compensate the writer for the risk incurred.
b. Except for the strike prices, the critical terms and conditions of the written
option component and the purchased option component are the same
(including underlying variable or variables, currency denomination and
maturity date). Also, the notional amount of the written option component is
not greater than the notional amount of the purchased option component.
F.1.4 Internal hedges
Some entities use internal derivative contracts (internal hedges) to transfer risk
exposures between different companies within a group or divisions within a single
legal entity. Does IAS 39.73 prohibit hedge accounting in such cases?
Yes, if the derivative contracts are internal to the entity being reported on. IAS 39 does not
specify how an entity should manage its risk. However, it states that internal hedging
transactions do not qualify for hedge accounting. This applies both (a) in consolidated
financial statements for intragroup hedging transactions, and (b) in the individual or
separate financial statements of a legal entity for hedging transactions between divisions in
the entity. The principles of preparing consolidated financial statements in IAS 27.24 require
that 'intragroup balances, transactions, income and expenses shall be eliminated in full'.
On the other hand, an intragroup hedging transaction may be designated as a hedge in the
individual or separate financial statements of a group entity, if the intragroup transaction is
an external transaction from the perspective of the group entity. In addition, if the internal
contract is offset with an external party the external contract may be regarded as the
hedging instrument and the hedging relationship may qualify for hedge accounting.
The following summarises the application of IAS 39 to internal hedging transactions.
• IAS 39 does not preclude an entity from using internal derivative contracts for
risk management purposes and it does not preclude internal derivatives from
being accumulated at the treasury level or some other central location so that
risk can be managed on an entity-wide basis or at some higher level than the
separate legal entity or division.
• Internal derivative contracts between two separate entities within a

consolidated group can qualify for hedge accounting by those entities in their
individual or separate financial statements, even though the internal contracts
are not offset by derivative contracts with a party external to the consolidated
group.
• Internal derivative contracts between two separate divisions within the same
legal entity can qualify for hedge accounting in the individual or separate
financial statements of that legal entity only if those contracts are offset by
derivative contracts with a party external to the legal entity.
• Internal derivative contracts between separate divisions within the same legal
entity and between separate entities within the consolidated group can qualify
for hedge accounting in the consolidated financial statements only if the
internal contracts are offset by derivative contracts with a party external to
the consolidated group.
• If the internal derivative contracts are not offset by derivative contracts with
external parties, the use of hedge accounting by group entities and divisions
using internal contracts must be reversed on consolidation.
To illustrate: the banking division of Entity A enters into an internal interest rate swap with
the trading division of the same entity. The purpose is to hedge the interest rate risk
exposure of a loan (or group of similar loans) in the loan portfolio. Under the swap, the
banking division pays fixed interest payments to the trading division and receives variable
interest rate payments in return.
If a hedging instrument is not acquired from an external party, IAS 39 does not allow hedge
accounting treatment for the hedging transaction undertaken by the banking and trading
divisions. IAS 39.73 indicates that only derivatives that involve a party external to the
entity can be designated as hedging instruments and, further, that any gains or losses on
intragroup or intra-entity transactions should be eliminated on consolidation. Therefore,
transactions between different divisions within Entity A do not qualify for hedge accounting
treatment in the financial statements of Entity A. Similarly, transactions between different
entities within a group do not qualify for hedge accounting treatment in consolidated
However, if in addition to the internal swap in the above example the trading division enters
into an interest rate swap or other contract with an external party that offsets the exposure
hedged in the internal swap, hedge accounting is permitted under IAS 39. For the purposes
of IAS 39, the hedged item is the loan (or group of similar loans) in the banking division and
the hedging instrument is the external interest rate swap or other contract.
The trading division may aggregate several internal swaps or portions of them that are not
offsetting each other and enter into a single third party derivative contract that offsets the
aggregate exposure. Under IAS 39, such external hedging transactions may qualify for
hedge accounting treatment provided that the hedged items in the banking division are
identified and the other conditions for hedge accounting are met.
F.1.5 Offsetting internal derivative contracts used to manage interest

rate risk
If a central treasury function enters into internal derivative contracts with

subsidiaries and various divisions within the consolidated group to manage
interest rate risk on a centralised basis, can those contracts qualify for hedge
accounting in the consolidated financial statements if, before laying off the risk,
the internal contracts are first netted against each other and only the net
exposure is offset in the marketplace with external derivative contracts?
No. An internal contract designated at the subsidiary level or by a division as a hedge

results in the recognition of changes in the fair value of the item being hedged in profit or
loss (a fair value hedge) or in the recognition of the changes in the fair value of the internal
derivative in other comprehensive income (a cash flow hedge). There is no basis for
changing the measurement attribute of the item being hedged in a fair value hedge unless
the exposure is offset with an external derivative. There is also no basis for recognising the
gain or loss on the internal derivative in other comprehensive income for one entity and
recognising it in profit or loss by the other entity unless it is offset with an external
derivative. In cases where two or more internal derivatives are used to manage interest
rate risk on assets or liabilities at the subsidiary or division level and those internal
derivatives are offset at the treasury level, the effect of designating the internal derivatives
as hedging instruments is that the hedged non-derivative exposures at the subsidiary or
division levels would be used to offset each other on consolidation. Accordingly, since
IAS 39.72 does not permit designating non-derivatives as hedging instruments, except for
foreign currency exposures, the results of hedge accounting from the use of internal
derivatives at the subsidiary or division level that are not laid off with external parties must
be reversed on consolidation.
It should be noted, however, that there will be no effect on profit or loss and other
comprehensive income of reversing the effect of hedge accounting in consolidation for
internal derivatives that offset each other at the consolidation level if they are used in the
same type of hedging relationship at the subsidiary or division level and, in the case of cash
flow hedges, where the hedged items affect profit or loss in the same period. Just as the
internal derivatives offset at the treasury level, their use as fair value hedges by two
separate entities or divisions within the consolidated group will also result in the offset of
the fair value amounts recognised in profit or loss, and their use as cash flow hedges by two
separate entities or divisions within the consolidated group will also result in the fair value
amounts being offset against each other in other comprehensive income. However, there
may be an effect on individual line items in both the consolidated statement of
comprehensive income and the consolidated statement of financial position, for example
when internal derivatives that hedge assets (or liabilities) in a fair value hedge are offset by
internal derivatives that are used as a fair value hedge of other assets (or liabilities) that
are recognised in a different line item in the statement of financial position or statement of
comprehensive income. In addition, to the extent that one of the internal contracts is used
as a cash flow hedge and the other is used in a fair value hedge, gains and losses
recognised would not offset since the gain (or loss) on the internal derivative used as a fair
value hedge would be recognised in profit or loss and the corresponding loss (or gain) on
the internal derivative used as a cash flow hedge would be recognised in other
Question F.1.4 describes the application of IAS 39 to internal hedging transactions.
F.1.6 Offsetting internal derivative contracts used to manage foreign

currency risk
If a central treasury function enters into internal derivative contracts with

subsidiaries and various divisions within the consolidated group to manage
foreign currency risk on a centralised basis, can those contracts be used as a basis
for identifying external transactions that qualify for hedge accounting in the
consolidated financial statements if, before laying off the risk, the internal
contracts are first netted against each other and only the net exposure is offset by
entering into a derivative contract with an external party?
It depends. IAS 27 Consolidated and Separate Financial Statements requires all internal
transactions to be eliminated in consolidated financial statements. As stated in IAS 39.73,
internal hedging transactions do not qualify for hedge accounting in the consolidated
financial statements of the group. Therefore, if an entity wishes to achieve hedge
accounting in the consolidated financial statements, it must designate a hedging
relationship between a qualifying external hedging instrument and a qualifying hedged item.
As discussed in Question F.1.5, the accounting effect of two or more internal derivatives
that are used to manage interest rate risk at the subsidiary or division level and are offset
at the treasury level is that the hedged non-derivative exposures at those levels would be
used to offset each other on consolidation. There is no effect on profit of loss or other
comprehensive income if (a) the internal derivatives are used in the same type of hedge
relationship (ie fair value or cash flow hedges) and (b), in the case of cash flow hedges, any
derivative gains and losses that are initially recognised in other comprehensive income are
reclassified from equity to profit or loss in the same period(s). When these two conditions
are met, the gains and losses on the internal derivatives that are recognised in profit or loss
or in other comprehensive income will offset on consolidation resulting in the same profit or
loss and other comprehensive income as if the derivatives had been eliminated. However,
there may be an effect on individual line items, in both the consolidated statement of
comprehensive income and the consolidated statement of financial position, that would need
to be eliminated. In addition, there is an effect on profit or loss and other comprehensive
income if some of the offsetting internal derivatives are used in cash flow hedges, while
others are used in fair value hedges. There is also an effect on profit or loss and other
comprehensive income for offsetting internal derivatives that are used in cash flow hedges if
the derivative gains and losses that are initially recognised in other comprehensive income
are reclassified from equity to profit or loss in different periods (because the hedged items
affect profit or loss in different periods).
As regards foreign currency risk, provided that the internal derivatives represent the
transfer of foreign currency risk on underlying non-derivative financial assets or liabilities,
hedge accounting can be applied because IAS 39.72 permits a non-derivative financial asset
or liability to be designated as a hedging instrument for hedge accounting purposes for a
hedge of a foreign currency risk. Accordingly, in this case the internal derivative contracts
can be used as a basis for identifying external transactions that qualify for hedge accounting
in the consolidated financial statements even if they are offset against each other. However,
for consolidated financial statements, it is necessary to designate the hedging relationship
so that it involves only external transactions.
Furthermore, the entity cannot apply hedge accounting to the extent that two or more
offsetting internal derivatives represent the transfer of foreign currency risk on underlying
forecast transactions or unrecognised firm commitments. This is because an unrecognised
firm commitment or forecast transaction does not qualify as a hedging instrument under
IAS 39. Accordingly, in this case the internal derivatives cannot be used as a basis for
identifying external transactions that qualify for hedge accounting in the consolidated
financial statements. As a result, any cumulative net gain or loss on an internal derivative
that has been included in the initial carrying amount of an asset or liability (basis
adjustment) or recognised in other comprehensive income would have to be reversed on
consolidation if it cannot be demonstrated that the offsetting internal derivative represented
the transfer of a foreign currency risk on a financial asset or liability to an external hedging
instrument.
F.1.7 Internal derivatives: examples of applying Question F.1.6
In each case, FC = foreign currency, LC = local currency (which is the entity's functional
currency), and TC = treasury centre.
Case 1 Offset of fair value hedges
Subsidiary A has trade receivables of FC100, due in 60 days, which it hedges using a
forward contract with TC. Subsidiary B has payables of FC50, also due in 60 days, which it
hedges using a forward contact with TC.
TC nets the two internal derivatives and enters into a net external forward contract to pay
FC50 and receive LC in 60 days.
At the end of month 1, FC weakens against LC. A incurs a foreign exchange loss of LC10 on
its receivables, offset by a gain of LC10 on its forward contract with TC. B makes a foreign
exchange gain of LC5 on its payables offset by a loss of LC5 on its forward contract with TC.
TC makes a loss of LC10 on its internal forward contract with A, a gain of LC5 on its internal
forward contract with B, and a gain of LC5 on its external forward contract.
At the end of month 1, the following entries are made in the individual or separate financial
statements of A, B and TC. Entries reflecting intragroup transactions or events are shown in
italics.
A's entries
Dr Foreign exchange loss LC10
Cr Receivables LC10
Dr Internal contract TC LC10
Cr Internal gain TC LC10
B's entries
Dr Payables LC5
Cr Foreign exchange gain LC5
Dr Internal loss TC LC5

Cr Internal contract TC LC5
TC's entries
Dr Internal loss A LC10
Cr Internal contract A LC10
Dr Internal contract B LC5

Cr Internal gain B LC5
Dr External forward contract LC5

Both A and B could apply hedge accounting in their individual financial statements provided
all conditions in IAS 39 are met. However, in this case, no hedge accounting is required
because gains and losses on the internal derivatives and the offsetting losses and gains on
the hedged receivables and payables are recognised immediately in profit or loss of A and B
without hedge accounting.
In the consolidated financial statements, the internal derivative transactions are eliminated.
In economic terms, the payable in B hedges FC50 of the receivables in A. The external
forward contract in TC hedges the remaining FC50 of the receivable in A. Hedge accounting
is not necessary in the consolidated financial statements because monetary items are
measured at spot foreign exchange rates under IAS 21 irrespective of whether hedge
accounting is applied.
The net balances before and after elimination of the accounting entries relating to the
internal derivatives are the same, as set out below. Accordingly, there is no need to make
any further accounting entries to meet the requirements of IAS 39.

Debit Credit
Receivables – LC10
Payables LC5 –
External LC5 –
forward
contract
Gains and – –
losses
Internal – –
contracts
Case 2 Offset of cash flow hedges
To extend the example, A also has highly probable future revenues of FC200 on which it
expects to receive cash in 90 days. B has highly probable future expenses of FC500
(advertising cost), also to be paid for in 90 days. A and B enter into separate forward
contracts with TC to hedge these exposures and TC enters into an external forward contract
to receive FC300 in 90 days.
As before, FC weakens at the end of month 1. A incurs a 'loss' of LC20 on its anticipated
revenues because the LC value of these revenues decreases. This is offset by a 'gain' of
LC20 on its forward contract with TC.
B incurs a 'gain' of LC50 on its anticipated advertising cost because the LC value of the
expense decreases. This is offset by a 'loss' of LC50 on its transaction with TC.
TC incurs a 'gain' of LC50 on its internal transaction with B, a 'loss' of LC20 on its internal
transaction with A and a loss of LC30 on its external forward contract.
A and B complete the necessary documentation, the hedges are effective, and both A and B
qualify for hedge accounting in their individual financial statements. A recognises the gain of
LC20 on its internal derivative transaction in other comprehensive income and B recognises
the loss of LC50 in other comprehensive income. TC does not claim hedge accounting, but
measures both its internal and external derivative positions at fair value, which net to zero.
italics.
A's entries
D I l TC LC20
Cr Other comprehensive income LC20
B's entries
Dr Other comprehensive income LC50
TC's entries


Cr External forward contract LC30
For the consolidated financial statements, TC's external forward contract on FC300 is
designated, at the beginning of month 1, as a hedging instrument of the first FC300 of B's
highly probable future expenses. IAS 39 requires that in the consolidated financial
statements at the end of month 1, the accounting effects of the internal derivative
transactions must be eliminated.
However, the net balances before and after elimination of the accounting entries relating to
the internal derivatives are the same, as set out below. Accordingly, there is no need to
make any further accounting entries in order for the requirements of IAS 39 to be met.
Debit Credit
External – LC30
forward
contract
Other LC30 –
comprehensive
income
Gains and – –
l

losses
Internal – –
contracts
Case 3 Offset of fair value and cash flow hedges
Assume that the exposures and the internal derivative transactions are the same as in cases
1 and 2. However, instead of entering into two external derivatives to hedge separately the
fair value and cash flow exposures, TC enters into a single net external derivative to receive
FC250 in exchange for LC in 90 days.
TC has four internal derivatives, two maturing in 60 days and two maturing in 90 days.
These are offset by a net external derivative maturing in 90 days. The interest rate
differential between FC and LC is minimal, and therefore the ineffectiveness resulting from
the mismatch in maturities is expected to have a minimal effect on profit or loss in TC.
As in cases 1 and 2, A and B apply hedge accounting for their cash flow hedges and TC
measures its derivatives at fair value. A recognises a gain of LC20 on its internal derivative
transaction in other comprehensive income and B recognises a loss of LC50 on its internal
derivative transaction in other comprehensive income.
italics.
A's entries
Cr Receivables LC10


B's entries
Dr Payables LC5
D I ll TC LC5

TC's entries




Cr External forward contract LC25
Combining these amounts with the external transactions (ie those not marked in italics
above) produces the total net balances before elimination of the internal derivatives as
follows:
Debit Credit
P bl LC5
Payables LC5 –
Forward – LC25
contract
Other LC30 –
comprehensive
income
Gains and – –
losses
Internal – –
contracts
For the consolidated financial statements, the following designations are made at the
beginning of month 1:
• the payable of FC50 in B is designated as a hedge of the first FC50 of the

highly probable future revenues in A. Therefore, at the end of month 1, the
following entries are made in the consolidated financial statements: Dr
Payable LC5; Cr Other comprehensive income LC5;
• the receivable of FC100 in A is designated as a hedge of the first FC100 of the

highly probable future expenses in B. Therefore, at the end of month 1, the
following entries are made in the consolidated financial statements: Dr Other
comprehensive income LC10; Cr Receivable LC10; and
• the external forward contract on FC250 in TC is designated as a hedge of the

next FC250 of highly probable future expenses in B. Therefore, at the end of
month 1, the following entries are made in the consolidated financial
statements: Dr Other comprehensive income LC25; Cr External forward
contract LC25.
In the consolidated financial statements at the end of month 1, IAS 39 requires the
accounting effects of the internal derivative transactions to be eliminated.
However, the total net balances before and after elimination of the accounting entries
relating to the internal derivatives are the same, as set out below. Accordingly, there is no
need to make any further accounting entries to meet the requirements of IAS 39.
Debit Credit
Payables LC5 –
Forward – LC25

contract
Other LC30 –
comprehensive
income
Gains and – –
losses
Internal – –
contracts
Case 4 Offset of fair value and cash flow hedges with adjustment to carrying
amount of inventory
Assume similar transactions as in case 3, except that the anticipated cash outflow of FC500
in B relates to the purchase of inventory that is delivered after 60 days. Assume also that
the entity has a policy of basis-adjusting hedged forecast non-financial items. At the end of
month 2, there are no further changes in exchange rates or fair values. At that date, the
inventory is delivered and the loss of LC50 on B's internal derivative, recognised in other
comprehensive income in month 1, is adjusted against the carrying amount of inventory in
B. The gain of LC20 on A's internal derivative is recognised in other comprehensive income
as before.
In the consolidated financial statements, there is now a mismatch compared with the result
that would have been achieved by unwinding and redesignating the hedges. The external
derivative (FC250) and a proportion of the receivable (FC50) offset FC300 of the anticipated
inventory purchase. There is a natural hedge between the remaining FC200 of anticipated
cash outflow in B and the anticipated cash inflow of FC200 in A. This relationship does not
qualify for hedge accounting under IAS 39 and this time there is only a partial offset
between gains and losses on the internal derivatives that hedge these amounts.
At the end of months 1 and 2, the following entries are made in the individual or separate
financial statements of A, B and TC. Entries reflecting intragroup transactions or events are
shown in italics.
A's entries (all at the end of month 1)

Cr Receivables LC10


B's entries
At the end of month 1:
Dr Payables LC5


At the end of month 2:

Dr Inventory LC50
TC's entries (all at the end of month 1)





Cr Forward LC25

Combining these amounts with the external transactions (ie those not marked in italics
above) produces the total net balances before elimination of the internal derivatives as
follows:
Debit Credit
Payables LC5 –
Forward – LC25
contract
Other – LC20
comprehensive
income
Basis LC50 –
adjustment
(inventory)
Gains and – –
losses
Internal – –
contracts
For the consolidated financial statements, the following designations are made at the
beginning of month 1:
• the payable of FC50 in B is designated as a hedge of the first FC50 of the

highly probable future revenues in A. Therefore, at the end of month 1, the
following entry is made in the consolidated financial statements: Dr Payables
LC5; Cr Other comprehensive income LC5.
• the receivable of FC100 in A is designated as a hedge of the first FC100 of the

highly probable future expenses in B. Therefore, at the end of month 1, the
following entries are made in the consolidated financial statements: Dr Other
comprehensive income LC10; Cr Receivable LC10; and at the end of month 2,
Dr Inventory LC10; Cr Other comprehensive income LC10.
• the external forward contract on FC250 in TC is designated as a hedge of the

next FC250 of highly probable future expenses in B. Therefore, at the end of
month 1, the following entry is made in the consolidated financial statements:
Dr Other comprehensive income LC25; Cr External forward contract LC25;
and at the end of month 2, Dr Inventory LC25; Cr Other comprehensive
income LC25.
The total net balances after elimination of the accounting entries relating to the internal
derivatives are as follows:
Debit Credit
Payables LC5 –
Forward – LC25
contract
Other – LC5
comprehensive
income
Basis LC35 –
adjustment
(inventory)
Gains and – –
losses
Internal – –
contracts
These total net balances are different from those that would be recognised if the internal
derivatives were not eliminated, and it is these net balances that IAS 39 requires to be
included in the consolidated financial statements. The accounting entries required to adjust
the total net balances before elimination of the internal derivatives are as follows:
a. to reclassify LC15 of the loss on B's internal derivative that is included in

inventory to reflect that FC150 of the forecast purchase of inventory is not
hedged by an external instrument (neither the external forward contract of
FC250 in TC nor the external payable of FC100 in A); and
b. to reclassify the gain of LC15 on A's internal derivative to reflect that the
forecast revenues of FC150 to which it relates is not hedged by an external
instrument.

The net effect of these two adjustments is as follows:

Cr Inventory LC15
F.1.8 Combination of written and purchased options
In most cases, IAS 39.AG94 prohibits the use of written options as hedging instruments.
If a combination of a written option and purchased option (such as an interest rate collar) is
transacted as a single instrument with one counterparty, can an entity split the derivative
instrument into its written option component and purchased option component and
designate the purchased option component as a hedging instrument?
No. IAS 39.74 specifies that a hedging relationship is designated by an entity for a hedging
instrument in its entirety. The only exceptions permitted are splitting the time value and
intrinsic value of an option and splitting the interest element and spot price on a forward.
Question F.1.3 addresses the issue of whether and when a combination of options is
considered as a written option.
F.1.9 Delta-neutral hedging strategy
Does IAS 39 permit an entity to apply hedge accounting for a 'delta-neutral'

hedging strategy and other dynamic hedging strategies under which the quantity
of the hedging instrument is constantly adjusted in order to maintain a desired
hedge ratio, for example, to achieve a delta-neutral position insensitive to
changes in the fair value of the hedged item?
Yes. IAS 39.74 states that 'a dynamic hedging strategy that assesses both the intrinsic
value and time value of an option contract can qualify for hedge accounting'. For example, a
portfolio insurance strategy that seeks to ensure that the fair value of the hedged item does
not drop below a certain level, while allowing the fair value to increase, may qualify for
hedge accounting.
To qualify for hedge accounting, the entity must document how it will monitor and update
the hedge and measure hedge effectiveness, be able to track properly all terminations and
redesignations of the hedging instrument, and demonstrate that all other criteria for hedge
accounting in IAS 39.88 are met. Also, it must be able to demonstrate an expectation that
the hedge will be highly effective for a specified short period of time during which the hedge
is not expected to be adjusted.
F.1.10
[Deleted]
F.1.11 Hedging instrument: proportion of the cash flows of a cash
instrument
In the case of foreign exchange risk, a non-derivative financial asset or

non-derivative financial liability can potentially qualify as a hedging instrument.
Can an entity treat the cash flows for specified periods during which a financial
asset or financial liability that is designated as a hedging instrument remains
outstanding as a proportion of the hedging instrument under IAS 39.75, and
exclude the other cash flows from the designated hedging relationship?
No. IAS 39.75 indicates that a hedging relationship may not be designated for only a
portion of the time period in which the hedging instrument is outstanding. For example, the
cash flows during the first three years of a ten-year borrowing denominated in a foreign
currency cannot qualify as a hedging instrument in a cash flow hedge of the first three
years of revenue in the same foreign currency. On the other hand, a non-derivative financial
asset or financial liability denominated in a foreign currency may potentially qualify as a
hedging instrument in a hedge of the foreign currency risk associated with a hedged item
that has a remaining time period until maturity that is equal to or longer than the remaining
maturity of the hedging instrument (see Question F.2.17).
F.1.12 Hedges of more than one type of risk
Issue (a) – Normally a hedging relationship is designated between an entire

hedging instrument and a hedged item so that there is a single measure of fair
value for the hedging instrument. Does this preclude designating a single financial
instrument simultaneously as a hedging instrument in both a cash flow hedge and
a fair value hedge?
No. For example, entities commonly use a combined interest rate and currency swap to
convert a variable rate position in a foreign currency to a fixed rate position in the functional
currency. IAS 39.76 allows the swap to be designated separately as a fair value hedge of
the currency risk and a cash flow hedge of the interest rate risk provided the conditions in
IAS 39.76 are met.
Issue (b) – If a single financial instrument is a hedging instrument in two

different hedges, is special disclosure required?
IFRS 7.22 requires disclosures separately for designated fair value hedges, cash flow
hedges and hedges of a net investment in a foreign operation. The instrument in question
would be reported in the IFRS 7.22 disclosures separately for each type of hedge.
F.1.13 Hedging instrument: dual foreign currency forward exchange

contract
Entity A's functional currency is the Japanese yen. Entity A has a five-year floating
rate US dollar liability and a ten-year fixed rate pound sterling-denominated note
receivable. The principal amounts of the asset and liability when converted into
the Japanese yen are the same. Entity A enters into a single foreign currency
forward contract to hedge its foreign currency exposure on both instruments
under which it receives US dollars and pays pounds sterling at the end of five
years. If Entity A designates the forward exchange contract as a hedging
instrument in a cash flow hedge against the foreign currency exposure on the
principal repayments of both instruments, can it qualify for hedge accounting?
Yes. IAS 39.76 permits designating a single hedging instrument as a hedge of multiple
types of risk if three conditions are met. In this example, the derivative hedging instrument
satisfies all of these conditions, as follows.
a. The risks hedged can be identified clearly. The risks are the exposures to
changes in the exchange rates between US dollars and yen, and yen and
pounds, respectively.
b. The effectiveness of the hedge can be demonstrated. For the pound sterling
loan, the effectiveness is measured as the degree of offset between the fair
value of the principal repayment in pounds sterling and the fair value of the
pound sterling payment on the forward exchange contract. For the US dollar
liability, the effectiveness is measured as the degree of offset between the
fair value of the principal repayment in US dollars and the US dollar receipt on
the forward exchange contract. Even though the receivable has a ten-year life
and the forward protects it for only the first five years, hedge accounting is
permitted for only a portion of the exposure as described in Question F.2.17.
c. It is possible to ensure that there is specific designation of the hedging

instrument and different risk positions. The hedged exposures are identified
as the principal amounts of the liability and the note receivable in their
respective currency of denomination.
F.1.14 Concurrent offsetting swaps and use of one as a hedging

instrument
Entity A enters into an interest rate swap and designates it as a hedge of the fair
value exposure associated with fixed rate debt. The fair value hedge meets the
hedge accounting criteria of IAS 39. Entity A simultaneously enters into a second
interest rate swap with the same swap counterparty that has terms that fully
offset the first interest rate swap. Is Entity A required to view the two swaps as
one unit and therefore precluded from applying fair value hedge accounting to the
first swap?
It depends. IAS 39 is transaction-based. If the second swap was not entered into in
contemplation of the first swap or there is a substantive business purpose for structuring
the transactions separately, then the swaps are not viewed as one unit.
For example, some entities have a policy that requires a centralised dealer or treasury
subsidiary to enter into third-party derivative contracts on behalf of other subsidiaries within
the organisation to hedge the subsidiaries' interest rate risk exposures. The dealer or
treasury subsidiary also enters into internal derivative transactions with those subsidiaries
in order to track those hedges operationally within the organisation. Because the dealer or
treasury subsidiary also enters into derivative contracts as part of its trading operations, or
because it may wish to rebalance the risk of its overall portfolio, it may enter into a
derivative contract with the same third party during the same business day that has
substantially the same terms as a contract entered into as a hedging instrument on behalf
of another subsidiary. In this case, there is a valid business purpose for entering into each
contract.
Judgement is applied to determine whether there is a substantive business purpose for

structuring the transactions separately. For example, if the sole purpose is to obtain fair
value accounting treatment for the debt, there is no substantive business purpose.
F.2 Hedged items
F.2.1 Whether a derivative can be designated as a hedged item
Does IAS 39 permit designating a derivative instrument (whether a stand-alone or

separately recognised embedded derivative) as a hedged item either individually
or as part of a hedged group in a fair value or cash flow hedge, for example, by
designating a pay-variable, receive-fixed Forward Rate Agreement (FRA) as a cash
flow hedge of a pay-fixed, receive-variable FRA?
No. Derivative instruments always meet the definition of held for trading and are measured
at fair value with gains and losses recognised in profit or loss unless they are designated
and effective hedging instruments (IAS 39.9 and IFRS 9 paragraphs 4.1–4.5, 5.4.1 and
5.4.3). As an exception, IAS 39.AG94 permits the designation of a purchased option as the
hedged item in a fair value hedge.
F.2.2 Cash flow hedge: anticipated issue of fixed rate debt
Is hedge accounting allowed for a hedge of an anticipated issue of fixed rate debt?
Yes. This would be a cash flow hedge of a highly probable forecast transaction that will
affect profit or loss (IAS 39.86) provided that the conditions in IAS 39.88 are met.
To illustrate: Entity R periodically issues new bonds to refinance maturing bonds, provide
working capital and for various other purposes. When Entity R decides it will be issuing
bonds, it may hedge the risk of changes in the long-term interest rate from the date it
decides to issue the bonds to the date the bonds are issued. If long-term interest rates go
up, the bond will be issued either at a higher rate or with a higher discount or smaller
premium than was originally expected. The higher rate being paid or decrease in proceeds is
normally offset by the gain on the hedge. If long-term interest rates go down, the bond will
be issued either at a lower rate or with a higher premium or a smaller discount than was
originally expected. The lower rate being paid or increase in proceeds is normally offset by
the loss on the hedge.
For example, in August 2000 Entity R decided it would issue CU200 million seven-year
bonds in January 2001. Entity R performed historical correlation studies and determined
that a seven-year treasury bond adequately correlates to the bonds Entity R expected to
issue, assuming a hedge ratio of 0.93 futures contracts to one debt unit. Therefore, Entity R
hedged the anticipated issue of the bonds by selling (shorting) CU186 million worth of
futures on seven-year treasury bonds. From August 2000 to January 2001 interest rates
increased. The short futures positions were closed in January 2001, the date the bonds
were issued, and resulted in a CU1.2 million gain that will offset the increased interest
payments on the bonds and, therefore, will affect profit or loss over the life of the bonds.
The hedge qualifies as a cash flow hedge of the interest rate risk on the forecast issue of
debt.
F.2.3 Hedge accounting: core deposit intangibles
Is hedge accounting treatment permitted for a hedge of the fair value exposure of
core deposit intangibles?
It depends on whether the core deposit intangible is generated internally or acquired (eg as
part of a business combination).
Internally generated core deposit intangibles are not recognised as intangible assets under
IAS 38. Because they are not recognised, they cannot be designated as a hedged item.
If a core deposit intangible is acquired together with a related portfolio of deposits, the core
deposit intangible is required to be recognised separately as an intangible asset (or as part
of the related acquired portfolio of deposits) if it meets the recognition criteria in
paragraph 21 of IAS 38 Intangible Assets. A recognised core deposit intangible asset could
be designated as a hedged item, but only if it meets the conditions in paragraph 88,
including the requirement in paragraph 88(d) that the effectiveness of the hedge can be
measured reliably. Because it is often difficult to measure reliably the fair value of a core
deposit intangible asset other than on initial recognition, it is unlikely that the requirement
in paragraph 88(d) will be met.
F.2.4 Hedge accounting: hedging of future foreign currency revenue

streams
Is hedge accounting permitted for a currency borrowing that hedges an expected

but not contractual revenue stream in foreign currency?
Yes, if the revenues are highly probable. Under IAS 39.86(b) a hedge of an anticipated sale
may qualify as a cash flow hedge. For example, an airline entity may use sophisticated
models based on experience and economic data to project its revenues in various
currencies. If it can demonstrate that forecast revenues for a period of time into the future
in a particular currency are 'highly probable', as required by IAS 39.88, it may designate a
currency borrowing as a cash flow hedge of the future revenue stream. The portion of the
gain or loss on the borrowing that is determined to be an effective hedge is recognised in
other comprehensive income until the revenues occur.
It is unlikely that an entity can reliably predict 100 per cent of revenues for a future year.
On the other hand, it is possible that a portion of predicted revenues, normally those

expected in the short term, will meet the 'highly probable' criterion.
F.2.5 Cash flow hedges: 'all in one' hedge
If a derivative instrument is expected to be settled gross by delivery of the

underlying asset in exchange for the payment of a fixed price, can the derivative
instrument be designated as the hedging instrument in a cash flow hedge of that
gross settlement assuming the other cash flow hedge accounting criteria are met?
Yes. A derivative instrument that will be settled gross can be designated as the hedging
instrument in a cash flow hedge of the variability of the consideration to be paid or received
in the future transaction that will occur on gross settlement of the derivative contract itself
because there would be an exposure to variability in the purchase or sale price without the
derivative. This applies to all fixed price contracts that are accounted for as derivatives
under IAS 39 and IFRS 9.
For example, if an entity enters into a fixed price contract to sell a commodity and that
contract is accounted for as a derivative under IAS 39 and IFRS 9 (for example, because the
entity has a practice of settling such contracts net in cash or of taking delivery of the
underlying and selling it within a short period after delivery for the purpose of generating a
profit from short-term fluctuations in price or dealer's margin), the entity may designate the
fixed price contract as a cash flow hedge of the variability of the consideration to be
received on the sale of the asset (a future transaction) even though the fixed price contract
is the contract under which the asset will be sold. Also, if an entity enters into a forward
contract to purchase a debt instrument that will be settled by delivery, but the forward
contract is a derivative because its term exceeds the regular way delivery period in the
marketplace, the entity may designate the forward as a cash flow hedge of the variability of
the consideration to be paid to acquire the debt instrument (a future transaction), even
though the derivative is the contract under which the debt instrument will be acquired.
F.2.6 Hedge relationships: entity-wide risk
An entity has a fixed rate asset and a fixed rate liability, each having the same
principal amount. Under the terms of the instruments, interest payments on the
asset and liability occur in the same period and the net cash flow is always
positive because the interest rate on the asset exceeds the interest rate on the
liability. The entity enters into an interest rate swap to receive a floating interest
rate and pay a fixed interest rate on a notional amount equal to the principal of
the asset and designates the interest rate swap as a fair value hedge of the fixed
rate asset. Does the hedging relationship qualify for hedge accounting even
though the effect of the interest rate swap on an entity-wide basis is to create an
exposure to interest rate changes that did not previously exist?
Yes. IAS 39 does not require risk reduction on an entity-wide basis as a condition for hedge
accounting. Exposure is assessed on a transaction basis and, in this instance, the asset
being hedged has a fair value exposure to interest rate increases that is offset by the
interest rate swap.

F.2.7 Cash flow hedge: forecast transaction related to an entity's
equity
Can a forecast transaction in the entity's own equity instruments or forecast

dividend payments to shareholders be designated as a hedged item in a cash flow
hedge?
No. To qualify as a hedged item, the forecast transaction must expose the entity to a
particular risk that can affect profit or loss (IAS 39.86). The classification of financial
instruments as liabilities or equity generally provides the basis for determining whether
transactions or other payments relating to such instruments are recognised in profit or loss
(IAS 32). For example, distributions to holders of an equity instrument are debited by the
issuer directly to equity (IAS 32.35). Therefore, such distributions cannot be designated as
a hedged item. However, a declared dividend that has not yet been paid and is recognised
as a financial liability may qualify as a hedged item, for example, for foreign currency risk if
it is denominated in a foreign currency.
F.2.8 Hedge accounting: risk of a transaction not occurring
Does IAS 39 permit an entity to apply hedge accounting to a hedge of the risk that
a transaction will not occur, for example, if that would result in less revenue to
the entity than expected?
No. The risk that a transaction will not occur is an overall business risk that is not eligible as
a hedged item. Hedge accounting is permitted only for risks associated with recognised
assets and liabilities, firm commitments, highly probable forecast transactions and net
investments in foreign operations (IAS 39.86).
F.2.9–F.2.11
[Deleted]
F.2.12 Hedge accounting: prepayable financial asset
If the issuer has the right to prepay a financial asset, can the investor designate
the cash flows after the prepayment date as part of the hedged item?
Cash flows after the prepayment date may be designated as the hedged item to the extent
it can be demonstrated that they are 'highly probable' (IAS 39.88). For example, cash flows
after the prepayment date may qualify as highly probable if they result from a group or pool
of similar assets (for example, mortgage loans) for which prepayments can be estimated
with a high degree of accuracy or if the prepayment option is significantly out of the money.
In addition, the cash flows after the prepayment date may be designated as the hedged
item if a comparable option exists in the hedging instrument.
F.2.13 Fair value hedge: risk that could affect profit or loss
Is fair value hedge accounting permitted for exposure to interest rate risk in fixed
rate loans that are measured at amortised cost?
Yes. Under IFRS 9, some fixed rate loans are measured at amortised cost. Banking
institutions in many countries hold the bulk of their fixed rate loans to collect their
contractual cash flows. Thus, changes in the fair value of such fixed rate loans that are due
to changes in market interest rates will not affect profit or loss. IAS 39.86 specifies that a
fair value hedge is a hedge of the exposure to changes in fair value that is attributable to a
particular risk and that can affect profit or loss. Therefore, IAS 39.86 may appear to
preclude fair value hedge accounting for fixed rate loans. However, the entity could sell
them and the change in fair values would affect profit or loss. Thus, fair value hedge
accounting is permitted for fixed rate loans.
F.2.14 Intragroup and intra-entity hedging transactions
An Australian entity, whose functional currency is the Australian dollar, has

forecast purchases in Japanese yen that are highly probable. The Australian entity
is wholly owned by a Swiss entity, which prepares consolidated financial
statements (which include the Australian subsidiary) in Swiss francs. The Swiss
parent entity enters into a forward contract to hedge the change in yen relative to
the Australian dollar. Can that hedge qualify for hedge accounting in the
consolidated financial statements, or must the Australian subsidiary that has the
foreign currency exposure be a party to the hedging transaction?
The hedge can qualify for hedge accounting provided the other hedge accounting criteria in
IAS 39 are met. Since the Australian entity did not hedge the foreign currency exchange
risk associated with the forecast purchases in yen, the effects of exchange rate changes
between the Australian dollar and the yen will affect the Australian entity's profit or loss
and, therefore, would also affect consolidated profit or loss. IAS 39 does not require that
the operating unit that is exposed to the risk being hedged be a party to the hedging
instrument.
F.2.15 Internal contracts: single offsetting external derivative
An entity uses what it describes as internal derivative contracts to document the

transfer of responsibility for interest rate risk exposures from individual divisions
to a central treasury function. The central treasury function aggregates the
internal derivative contracts and enters into a single external derivative contract
that offsets the internal derivative contracts on a net basis. For example, if the
central treasury function has entered into three internal receive-fixed,
pay-variable interest rate swaps that lay off the exposure to variable interest cash
flows on variable rate liabilities in other divisions and one internal
receive-variable, pay-fixed interest rate swap that lays off the exposure to
variable interest cash flows on variable rate assets in another division, it would
enter into an interest rate swap with an external counterparty that exactly offsets
the four internal swaps. Assuming that the hedge accounting criteria are met, in
the entity's financial statements would the single offsetting external derivative
qualify as a hedging instrument in a hedge of a part of the underlying items on a
gross basis?
Yes, but only to the extent the external derivative is designated as an offset of cash inflows
or cash outflows on a gross basis. IAS 39.84 indicates that a hedge of an overall net
position does not qualify for hedge accounting. However, it does permit designating a part
of the underlying items as the hedged position on a gross basis. Therefore, even though the
purpose of entering into the external derivative was to offset internal derivative contracts
on a net basis, hedge accounting is permitted if the hedging relationship is defined and
documented as a hedge of a part of the underlying cash inflows or cash outflows on a gross
basis. An entity follows the approach outlined in IAS 39.84 and IAS 39.AG101 to designate
part of the underlying cash flows as the hedged position.
F.2.16 Internal contracts: external derivative contracts that are settled

net
Issue (a) – An entity uses internal derivative contracts to transfer interest rate
risk exposures from individual divisions to a central treasury function. For each
internal derivative contract, the central treasury function enters into a derivative
contract with a single external counterparty that offsets the internal derivative
contract. For example, if the central treasury function has entered into a
receive-5 per cent-fixed, pay-LIBOR interest rate swap with another division that
has entered into the internal contract with central treasury to hedge the exposure
to variability in interest cash flows on a pay-LIBOR borrowing, central treasury
would enter into a pay-5 per cent-fixed, receive-LIBOR interest rate swap on the
same principal terms with the external counterparty. Although each of the
external derivative contracts is formally documented as a separate contract, only
the net of the payments on all of the external derivative contracts is settled since
there is a netting agreement with the external counterparty. Assuming that the
other hedge accounting criteria are met, can the individual external derivative
contracts, such as the pay-5 per cent-fixed, receive-LIBOR interest rate swap
above, be designated as hedging instruments of underlying gross exposures, such
as the exposure to changes in variable interest payments on the pay-LIBOR
borrowing above, even though the external derivatives are settled on a net basis?
Generally, yes. External derivative contracts that are legally separate contracts and serve a
valid business purpose, such as laying off risk exposures on a gross basis, qualify as
hedging instruments even if those external contracts are settled on a net basis with the
same external counterparty, provided the hedge accounting criteria in IAS 39 are met. See
also Question F.1.14.
Issue (b) – Treasury observes that by entering into the external offsetting
contracts and including them in the centralised portfolio, it is no longer able to
evaluate the exposures on a net basis. Treasury wishes to manage the portfolio of
offsetting external derivatives separately from other exposures of the entity.
Therefore, it enters into an additional, single derivative to offset the risk of the
portfolio. Can the individual external derivative contracts in the portfolio still be
designated as hedging instruments of underlying gross exposures even though a
single external derivative is used to offset fully the market exposure created by
entering into the external contracts?
Generally, yes. The purpose of structuring the external derivative contracts in this manner
is consistent with the entity's risk management objectives and strategies. As indicated
above, external derivative contracts that are legally separate contracts and serve a valid
business purpose qualify as hedging instruments. Moreover, the answer to Question F.1.14
specifies that hedge accounting is not precluded simply because the entity has entered into
a swap that mirrors exactly the terms of another swap with the same counterparty if there
is a substantive business purpose for structuring the transactions separately.
F.2.17 Partial term hedging
IAS 39.75 indicates that a hedging relationship may not be designated for only a portion of
the time period during which a hedging instrument remains outstanding. Is it permitted to
designate a derivative as hedging only a portion of the time period to maturity of a hedged
item?
Yes. A financial instrument may be a hedged item for only a portion of its cash flows or fair
value, if effectiveness can be measured and the other hedge accounting criteria are met.
To illustrate: Entity A acquires a 10 per cent fixed rate government bond with a remaining
term to maturity of ten years. Entity A classifies the bond as measured at amortised cost.
To hedge itself against fair value exposure on the bond associated with the present value of
the interest rate payments until year 5, Entity A acquires a five-year pay-fixed,
receive-floating swap. The swap may be designated as hedging the fair value exposure of
the interest rate payments on the government bond until year 5 and the change in value of
the principal payment due at maturity to the extent affected by changes in the yield curve
relating to the five years of the swap.
F.2.18 Hedging instrument: cross-currency interest rate swap
Entity A's functional currency is the Japanese yen. Entity A has a five-year floating
rate US dollar liability and a 10-year fixed rate pound sterling-denominated note
receivable. Entity A wishes to hedge the foreign currency exposure on its asset
and liability and the fair value interest rate exposure on the receivable and enters
into a matching cross-currency interest rate swap to receive floating rate US
dollars and pay fixed rate pounds sterling and to exchange the dollars for the
pounds at the end of five years. Can Entity A designate the swap as a hedging
instrument in a fair value hedge against both foreign currency risk and interest
rate risk, although both the pound sterling and US dollar are foreign currencies to
Entity A?
Yes. IAS 39.81 permits hedge accounting for components of risk, if effectiveness can be
measured. Also, IAS 39.76 permits designating a single hedging instrument as a hedge of
more than one type of risk if the risks can be identified clearly, effectiveness can be
demonstrated, and specific designation of the hedging instrument and different risk
positions can be ensured. Therefore, the swap may be designated as a hedging instrument
in a fair value hedge of the pound sterling receivable against exposure to changes in its fair
value associated with changes in UK interest rates for the initial partial term of five years
and the exchange rate between pounds and US dollars. The swap is measured at fair value
with changes in fair value recognised in profit or loss. The carrying amount of the receivable
is adjusted for changes in its fair value caused by changes in UK interest rates for the first
five-year portion of the yield curve. The receivable and payable are remeasured using spot
exchange rates under IAS 21 and the changes to their carrying amounts recognised in profit
or loss.
F.2.19–F.2.20
[Deleted]
F.2.21 Hedge accounting: netting of assets and liabilities
May an entity group financial assets together with financial liabilities for the
purpose of determining the net cash flow exposure to be hedged for hedge
accounting purposes?
An entity's hedging strategy and risk management practices may assess cash flow risk on a
net basis but IAS 39.84 does not permit designating a net cash flow exposure as a hedged
item for hedge accounting purposes. IAS 39.AG101 provides an example of how a bank
might assess its risk on a net basis (with similar assets and liabilities grouped together) and
then qualify for hedge accounting by hedging on a gross basis.
F.3 Hedge accounting
F.3.1 Cash flow hedge: fixed interest rate cash flows
An entity issues a fixed rate debt instrument and enters into a receive-fixed,
pay-variable interest rate swap to offset the exposure to interest rate risk
associated with the debt instrument. Can the entity designate the swap as a cash
flow hedge of the future interest cash outflows associated with the debt
instrument?
No. IAS 39.86(b) states that a cash flow hedge is 'a hedge of the exposure to variability in
cash flows'. In this case, the issued debt instrument does not give rise to any exposure to
variability in cash flows since the interest payments are fixed. The entity may designate the
swap as a fair value hedge of the debt instrument, but it cannot designate the swap as a
cash flow hedge of the future cash outflows of the debt instrument.
F.3.2 Cash flow hedge: reinvestment of fixed interest rate cash flows
An entity manages interest rate risk on a net basis. On 1 January 2001, it

forecasts aggregate cash inflows of CU100 on fixed rate assets and aggregate
cash outflows of CU90 on fixed rate liabilities in the first quarter of 2002. For risk
management purposes it uses a receive-variable, pay-fixed Forward Rate
Agreement (FRA) to hedge the forecast net cash inflow of CU10. The entity
designates as the hedged item the first CU10 of cash inflows on fixed rate assets
in the first quarter of 2002. Can it designate the receive-variable, pay-fixed FRA as
a cash flow hedge of the exposure to variability to cash flows in the first quarter
of 2002 associated with the fixed rate assets?
No. The FRA does not qualify as a cash flow hedge of the cash flow relating to the fixed rate
assets because they do not have a cash flow exposure. The entity could, however,
designate the FRA as a hedge of the fair value exposure that exists before the cash flows
are remitted.
In some cases, the entity could also hedge the interest rate exposure associated with the
forecast reinvestment of the interest and principal it receives on fixed rate assets (see
Question F.6.2). However, in this example, the FRA does not qualify for cash flow hedge
accounting because it increases rather than reduces the variability of interest cash flows
resulting from the reinvestment of interest cash flows (for example, if market rates
increase, there will be a cash inflow on the FRA and an increase in the expected interest
cash inflows resulting from the reinvestment of interest cash inflows on fixed rate assets).
However, potentially it could qualify as a cash flow hedge of a portion of the refinancing of
cash outflows on a gross basis.
F.3.3 Foreign currency hedge
Entity A has a foreign currency liability payable in six months' time and it wishes
to hedge the amount payable on settlement against foreign currency fluctuations.
To that end, it takes out a forward contract to buy the foreign currency in six
months' time. Should the hedge be treated as:
a. a fair value hedge of the foreign currency liability with gains and
losses on revaluing the liability and the forward contract at the
year-end both recognised in profit or loss; or
b. a cash flow hedge of the amount to be settled in the future with gains
and losses on revaluing the forward contract recognised in other
comprehensive income?
IAS 39 does not preclude either of these two methods. If the hedge is treated as a fair
value hedge, the gain or loss on the fair value remeasurement of the hedging instrument
and the gain or loss on the fair value remeasurement of the hedged item for the hedged risk
are recognised immediately in profit or loss. If the hedge is treated as a cash flow hedge
with the gain or loss on remeasuring the forward contract recognised in other
comprehensive income, that amount is recognised in profit or loss in the same period or
periods during which the hedged item (the liability) affects profit or loss, ie when the
liability is remeasured for changes in foreign exchange rates. Therefore, if the hedge is
effective, the gain or loss on the derivative is released to profit or loss in the same periods
during which the liability is remeasured, not when the payment occurs. See Question F.3.4.
F.3.4 Foreign currency cash flow hedge
An entity exports a product at a price denominated in a foreign currency. At the

date of the sale, the entity obtains a receivable for the sale price payable in 90
days and takes out a 90-day forward exchange contract in the same currency as
the receivable to hedge its foreign currency exposure.
Under IAS 21, the sale is recorded at the spot rate at the date of sale, and the receivable
is restated during the 90-day period for changes in exchange rates with the difference being
taken to profit or loss (IAS 21.23 and IAS 21.28).
If the foreign exchange contract is designated as a hedging instrument, does the

entity have a choice whether to designate the foreign exchange contract as a fair
value hedge of the foreign currency exposure of the receivable or as a cash flow
hedge of the collection of the receivable?
Yes. If the entity designates the foreign exchange contract as a fair value hedge, the gain or
loss from remeasuring the forward exchange contract at fair value is recognised
immediately in profit or loss and the gain or loss on remeasuring the receivable is also
If the entity designates the foreign exchange contract as a cash flow hedge of the foreign
currency risk associated with the collection of the receivable, the portion of the gain or loss
that is determined to be an effective hedge is recognised in other comprehensive income,
and the ineffective portion in profit or loss (IAS 39.95). The amount recognised in other
comprehensive income is reclassified from equity to profit or loss as a reclassification
adjustment in the same period or periods during which changes in the measurement of the
receivable affect profit or loss (IAS 39.100).
F.3.5 Fair value hedge: variable rate debt instrument
Does IAS 39 permit an entity to designate a portion of the risk exposure of a

variable rate debt instrument as a hedged item in a fair value hedge?
Yes. A variable rate debt instrument may have an exposure to changes in its fair value due
to credit risk. It may also have an exposure to changes in its fair value relating to
movements in the market interest rate in the periods between which the variable interest
rate on the debt instrument is reset. For example, if the debt instrument provides for
annual interest payments reset to the market rate each year, a portion of the debt
instrument has an exposure to changes in fair value during the year.
F.3.6 Fair value hedge: inventory
IAS 39.86(a) states that a fair value hedge is 'a hedge of the exposure to changes in fair
value of a recognised asset or liability ... that is attributable to a particular risk and could
affect profit or loss'. Can an entity designate inventories, such as copper inventory, as the
hedged item in a fair value hedge of the exposure to changes in the price of the inventories,
such as the copper price, although inventories are measured at the lower of cost and net
realisable value under IAS 2 Inventories?
Yes. The inventories may be hedged for changes in fair value due to changes in the copper
price because the change in fair value of inventories will affect profit or loss when the
inventories are sold or their carrying amount is written down. The adjusted carrying amount
becomes the cost basis for the purpose of applying the lower of cost and net realisable
value test under IAS 2. The hedging instrument used in a fair value hedge of inventories
may alternatively qualify as a cash flow hedge of the future sale of the inventory.
F.3.7 Hedge accounting: forecast transaction
For cash flow hedges, a forecast transaction that is subject to a hedge must be
'highly probable'. How should the term 'highly probable' be interpreted?
The term 'highly probable' indicates a much greater likelihood of happening than the term
'more likely than not'. An assessment of the likelihood that a forecast transaction will take
place is not based solely on management's intentions because intentions are not verifiable.
A transaction's probability should be supported by observable facts and the attendant
circumstances.
In assessing the likelihood that a transaction will occur, an entity should consider the
following circumstances:
a. the frequency of similar past transactions;
b. the financial and operational ability of the entity to carry out the transaction;
c. substantial commitments of resources to a particular activity (for example, a

manufacturing facility that can be used in the short run only to process a
particular type of commodity);
d. the extent of loss or disruption of operations that could result if the

transaction does not occur;
e. the likelihood that transactions with substantially different characteristics

might be used to achieve the same business purpose (for example, an entity
that intends to raise cash may have several ways of doing so, ranging from a
short-term bank loan to an offering of ordinary shares); and
f. the entity's business plan.
The length of time until a forecast transaction is projected to occur is also a factor in
determining probability. Other factors being equal, the more distant a forecast transaction
is, the less likely it is that the transaction would be regarded as highly probable and the
stronger the evidence that would be needed to support an assertion that it is highly
probable.
For example, a transaction forecast to occur in five years may be less likely to occur than a
transaction forecast to occur in one year. However, forecast interest payments for the next
20 years on variable rate debt would typically be highly probable if supported by an existing
contractual obligation.
In addition, other factors being equal, the greater the physical quantity or future value of a
forecast transaction in proportion to the entity's transactions of the same nature, the less
likely it is that the transaction would be regarded as highly probable and the stronger the
evidence that would be required to support an assertion that it is highly probable. For
example, less evidence generally would be needed to support forecast sales of 100,000
units in the next month than 950,000 units in that month when recent sales have averaged
950,000 units per month for the past three months.
A history of having designated hedges of forecast transactions and then determining that
the forecast transactions are no longer expected to occur would call into question both an
entity's ability to predict forecast transactions accurately and the propriety of using hedge
accounting in the future for similar forecast transactions.
F.3.8 Retrospective designation of hedges
Does IAS 39 permit an entity to designate hedge relationships retrospectively?
No. Designation of hedge relationships takes effect prospectively from the date all hedge
accounting criteria in IAS 39.88 are met. In particular, hedge accounting can be applied
only from the date the entity has completed the necessary documentation of the hedge
relationship, including identification of the hedging instrument, the related hedged item or
transaction, the nature of the risk being hedged, and how the entity will assess hedge
effectiveness.
F.3.9 Hedge accounting: designation at the inception of the hedge
Does IAS 39 permit an entity to designate and formally document a derivative

contract as a hedging instrument after entering into the derivative contract?
Yes, prospectively. For hedge accounting purposes, IAS 39 requires a hedging instrument to
be designated and formally documented as such from the inception of the hedge
relationship (IAS 39.88); in other words, a hedge relationship cannot be designated
retrospectively. Also, it precludes designating a hedging relationship for only a portion of
the time period during which the hedging instrument remains outstanding (IAS 39.75).
However, it does not require the hedging instrument to be acquired at the inception of the
hedge relationship.
F.3.10 Hedge accounting: identification of hedged forecast transaction
Can a forecast transaction be identified as the purchase or sale of the last 15,000
units of a product in a specified period or as a percentage of purchases or sales
during a specified period?
No. The hedged forecast transaction must be identified and documented with sufficient
specificity so that when the transaction occurs, it is clear whether the transaction is or is not
the hedged transaction. Therefore, a forecast transaction may be identified as the sale of
the first 15,000 units of a specific product during a specified three-month period, but it
could not be identified as the last 15,000 units of that product sold during a three-month
period because the last 15,000 units cannot be identified when they are sold. For the same
reason, a forecast transaction cannot be specified solely as a percentage of sales or
purchases during a period.
F.3.11 Cash flow hedge: documentation of timing of forecast
transaction
For a hedge of a forecast transaction, should the documentation of the hedge

relationship that is established at inception of the hedge identify the date when,
or time period in which, the forecast transaction is expected to occur?
Yes. To qualify for hedge accounting, the hedge must relate to a specific identified and
designated risk (IAS 39.AG110) and it must be possible to measure its effectiveness reliably
(IAS 39.88(d)). Also, the hedged forecast transaction must be highly probable
(IAS 39.88(c)). To meet these criteria, an entity is not required to predict and document the
exact date a forecast transaction is expected to occur. However, it is required to identify
and document the time period during which the forecast transaction is expected to occur
within a reasonably specific and generally narrow range of time from a most probable date,
as a basis for assessing hedge effectiveness. To determine that the hedge will be highly
effective in accordance with IAS 39.88(d), it is necessary to ensure that changes in the fair
value of the expected cash flows are offset by changes in the fair value of the hedging
instrument and this test may be met only if the timing of the cash flows occur within close
proximity to each other. If the forecast transaction is no longer expected to occur, hedge
accounting is discontinued in accordance with IAS 39.101(c).
F.4 Hedge effectiveness
F.4.1 Hedging on an after-tax basis
Hedging is often done on an after-tax basis. Is hedge effectiveness assessed after

taxes?
IAS 39 permits, but does not require, assessment of hedge effectiveness on an after-tax
basis. If the hedge is undertaken on an after-tax basis, it is so designated at inception as
part of the formal documentation of the hedging relationship and strategy.
F.4.2 Hedge effectiveness: assessment on cumulative basis
IAS 39.88(b) requires that the hedge is expected to be highly effective. Should expected
hedge effectiveness be assessed separately for each period or cumulatively over the life of
the hedging relationship?
Expected hedge effectiveness may be assessed on a cumulative basis if the hedge is so

designated, and that condition is incorporated into the appropriate hedging documentation.
Therefore, even if a hedge is not expected to be highly effective in a particular period,
hedge accounting is not precluded if effectiveness is expected to remain sufficiently high
over the life of the hedging relationship. However, any ineffectiveness is required to be
recognised in profit or loss as it occurs.
To illustrate: an entity designates a LIBOR-based interest rate swap as a hedge of a

borrowing whose interest rate is a UK base rate plus a margin. The UK base rate changes,
perhaps, once each quarter or less, in increments of 25–50 basis points, while LIBOR
changes daily. Over a period of 1–2 years, the hedge is expected to be almost perfect.
However, there will be quarters when the UK base rate does not change at all, while LIBOR
has changed significantly. This would not necessarily preclude hedge accounting.
F.4.3 Hedge effectiveness: counterparty credit risk
Must an entity consider the likelihood of default by the counterparty to the

hedging instrument in assessing hedge effectiveness?
Yes. An entity cannot ignore whether it will be able to collect all amounts due under the
contractual provisions of the hedging instrument. When assessing hedge effectiveness, both
at the inception of the hedge and on an ongoing basis, the entity considers the risk that the
counterparty to the hedging instrument will default by failing to make any contractual
payments to the entity. For a cash flow hedge, if it becomes probable that a counterparty
will default, an entity would be unable to conclude that the hedging relationship is expected
to be highly effective in achieving offsetting cash flows. As a result, hedge accounting would
be discontinued. For a fair value hedge, if there is a change in the counterparty's
creditworthiness, the fair value of the hedging instrument will change, which affects the
assessment of whether the hedge relationship is effective and whether it qualifies for
continued hedge accounting.
F.4.4 Hedge effectiveness: effectiveness tests
How should hedge effectiveness be measured for the purposes of initially

qualifying for hedge accounting and for continued qualification?
IAS 39 does not provide specific guidance about how effectiveness tests are performed.
IAS 39.AG105 specifies that a hedge is normally regarded as highly effective only if (a) at
inception and in subsequent periods, the hedge is expected to be highly effective in
achieving offsetting changes in fair value or cash flows attributable to the hedged risk
during the period for which the hedge is designated, and (b) the actual results are within a
range of 80–125 per cent. IAS 39.AG105 also states that the expectation in (a) can be
demonstrated in various ways.
The appropriateness of a given method of assessing hedge effectiveness will depend on the
nature of the risk being hedged and the type of hedging instrument used. The method of
assessing effectiveness must be reasonable and consistent with other similar hedges unless
different methods are explicitly justified. An entity is required to document at the inception
of the hedge how effectiveness will be assessed and then to apply that effectiveness test on
a consistent basis for the duration of the hedge.
Several mathematical techniques can be used to measure hedge effectiveness, including

ratio analysis, ie a comparison of hedging gains and losses with the corresponding gains and
losses on the hedged item at a point in time, and statistical measurement techniques such
as regression analysis. If regression analysis is used, the entity's documented policies for
assessing effectiveness must specify how the results of the regression will be assessed.

F.4.5 Hedge effectiveness: less than 100 per cent offset
If a cash flow hedge is regarded as highly effective because the actual risk offset
is within the allowed 80–125 per cent range of deviation from full offset, is the
gain or loss on the ineffective portion of the hedge recognised in other
comprehensive income?
No. IAS 39.95(a) indicates that only the effective portion is recognised in other
comprehensive income. IAS 39.95(b) requires the ineffective portion to be recognised in
profit or loss.
F.4.7 Assuming perfect hedge effectiveness
If the principal terms of the hedging instrument and of the entire hedged asset or
liability or hedged forecast transaction are the same, can an entity assume perfect
hedge effectiveness without further effectiveness testing?
No. IAS 39.88(e) requires an entity to assess hedges on an ongoing basis for hedge
effectiveness. It cannot assume hedge effectiveness even if the principal terms of the
hedging instrument and the hedged item are the same, since hedge ineffectiveness may
arise because of other attributes such as the liquidity of the instruments or their credit risk
(IAS 39.AG109). It may, however, designate only certain risks in an overall exposure as
being hedged and thereby improve the effectiveness of the hedging relationship.
For example, for a fair value hedge of a debt instrument, if the derivative hedging
instrument has a credit risk that is equivalent to the AA-rate, it may designate only the risk
related to AA-rated interest rate movements as being hedged, in which case changes in
credit spreads generally will not affect the effectiveness of the hedge.
F.5 Cash flow hedges
F.5.1 Hedge accounting: non-derivative monetary asset or

non-derivative monetary liability used as a hedging instrument
If an entity designates a non-derivative monetary asset as a foreign currency cash

flow hedge of the repayment of the principal of a non-derivative monetary
liability, would the exchange differences on the hedged item be recognised in
profit or loss (IAS 21.28) and the exchange differences on the hedging instrument be
recognised in other comprehensive income until the repayment of the liability (IAS 39.95)?
No. Exchange differences on the monetary asset and the monetary liability are both
recognised in profit or loss in the period in which they arise (IAS 21.28). IAS 39.AG83
specifies that if there is a hedge relationship between a non-derivative monetary asset and
a non-derivative monetary liability, changes in fair values of those financial instruments are
F.5.2 Cash flow hedges: performance of hedging instrument (1)

Entity A has a floating rate liability of CU1,000 with five years remaining to
maturity. It enters into a five-year pay-fixed, receive-floating interest rate swap in
the same currency and with the same principal terms as the liability to hedge the
exposure to variable cash flow payments on the floating rate liability attributable
to interest rate risk. At inception, the fair value of the swap is zero. Subsequently,
there is an increase of CU49 in the fair value of the swap. This increase consists of
a change of CU50 resulting from an increase in market interest rates and a change
of minus CU1 resulting from an increase in the credit risk of the swap
counterparty. There is no change in the fair value of the floating rate liability, but
the fair value (present value) of the future cash flows needed to offset the
exposure to variable interest cash flows on the liability increases by CU50.
Assuming that Entity A determines that the hedge is still highly effective, is there
ineffectiveness that should be recognised in profit or loss?
No. A hedge of interest rate risk is not fully effective if part of the change in the fair value of
the derivative is attributable to the counterparty's credit risk (IAS 39.AG109). However,
because Entity A determines that the hedge relationship is still highly effective, it recognises
the effective portion of the change in fair value of the swap, ie the net change in fair value
of CU49, in other comprehensive income. There is no debit to profit or loss for the change in
fair value of the swap attributable to the deterioration in the credit quality of the swap
counterparty, because the cumulative change in the present value of the future cash flows
needed to offset the exposure to variable interest cash flows on the hedged item, ie CU50,
exceeds the cumulative change in value of the hedging instrument, ie CU49.
Dr Swap CU49
Cr Other comprehensive income CU49
If Entity A concludes that the hedge is no longer highly effective, it discontinues hedge
accounting prospectively as from the date the hedge ceased to be highly effective in
Would the answer change if the fair value of the swap instead increases to CU51
of which CU50 results from the increase in market interest rates and CU1 from a
decrease in the credit risk of the swap counterparty?
Yes. In this case, there is a credit to profit or loss of CU1 for the change in fair value of the
swap attributable to the improvement in the credit quality of the swap counterparty. This is
because the cumulative change in the value of the hedging instrument, ie CU51, exceeds
the cumulative change in the present value of the future cash flows needed to offset the
exposure to variable interest cash flows on the hedged item, ie CU50. The difference of CU1
represents the excess ineffectiveness attributable to the derivative hedging instrument, the
swap, and is recognised in profit or loss.

Dr Swap CU51
Cr Other comprehensive income CU50
Cr Profit or loss CU1
F.5.3 Cash flow hedges: performance of hedging instrument (2)
On 30 September 20X1, Entity A hedges the anticipated sale of 24 tonnes of pulp

on 1 March 20X2 by entering into a short forward contract on 24 tonnes of pulp.
The contract requires net settlement in cash determined as the difference
between the future spot price of pulp on a specified commodity exchange and
CU1,000. Entity A expects to sell the pulp in a different, local market. Entity A
determines that the forward contract is an effective hedge of the anticipated sale
and that the other conditions for hedge accounting are met. It assesses hedge
effectiveness by comparing the entire change in the fair value of the forward
contract with the change in the fair value of the expected cash inflows. On 31
December, the spot price of pulp has increased both in the local market and on the
exchange. The increase in the local market exceeds the increase on the exchange.
As a result, the present value of the expected cash inflow from the sale on the
local market is CU1,100. The fair value of Entity A's forward contract is negative
CU80. Assuming that Entity A determines that the hedge is still highly effective, is
there ineffectiveness that should be recognised in profit or loss?
No. In a cash flow hedge, ineffectiveness is not recognised in the financial statements when
the cumulative change in the fair value of the hedged cash flows exceeds the cumulative
change in the value of the hedging instrument. In this case, the cumulative change in the
fair value of the forward contract is CU80, while the fair value of the cumulative change in
expected future cash flows on the hedged item is CU100. Since the fair value of the
cumulative change in expected future cash flows on the hedged item from the inception of
the hedge exceeds the cumulative change in fair value of the hedging instrument
(in absolute amounts), no portion of the gain or loss on the hedging instrument is
recognised in profit or loss (IAS 39.95(b)). Because Entity A determines that the hedge
relationship is still highly effective, it recognises the entire change in fair value of the
forward contract (CU80) in other comprehensive income.
Dr Other comprehensive income CU80

Cr Forward CU80
If Entity A concludes that the hedge is no longer highly effective, it discontinues hedge
accounting prospectively as from the date the hedge ceases to be highly effective in
F.5.4 Cash flow hedges: forecast transaction occurs before the
specified period
An entity designates a derivative as a hedging instrument in a cash flow hedge of

a forecast transaction, such as a forecast sale of a commodity. The hedging
relationship meets all the hedge accounting conditions, including the requirement
to identify and document the period in which the transaction is expected to occur
within a reasonably specific and narrow range of time (see Question F.2.17). If, in
a subsequent period, the forecast transaction is expected to occur in an earlier period than
originally anticipated, can the entity conclude that this transaction is the same as the one
that was designated as being hedged?
Yes. The change in timing of the forecast transaction does not affect the validity of the
designation. However, it may affect the assessment of the effectiveness of the hedging
relationship. Also, the hedging instrument would need to be designated as a hedging
instrument for the whole remaining period of its existence in order for it to continue to
qualify as a hedging instrument (see IAS 39.75 and Question F.2.17).
F.5.5 Cash flow hedges: measuring effectiveness for a hedge of a

forecast transaction in a debt instrument
A forecast investment in an interest-earning asset or forecast issue of an

interest-bearing liability creates a cash flow exposure to interest rate changes
because the related interest payments will be based on the market rate that exists
when the forecast transaction occurs. The objective of a cash flow hedge of the
exposure to interest rate changes is to offset the effects of future changes in
interest rates so as to obtain a single fixed rate, usually the rate that existed at
the inception of the hedge that corresponds with the term and timing of the
forecast transaction. During the period of the hedge, it is not possible to
determine what the market interest rate for the forecast transaction will be at the
time the hedge is terminated or when the forecast transaction occurs. In this case,
how is the effectiveness of the hedge assessed and measured?
During this period, effectiveness can be measured on the basis of changes in interest rates
between the designation date and the interim effectiveness measurement date. The interest
rates used to make this measurement are the interest rates that correspond with the term
and occurrence of the forecast transaction that existed at the inception of the hedge and
that exist at the measurement date as evidenced by the term structure of interest rates.
Generally it will not be sufficient simply to compare cash flows of the hedged item with cash
flows generated by the derivative hedging instrument as they are paid or received, since
such an approach ignores the entity's expectations of whether the cash flows will offset in
subsequent periods and whether there will be any resulting ineffectiveness.
The discussion that follows illustrates the mechanics of establishing a cash flow hedge and
measuring its effectiveness. For the purpose of the illustrations, assume that an entity
expects to issue a CU100,000 one-year debt instrument in three months. The instrument
will pay interest quarterly with principal due at maturity. The entity is exposed to interest
rate increases and establishes a hedge of the interest cash flows of the debt by entering
into a forward starting interest rate swap. The swap has a term of one year and will start in
three months to correspond with the terms of the forecast debt issue. The entity will pay a
fixed rate and receive a variable rate, and the entity designates the risk being hedged as
the LIBOR-based interest component in the forecast issue of the debt.
Yield curve
The yield curve provides the foundation for computing future cash flows and the fair value
of such cash flows both at the inception of, and during, the hedging relationship. It is based
on current market yields on applicable reference bonds that are traded in the marketplace.
Market yields are converted to spot interest rates ('spot rates' or 'zero coupon rates') by
eliminating the effect of coupon payments on the market yield. Spot rates are used to
discount future cash flows, such as principal and interest rate payments, to arrive at their
fair value. Spot rates also are used to compute forward interest rates that are used to
compute variable and estimated future cash flows. The relationship between spot rates and
one-period forward rates is shown by the following formula:
Spot-forward relationship
Also, for the purpose of this illustration, assume that the following quarterly-period term
structure of interest rates using quarterly compounding exists at the inception of the hedge.
The one-period forward rates are computed on the basis of spot rates for the applicable
maturities. For example, the current forward rate for Period 2 calculated using the formula
above is equal to [1.04502/1.0375] – 1 = 5.25 per cent. The current one-period forward
rate for Period 2 is different from the current spot rate for Period 2, since the spot rate is an
interest rate from the beginning of Period 1 (spot) to the end of Period 2, while the forward
rate is an interest rate from the beginning of Period 2 to the end of Period 2.
Hedged item
In this example, the entity expects to issue a CU100,000 one-year debt instrument in three
months with quarterly interest payments. The entity is exposed to interest rate increases
and would like to eliminate the effect on cash flows of interest rate changes that may
happen before the forecast transaction takes place. If that risk is eliminated, the entity
would obtain an interest rate on its debt issue that is equal to the one-year forward coupon
rate currently available in the marketplace in three months. That forward coupon rate,
which is different from the forward (spot) rate, is 6.86 per cent, computed from the term
structure of interest rates shown above. It is the market rate of interest that exists at the
inception of the hedge, given the terms of the forecast debt instrument. It results in the fair
value of the debt being equal to par at its issue.
At the inception of the hedging relationship, the expected cash flows of the debt instrument
can be calculated on the basis of the existing term structure of interest rates. For this
purpose, it is assumed that interest rates do not change and that the debt would be issued
at 6.86 per cent at the beginning of Period 2. In this case, the cash flows and fair value of
the debt instrument would be as follows at the beginning of Period 2.
Since it is assumed that interest rates do not change, the fair value of the interest and
principal amounts equals the par amount of the forecast transaction. The fair value amounts
are computed on the basis of the spot rates that exist at the inception of the hedge for the
applicable periods in which the cash flows would occur had the debt been issued at the date
of the forecast transaction. They reflect the effect of discounting those cash flows on the
basis of the periods that will remain after the debt instrument is issued. For example, the
spot rate of 6.38 per cent is used to discount the interest cash flow that is expected to be
paid in Period 3, but it is discounted for only two periods because it will occur two periods
after the forecast transaction.
The forward interest rates are the same as shown previously, since it is assumed that
interest rates do not change. The spot rates are different but they have not actually
changed. They represent the spot rates one period forward and are based on the applicable
forward rates.
Hedging instrument
The objective of the hedge is to obtain an overall interest rate on the forecast transaction
and the hedging instrument that is equal to 6.86 per cent, which is the market rate at the
inception of the hedge for the period from Period 2 to Period 5. This objective is
accomplished by entering into a forward starting interest rate swap that has a fixed rate of
6.86 per cent. Based on the term structure of interest rates that exist at the inception of the
hedge, the interest rate swap will have such a rate. At the inception of the hedge, the fair
value of the fixed rate payments on the interest rate swap will equal the fair value of the
variable rate payments, resulting in the interest rate swap having a fair value of zero.
The expected cash flows of the interest rate swap and the related fair value amounts are
shown as follows.
At the inception of the hedge, the fixed rate on the forward swap is equal to the fixed rate
the entity would receive if it could issue the debt in three months under terms that exist
today.
Measuring hedge effectiveness

If interest rates change during the period the hedge is outstanding, the effectiveness of the
hedge can be measured in various ways.
Assume that interest rates change as follows immediately before the debt is issued at the
beginning of Period 2.
Under the new interest rate environment, the fair value of the pay-fixed at 6.86 per cent,
receive-variable interest rate swap that was designated as the hedging instrument would be
as follows.
In order to compute the effectiveness of the hedge, it is necessary to measure the change
in the present value of the cash flows or the value of the hedged forecast transaction. There
are at least two methods of accomplishing this measurement.

Under Method A, a computation is made of the fair value in the new interest rate
environment of debt that carries interest that is equal to the coupon interest rate that
existed at the inception of the hedging relationship (6.86 per cent). This fair value is
compared with the expected fair value as of the beginning of Period 2 that was calculated
on the basis of the term structure of interest rates that existed at the inception of the
hedging relationship, as illustrated above, to determine the change in the fair value. Note
that the difference between the change in the fair value of the swap and the change in the
expected fair value of the debt exactly offset in this example, since the terms of the swap
and the forecast transaction match each other.

Under Method B, the present value of the change in cash flows is computed on the basis of
the difference between the forward interest rates for the applicable periods at the
effectiveness measurement date and the interest rate that would have been obtained if the
debt had been issued at the market rate that existed at the inception of the hedge.
The market rate that existed at the inception of the hedge is the one-year forward coupon
rate in three months. The present value of the change in cash flows is computed on the
basis of the current spot rates that exist at the effectiveness measurement date for the
applicable periods in which the cash flows are expected to occur. This method also could be
referred to as the 'theoretical swap' method (or 'hypothetical derivative' method) because
the comparison is between the hedged fixed rate on the debt and the current variable rate,
which is the same as comparing cash flows on the fixed and variable rate legs of an interest
rate swap.
As before, the difference between the change in the fair value of the swap and the change
in the present value of the cash flows exactly offset in this example, since the terms match.
Other considerations
There is an additional computation that should be performed to compute ineffectiveness

before the expected date of the forecast transaction that has not been considered for the
purpose of this illustration. The fair value difference has been determined in each of the
illustrations as of the expected date of the forecast transaction immediately before the
forecast transaction, ie at the beginning of Period 2. If the assessment of hedge
effectiveness is done before the forecast transaction occurs, the difference should be
discounted to the current date to arrive at the actual amount of ineffectiveness.
For example, if the measurement date were one month after the hedging relationship was
established and the forecast transaction is now expected to occur in two months, the
amount would have to be discounted for the remaining two months before the forecast
transaction is expected to occur to arrive at the actual fair value. This step would not be
necessary in the examples provided above because there was no ineffectiveness. Therefore,
additional discounting of the amounts, which net to zero, would not have changed the
result.
Under Method B, ineffectiveness is computed on the basis of the difference between the
forward coupon interest rates for the applicable periods at the effectiveness measurement
date and the interest rate that would have been obtained if the debt had been issued at the
market rate that existed at the inception of the hedge. Computing the change in cash flows
based on the difference between the forward interest rates that existed at the inception of
the hedge and the forward rates that exist at the effectiveness measurement date is
inappropriate if the objective of the hedge is to establish a single fixed rate for a series of
forecast interest payments. This objective is met by hedging the exposures with an interest
rate swap as illustrated in the above example. The fixed interest rate on the swap is a
blended interest rate composed of the forward rates over the life of the swap. Unless the
yield curve is flat, the comparison between the forward interest rate exposures over the life
of the swap and the fixed rate on the swap will produce different cash flows whose fair
values are equal only at the inception of the hedging relationship. This difference is shown
in the table below.
If the objective of the hedge is to obtain the forward rates that existed at the inception of
the hedge, the interest rate swap is ineffective because the swap has a single blended fixed
coupon rate that does not offset a series of different forward interest rates. However, if the
objective of the hedge is to obtain the forward coupon rate that existed at the inception of
the hedge, the swap is effective, and the comparison based on differences in forward
interest rates suggests ineffectiveness when none may exist. Computing ineffectiveness
based on the difference between the forward interest rates that existed at the inception of
the hedge and the forward rates that exist at the effectiveness measurement date would be
an appropriate measurement of ineffectiveness if the hedging objective is to lock in those
forward interest rates. In that case, the appropriate hedging instrument would be a series
of forward contracts each of which matures on a repricing date that corresponds with the
date of the forecast transactions.
It also should be noted that it would be inappropriate to compare only the variable cash
flows on the interest rate swap with the interest cash flows in the debt that would be

generated by the forward interest rates. That methodology has the effect of measuring
ineffectiveness only on a portion of the derivative, and IAS 39 does not permit the
bifurcation of a derivative for the purposes of assessing effectiveness in this situation
(IAS 39.74). It is recognised, however, that if the fixed interest rate on the interest rate
swap is equal to the fixed rate that would have been obtained on the debt at inception,
there will be no ineffectiveness assuming that there are no differences in terms and no
change in credit risk or it is not designated in the hedging relationship.
F.5.6 Cash flow hedges: firm commitment to purchase inventory in a

foreign currency
Entity A has the Local Currency (LC) as its functional currency and presentation
currency. On 30 June 20X1, it enters into a forward exchange contract to receive
Foreign Currency (FC) 100,000 and deliver LC109,600 on 30 June 20X2 at an
initial cost and fair value of zero. It designates the forward exchange contract as a
hedging instrument in a cash flow hedge of a firm commitment to purchase a
certain quantity of paper on 31 March 20X2 and the resulting payable of
FC100,000, which is to be paid on 30 June 20X2. All hedge accounting conditions
in IAS 39 are met.
As indicated in the table below, on 30 June 20X1, the spot exchange rate is LC1.072 to FC1,
while the twelve-month forward exchange rate is LC1.096 to FC1. On 31 December 20X1,
the spot exchange rate is LC1.080 to FC1, while the six-month forward exchange rate is
LC1.092 to FC1. On 31 March 20X2, the spot exchange rate is LC1.074 to FC1, while the
three-month forward rate is LC1.076 to FC1. On 30 June 20X2, the spot exchange rate is
LC1.072 to FC1. The applicable yield curve in the local currency is flat at 6 per cent per year
throughout the period. The fair value of the forward exchange contract is negative LC388 on
31 December 20X1 {([1.092 × 100,000] – 109,600)/1.06(6/12)}, negative LC1.971 on 31
March 20X2 {([1.076 × 100,000] – 109,600)/1.06((3/12))}, and negative LC2,400 on 30
June 20X2 {1.072 × 100,000 – 109,600}.
Issue (a) – What is the accounting for these transactions if the hedging
relationship is designated as being for changes in the fair value of the forward
exchange contract and the entity's accounting policy is to apply basis adjustment
to non-financial assets that result from hedged forecast transactions?
The accounting entries are as follows.

30 June 20X1
Dr Forward LC0
Cr Cash LC0
To record the forward exchange contract at its initial amount of zero (IAS 39.43).
The hedge is expected to be fully effective because the critical terms of the forward
exchange contract and the purchase contract and the assessment of hedge effectiveness
are based on the forward price (IAS 39.AG108).
31 December 20X1
Cr Forward liability LC388
To record the change in the fair value of the forward exchange contract between 30 June
20X1 and 31 December 20X1, ie LC388 – 0 = LC388, in other comprehensive income
(IAS 39.95). The hedge is fully effective because the loss on the forward exchange contract
(LC388) exactly offsets the change in cash flows associated with the purchase contract
based on the forward price [(LC388) = {([1.092 × 100,000] – 109,600)/1.06(6/12)} –
{([1.096 × 100,000] – 109,600)/1.06}].
31 March 20X2
Dr Other comprehensive income LC1,583
Cr Forward liability LC1,583
To record the change in the fair value of the forward exchange contract between 1 January
20X2 and 31 March 20X2 (ie LC1,971 – LC388 = LC1,583) in other comprehensive income
(IAS 39.95). The hedge is fully effective because the loss on the forward exchange contract
(LC1,583) exactly offsets the change in cash flows associated with the purchase contract
based on the forward price [(LC1,583) = {([1.076 × 100,000] – 109,600)/1.06(3/12)} –
{([1.092 × 100,000] – 109,600)/1.06(6/12)}].
D P ( andhProprietary
Confidential i —) for Use Solely by Authorised Personnel LC107
Only 400
Dr Paper (purchase price) LC107,400
Dr Paper (hedging loss) LC1,971
Cr Other comprehensive income LC1,971
Cr Payable LC107,400
To recognise the purchase of the paper at the spot rate (1.074 × FC100,000) and remove
the cumulative loss on the forward exchange contract that has been recognised in other
comprehensive income (LC1,971) and include it in the initial measurement of the purchased
paper. Accordingly, the initial measurement of the purchased paper is LC109,371 consisting
of a purchase consideration of LC107,400 and a hedging loss of LC1,971.
30 June 20X2
Dr Payable LC107,400
Cr Cash LC107,200
Cr Profit or loss LC200
To record the settlement of the payable at the spot rate (FC100,000 × 1.072 = 107,200)
and the associated exchange gain of LC200 (LC107,400 – LC107,200).
Dr Profit or loss LC429

To record the loss on the forward exchange contract between 1 April 20X2 and 30 June
20X2 (ie LC2,400 – LC1,971 = LC429) in profit or loss. The hedge is regarded as fully
effective because the loss on the forward exchange contract (LC429) exactly offsets the
change in the fair value of the payable based on the forward price (LC429 = ([1.072 ×
100,000] – 109,600 – {([1.076 × 100,000] – 109,600)/1.06(3/12)}).
Dr Forward liability LC2,400

Cr Cash LC2,400
To record the net settlement of the forward exchange contract.

Issue (b) – What is the accounting for these transactions if the hedging
relationship instead is designated as being for changes in the spot element of the
forward exchange contract and the interest element is excluded from the
designated hedging relationship (IAS 39.74)?
The accounting entries are as follows.
30 June 20X1
Dr Forward LC0
Cr Cash LC0
To record the forward exchange contract at its initial amount of zero (IAS 39.43). The
hedge is expected to be fully effective because the critical terms of the forward exchange
contract and the purchase contract are the same and the change in the premium or
discount on the forward contract is excluded from the assessment of effectiveness
(IAS 39.AG108).
31 December 20X1
Dr Profit or loss (interest element) LC1,165
Cr Other comprehensive income (spot element) LC777
To record the change in the fair value of the forward exchange contract between 30 June
20X1 and 31 December 20X1, ie LC388 – 0 = LC388. The change in the present value of
spot settlement of the forward exchange contract is a gain of LC777 ({([1.080 × 100,000]
– 107,200)/1.06(6/12)} – {([1.072 × 100,000] – 107,200)/1.06}), which is recognised in
other comprehensive income (IAS 39.95(a)). The change in the interest element of the
forward exchange contract (the residual change in fair value) is a loss of LC1,165 (388 +
777), which is recognised in profit or loss (IAS 39.74 and IAS 39.55). The hedge is fully
effective because the gain in the spot element of the forward contract (LC777) exactly
offsets the change in the purchase price at spot rates (LC777 = {([1.080 × 100,000] –
107,200)/1.06(6/12)} – {([1.072 × 100,000] – 107,200)/1.06}).
31 March 20X2
Dr Other comprehensive income (spot LC580
l )
element)
Dr Profit or loss (interest element) LC1,003
Cr Forward liability LC1,583
To record the change in the fair value of the forward exchange contract between 1 January
20X2 and 31 March 20X2, ie LC1,971 – LC388 = LC1,583. The change in the present value
of the spot settlement of the forward exchange contract is a loss of LC580 ({([1.074 ×
100,000] – 107,200)/1.06(3/12)} – {([1.080 × 100,000] – 107,200)/1.06(6/12)}), which
is recognised in other comprehensive income (IAS 39.95(a)). The change in the interest
element of the forward exchange contract (the residual change in fair value) is a loss of
LC1,003 (LC1,583 – LC580), which is recognised in profit or loss (IAS 39.74 and
IAS 39.55). The hedge is fully effective because the loss in the spot element of the forward
contract (LC580) exactly offsets the change in the purchase price at spot rates [(580) =
{([1.074 × 100,000] – 107,200)/1.06(3/12)} – {([1.080 × 100,000] – 107,200)
/1.06(6/12)}].
Dr Paper (purchase price) LC107,400

Cr Paper (hedging gain) LC197
Cr Payable LC107,400
To recognise the purchase of the paper at the spot rate (= 1.074 × FC100,000) and remove
the cumulative gain on the spot element of the forward exchange contract that has been
recognised in other comprehensive income (LC777 – LC580 = LC197) and include it in the
initial measurement of the purchased paper. Accordingly, the initial measurement of the
purchased paper is LC107,203, consisting of a purchase consideration of LC107,400 and a
hedging gain of LC197.
30 June 20X2
Dr Payable LC107,400
Cr Cash LC107,200
Cr Profit or loss LC200
To record the settlement of the payable at the spot rate (FC100,000 × 1.072 = LC107,200)
and the associated exchange gain of LC200 (– [1.072 – 1.074] × FC100,000).

Dr Profit or loss (spot element) LC197
Dr Profit or loss (interest element) LC232
To record the change in the fair value of the forward exchange contract between 1 April
20X2 and 30 June 20X2 (ie LC2,400 – LC1,971 = LC429). The change in the present value
of the spot settlement of the forward exchange contract is a loss of LC197 ([1.072 ×
100,000] – 107,200 – {([1.074 × 100,000] – 107,200)/1.06(3/12)}), which is recognised
in profit or loss. The change in the interest element of the forward exchange contract (the
residual change in fair value) is a loss of LC232 (LC429 – LC197), which is recognised in
profit or loss. The hedge is fully effective because the loss in the spot element of the
forward contract (LC197) exactly offsets the change in the present value of the spot
settlement of the payable [(LC197) = {[1.072 × 100,000] – 107,200 – {([1.074 ×
100,000] – 107,200)/1.06(3/12)}].
Dr Forward liability LC2,400

Cr Cash LC2,400
To record the net settlement of the forward exchange contract.
The following table provides an overview of the components of the change in fair value of
the hedging instrument over the term of the hedging relationship. It illustrates that the way
in which a hedging relationship is designated affects the subsequent accounting for that
hedging relationship, including the assessment of hedge effectiveness and the recognition of
gains and losses.

F.6 Hedges: other issues
F.6.1 Hedge accounting: management of interest rate risk in financial

institutions
Banks and other financial institutions often manage their exposure to interest rate
risk on a net basis for all or parts of their activities. They have systems to
accumulate critical information throughout the entity about their financial assets,
financial liabilities and forward commitments, including loan commitments. This
information is used to estimate and aggregate cash flows and to schedule such
estimated cash flows into the applicable future periods in which they are expected
to be paid or received. The systems generate estimates of cash flows based on the
contractual terms of the instruments and other factors, including estimates of
prepayments and defaults. For risk management purposes, many financial
institutions use derivative contracts to offset some or all exposure to interest rate
risk on a net basis.
If a financial institution manages interest rate risk on a net basis, can its activities
potentially qualify for hedge accounting under IAS 39?
Yes. However, to qualify for hedge accounting the derivative hedging instrument that
hedges the net position for risk management purposes must be designated for accounting
purposes as a hedge of a gross position related to assets, liabilities, forecast cash inflows or
forecast cash outflows giving rise to the net exposure (IAS 39.84, IAS 39.AG101 and
IAS 39.AG111). It is not possible to designate a net position as a hedged item under IAS 39
because of the inability to associate hedging gains and losses with a specific item being
hedged and, correspondingly, to determine objectively the period in which such gains and
losses should be recognised in profit or loss.
Hedging a net exposure to interest rate risk can often be defined and documented to meet
the qualifying criteria for hedge accounting in IAS 39.88 if the objective of the activity is to
offset a specific, identified and designated risk exposure that ultimately affects the entity's
profit or loss (IAS 39.AG110) and the entity designates and documents its interest rate risk
exposure on a gross basis. Also, to qualify for hedge accounting the information systems
must capture sufficient information about the amount and timing of cash flows and the
effectiveness of the risk management activities in accomplishing their objective.
The factors an entity must consider for hedge accounting purposes if it manages interest
rate risk on a net basis are discussed in Question F.6.2.
F.6.2 Hedge accounting considerations when interest rate risk is

managed on a net basis
If an entity manages its exposure to interest rate risk on a net basis, what are the
issues the entity should consider in defining and documenting its interest rate risk
management activities to qualify for hedge accounting and in establishing and
accounting for the hedge relationship?
Issues (a)–(l) below deal with the main issues. First, Issues (a) and (b) discuss the
designation of derivatives used in interest rate risk management activities as fair value
hedges or cash flow hedges. As noted there, hedge accounting criteria and accounting
consequences differ between fair value hedges and cash flow hedges. Since it may be easier
to achieve hedge accounting treatment if derivatives used in interest rate risk management
activities are designated as cash flow hedging instruments, Issues (c)–(l) expand on various
aspects of the accounting for cash flow hedges. Issues (c)–(f) consider the application of
the hedge accounting criteria for cash flow hedges in IAS 39, and Issues (g) and (h) discuss
the required accounting treatment. Finally, Issues (i)–(l) elaborate on other specific issues
relating to the accounting for cash flow hedges.
Issue (a) – Can a derivative that is used to manage interest rate risk on a net
basis be designated under IAS 39 as a hedging instrument in a fair value hedge or
a cash flow hedge of a gross exposure?
Both types of designation are possible under IAS 39. An entity may designate the derivative
used in interest rate risk management activities either as a fair value hedge of assets,
liabilities and firm commitments or as a cash flow hedge of forecast transactions, such as
the anticipated reinvestment of cash inflows, the anticipated refinancing or rollover of a
financial liability, and the cash flow consequences of the resetting of interest rates for an
asset or a liability.
In economic terms, it does not matter whether the derivative instrument is regarded as a
fair value hedge or as a cash flow hedge. Under either perspective of the exposure, the
derivative has the same economic effect of reducing the net exposure. For example, a
receive-fixed, pay-variable interest rate swap can be considered to be a cash flow hedge of
a variable rate asset or a fair value hedge of a fixed rate liability. Under either perspective,
the fair value or cash flows of the interest rate swap offset the exposure to interest rate
changes. However, accounting consequences differ depending on whether the derivative is
designated as a fair value hedge or a cash flow hedge, as discussed in Issue (b).
To illustrate: a bank has the following assets and liabilities with a maturity of two years.

The bank takes out a two-year swap with a notional principal of CU40 to receive a variable
interest rate and pay a fixed interest rate to hedge the net exposure. As discussed above,
this may be regarded and designated either as a fair value hedge of CU40 of the fixed rate
assets or as a cash flow hedge of CU40 of the variable rate liabilities.
Issue (b) – What are the critical considerations in deciding whether a derivative
that is used to manage interest rate risk on a net basis should be designated as a
hedging instrument in a fair value hedge or a cash flow hedge of a gross
exposure?
Critical considerations include the assessment of hedge effectiveness in the presence of

prepayment risk and the ability of the information systems to attribute fair value or cash
flow changes of hedging instruments to fair value or cash flow changes, respectively, of
hedged items, as discussed below.
For accounting purposes, the designation of a derivative as hedging a fair value exposure or
a cash flow exposure is important because both the qualification requirements for hedge
accounting and the recognition of hedging gains and losses for these categories are
different. It is often easier to demonstrate high effectiveness for a cash flow hedge than for
a fair value hedge.
Effects of prepayments
Prepayment risk inherent in many financial instruments affects the fair value of an
instrument and the timing of its cash flows and impacts on the effectiveness test for fair
value hedges and the highly probable test for cash flow hedges, respectively.
Effectiveness is often more difficult to achieve for fair value hedges than for cash flow
hedges when the instrument being hedged is subject to prepayment risk. For a fair value
hedge to qualify for hedge accounting, the changes in the fair value of the derivative
hedging instrument must be expected to be highly effective in offsetting the changes in the
fair value of the hedged item (IAS 39.88(b)). This test may be difficult to meet if, for
example, the derivative hedging instrument is a forward contract having a fixed term and
the financial assets being hedged are subject to prepayment by the borrower. Also, it may
be difficult to conclude that, for a portfolio of fixed rate assets that are subject to
prepayment, the changes in the fair value for each individual item in the group will be
expected to be approximately proportional to the overall changes in fair value attributable
to the hedged risk of the group. Even if the risk being hedged is a benchmark interest rate,
to be able to conclude that fair value changes will be proportional for each item in the
portfolio, it may be necessary to disaggregate the asset portfolio into categories based on
term, coupon, credit, type of loan and other characteristics.
In economic terms, a forward derivative instrument could be used to hedge assets that are
subject to prepayment but it would be effective only for small movements in interest rates.
A reasonable estimate of prepayments can be made for a given interest rate environment
and the derivative position can be adjusted as the interest rate environment changes. If an
entity's risk management strategy is to adjust the amount of the hedging instrument
periodically to reflect changes in the hedged position, the entity needs to demonstrate that
the hedge is expected to be highly effective only for the period until the amount of the
hedging instrument is next adjusted. However, for that period, the expectation of
effectiveness has to be based on existing fair value exposures and the potential for interest
rate movements without consideration of future adjustments to those positions.
Furthermore, the fair value exposure attributable to prepayment risk can generally be
hedged with options.
For a cash flow hedge to qualify for hedge accounting, the forecast cash flows, including the
reinvestment of cash inflows or the refinancing of cash outflows, must be highly probable
(IAS 39.88(c)) and the hedge expected to be highly effective in achieving offsetting
changes in the cash flows of the hedged item and hedging instrument (IAS 39.88(b)).
Prepayments affect the timing of cash flows and, therefore, the probability of occurrence of
the forecast transaction. If the hedge is established for risk management purposes on a net
basis, an entity may have sufficient levels of highly probable cash flows on a gross basis to
support the designation for accounting purposes of forecast transactions associated with a
portion of the gross cash flows as the hedged item. In this case, the portion of the gross
cash flows designated as being hedged may be chosen to be equal to the amount of net
cash flows being hedged for risk management purposes.
Systems considerations
The accounting for fair value hedges differs from that for cash flow hedges. It is usually
easier to use existing information systems to manage and track cash flow hedges than it is
for fair value hedges.
Under fair value hedge accounting, the assets or liabilities that are designated as being
hedged are remeasured for those changes in fair values during the hedge period that are
attributable to the risk being hedged. Such changes adjust the carrying amount of the
hedged items and, for interest sensitive assets and liabilities, may result in an adjustment
of the effective interest rate of the hedged item (IAS 39.89). As a consequence of fair value
hedging activities, the changes in fair value have to be allocated to the assets or liabilities
being hedged in order for the entity to be able to recompute their effective interest rate,
determine the subsequent amortisation of the fair value adjustment to profit or loss, and
determine the amount that should be reclassified from equity to profit or loss when assets
are sold or liabilities extinguished (IAS 39.89 and IAS 39.92). To comply with the
requirements for fair value hedge accounting, it will generally be necessary to establish a
system to track the changes in the fair value attributable to the hedged risk, associate
those changes with individual hedged items, recompute the effective interest rate of the
hedged items, and amortise the changes to profit or loss over the life of the respective
hedged item.

Under cash flow hedge accounting, the cash flows relating to the forecast transactions that
are designated as being hedged reflect changes in interest rates. The adjustment for
changes in the fair value of a hedging derivative instrument is initially recognised in other
comprehensive income (IAS 39.95). To comply with the requirements for cash flow hedge
accounting, it is necessary to determine when the cumulative gains and losses recognised in
other comprehensive income from changes in the fair value of a hedging instrument should
be reclassified to profit or loss (IAS 39.100 and IAS 39.101). For cash flow hedges, it is not
necessary to create a separate system to make this determination. The system used to
determine the extent of the net exposure provides the basis for scheduling the changes in
the cash flows of the derivative and the recognition of such changes in profit or loss.
The timing of the recognition in profit or loss can be predetermined when the hedge is
associated with the exposure to changes in cash flows. The forecast transactions that are
being hedged can be associated with a specific principal amount in specific future periods
composed of variable rate assets and cash inflows being reinvested or variable rate liabilities
and cash outflows being refinanced, each of which creates a cash flow exposure to changes
in interest rates. The specific principal amounts in specific future periods are equal to the
notional amount of the derivative hedging instruments and are hedged only for the period
that corresponds to the repricing or maturity of the derivative hedging instruments so that
the cash flow changes resulting from changes in interest rates are matched with the
derivative hedging instrument. IAS 39.100 specifies that the amounts recognised in other
comprehensive income should be reclassified from equity to profit or loss in the same period
or periods during which the hedged item affects profit or loss.
Issue (c) – If a hedging relationship is designated as a cash flow hedge relating to

changes in cash flows resulting from interest rate changes, what would be
included in the documentation required by IAS 39.88(a)?
The following would be included in the documentation.
The hedging relationship - The maturity schedule of cash flows used for risk management
purposes to determine exposures to cash flow mismatches on a net basis would provide
part of the documentation of the hedging relationship.
The entity's risk management objective and strategy for undertaking the hedge - The
entity's overall risk management objective and strategy for hedging exposures to interest
rate risk would provide part of the documentation of the hedging objective and strategy.
The type of hedge - The hedge is documented as a cash flow hedge.
The hedged item - The hedged item is documented as a group of forecast transactions
(interest cash flows) that are expected to occur with a high degree of probability in specified
future periods, for example, scheduled on a monthly basis. The hedged item may include
interest cash flows resulting from the reinvestment of cash inflows, including the resetting
of interest rates on assets, or from the refinancing of cash outflows, including the resetting
of interest rates on liabilities and rollovers of financial liabilities. As discussed in Issue (e),
the forecast transactions meet the probability test if there are sufficient levels of highly
probable cash flows in the specified future periods to encompass the amounts designated as
being hedged on a gross basis.
The hedged risk - The risk designated as being hedged is documented as a portion of the
overall exposure to changes in a specified market interest rate, often the risk-free interest
rate or an interbank offered rate, common to all items in the group. To help ensure that the
hedge effectiveness test is met at inception of the hedge and subsequently, the designated
hedged portion of the interest rate risk could be documented as being based on the same
yield curve as the derivative hedging instrument.
The hedging instrument - Each derivative hedging instrument is documented as a hedge of

specified amounts in specified future time periods corresponding with the forecast
transactions occurring in the specified future time periods designated as being hedged.
The method of assessing effectiveness - The effectiveness test is documented as being

measured by comparing the changes in the cash flows of the derivatives allocated to the
applicable periods in which they are designated as a hedge to the changes in the cash flows
of the forecast transactions being hedged. Measurement of the cash flow changes is based
on the applicable yield curves of the derivatives and hedged items.
Issue (d) – If the hedging relationship is designated as a cash flow hedge, how
does an entity satisfy the requirement for an expectation of high effectiveness in
achieving offsetting changes in IAS 39.88(b)?
An entity may demonstrate an expectation of high effectiveness by preparing an analysis

demonstrating high historical and expected future correlation between the interest rate risk
designated as being hedged and the interest rate risk of the hedging instrument. Existing
documentation of the hedge ratio used in establishing the derivative contracts may also
serve to demonstrate an expectation of effectiveness.
Issue (e) – If the hedging relationship is designated as a cash flow hedge, how
does an entity demonstrate a high probability of the forecast transactions
occurring as required by IAS 39.88(c)?
An entity may do this by preparing a cash flow maturity schedule showing that there exist
sufficient aggregate gross levels of expected cash flows, including the effects of the
resetting of interest rates for assets or liabilities, to establish that the forecast transactions
that are designated as being hedged are highly probable to occur. Such a schedule should
be supported by management's stated intentions and past practice of reinvesting cash
inflows and refinancing cash outflows.
For example, an entity may forecast aggregate gross cash inflows of CU100 and aggregate
gross cash outflows of CU90 in a particular time period in the near future. In this case, it
may wish to designate the forecast reinvestment of gross cash inflows of CU10 as the
hedged item in the future time period. If more than CU10 of the forecast cash inflows are
contractually specified and have low credit risk, the entity has strong evidence to support an
assertion that gross cash inflows of CU10 are highly probable to occur and to support the
designation of the forecast reinvestment of those cash flows as being hedged for a
particular portion of the reinvestment period. A high probability of the forecast transactions
occurring may also be demonstrated under other circumstances.
Issue (f) – If the hedging relationship is designated as a cash flow hedge, how
does an entity assess and measure effectiveness under IAS 39.88(d) and
IAS 39.88(e)?
Effectiveness is required to be measured at a minimum at the time an entity prepares its

annual or interim financial reports. However, an entity may wish to measure it more
frequently on a specified periodic basis, at the end of each month or other applicable
reporting period. It is also measured whenever derivative positions designated as hedging
instruments are changed or hedges are terminated to ensure that the recognition in profit
or loss of the changes in the fair value amounts on assets and liabilities and the recognition
of changes in the fair value of derivative instruments designated as cash flow hedges are
appropriate.
Changes in the cash flows of the derivative are computed and allocated to the applicable
periods in which the derivative is designated as a hedge and are compared with
computations of changes in the cash flows of the forecast transactions. Computations are
based on yield curves applicable to the hedged items and the derivative hedging
instruments and applicable interest rates for the specified periods being hedged.
The schedule used to determine effectiveness could be maintained and used as the basis for
determining the period in which the hedging gains and losses recognised initially in other
comprehensive income are reclassified from equity to profit or loss.
Issue (g) – If the hedging relationship is designated as a cash flow hedge, how
does an entity account for the hedge?
The hedge is accounted for as a cash flow hedge in accordance with the provisions in
IAS 39.95–IAS 39.100, as follows:
i. the portion of gains and losses on hedging derivatives determined to result

from effective hedges is recognised in other comprehensive income whenever
effectiveness is measured; and
ii. the ineffective portion of gains and losses resulting from hedging derivatives
is recognised in profit or loss.
IAS 39.100 specifies that the amounts recognised in other comprehensive income should be
reclassified from equity to profit or loss in the same period or periods during which the
hedged item affects profit or loss. Accordingly, when the forecast transactions occur, the
amounts previously recognised in other comprehensive income are reclassified from equity
to profit or loss. For example, if an interest rate swap is designated as a hedging instrument
of a series of forecast cash flows, the changes in the cash flows of the swap are reclassified
from equity to profit or loss in the periods when the forecast cash flows and the cash flows
of the swap offset each other.
Issue (h) – If the hedging relationship is designated as a cash flow hedge, what is
the treatment of any net cumulative gains and losses recognised in other
comprehensive income if the hedging instrument is terminated prematurely, the
hedge accounting criteria are no longer met, or the hedged forecast transactions
are no longer expected to take place?

If the hedging instrument is terminated prematurely or the hedge no longer meets the
criteria for qualification for hedge accounting, for example, the forecast transactions are no
longer highly probable, the net cumulative gain or loss recognised in other comprehensive
income remains in equity until the forecast transaction occurs (IAS 39.101(a) and
IAS 39.101(b)). If the hedged forecast transactions are no longer expected to occur, the net
cumulative gain or loss is reclassified from equity to profit or loss (IAS 39.101(c)).
Issue (i) – IAS 39.75 states that a hedging relationship may not be designated for only a
portion of the time period in which a hedging instrument is outstanding. If the hedging
relationship is designated as a cash flow hedge, and the hedge subsequently fails the test
for being highly effective, does IAS 39.75 preclude redesignating the hedging instrument?
No. IAS 39.75 indicates that a derivative instrument may not be designated as a hedging
instrument for only a portion of its remaining period to maturity. IAS 39.75 does not refer
to the derivative instrument's original period to maturity. If there is a hedge effectiveness
failure, the ineffective portion of the gain or loss on the derivative instrument is recognised
immediately in profit or loss (IAS 39.95(b)) and hedge accounting based on the previous
designation of the hedge relationship cannot be continued (IAS 39.101). In this case, the
derivative instrument may be redesignated prospectively as a hedging instrument in a new
hedging relationship provided this hedging relationship satisfies the necessary conditions.
The derivative instrument must be redesignated as a hedge for the entire time period it
remains outstanding.
Issue (j) – For cash flow hedges, if a derivative is used to manage a net exposure
to interest rate risk and the derivative is designated as a cash flow hedge of
forecast interest cash flows or portions of them on a gross basis, does the
occurrence of the hedged forecast transaction give rise to an asset or liability that
will result in a portion of the hedging gains and losses that were recognised in
other comprehensive income remaining in equity?
No. In the hedging relationship described in Issue (c) above, the hedged item is a group of
forecast transactions consisting of interest cash flows in specified future periods.
The hedged forecast transactions do not result in the recognition of assets or liabilities and
the effect of interest rate changes that are designated as being hedged is recognised in
profit or loss in the period in which the forecast transactions occur. Although this is not
relevant for the types of hedges described here, if instead the derivative is designated as a
hedge of a forecast purchase of a financial asset or issue of a financial liability, the
associated gains or losses that were recognised in other comprehensive income are
reclassified from equity to profit or loss in the same period or periods during which the
hedged forecast cash flows affect profit or loss (such as in the periods that interest
expenses are recognised). However, if an entity expects at any time that all or a portion of
a net loss recognised in other comprehensive income will not be recovered in one or more
future periods, it shall reclassify immediately from equity to profit or loss the amount that is
not expected to be recovered.
Issue (k) – In the answer to Issue (c) above it was indicated that the designated
hedged item is a portion of a cash flow exposure. Does IAS 39 permit a portion of a cash
flow exposure to be designated as a hedged item?

Yes. IAS 39 does not specifically address a hedge of a portion of a cash flow exposure for a
forecast transaction. However, IAS 39.81 specifies that a financial asset or liability may be a
hedged item with respect to the risks associated with only a portion of its cash flows or fair
value, if effectiveness can be measured. The ability to hedge a portion of a cash flow
exposure resulting from the resetting of interest rates for assets and liabilities suggests that
a portion of a cash flow exposure resulting from the forecast reinvestment of cash inflows or
the refinancing or rollover of financial liabilities can also be hedged. The basis for
qualification as a hedged item of a portion of an exposure is the ability to measure
effectiveness. This is further supported by IAS 39.82, which specifies that a non-financial
asset or liability can be hedged only in its entirety or for foreign currency risk but not for a
portion of other risks because of the difficulty of isolating and measuring the appropriate
portion of the cash flows or fair value changes attributable to a specific risk. Accordingly,
assuming effectiveness can be measured, a portion of a cash flow exposure of forecast
transactions associated with, for example, the resetting of interest rates for a variable rate
asset or liability can be designated as a hedged item.
Issue (l) – In the answer to Issue (c) above it was indicated that the hedged item is
documented as a group of forecast transactions. Since these transactions will have different
terms when they occur, including credit exposures, maturities and option features, how can
an entity satisfy the tests in IAS 39.78 and IAS 39.83 requiring the hedged group to have
similar risk characteristics?
IAS 39.78 provides for hedging a group of assets, liabilities, firm commitments or forecast
transactions with similar risk characteristics. IAS 39.83 provides additional guidance and
specifies that portfolio hedging is permitted if two conditions are met, namely: the individual
items in the portfolio share the same risk for which they are designated, and the change in
the fair value attributable to the hedged risk for each individual item in the group will be
expected to be approximately proportional to the overall change in fair value.
When an entity associates a derivative hedging instrument with a gross exposure, the
hedged item typically is a group of forecast transactions. For hedges of cash flow exposures
relating to a group of forecast transactions, the overall exposure of the forecast transactions
and the assets or liabilities that are repriced may have very different risks. The exposure
from forecast transactions may differ depending on the terms that are expected as they
relate to credit exposures, maturities, options and other features. Although the overall risk
exposures may be different for the individual items in the group, a specific risk inherent in
each of the items in the group can be designated as being hedged.
The items in the portfolio do not necessarily have to have the same overall exposure to risk,
provided they share the same risk for which they are designated as being hedged.
A common risk typically shared by a portfolio of financial instruments is exposure to
changes in the risk-free or benchmark interest rate or to changes in a specified rate that
has a credit exposure equal to the highest credit-rated instrument in the portfolio (ie the
instrument with the lowest credit risk). If the instruments that are grouped into a portfolio
have different credit exposures, they may be hedged as a group for a portion of the
exposure. The risk they have in common that is designated as being hedged is the exposure
to interest rate changes from the highest credit rated instrument in the portfolio. This
ensures that the change in fair value attributable to the hedged risk for each individual item
in the group is expected to be approximately proportional to the overall change in fair value
attributable to the hedged risk of the group. It is likely there will be some ineffectiveness if
the hedging instrument has a credit quality that is inferior to the credit quality of the
highest credit-rated instrument being hedged, since a hedging relationship is designated for
a hedging instrument in its entirety (IAS 39.74). For example, if a portfolio of assets
consists of assets rated A, BB and B, and the current market interest rates for these assets
are LIBOR+20 basis points, LIBOR+40 basis points and LIBOR+60 basis points,
respectively, an entity may use a swap that pays fixed interest rate and for which variable
interest payments based on LIBOR are made to hedge the exposure to variable interest
rates. If LIBOR is designated as the risk being hedged, credit spreads above LIBOR on the
hedged items are excluded from the designated hedge relationship and the assessment of
hedge effectiveness.
F.6.3 Illustrative example of applying the approach in Question F.6.2
The purpose of this example is to illustrate the process of establishing, monitoring

and adjusting hedge positions and of qualifying for cash flow hedge accounting in
applying the approach to hedge accounting described in Question F.6.2 when a
financial institution manages its interest rate risk on an entity-wide basis. To this end, this
example identifies a methodology that allows for the use of hedge accounting and takes
advantage of existing risk management systems so as to avoid unnecessary changes to it
and to avoid unnecessary bookkeeping and tracking.
The approach illustrated here reflects only one of a number of risk management processes
that could be employed and could qualify for hedge accounting. Its use is not intended to
suggest that other alternatives could not or should not be used. The approach being
illustrated could also be applied in other circumstances (such as for cash flow hedges of
commercial entities), for example, hedging the rollover of commercial paper financing.
Identifying, assessing and reducing cash flow exposures
The discussion and illustrations that follow focus on the risk management activities of a
financial institution that manages its interest rate risk by analysing expected cash flows in a
particular currency on an entity-wide basis. The cash flow analysis forms the basis for
identifying the interest rate risk of the entity, entering into hedging transactions to manage
the risk, assessing the effectiveness of risk management activities, and qualifying for and
applying cash flow hedge accounting.
The illustrations that follow assume that an entity, a financial institution, had the following
expected future net cash flows and hedging positions outstanding in a specific currency,
consisting of interest rate swaps, at the beginning of Period X0. The cash flows shown are
expected to occur at the end of the period and, therefore, create a cash flow interest
exposure in the following period as a result of the reinvestment or repricing of the cash
inflows or the refinancing or repricing of the cash outflows.
The illustrations assume that the entity has an ongoing interest rate risk management
programme. Schedule I shows the expected cash flows and hedging positions that existed
at the beginning of Period X0. It is included here to provide a starting point in the analysis.
It provides a basis for considering existing hedges in connection with the evaluation that
occurs at the beginning of Period X1.
The schedule depicts five quarterly periods. The actual analysis would extend over a period
of many years, represented by the notation '…n'. A financial institution that manages its
interest rate risk on an entity-wide basis re-evaluates its cash flow exposures periodically.
The frequency of the evaluation depends on the entity's risk management policy.
For the purposes of this illustration, the entity is re-evaluating its cash flow exposures at
the end of Period X0. The first step in the process is the generation of forecast net cash flow
exposures from existing interest-earning assets and interest-bearing liabilities, including the
rollover of short-term assets and short-term liabilities. Schedule II below illustrates the
forecast of net cash flow exposures. A common technique for assessing exposure to interest
rates for risk management purposes is an interest rate sensitivity gap analysis showing the
gap between interest rate-sensitive assets and interest rate-sensitive liabilities over
different time intervals. Such an analysis could be used as a starting point for identifying
cash flow exposures to interest rate risk for hedge accounting purposes.

1. The cash flows are estimated using contractual terms and assumptions based
on management's intentions and market factors. It is assumed that
short-term assets and liabilities will continue to be rolled over in succeeding
periods. Assumptions about prepayments and defaults and the withdrawal of
deposits are based on market and historical data. It is assumed that principal
and interest inflows and outflows will be reinvested and refinanced,
respectively, at the end of each period at the then current market interest
rates and share the benchmark interest rate risk to which they are exposed.
2. Forward interest rates obtained from Schedule VI are used to forecast interest
payments on variable rate financial instruments and expected rollovers of
short-term assets and liabilities. All forecast cash flows are associated with
the specific time periods (3 months, 6 months, 9 months and 12 months) in
which they are expected to occur. For completeness, the interest cash flows
resulting from reinvestments, refinancings and repricings are included in the
schedule and shown gross even though only the net margin may actually be
reinvested. Some entities may choose to disregard the forecast interest cash
flows for risk management purposes because they may be used to absorb
operating costs and any remaining amounts would not be significant enough
to affect risk management decisions.
3. The cash flow forecast is adjusted to include the variable rate asset and
liability balances in each period in which such variable rate asset and liability
balances are repriced. The principal amounts of these assets and liabilities are
not actually being paid and, therefore, do not generate a cash flow. However,
since interest is computed on the principal amounts for each period based on
the then current market interest rate, such principal amounts expose the
entity to the same interest rate risk as if they were cash flows being
reinvested or refinanced.
4. The forecast cash flow and repricing exposures that are identified in each
period represent the principal amounts of cash inflows that will be reinvested
or repriced and cash outflows that will be refinanced or repriced at the market
interest rates that are in effect when those forecast transactions occur.
5. The net cash flow and repricing exposure is the difference between the cash
inflow and repricing exposures from assets and the cash outflow and repricing
exposures from liabilities. In the illustration, the entity is exposed to interest
rate declines because the exposure from assets exceeds the exposure from
liabilities and the excess (ie the net amount) will be reinvested or repriced at
the current market rate and there is no offsetting refinancing or repricing of
outflows.
Note that some banks regard some portion of their non-interest bearing demand deposits as
economically equivalent to long-term debt. However, these deposits do not create a cash
flow exposure to interest rates and would therefore be excluded from this analysis for
accounting purposes.
Schedule II Forecast net cash flow and repricing exposures provides no more than a starting
point for assessing cash flow exposure to interest rates and for adjusting hedging positions.
The complete analysis includes outstanding hedging positions and is shown in Schedule III
Analysis of expected net exposures and hedging positions. It compares the forecast net
cash flow exposures for each period (developed in Schedule II) with existing hedging
positions (obtained from Schedule I), and provides a basis for considering whether
adjustment of the hedging relationship should be made.

The notional amounts of the interest rate swaps that are outstanding at the analysis date
are included in each of the periods in which the interest rate swaps are outstanding to
illustrate the impact of the outstanding interest rate swaps on the identified cash flow
exposures. The notional amounts of the outstanding interest rate swaps are included in
each period because interest is computed on the notional amounts each period, and the
variable rate components of the outstanding swaps are repriced to the current market rate
quarterly. The notional amounts create an exposure to interest rates that in part is similar
to the principal balances of variable rate assets and variable rate liabilities.
The exposure that remains after considering the existing positions is then evaluated to
determine the extent to which adjustments of existing hedging positions are necessary. The
bottom portion of Schedule III shows the beginning of Period X1 using interest rate swap
transactions to reduce the net exposures further to within the tolerance levels established
under the entity's risk management policy.
Note that in the illustration, the cash flow exposure is not entirely eliminated. Many financial
institutions do not fully eliminate risk but rather reduce it to within some tolerable limit.
Various types of derivative instruments could be used to manage the cash flow exposure to
interest rate risk identified in the schedule of forecast net cash flows (Schedule II).
However, for the purpose of the illustration, it is assumed that interest rate swaps are used
for all hedging activities. It is also assumed that in periods in which interest rate swaps
should be reduced, rather than terminating some of the outstanding interest rate swap
positions, a new swap with the opposite return characteristics is added to the portfolio.
In the illustration in Schedule III above, swap 1, a receive-fixed, pay-variable swap, is used
to reduce the net exposure in Periods X1 and X2. Since it is a 10-year swap, it also reduces
exposures identified in other future periods not shown. However, it has the effect of
creating an over-hedged position in Periods X3–X5. Swap 2, a forward starting pay-fixed,
receive-variable interest rate swap, is used to reduce the notional amount of the
outstanding receive-fixed, pay-variable interest rate swaps in Periods X3–X5 and thereby
reduce the over-hedged positions.
It also is noted that in many situations, no adjustment or only a single adjustment of the
outstanding hedging position is necessary to bring the exposure to within an acceptable
limit. However, when the entity's risk management policy specifies a very low tolerance of
risk a greater number of adjustments to the hedging positions over the forecast period
would be needed to further reduce any remaining risk.
To the extent that some of the interest rate swaps fully offset other interest rate swaps that
have been entered into for hedging purposes, it is not necessary to include them in a
designated hedging relationship for hedge accounting purposes. These offsetting positions
can be combined, de-designated as hedging instruments, if necessary, and reclassified for
accounting purposes from the hedging portfolio to the trading portfolio. This procedure
limits the extent to which the gross swaps must continue to be designated and tracked in a
hedging relationship for accounting purposes. For the purposes of this illustration it is
assumed that CU500 of the pay-fixed, receive-variable interest rate swaps fully offset
CU500 of the receive-fixed, pay-variable interest rate swaps at the beginning of Period X1
and for Periods X1–X5, and are de-designated as hedging instruments and reclassified to
the trading account.
After reflecting these offsetting positions, the remaining gross interest rate swap positions
from Schedule III are shown in Schedule IV as follows.
For the purposes of the illustrations, it is assumed that swap 2, entered into at the
beginning of Period X1, only partially offsets another swap being accounted for as a hedge
and therefore continues to be designated as a hedging instrument.
Hedge accounting considerations

Illustrating the designation of the hedging relationship
The discussion and illustrations thus far have focused primarily on economic and risk
management considerations relating to the identification of risk in future periods and the
adjustment of that risk using interest rate swaps. These activities form the basis for
designating a hedging relationship for accounting purposes.
The examples in IAS 39 focus primarily on hedging relationships involving a single hedged
item and a single hedging instrument, but there is little discussion and guidance on portfolio
hedging relationships for cash flow hedges when risk is being managed centrally. In this
illustration, the general principles are applied to hedging relationships involving a
component of risk in a portfolio having multiple risks from multiple transactions or positions.
Although designation is necessary to achieve hedge accounting, the way in which the
designation is described also affects the extent to which the hedging relationship is judged
to be effective for accounting purposes and the extent to which the entity's existing system
for managing risk will be required to be modified to track hedging activities for accounting
purposes. Accordingly, an entity may wish to designate the hedging relationship in a
manner that avoids unnecessary systems changes by taking advantage of the information
already generated by the risk management system and avoids unnecessary bookkeeping
and tracking. In designating hedging relationships, the entity may also consider the extent
to which ineffectiveness is expected to be recognised for accounting purposes under
alternative designations.
The designation of the hedging relationship needs to specify various matters. These are
illustrated and discussed here from the perspective of the hedge of the interest rate risk
associated with the cash inflows, but the guidance can also be applied to the hedge of the
risk associated with the cash outflows. It is fairly obvious that only a portion of the gross
exposures relating to the cash inflows is being hedged by the interest rate swaps.
Schedule V The general hedging relationship illustrates the designation of the portion of the
gross reinvestment risk exposures identified in Schedule II as being hedged by the interest
rate swaps.
The hedged exposure percentage is computed as the ratio of the notional amount of the
receive-fixed, pay-variable swaps that are outstanding divided by the gross exposure. Note
that in Schedule V there are sufficient levels of forecast reinvestments in each period to
offset more than the notional amount of the receive-fixed, pay-variable swaps and satisfy
the accounting requirement that the forecast transaction is highly probable.
It is not as obvious, however, how the interest rate swaps are specifically related to the
cash flow interest risks designated as being hedged and how the interest rate swaps are
effective in reducing that risk. The more specific designation is illustrated in Schedule VI The
specific hedging relationship below. It provides a meaningful way of depicting the more
complicated narrative designation of the hedge by focusing on the hedging objective to
eliminate the cash flow variability associated with future changes in interest rates and to
obtain an interest rate equal to the fixed rate inherent in the term structure of interest rates
that exists at the commencement of the hedge.
The expected interest from the reinvestment of the cash inflows and repricings of the assets
is computed by multiplying the gross amounts exposed by the forward rate for the period.
For example, the gross exposure for Period X2 of CU14,100 is multiplied by the forward rate
for Periods X2–X5 of 5.50 per cent, 6.00 per cent, 6.50 per cent and 7.25 per cent,
respectively, to compute the expected interest for those quarterly periods based on the
current term structure of interest rates. The hedged expected interest is computed by
multiplying the expected interest for the applicable three-month period by the hedged
exposure percentage.

It does not matter whether the gross amount exposed is reinvested in long-term fixed rate
debt or variable rate debt, or in short-term debt that is rolled over in each subsequent
period. The exposure to changes in the forward interest rate is the same. For example, if
the CU14,100 is reinvested at a fixed rate at the beginning of Period X2 for six months, it
will be reinvested at 5.75 per cent. The expected interest is based on the forward interest
rates for Period X2 of 5.50 per cent and for Period X3 of 6.00 per cent, equal to a blended
rate of 5.75 per cent (1.055 × 1.060)0.5, which is the Period X2 spot rate for the next
six months.
However, only the expected interest from the reinvestment of the cash inflows or repricing
of the gross amount for the first three-month period after the forecast transaction occurs is
designated as being hedged. The expected interest being hedged is represented by the
shaded cells. The exposure for the subsequent periods is not hedged. In the example, the
portion of the interest rate exposure being hedged is the forward rate of 5.50 per cent for
Period X2. In order to assess hedge effectiveness and compute actual hedge ineffectiveness
on an ongoing basis, the entity may use the information on hedged interest cash inflows in
Schedule VI and compare it with updated estimates of expected interest cash inflows
(for example, in a table that looks like Schedule II). As long as expected interest cash
inflows exceed hedged interest cash inflows, the entity may compare the cumulative change
in the fair value of the hedged cash inflows with the cumulative change in the fair value of
the hedging instrument to compute actual hedge effectiveness. If there are insufficient
expected interest cash inflows, there will be ineffectiveness. It is measured by comparing
the cumulative change in the fair value of the expected interest cash flows to the extent
they are less than the hedged cash flows with the cumulative change in the fair value of the
hedging instrument.
Describing the designation of the hedging relationship
As mentioned previously, there are various matters that should be specified in the
designation of the hedging relationship that complicate the description of the designation
but are necessary to limit ineffectiveness to be recognised for accounting purposes and to
avoid unnecessary systems changes and bookkeeping. The example that follows describes
the designation more fully and identifies additional aspects of the designation not apparent
from the previous illustrations.
E l d i i

Example designation
Hedging objective
The hedging objective is to eliminate the risk of interest rate fluctuations over the
hedging period, which is the life of the interest rate swap, and in effect obtain a
fixed interest rate during this period that is equal to the fixed interest rate on the
interest rate swap.
Type of hedge
Cash flow hedge.
Hedging instrument
The receive-fixed, pay-variable swaps are designated as the hedging instrument.
They hedge the cash flow exposure to interest rate risk.
Each repricing of the swap hedges a three-month portion of the interest cash
inflows that results from:
• the forecast reinvestment or repricing of the principal amounts shown in
Schedule V.
• unrelated investments or repricings that occur after the repricing dates on the
swap over its life and involve different borrowers or lenders.
The hedged item—General
The hedged item is a portion of the gross interest cash inflows that will result
from the reinvestment or repricing of the cash flows identified in Schedule V and
are expected to occur within the periods shown on such schedule. The portion of
the interest cash inflow that is being hedged has three components:
• the principal component giving rise to the interest cash inflow and the period
in which it occurs,
• the interest rate component, and
h i i d db h h d

• the time component or period covered by the hedge.
The hedged item—The principal component
The portion of the interest cash inflows being hedged is the amount that results
from the first portion of the principal amounts being invested or repriced in each
period:
• that is equal to the sum of the notional amounts of the received-fixed,
pay-variable interest rate swaps that are designated as hedging instruments
and outstanding in the period of the reinvestment or repricing, and
• that corresponds to the first principal amounts of cash flow exposures that are
invested or repriced at or after the repricing dates of the interest rate swaps.
The hedged item—The interest rate component
The portion of the interest rate change that is being hedged is the change in both
of the following:
• the credit component of the interest rate being paid on the principal amount
invested or repriced that is equal to the credit risk inherent in the interest
rate swap. It is that portion of the interest rate on the investment that is
equal to the interest index of the interest rate swap, such as LIBOR, and
• the yield curve component of the interest rate that is equal to the repricing
period on the interest rate swap designated as the hedging instrument.
The hedged item—The hedged period
The period of the exposure to interest rate changes on the portion of the cash
flow exposures being hedged is:
• the period from the designation date to the repricing date of the interest rate
swap that occurs within the quarterly period in which, but not before, the
forecast transactions occur, and
• its effects for the period after the forecast transactions occur equal to the
repricing interval of the interest rate swap.
It is important to recognise that the swaps are not hedging the cash flow risk for a single
investment over its entire life. The swaps are designated as hedging the cash flow risk from
different principal investments and repricings that are made in each repricing period of the
swaps over their entire term. The swaps hedge only the interest accruals that occur in the
first period following the reinvestment. They are hedging the cash flow impact resulting
from a change in interest rates that occurs up to the repricing of the swap. The exposure to
changes in rates for the period from the repricing of the swap to the date of the hedged
reinvestment of cash inflows or repricing of variable rate assets is not hedged. When the
swap is repriced, the interest rate on the swap is fixed until the next repricing date and the
accrual of the net swap settlements is determined. Any changes in interest rates after that
date that affect the amount of the interest cash inflow are no longer hedged for accounting
purposes.
Designation objectives
Systems considerations
Many of the tracking and bookkeeping requirements are eliminated by designating each
repricing of an interest rate swap as hedging the cash flow risk from forecast reinvestments
of cash inflows and repricings of variable rate assets for only a portion of the lives of the
related assets. Much tracking and bookkeeping would be necessary if the swaps were
instead designated as hedging the cash flow risk from forecast principal investments and
repricings of variable rate assets over the entire lives of these assets.
This type of designation avoids keeping track of gains and losses recognised in other
comprehensive income after the forecast transactions occur (IAS 39.97 and IAS 39.98)
because the portion of the cash flow risk being hedged is that portion that will be
reclassified from equity to profit or loss in the period immediately following the forecast
transactions that corresponds with the periodic net cash settlements on the swap. If the
hedge were to cover the entire life of the assets being acquired, it would be necessary to
associate a specific interest rate swap with the asset being acquired. If a forecast
transaction is the acquisition of a fixed rate instrument, the fair value of the swap that
hedged that transaction would be reclassified from equity to profit or loss to adjust the
interest income on the asset when the interest income is recognised. The swap would then
have to be terminated or redesignated in another hedging relationship. If a forecast
transaction is the acquisition of a variable rate asset, the swap would continue in the
hedging relationship but it would have to be tracked back to the asset acquired so that any
fair value amounts on the swap recognised in other comprehensive income could be
reclassified from equity to profit or loss upon the subsequent sale of the asset.
It also avoids the necessity of associating with variable rate assets any portion of the fair
value of the swaps that is recognised in other comprehensive income. Accordingly, there is
no portion of the fair value of the swap that is recognised in other comprehensive income
that should be reclassified from equity to profit or loss when a forecast transaction occurs or
upon the sale of a variable rate asset.
This type of designation also permits flexibility in deciding how to reinvest cash flows when
they occur. Since the hedged risk relates only to a single period that corresponds with the
repricing period of the interest rate swap designated as the hedging instrument, it is not
necessary to determine at the designation date whether the cash flows will be reinvested in
fixed rate or variable rate assets or to specify at the date of designation the life of the asset
to be acquired.
Effectiveness considerations
Ineffectiveness is greatly reduced by designating a specific portion of the cash flow

exposure as being hedged.
• Ineffectiveness due to credit differences between the interest rate swap and
hedged forecast cash flow is eliminated by designating the cash flow risk
being hedged as the risk attributable to changes in the interest rates that
correspond with the rates inherent in the swap, such as the AA rate curve.
This type of designation prevents changes resulting from changes in credit
spreads from being considered as ineffectiveness.
• Ineffectiveness due to duration differences between the interest rate swap

and hedged forecast cash flow is eliminated by designating the interest rate
risk being hedged as the risk relating to changes in the portion of the yield
curve that corresponds with the period in which the variable rate leg of the
interest rate swap is repriced.
• Ineffectiveness due to interest rate changes that occur between the repricing
date of the interest rate swap and the date of the forecast transactions is
eliminated by simply not hedging that period of time. The period from the
repricing of the swap and the occurrence of the forecast transactions in the
period immediately following the repricing of the swap is left unhedged.
Therefore, the difference in dates does not result in ineffectiveness.
Accounting considerations
The ability to qualify for hedge accounting using the methodology described here is founded
on provisions in IAS 39 and on interpretations of its requirements. Some of those are
described in the answer to Question F.6.2 Hedge accounting considerations when interest
rate risk is managed on a net basis. Some additional and supporting provisions and
interpretations are identified below.
Hedging a portion of the risk exposure
The ability to identify and hedge only a portion of the cash flow risk exposure resulting from
the reinvestment of cash flows or repricing of variable rate instruments is found in
IAS 39.81 as interpreted in the answers to Questions F.6.2 Issue (k) and F.2.17 Partial term
hedging.
Hedging multiple risks with a single instrument
The ability to designate a single interest rate swap as a hedge of the cash flow exposure to
interest rates resulting from various reinvestments of cash inflows or repricings of variable
rate assets that occur over the life of the swap is founded on IAS 39.76 as interpreted in
the answer to Question F.1.12 Hedges of more than one type of risk.
Hedging similar risks in a portfolio
The ability to specify the forecast transaction being hedged as a portion of the cash flow
exposure to interest rates for a portion of the duration of the investment that gives rise to
the interest payment without specifying at the designation date the expected life of the
instrument and whether it pays a fixed or variable rate is founded on the answer to
Question F.6.2 Issue (l), which specifies that the items in the portfolio do not necessarily
have to have the same overall exposure to risk, providing they share the same risk for
which they are designated as being hedged.
Hedge terminations
The ability to de-designate the forecast transaction (the cash flow exposure on an
investment or repricing that will occur after the repricing date of the swap) as being hedged
is provided for in IAS 39.101 dealing with hedge terminations. While a portion of the
forecast transaction is no longer being hedged, the interest rate swap is not de-designated,
and it continues to be a hedging instrument for the remaining transactions in the series that
have not occurred. For example, assume that an interest rate swap having a remaining life
of one year has been designated as hedging a series of three quarterly reinvestments of
cash flows. The next forecast cash flow reinvestment occurs in three months. When the
interest rate swap is repriced in three months at the then current variable rate, the fixed
rate and the variable rate on the interest rate swap become known and no longer provide
hedge protection for the next three months. If the next forecast transaction does not occur
until three months and ten days, the ten-day period that remains after the repricing of the
interest rate swap is not hedged.
F.6.4 Hedge accounting: premium or discount on forward exchange

contract
A forward exchange contract is designated as a hedging instrument, for example,

in a hedge of a net investment in a foreign operation. Is it permitted to amortise
the discount or premium on the forward exchange contract to profit or loss over
the term of the contract?
No. The premium or discount on a forward exchange contract may not be amortised to
profit or loss under IAS 39 or IFRS 9. Derivatives are always measured at fair value in the
statement of financial position. The gain or loss resulting from a change in the fair value of
the forward exchange contract is always recognised in profit or loss unless the forward
exchange contract is designated and effective as a hedging instrument in a cash flow hedge
or in a hedge of a net investment in a foreign operation, in which case the effective portion
of the gain or loss is recognised in other comprehensive income. In that case, the amounts
recognised in other comprehensive income are reclassified from equity to profit or loss when
the hedged future cash flows occur or on the disposal of the net investment, as appropriate.
Under IAS 39.74(b), the interest element (time value) of the fair value of a forward may be
excluded from the designated hedge relationship. In that case, changes in the interest
element portion of the fair value of the forward exchange contract are recognised in profit
or loss.
F.6.5 IAS 39 and IAS 21 Fair value hedge of asset measured at cost
If the future sale of a ship carried at historical cost is hedged against the exposure
to currency risk by foreign currency borrowing, does IAS 39 require the ship to be
remeasured for changes in the exchange rate even though the basis of
measurement for the asset is historical cost?
No. In a fair value hedge, the hedged item is remeasured. However, a foreign currency
borrowing cannot be classified as a fair value hedge of a ship since a ship does not contain
any separately measurable foreign currency risk. If the hedge accounting conditions in
IAS 39.88 are met, the foreign currency borrowing may be classified as a cash flow hedge
of an anticipated sale in that foreign currency. In a cash flow hedge, the hedged item is not
remeasured.
To illustrate: a shipping entity in Denmark has a US subsidiary that has the same functional
currency (the Danish krone). The shipping entity measures its ships at historical cost less
depreciation in the consolidated financial statements. In accordance with IAS 21.23(b), the
ships are recognised in Danish krone using the historical exchange rate. To hedge, fully or

partly, the potential currency risk on the ships at disposal in US dollars, the shipping entity
normally finances its purchases of ships with loans denominated in US dollars.
In this case, a US dollar borrowing (or a portion of it) may be designated as a cash flow
hedge of the anticipated sale of the ship financed by the borrowing provided the sale is
highly probable, for example, because it is expected to occur in the immediate future, and
the amount of the sales proceeds designated as being hedged is equal to the amount of the
foreign currency borrowing designated as the hedging instrument. The gains and losses on
the currency borrowing that are determined to constitute an effective hedge of the
anticipated sale are recognised in other comprehensive income in accordance with
IAS 39.95(a).
Section G Other
G.1 Disclosure of changes in fair value
IAS 39 and IFRS 9 require remeasurement of financial assets and financial

liabilities measured at fair value. Unless a financial asset or a financial liability is
designated as a cash flow hedging instrument, fair value changes for financial
assets and financial liabilities at fair value through profit or loss are recognised in
profit or loss, and fair value changes for financial assets designated at fair value
through other comprehensive income are recognised in other comprehensive
income. What disclosures are required regarding the amounts of the fair value
changes during a reporting period?
IFRS 7.20 requires items of income, expense and gains and losses to be disclosed. This
disclosure requirement encompasses items of income, expense and gains and losses that
arise on remeasurement to fair value. Therefore, an entity provides disclosures of fair value
changes, distinguishing between changes that are recognised in profit or loss and changes
that are recognised in other comprehensive income. Further breakdown is provided of
changes that relate to:
a. financial assets or financial liabilities at fair value through profit or loss,

showing separately those fair value changes on financial assets or financial
liabilities (i) designated as such upon initial recognition and (ii) mandatorily
classified as such in accordance with IFRS 9; and
b. hedging instruments.
In addition, IFRS 7.20A requires an entity to disclose the amount of gain or loss recognised
in other comprehensive income for financial assets measured at fair value through other
comprehensive income, including any amount transferred within equity.
IFRS 7 neither requires nor prohibits disclosure of components of the change in fair value by
the way items are classified for internal purposes. For example, an entity may choose to
disclose separately the change in fair value of those derivatives that meet the definition of
held for trading in IAS 39, but the entity classifies as part of risk management activities
outside the trading portfolio.
In addition, IFRS 7.8 requires disclosure of the carrying amounts of financial assets or
financial liabilities at fair value through profit or loss, showing separately: (i) those
designated as such upon initial recognition and (ii) those mandatorily classified as such in
accordance with IAS 39and IFRS 9.
G.2 IAS 39 and IAS 7 Hedge accounting: statements of cash flows
How should cash flows arising from hedging instruments be classified in

statements of cash flows?
Cash flows arising from hedging instruments are classified as operating, investing or
financing activities, on the basis of the classification of the cash flows arising from the
hedged item. While the terminology in IAS 7 has not been updated to reflect IAS 39, the
classification of cash flows arising from hedging instruments in the statement of cash flows
should be consistent with the classification of these instruments as hedging instruments
under IAS 39.
1 In this guidance, monetary amounts are denominated in 'currency units (CU)'.

[Renumbered to IAS 40: 20-3 on 24 September 2010]
Renumbered
Q&A IAS 40: 5-1 — ACCOUNTING FOR PROPERTY ACCEPTED AS LOAN

SETTLEMENT
Background
Entity A, a financial institution, provides mortgage loans to individuals or corporate

entities to finance the acquisition of properties. The terms of these mortgage loans
require the property to be pledged as collateral for the loan. If a counterparty
defaults under the terms of a mortgage loan and is no longer entitled to redeem the
collateral, Entity A accepts the property as settlement of the loan receivable. The
former owner ceases to have any rights over the property or over the income that it
generates. The derecognition criteria in paragraph 17 of IAS 39 Financial
Instruments: Recognition and Measurement are met. In accordance with IAS 39.37,
Entity A recognises the property as its asset, initially measured at fair value. Under
local regulations, Entity A is required to sell the asset within two years.
Question
Should Entity A classify the property as an investment property in accordance with
IAS 40 or as inventories in accordance with IAS 2 Inventories? How should Entity A
account for rentals received during the period for which it holds the asset?
Answer
The appropriate classification of the property as investment property or inventories
depends on management's intent. If management intends to hold the property to
earn rentals or for capital appreciation (or both), the property would meet the
definition of an investment property and should be accounted for under IAS 40. In
contrast, if the property is being actively marketed for sale, but it is not sold within a
short timeframe (e.g. because of seasonal fluctuations in the property market), such
activity would indicate that Entity A views the property as a form of settlement of
amounts due under the defaulted mortgage loan and that it is an asset acquired and
held for sale in the ordinary course of business. In such circumstances, the property
should be accounted for as inventories under IAS 2.
Regardless of whether the property is classified as investment property or

inventories, any rentals received should be recognised as rental income in profit or
loss.
Q&A IAS 40: 5-2 — A GROUP OF ASSETS LEASED UNDER A SINGLE

OPERATING LEASE
Background
IAS 40.5 defines investment property as "property (land or a building — or part of a

building — or both) held (by the owner or by the lessee under a finance lease) to
earn rentals or for capital appreciation or both".
IAS 40.50 states that in determining the fair value of investment property, “an entity
does not double-count assets or liabilities that are recognised as separate assets or
liabilities. For example:
1. equipment such as lifts or air-conditioning is often an integral part of a

building and is generally included in the fair value of the investment
property, rather than recognised separately as property, plant and
equipment.
2. if an office is leased on a furnished basis, the fair value of the office

generally includes the fair value of the furniture, because the rental income
relates to the furnished office. When furniture is included in the fair value
of investment property, an entity does not recognise that furniture as a
separate asset”.
Consider the following example:
• a lessor leases out a farm for the purpose of earning rentals;
• the farm is made up of the following assets: (a) land and agricultural
buildings; and (b) agricultural fittings, fixtures and machinery that are an
integral part of the agricultural buildings;
• the lease agreement meets the definition of an operating lease for the
lessor; and
• the lessor measures investment property after initial recognition at fair

value.
Question
Should the lessor account for all the assets included in the operating lease
agreement as a unique investment property and, as a consequence, measure it using
the fair value model?
Answer
Yes. Although agricultural fittings, fixtures and machinery do not meet the definition
of investment property in their own right, the lessor should follow the requirements
in IAS 40.50 to determine the fair value of its investment property, including the
other assets that form part of the lease agreement.
In the above example, the lease agreement includes all the assets (i.e. land and
agricultural buildings and fittings, fixtures and machinery) that are an integral part of
the farm and are necessary for operating the farm. Therefore, the rental income
reflects the right-of-use of the complete set of assets. Consequently, the lessor
should recognise investment property comprising all the assets (i.e. the land and
agricultural buildings and the agricultural fittings, fixtures and machinery), measured
in accordance with IAS 40.
Specific facts and circumstances should be considered by the lessor in each

operating lease agreement covering a piece of land, or a building, or part of a
building, or both, together with property, plant and equipment items held to earn
rentals, in order to establish which assets covered by the agreement should be
regarded as investment property.

Deleted

Deleted
Q&A IAS 40: 11-1 — SERVICES PROVIDED BY THE OWNER OF AN

OFFICE BUILDING
Background
The owner of an office building provides cleaning services for the lessees of the
building and these services are 'insignificant' in the context of the total arrangement.
Question
Do these services prevent the office building from being classified and accounted for
as an investment property?
Answer
No. IAS 40.11 requires that if an entity provides ancillary services to the occupants
of its property, the property is accounted for as investment property provided that
the services are an 'insignificant' portion of the arrangement.
It would be unusual for cleaning services to be so material that they would prevent a
property from being classified as an investment property. A similar conclusion is
likely for security and maintenance services. At the other extreme, some entities
rent out fully furnished offices including a whole range of services such as IT systems
and secretarial services. Such arrangements are in the nature of the rendering of a
service rather than property investment and the property would be classified as
owner-occupied and accounted for under IAS 16 Property, Plant and Equipment.
However, there are many instances in between the extremes when the appropriate
classification can only be determined based on a detailed assessment of the
arrangements and whether the services provided are judged to be 'insignificant'.
Q&A IAS 40: 12-1 — HOTEL PROPERTY AS INVESTMENT PROPERTY

Background
A hotel operator owns a significant number of buildings. The hotel operator seeks to
maximise revenue by selling room occupancy.
Question
Is it acceptable for the hotel operator to classify these buildings as investment
properties?
Answer
No. The property is for use by the hotel operator in the normal course of business
and, therefore, is not investment property. IAS 40.12 cites the direct provision of
services to hotel guests as services that will generally be considered to be
'significant'. Although the hotel operator may hold the buildings for long-term
appreciation, that is not the principal reason for holding them.
Q&A IAS 40: 19-1 — RECOGNITION OF REPLACEMENT LIFT AS AN

ASSET
Background
A lift is replaced in 20X2 (at a cost of CU90,000) in an office building which is being
held as an investment property and measured using the fair value model. The net
carrying amount of the replaced lift at the time of replacement was CU20,000 and
was included in the fair value of the investment property of CU1,000,000. The fair
value of the lift being replaced cannot be reliably determined, while the fair value of
the investment property at the end of the 20X2 reporting period is CU1,100,000.
Question
What is the appropriate accounting treatment for the replacement?
Answer
The cost of the replacement lift should be capitalised and the fair value of the
property should be assessed as follows at the end of the 20X2 reporting period.
Any movement between the carrying amount and the fair value of the replaced lift is,
therefore, recognised in profit or loss as a change in the fair value of the property.

Reserved
Q&A IAS 40: 20-2 — INVESTMENT PROPERTY IN THE COURSE OF

CONSTRUCTION
Background
With effect from the date of implementation of Improvements to IFRSs issued in May
2008 (1 January 2009 or date of earlier adoption), property under construction or
development for future use as an investment property falls within the scope of IAS
40.
Question
How should an entity that applies IAS 40's fair value model account for the costs of
investment property in the course of construction?
Answer
IAS 40 does not deal specifically with the recognition of the cost of a self-constructed
investment property. The appropriate accounting for such property is therefore
determined in accordance with general principles.
Over the period of construction, the costs of construction will be capitalised as part
of the cost of the investment property in accordance with the general principle
outlined in IAS 40.16. Paragraphs 16–22 of IAS 16 Property, Plant and Equipment
provide guidance as to what is appropriately included within such costs.
The capitalisation of borrowing costs is considered in accordance with the general

requirements of IAS 23 Borrowing Costs. IAS 23.4 provides an optional exemption
from the requirement to capitalise borrowing costs for qualifying assets that are
measured at fair value (which would include investment property under construction
if an entity follows the fair value model for investment property). Therefore, entities
can choose, as a matter of accounting policy, whether to capitalise borrowing costs
in respect of such assets. When relevant to an understanding of the financial
statements, that accounting policy should be disclosed.
If an entity follows the fair value model in accounting for its investment property,
paragraphs 53–53B of IAS 40 provide specific guidance for circumstances when fair
value cannot be determined reliably.
Assuming that the fair value of the property under construction can be estimated
reliably, then the costs capitalised during the course of construction will not affect
the carrying amount of the investment property under construction, which is
remeasured to fair value at the end of each reporting period. Therefore, any costs
capitalised during the reporting period will simply reduce the amount recognised in
profit or loss for any gain (or increase the amount recognised for any loss) arising on
remeasurement to fair value at the end of the reporting period. Although the amount
reported in the statement of financial position is not affected, it is important to
capitalise construction costs when appropriate, because this may affect the
classification of amounts in the statement of comprehensive income (e.g. any gain
on remeasurement may be over-stated and property expenses over-stated by the
same amount).

Q&A IAS 40: 20-3 — EXPENDITURE TO BE CAPITALISED AS PART OF
AN INVESTMENT PROPERTY
[Amended and Renumbered from IAS 40: 3-1 on 24 September 2010]
Background
Entity R acquires a building for CU95 million in March 20X1 as an investment

property. In June 20X1, Entity R refurbishes entirely the building at a cost of CU5
million to bring it to the condition required by the rental market. Entity R will pay an
estate agent two months' rent if the agent locates a lessee. In December 20X1,
Entity R (the lessor) finally rents the property under an operating lease to Entity S
(the lessee).
Question
Is it appropriate for Entity R to include the refurbishment costs and the estate
agent's fees as part of the initial cost of the investment property?
Answer
Yes. When it buys the building, Entity R should recognise the purchase price as the
initial cost of the building under IAS 40. The refurbishment costs are necessary to
bring the property to a condition suitable for renting out and, therefore, these costs
should also be included in the initial cost of the building.
The estate agent's fees are not part of the initial cost of the building but they are
considered to be “[i]nitial direct costs incurred by lessors in negotiating and
arranging an operating lease” under IAS 17 Leases. They are, therefore, capitalised
as part of the leased building in accordance with IAS 17.52. When the cost model is
used, the expenditure should be depreciated over the lease term. However, when
the fair value model is used, these costs will be recognised in profit or loss to the
extent that they increase the carrying value of the building above its fair value.
Q&A IAS 40: 20-4 — ACQUISITION OF INVESTMENT PROPERTY WITH

EXISTING OPERATING LEASE IN PLACE
[Amended and Renumbered from IFRS 3: 37-1 on 24 September 2010]
Question
Company C acquires an investment property with an operating lease that is not at
current market rates. How should the investment property be accounted for?
Answer
IAS 40.40 states:
The fair value of investment property reflects, among other things, rental
income from current leases and reasonable and supportable assumptions
that represent what knowledgeable, willing parties would assume about
rental income from future leases in the light of current conditions. It also
reflects, on a similar basis, any cash outflows (including rental payments
and other outflows) that could be expected in respect of the property.
Some of those outflows are reflected in the liability whereas others relate
to outflows that are not recognised in the financial statements until a later
date (eg periodic payments such as contingent rents).
Additionally, IAS 40.26 states that a premium paid for a lease should be included in
the cost of an investment property. This acknowledges the fact that an investment
property includes not only land and buildings but other assets (customer
relationships, furniture and favourable leases) and liabilities (unfavourable leases)
that are interrelated in determining the fair value of the investment property.
Therefore, the fair value of operating leases at above or below market rates should
be incorporated into the fair value of the investment property.
However, in accordance with IAS 40.50, in determining the fair value of an

investment property, an entity should not “double-count assets or liabilities that are
recognised as separate assets or liabilities”. Therefore, the fair value of an
investment property is adjusted to exclude, among other things, assets or liabilities
arising from favourable or unfavourable leases.
These requirements would extend to lease incentives. Specifically, assets/liabilities

recognised for lease incentives received/given should not be double-counted in the
statement of financial position.
Q&A IAS 40: 20-5 — TERMINATION PAYMENTS BY A LESSOR TO A

LESSEE
[Amended and Renumbered from IAS 16: 16-4 on 24 September 2010]
Background
Company A owns an office building that it leases to Company B. The lease is

classified as an operating lease in accordance with IAS 17 Leases. Company A would
like to convert the office building into a block of flats, believing that this will attract
significantly higher rental income. First, however, Company A must terminate the
lease contract with Company B.
Company A applies the cost model as its accounting policy for the subsequent
measurement of its investment property.
Question
Should Company A capitalise the lease termination costs as part of the cost of
constructing the block of flats?
Answer
Investment property accounted for using the cost model should be measured in
accordance with the requirements for that model set out in IAS 16 Property, Plant
and Equipment. [IAS 40.56]
IAS 16.16(b) states that the cost includes “any costs directly attributable to bringing
the asset to the location and condition necessary for it to be capable of operating in
the manner intended by management”. IAS 16.7 requires that the cost of an item of
property, plant and equipment be recognised as an asset if “it is probable that future
economic benefits associated with the item will flow to the entity” and if “the cost of
the item can be measured reliably”.
Therefore, if Company A's cost of terminating Company B's operating lease meets
the recognition criteria for property, plant and equipment in IAS 16.7, then Company
A should capitalise this cost because it is a directly attributable cost of enabling
operation of the asset in the manner intended by management.
Company A should also consider whether there is an indicator of impairment and

whether any further impairment testing should be performed to ensure that the
building is not recognised at a carrying amount higher than its recoverable amount
as a result of capitalising the lease termination costs.

Deleted

Q&A IAS 40: 47-1 — USE OF 'HIGHEST AND BEST VALUE'
Background
In recent years, a local authority has been prepared to grant planning permission to
redevelop petrol station sites for residential purposes. To obtain planning permission,
an entity must make a formal application and meet whatever specific requirements
are imposed by the local authority (i.e. the application is not a mere formality).
Company A owns a petrol station site, which it leases to a third party and classifies
as investment property for reporting purposes. Company A intends to sell the site to
a construction and development entity after the end of the reporting period.
Company A determines that:
• the value of the petrol station site in its current use and condition is
CU10,000 ( i.e. this is the value if the property is intended to be used as a
petrol station for the foreseeable future);
• the value of the petrol station site for residential use, if planning
permission had already been granted to Company A, would be CU15,000;
• the costs to be incurred in applying for planning permission are expected to

be CU1,000.
Question
At what amount should the investment property be measured at the end of the
reporting period?
Answer
The fair value of the petrol station site to be reported in Company A's financial
statements will lie in the range from CU10,000 (value based on existing use) to
CU14,000 (value based on alternative use, after taking account of necessary costs).
Whether the value is at the lower or upper end of this range will depend on how
likely it is that the application for planning permission will be successful.
Q&A IAS 40: 49-1 — DETERMINING FAIR VALUE — TAX

CONSEQUENCES

Background
In many jurisdictions, the tax consequences that would flow from acquiring, holding
and selling an investment property will have a significant impact on the value a
market participant would be willing to pay to acquire the property. It is common that
the difference in the market price will not be directly equal to the tax consequences
under existing tax law, because market participants will also factor into the price
they are willing to pay the risk that tax law may change.
Question
In determining the fair value of an investment property, should the valuation take
account of such tax consequences?
Answer
The valuation should take account of all tax consequences that are available to all
market participants, but should not reflect those tax consequences that are unique
to the buyer. For example, when the acquisition of the property will enable the entity
to recover some unused tax losses, this should not be taken into account in the
valuation of the investment property (although such deferred tax assets may have to
be recognised under IAS 12 Income Taxes). In contrast, when there is a tax benefit
from holding the property that is available to all participants, the tax benefit should
be taken into account in determining the fair value in accordance with IAS 40.49(d).

Deleted

Deleted
Q&A IAS 40: 73-1 — INSURANCE CLAIM


Background
A building carried as an investment property burns down during the reporting period.
A valuation of the building in its damaged state is performed at the end of the
reporting period.
Question
Should the value of the property at the end of the reporting period include any
amount receivable from insurance?
Answer
IAS 40.73 states:
Impairments or losses of investment property, related claims for or

payments of compensation from third parties and any subsequent
purchase or construction of replacement assets are separate
economic events and are accounted for separately as follows:
1. impairments of investment property are recognised in accordance
with IAS 36;
2. retirements or disposals of investment property are recognised in

accordance with [IAS 40.66–71];
3. compensation from third parties for investment property that was

impaired, lost or given up is recognised in profit or loss when it
becomes receivable; and
4. the cost of assets restored, purchased or constructed as

replacements is determined in accordance with [IAS 40.20–29].
In the circumstances described, the amount receivable from insurance should be

recognised separately in the statement of financial position if it meets the relevant
recognition criteria. Any valuation of the property recognised as an investment
property should not include the insurance receivable.
Q&A IAS 41: 2-1 — PLANT BREEDING: NEW PLANT DEVELOPMENT

Background
Company A is a plant breeding entity. In the initial stages of the plant breeding
process, Entity A must develop new varieties by selecting seeds and cross-breeding
in a laboratory, as well as performing field tests. This process can take up to 12
years.
Question
Is the development of new breeds of seed an agricultural activity within the scope of
IAS 41?
Answer
No. IAS 41.2(b) states that IAS 41 does not apply to intangible assets related to
agricultural activity. The development of new breeds of seed is accounted for in
accordance with the requirements of paragraphs 51–67 of IAS 38, Intangible Assets,
that relate to research and development costs.
Q&A IAS 41: 5-1 — DEFINITION OF AGRICULTURAL ACTIVITIES

[Issued 25 April 2003]
Question
How are agricultural activities differentiated from other related activities?
Answer
Agricultural activities have three common features: capability to change,
management of that change and measurement of change (IAS 41.6). The key
feature that often differentiates agricultural activities from other related activities is
the entity's management of the biological transformation. For example, the entity
may manage biological transformation by enhancing, or at least stabilising,
conditions necessary for the process to take place. Harvesting from unmanaged
sources (such as open ocean fishing and deforestation) is not 'agricultural activity'
because it does not involve management of the resource.
A resource may be managed by government through the use of mechanisms such as

licensing and quotas, but this does not of itself result in the activity being classified
as an agricultural activity under IAS 41, because the entity does not manage the

resource.
Agricultural activities do not include:
• Holding investments in a forest as a carbon sink, which gives rise to carbon

credits that can either be sold or used to offset pollution caused by the
entity (provided that the forest is not managed);
• Using animals such as greyhounds, horses, pigeons, or whippets for

racing;
• Exhibiting performing animals (e.g. in a theme park); or
• Managing living assets that are not animals or plants, such as viruses and
blood cells used in research.
Q&A IAS 41: 5-2 — PLANT BREEDING: SEED MULTIPLICATION

Background
Entity A is a plant breeding entity. Following on the development of new plant

breeds, Entity A uses the developed breeding seeds to multiply the seeds into basic
seeds which will then be sold.
Question
Is the multiplication of seeds to be harvested for sale an agricultural activity within
the scope of IAS 41?
Answer
Yes. The multiplication of seeds to be harvested for sale is an agricultural activity as
it represents a biological transformation process of biological assets managed by the
entity for sale — that is, the entity transforms the breeding seeds into seeds for sale
using biological processes, and this activity is, therefore, within the scope of IAS 41.
Q&A IAS 41: 9-1 — COSTS TO SELL

Question

Which 'costs to sell' should be deducted in the measurement of biological assets and
agricultural produce?
Answer
It is necessary to distinguish between costs necessary to get an asset to market and
'costs to sell'. The former are deducted in arriving at fair value; the latter are
deducted from fair value for the purposes of measurement under IAS 41.
Under IAS 41.9, transport and other costs necessary to get an asset to a market
(e.g. the transportation costs associated with getting cattle from the farm to the
cattle market where they are to be sold) are deducted in arriving at fair value; such
costs are considered to be separate from the sale transaction itself.
Costs to sell, in contrast, are defined as “the incremental costs directly attributable
to the disposal of an asset, excluding finance costs and income taxes”. [IAS 41.5]
They are therefore incremental costs associated with the sale transaction itself (and
they will not already have been deducted in arriving at fair value). Such costs may
include:
• brokers' and dealers' commissions;
• levies by regulatory agencies and commodity exchanges; and
• transfer taxes and other duties.
Because costs to sell are deducted from fair value when biological assets are first
recognised, they can give rise to an immediate loss. For example, if an asset is
purchased for its fair value of CU100, and it is estimated that a 10 per cent
commission would be payable if the asset were ever sold, then the asset is
recognised in the statement of financial position at CU90, and a CU10 loss is
recognised immediately in profit or loss. This is irrespective of whether the entity
expects to make a profit on the ultimate realisation of the asset or, indeed, whether
it has any intention of ever selling the asset (e.g. a bearer biological asset that will
not be sold).
Q&A IAS 41: 10-1 — SEPARATE RECOGNITION OF PRODUCE BEFORE

HARVEST
Question
When future agricultural produce (fruit, wool, etc.) is attached to biological assets
(trees, vines, animals, etc.), is it acceptable to recognise that produce separately
from the biological asset to which it is attached before harvest?
Answer
No. Until harvest, the future agricultural produce forms part of the total biological
asset and this asset should be measured as a whole. For example, all else being
equal, trees with fruit have a higher fair value immediately before harvest than
immediately after harvest, and unshorn sheep have a higher fair value than those
that are shorn.
Q&A IAS 41: 10-EX-1 — SEPARATE RECOGNITION OF PRODUCE

BEFORE HARVEST
Example
Entity A owns an apple orchard. The trees are mature and their fair value (excluding
fruit) has not increased during the reporting period. However, the fair value (less
costs to sell) of the apples on the trees is 100,000 immediately before harvest.
The following journal entries would be recorded to reflect the recognition and
harvesting of the apples.

Deleted
Q&A IAS 41: 12-2 — MEASUREMENT OF LEASED BIOLOGICAL ASSETS

Question
Should biological assets that are leased under a finance or operating lease be
measured in accordance with the requirements of IAS 41?
Answer
IAS 17 Leases applies to accounting for leases of biological assets, but does not
apply to the measurement by lessees of biological assets held under financial leases,
or by lessors of biological assets leased out under operating leases (IAS 17.1).
Therefore, biological assets acquired under a finance lease should be initially

recognised and subsequently measured in accordance with the measurement
requirements of IAS 41 (i.e. at fair value less costs to sell except when the fair value
cannot be measured reliably). Due to the nature of biological assets, it is unlikely
that fair value could not be measured reliably for leased assets.
The disclosure requirements of both IAS 41 and IAS 17 should be applied to leased
biological assets.

Q&A IAS 41: 13-1 — MEASUREMENT OF HARVESTED AGRICULTURAL
PRODUCE
Question
Should harvested agricultural produce be measured on a basis other than fair value
less costs to sell?
Answer
No. Although IAS 41.30 allows a biological asset (i.e. living animal or plant) to be
measured on a historical cost basis in specified circumstances, the Standard does not
include an equivalent measurement reliability exception for agricultural produce
derived from biological assets. Because harvested produce is a marketable
commodity, IAS 41 reflects the view that the fair value of agricultural produce at the
point of harvest can always be measured reliably. Therefore, all agricultural produce
must be measured in accordance with IAS 41.13 at fair value less costs to sell. IAS
41.32 reflects the view that agricultural produce can be measured reliably.
The fair value measurement of agricultural produce at the point of harvest is deemed
to be the cost of that harvest for subsequent accounting under IAS 2 Inventories or
other applicable IFRSs. Subsequent to harvest, agricultural produce is treated in the
same manner as any other inventory item under IAS 2.
Thus, for example, corn that has not yet been harvested will be remeasured at the
end of each reporting period, reflecting changes in market prices, because it will
meet the definition of a biological asset. Once it has been harvested, however, that
remeasurement will generally cease, and it will be accounted for under IAS 2 at the
lower of cost (defined as fair value less costs to sell at the point of harvest) and net
realisable value.

Deleted
Q&A IAS 41: 13-3 — DETERMINATION OF NET REALISABLE VALUE

APPLIED TO HARVESTED AGRICULTURAL PRODUCE
Question
How is the 'lower of cost and net realisable value' test applied to harvested
agricultural produce?
Answer
IAS 41.13 requires that harvested agricultural produce be measured at its fair value
less costs to sell at the point of harvest. This amount is treated as the cost of the
harvested agricultural produce for the purposes of subsequent accounting under IAS
2 Inventories.
IAS 2 requires inventories to be measured at the lower of cost and net realisable
value (NRV), which is defined as the "estimated selling price in the ordinary course
of business less the estimated costs of completion and the estimated costs necessary
to make the sale" (IAS 2.6).
IAS 2.7 distinguishes between NRV ("the net amount that an entity expects to
realise from the sale of the inventory in the ordinary course of business") and fair
value ("the amount for which the same inventory could be exchanged between
knowledgeable and willing buyers and sellers in the marketplace"). NRV is an
entity-specific value; fair value is not. Therefore, NRV for inventories may not equal
fair value less costs to sell.
Contracted sales prices should be taken into account in determining entity-specific

NRV in terms of IAS 2.7. This may give rise to differences between NRV and fair
value less costs to sell in terms of IAS 41.13.
Q&A IAS 41: 21-1 — DISCOUNT RATE ASSUMPTION USED IN FAIR

VALUE CALCULATIONS
Background
An entity owns biological assets for which no market prices or values are available in
their present condition. In such circumstances, for the purpose of determining fair
value, IAS 41.20 requires the entity to use the present value of expected net cash
flows from the asset, discounted at a current market-determined rate.

Question
How should the entity determine an appropriate discount rate for the estimation of
the fair value of biological assets at the present value of expected net cash flows?
Answer
IAS 41 provides only limited guidance for these circumstances.
The objective of calculating the present value of expected net cash flows is to
determine the fair value of the biological asset in its present location and condition.
In accordance with IAS 41.21, in determining the present value of net cash flows, an
entity includes the net cash flows that market participants would expect the asset to
generate in its most relevant market.
IAS 41.24 states that when an entity incurred an initial cost for a biological asset,
that cost may approximate fair value when little biological transformation has taken
place since the cost was incurred or the impact of the biological transformation on
the fair value is not expected to be material. In such circumstances, the discount
rate selected should result in a fair value that approximates cost at inception.
It should also be noted that the objective of fair value measurement under IAS 41 is
consistent with that in other Standards (e.g. IAS 39 Financial Instruments:
Recognition and Measurement) and the guidance included in those Standards
regarding the estimation of fair values for assets that do not have readily observable
prices in active markets would also be relevant for biological assets.

Deleted


Deleted


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DELOITTE TOUCHE TOHMATSU GUIDANCE

Q&A IAS 2: 6-1 — ACCOUNTING FOR PIPELINE FILL —

Q&A IAS 2: 6-2 — NET REALISABLE VALUE — COSTS TO SELL

Q&A IAS 2: 6-3 — RENUMBERED

Q&A IAS 2: 6-4 — CLASSIFICATION OF ASSETS ACQUIRED FOR SALE

When an extension option is exercised by the lessee, ownership of the asset is

Q&A IAS 2: 6-5 — INVENTORIES ON CONSIGNMENT

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

In some industries it is common for a manufacturer to supply goods to a distributor

IFRSs do not provide any other guidance on accounting for consignment

Q&A IAS 2: 10-1 — IS IT ACCEPTABLE TO INCLUDE EXCHANGE

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

Q&A IAS 2: 10-2 — LEASE COSTS INCLUDED IN THE COST OF

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

• transportation of goods from the supplier;

• transportation or distribution at an intermediate stage in the production

• transportation or distribution of inventories to a temporary storage location

• transportation or distribution of inventories from a warehouse or

Q&A IAS 2: 11-1 — DISCOUNTS AND REBATES

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

This is consistent with the accounting by the supplier required by paragraph 10 of

Q&A IAS 2: 12-1 — IS IT ACCEPTABLE TO OMIT OVERHEADS FROM THE

Q&A IAS 2: 12-2 — 'MARGINAL COSTING' APPROACHES TO

Q&A IAS 2: 12-3 — BORROWING COSTS INCLUDED IN THE COST OF

IAS 23(2007).7 expressly states that “inventories that are manufactured, or

An example of circumstances when it is appropriate to include borrowing costs in the

Q&A IAS 2: 12-4 — DELETED

Q&A IAS 2: 12-5 — DIRECT MATERIALS AND WASTAGE

Q&A IAS 2: 12-6 — ALLOCATION OF OVERHEADS TO THE COST OF

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

Other non-production overheads should only be included when this is justified by

The process for determining the amount of overheads to be carried forward in

• by way of a labour-hour or machine-hour rate;

• in proportion to direct labour costs;

• in proportion to material costs;

• in proportion to prime costs; and

• equally to each unit of production. (This is only appropriate where a single

Whichever method for allocating overheads is adopted, the overheads should be

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

Q&A IAS 2: 15-1 — OTHER COSTS INCURRED IN BRINGING

Q&A IAS 2: 22 -1 — RETAIL METHOD FOR THE MEASUREMENT OF THE

This method results in a valuation of inventories that approximates to average price

Q&A IAS 2: 22-EX-1 — RETAIL METHOD FOR THE MEASUREMENT OF

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

To convert closing inventories at retail value to closing inventories at cost, multiply

CU1,300,000 / CU2,000,000 = 65%

65% × CU500,000 = CU325,000 = closing value of inventories

Q&A IAS 2: 23-1 — CHANGE FROM ONE COST FORMULA TO ANOTHER

• IAS 2.36(a) requires disclosure of the accounting policies used for

Q&A IAS 2: 27-EX-1 — WEIGHTED AVERAGE COST FORMULA —

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

CU382,000 / 90,000 = CU4.24

The value of closing inventories is CU4.24 × 20,000 = CU84,800.

Q&A IAS 2: 27-EX-2 — FIFO COST FORMULA — EXAMPLE

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

Closing inventories are 20,000 units.

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

Q&A IAS 2: 30-1 — SALES AFTER THE REPORTING PERIOD

Q&A IAS 2: 30-2 — NET REALISABLE VALUE FOR INVENTORIES

At 31 December 20X0, Entity P holds a property as development work in progress.

Confidential and Proprietary — for Use Solely by Authorised Personnel Only

DELOITTE TOUCHE TOHMATSU GUIDANCE

Q&A IAS 7: 6-1 — MEANING OF "DEMAND DEPOSITS"