Fin119 CSG PDF
Fin119 CSG PDF
Fin119 CSG PDF
& Reporting
(FIN)119
January 2019
Dear Candidate,
Welcome to the Financial Accounting & Reporting (FIN) module of the Chartered Accountants Program.
On completion of this module you will be one step closer to becoming a Chartered Accountant.
Inside this pack you will find your Candidate Study Guide (CSG), which includes the core content for
each unit. For those new to the Chartered Accountants Program, the Module Outline directs you to the
key resources available to you, both within this printed CSG and online through myLearning.
In choosing the Chartered Accountants Program, you are partnering with one of the world’s leading
higher education providers in accounting.
Candidate feedback is vital to our success, and each term we reflect carefully on candidate feedback.
The following pages discuss the changes we have made to the module in response to this feedback.
Above all, work hard to achieve the exam results you want and to set yourself up for a successful
career as a Chartered Accountant.
Yours faithfully,
Joanne Ross CA
Senior Module Leader, Financial Accounting & Reporting module
charteredaccountantsanz.com
Copyright © Chartered Accountants Australia and New Zealand 2019. All rights reserved.
This publication is copyright. Apart from any use as permitted under the Copyright Act 1968 (Australia) and Copyright Act 1994 (New Zealand), as applicable, it may not be copied, adapted, amended, published,
communicated or otherwise made available to third parties, in whole or in part, in any form or by any means, without the prior written consent of Chartered Accountants Australia and New Zealand.
Contents
Introduction i
Module outline v
Introduction
Welcome to the Financial Accounting & Reporting (FIN) module. This module will develop
your understanding of the conceptual framework for financial reporting, and enable you to
reference Accounting Standards and pronouncements and apply your knowledge to various
practical scenarios.
Learning model
The Chartered Accountants Program (the Program) material has been constructed applying
the learning principles of ‘tell, show, do’ to learning outcomes devised for each unit. Each unit
is made up, primarily, of core content, worked examples, activities and a unit quiz.
TELL SHOW DO
Tell me the relevant + Show me how to + Can I do the task
theory do the task unassisted?
Where do I start?
•• The module outline (included in this pack).
•• The module plan (included in this pack), to help structure your studies.
•• The online orientation video, to introduce you to myLearning.
•• Past papers (available in myLearning), to understand how topics are addressed in exams.
It is best to work through the Candidate Study Guide (CSG) units in order. The CSG provides
the ‘Tell’ part of your learning, giving core principles and basic examples. The CSG also directs
you to required readings, which are an essential part of your studies in FIN.
myLearning is an important part of your studies. It contains:
•• Important announcements.
•• Overview videos in each unit.
•• Worked examples and solutions (the ‘show’ part of your learning).
•• Activities and solutions (the ‘do’ part of your learning).
•• Tables of required readings by unit.
•• Adaptive learning lesson in Unit 16 – an interactive online problem that ‘adapts’ and
‘changes’ based on your responses. This lesson was designed to support your learning
in consolidations.
•• Quiz on each unit.
•• PDFs of all activities, worked examples and their solutions.
Introduction Page i
Financial Accounting & Reporting Chartered Accountants Program
When reviewing the Module outline in the following pages, check that you understand
the following:
•• Assumed knowledge.
•• Accounting Standards.
•• Assessment requirements.
•• Prescribed textbooks.
•• The six-month rule.
•• Date formats.
Some candidate concerns, particularly around the structure of learning, the number of learning
outcomes and the alignment of online assessments to final exams will be addressed via a longer
term CA Program review across all modules.
Page ii Introduction
Chartered Accountants Program Financial Accounting & Reporting
Good luck!
The Chartered Accountants Program is challenging. It is designed to be the best educational
product it can be for you, the future practitioners in this profession. As it constantly evolves,
Chartered Accountants Australia and New Zealand will continually be actively seeking your
feedback to ensure the Program meets the learner’s needs now and for future development.
We hope you find your journey through the Program a rewarding and enjoyable experience
and encourage you to work steadily through the material. If you require further assistance,
post your questions on the discussion forum.
Finally, best of luck with your studies. I and the FIN team look forward to conversing with
you on the discussion forum online over the course of your studies.
Joanne Ross
Senior Module Leader, FIN module
Page iv
Chartered Accountants Program Financial Accounting & Reporting
Module outline
Overview
Financial accounting is a pivotal aspect of an accountant’s work and is the main reporting
mechanism for preparing financial statements for organisations across all sectors of the economy.
FIN includes practical examples and activities that will develop your understanding of
the conceptual framework for financial reporting, and enable you to reference Accounting
Standards and pronouncements and apply your knowledge to a variety of practical scenarios.
The FIN module is one of the five compulsory modules in the Chartered Accountants Program.
It requires a good understanding of financial accounting from a candidate’s previous tertiary
studies.
Assessment
The assessment components are outlined below:
Exam 80 marks Format: Four (4) compulsory multi-part written questions based on
the learning outcomes.
Time: Three (3) hours, plus 15 minutes reading time.
Resources: The exam is open book – you can bring in any printed or
handwritten resources you require.
MUST PASS
Introduction Page v
Financial Accounting & Reporting Chartered Accountants Program
Time allocation
The expected workload for this module is a minimum of 10 hours per week over 12 weeks, or
120 hours in total, excluding module orientation, online assessments, final exam and study time
for the final exam. Candidates are advised to plan their enrolment carefully around work and
other commitments, to ensure they are able to devote the time required to their studies.
Assumed knowledge
It is assumed that candidates have a good understanding of financial accounting and reporting
from their tertiary studies. Detailed below is a summary of the assumed knowledge of the
module:
•• Understanding of the relevant framework, in particular the definitions of and recognition
criteria for assets, liabilities, equity, income and expenses.
•• Basic understanding of financial accounting and reporting concepts, particularly the general
format and content of a set of financial statements.
•• Understanding of the principles of disclosure relating to the presentation of financial
statements.
•• Understanding of the principles relating to the selection and changing of accounting
policies.
•• Understanding of the accounting treatment and disclosure of changes in accounting
policies, accounting estimates and corrections of errors.
•• Basic understanding of revenue recognition requirements.
•• Understanding of the principles of accrual accounting.
•• Basic understanding of the taxation treatments for assets, liabilities, income and expenses.
•• Understanding of accounting for inventory.
•• Basic understanding of accounting for property, plant and equipment and intangible assets.
•• Basic understanding of the principles of consolidated financial statements.
•• Basic understanding of accounting for intragroup transactions.
•• Basic understanding of acquired goodwill – its nature and accounting treatment under the
relevant standard on business combinations.
•• Understanding of the concept of the time value of money and discounted cash flows and
how to calculate its impact.
•• Understanding of accounting for equity.
•• Understanding of accounting for the issue of equity and movements in retained earnings
and other reserves.
•• Basic understanding of the accounting for income tax.
•• Basic understanding of the accounting for a business combination.
•• Understanding of the translation of an amount from one currency to a foreign currency.
Candidates can check their assumed knowledge for each of the technical modules by taking the
Quiz in myLearning and if necessary, using the recommended resources to refresh their learning.
Page vi Introduction
Chartered Accountants Program Financial Accounting & Reporting
Additional support
•• Virtual classrooms have been replaced this offering with videos that include live polling.
These are designed to prepare you for each online assessment.
•• Candidate Study Guide – after enrolment you will receive a Candidate Study Guide for all
technical modules, containing the module core content and the list of required readings for
each unit.
•• Discussion forums
–– Technical query forums – where candidates can post specific questions to a technical
specialist.
–– Peer-to-peer forums – where candidates can form study groups or discuss issues with
other candidates.
•• Past exams – to help candidates prepare for the final exam, past exams will be available to
download with suggested solutions.
Accounting Standards
All references to Accounting Standards in the learning elements are to International Standards,
except where they relate to jurisdiction-specific content.
The unit landing page on myLearning provides a summary of the readings from the
International Pronouncements together with the equivalent Australian and New Zealand
Pronouncements.
In the exam, you can refer to the International Standards or the Australian or New Zealand
Standards. This is explained in more detail in Unit 1.
Unit 6 (4 hrs)
commencing
11 February Unit 7 (5 hrs) INTEGRATED
Forex/Fair value/PPE ACTIVITY 1
WEEK 5 Unit 8 (5 hrs) (1 hr)
commencing Unit 9 Part A (9 hrs) CENSUS DATE
18 February Intangibles/Fin. Instruments 22 February 2019
module)
WEEK 13 Exam
commencing preparation
15 April
EXAM
23 April 2019
Results: 17 May 2019
Date convention
Generally, the date format is as follows:
Dates for the current decade are expressed as 20XX, the preceding decade are expressed as
20WX and future years outside of this decade dates are expressed as 20Y3. For example, if a
date given in an example is 20X6, 20W6 would be 10 years earlier and 20Y6 would be 10 years in
the future. All years are treated as having 365 days.
Dates in the exam will use actual years e.g. 2019.
Learning outcomes
Learning outcomes provide an outline of the expected knowledge and skill level achieved on
completion of the unit. Learning outcomes are shown on the unit learning page and on the
first CSG page for each unit. Each learning outcome commences with a verb, such as explain,
calculate, demonstrate etc. These terms are in the following table of task words.
Word Meaning
Analyse Examine closely; examine something in terms of its parts and show how they are
related to each other
Consider Think carefully about something before making a decision, to look closely or attentively
at something
Construct Build or make something, to form an idea, a process or procedure by bringing together
various theoretical and conceptual elements
Critique Give a judgement about the value of something and support that judgement with
evidence
Define Make clear what is meant by something; or use a definition or definitions to explore
a concept
Determine Establish the most appropriate or most correct answer or course of action from a range
of available options
Develop Bring something into existence that has not previously existed, or to reshape
something from its initial position into something more refined
Introduction Page ix
Financial Accounting & Reporting Chartered Accountants Program
Word Meaning
Evaluate Determine the value of something, normally with reference to specific criteria
Explain Make clear the details of something; or show the reason for or underlying cause of
something; or the means by which something occurs
Identify Point to the essential part or parts. You might also have to explain clearly what
is involved
Illustrate Offer an example or examples, to show how something happens, or that something
happens, or to make concrete a concept by giving examples
Integrate Combine one aspect of their learning with another to form a holistic understanding
of a process, procedure or course of action
Justify Provide reasons why certain decisions should be made, conclusions reached and/or
courses of action taken
Prioritise Designate or treat something as being very or more important; or determine the order
for dealing with (a series of items or tasks) according to their relative importance
Produce Without using a pro forma spreadsheet, or without any guidance, create a report of
financial information with commentary
Unit 1
At the end of this unit you will be able to:
1. Describe the purpose of financial reporting.
2. Analyse the reporting requirements of an entity based on the national regulatory framework
including whether an entity is a reporting entity.
3. Explain the interaction between the national and international financial reporting regulatory
frameworks including the relationship with their respective Accounting Standards.
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.
5. Explain contemporary issues affecting financial reporting.
Page x Introduction
Chartered Accountants Program Financial Accounting & Reporting
Unit 2
At the end of this unit you will be able to:
1. Advise on the requirements for financial statements
2. Prepare, analyse and explain a complete set of financial statements.
3. Explain and account for changes in accounting policies, revisions of accounting estimates
and errors.
4. Identify and analyse related parties.
5. Explain and account for discontinued operations.
6. Explain and account for events after the reporting period.
Unit 3
At the end of this unit you will be able to:
1. Identify, measure and recognise revenue from contracts with customers.
Unit 4
At the end of this unit you will be able to:
1. Explain the purpose of tax effect accounting.
2. Calculate and account for current tax.
3. Calculate and account for deferred tax.
4. Explain and account for changes in prior year taxes.
5. Explain and account for income tax expense.
Unit 5
At the end of this unit you will be able to:
1 Explain and account for foreign currency transactions and balances.
2. Determine the functional currency.
3. Explain and account for the translation of financial statements of an entity from its
functional currency to its presentation currency.
Unit 6
At the end of this unit you will be able to:
1. Explain and identify the key principles of fair value measurement, along with the related
disclosure requirements.
Unit 7
At the end of this unit you will be able to:
1. Describe the nature of property, plant and equipment.
2. Explain and account for property, plant and equipment during its useful life.
3. Explain and account for borrowing costs in relation to a qualifying asset.
Unit 8
At the end of this unit you will be able to:
1. Identify and explain the key characteristics of an intangible asset, including whether it can
be recognised for financial reporting purposes.
2. Explain and account for an intangible asset.
Introduction Page xi
Financial Accounting & Reporting Chartered Accountants Program
Unit 9
At the end of this unit you will be able to:
1. Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
2. Account for financial assets, financial liabilities and equity instruments of the issuer
(including derivatives).
3. Explain and account for basic cash flow and fair value hedges.
4. Explain and account for impairment of financial assets.
5. Explain and account for the derecognition of financial assets and financial liabilities.
Unit 10
At the end of this unit you will be able to:
1. Explain and account for an impairment loss for an individual asset.
2. Identify, explain and account for an impairment loss for a cash-generating unit (CGU)
including impairment of goodwill.
3. Explain and account for reversals of impairment losses.
Unit 11
At the end of this unit you will be able to:
1. Explain and account for a provision.
2. Identify and explain a contingent liability.
3. Identify and explain a contingent asset.
Unit 12
At the end of this unit you will be able to:
1. Discuss the characteristics of a lease.
2. Explain and account for lease transactions (for lessees).
3. Explain and account for lease transactions (for lessors).
4. Explain and account for sale and leaseback transactions.
Unit 13
At the end of this unit you will be able to:
1. Explain the requirements for disclosing earnings per share (EPS) information, including
which entities need to include EPS information.
2. Calculate basic and diluted EPS for continuing and discontinued operations.
Unit 14
At the end of this unit you will be able to:
1. Identify and account for share-based payments.
Units 15-17
At the end of this introduction you will be able to:
1. Identify the appropriate classification for investments as subsidiaries, associates or joint
arrangements.
Unit 15
At the end of this unit you will be able to:
1. Identify a business combination.
2. Explain the concept of control.
3. Explain and account for a business combination in the books of the acquirer.
4. Account for subsequent adjustments to the initial accounting for a business combination.
Unit 16
At the end of this unit you will be able to:
1. Explain how a business combination is accounted for in the books of the acquiree.
2. Explain and account for a consolidation for a wholly-owned subsidiary.
3. Explain and account for a consolidation for a partly-owned subsidiary.
4. Account for movements in the parent’s interest in a subsidiary
Unit 17
At the end of this unit you will be able to:
1. Explain and account for an investment using the equity method.
2. Explain the concepts of significant influence and joint control.
Six-month rule
Legislation changes constantly. In the Program modules, you are expected to be up to date with
relevant legislation, Standards, cases, rulings, determinations and other guidance as they stand
six months before the exam date unless otherwise stated. In some instances the International
Accounting Standard may have been updated while the Australian Standard or New Zealand
Standard may not. International Standards can be accessed from the IFRS website (www.ifrs.org),
you will need to register to access the content on this website but it is free to do so
You are always encouraged to be aware of developments in financial reporting. The relevant
date for legislation is the date the legislation receives royal assent. The relevant date for
Accounting Standards and other material is the issue date. Early adoption of Standards
is generally encouraged.
Contents
Introduction 1-3
Overview of international standard-setting 1-4
Convergence of national and international standards 1-5
International financial reporting regulatory framework 1-6
The Conceptual Framework and the purpose of financial reporting 1-7
Qualitative characteristics 1-7
Elements of financial statements, recognition and measurement criteria 1-8
Definition and recognition criteria 1-9
Future developments 1-10
Practical issues in using Accounting Standards 1-11
Comparing the IASB, AASB and XRB standards 1-11
Australia-specific 1-12
New Zealand-specific 1-12
National reporting requirements and the regulatory framework 1-12
Australia-specific 1-13
New Zealand-specific 1-23
Interrelationship between international and national requirements 1-28
International and national frameworks – interaction and key differences 1-28
Australia-specific 1-28
New Zealand-specific 1-31
Ethical requirements in preparing financial reports 1-38
Ethical requirements 1-38
IESBA Code 1-39
Fundamental principles 1-39
Threats and safeguards 1-39
Australia-specific 1-41
New Zealand-specific 1-41
Non-compliance with laws and regulations (NOCLAR) 1-43
Contemporary financial reporting issues 1-44
International level 1-44
Australia-specific 1-47
fin11901_csg_13
Learning outcomes
At the end of this unit you will be able to:
1. Describe the purpose of financial reporting.
2. Analyse the reporting requirements of an entity based on the national regulatory
framework including whether an entity is a reporting entity.
3. Explain the interaction between the national and international financial reporting
regulatory frameworks including the relationship with their respective Accounting
Standards.
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.
5. Explain contemporary issues affecting financial reporting.
Introduction
Financial reporting is a key tool that entities use to communicate with users of financial reports.
Information about the resources of the entity and claims against those resources is central to
users’ decision-making.
The new Conceptual Framework for Financial Reporting (the Conceptual Framework), issued in
March 2018, describes the objective of general purpose financial reporting and defines the
concepts supporting this objective.
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in
making decisions relating to providing resources to the entity.
Those decisions involve decisions about:
(a) buying, selling or holding equity and debt instruments;
(b) providing or settling loans and other forms of credit; or
(c) exercising rights to vote on, or otherwise influence, management’s actions that affect the use of
the entity’s economic resources.
IASB 2018, The Conceptual Framework for Financial Reporting
Users of financial reports also use such information when trying to form a view about an entity
and its management. For example, what can the user expect in terms of future cash flows? How
does this entity compare to other entities? How has management discharged its responsibilities?
Has management used the entity’s resource efficiently and effectively?
Financial reporting relies on the information from financial accounting processes within the
entity, and entities use this information to prepare reports for external users. However, users
have different information needs, and they generally do not have the power to request tailored
financial information. This is where general purpose financial reports (GPFR), prepared under
International Financial Reporting Standards (IFRS), play a vital role.
The Financial Accounting & Reporting (FIN) module considers both the financial accounting
methods and the formal financial reports. Entities want to minimise the work during report
preparation, so financial accounting processes are designed with the Accounting Standards and
disclosure requirements in mind.
This unit provides an overview of the financial reporting framework and the regulatory
requirements applicable to financial reporting, both nationally and internationally. It also
explains the ethical requirements that apply to the work of a Chartered Accountant when
preparing financial reports.
This unit addresses the learning outcomes via the following sections:
•• Overview of international standard-setting.
•• The Conceptual Framework and the purpose of financial reporting.
•• Practical issues in using Accounting Standards.
•• National reporting requirements and the regulatory frameworks.
•• Interrelationship between international and national requirements.
•• Ethical requirements in preparing financial reports.
•• Contemporary issues in financial reporting.
Later units discuss financial reporting from an International perspective, applying the IFRS
standards topic by topic in more detail.
Please note that for exam purposes only, the international standards, the Australian Accounting
Standards Board (AASB) standards, or the New Zealand IFRS (NZ IFRS) can be used
interchangeably. This unit will explain how to navigate the different standards for the purposes
of both your study and your professional practice.
‘Our mission is to develop IFRS Standards that bring transparency, accountability and
efficiency to financial markets around the world. Our work serves the public interest by
fostering trust, growth and long-term financial stability in the global economy.’
www.IFRS.org, accessed 13 April 2018
‘If we really believe in open international markets and the benefits of global finance, then it
can’t make sense to have different accounting rules and practices for companies and investors
operating across national borders. That is why we need global standards.
Ultimately this will get done.’
Paul A Volcker
Chairman of the US Federal Reserve (1979–1987) and
Chairman of the IFRS Foundation Trustees (2000–2005).
‘The IASB is committed to developing, in the public interest, a single set of high quality global
accounting standards that provide high quality, transparent and comparable information in
general-purpose financial Statements.’
Pacter, Paul 2015, IFRS as Global Standards: a Pocket Guide, IFRS Foundation.
A converged set of financial reporting standards make sense. As entities expand and operate
across many jurisdictions, converged reporting is less costly, improves an entity’s access to
capital and ensures reports to the users are comparable.
The extent of cross-border investment is growing constantly, and financial reporting must
respond to, and enhance, this growth. In line with the IASB and IFRS Foundation’s aims,
convergence should aid in bringing transparency, accountability and efficiency to financial
markets around the world.
It is important to remember that measurements in financial reporting are often not exact.
In practice, decisions around applying Accounting Standards are not always black and white.
The IASB’s Conceptual Framework for Financial Reporting (the Conceptual Framework) states that
’to a large extent, financial reports are based on estimates, judgements and models’. This use
of estimates and judgements in reporting creates even more need for converged standards and
agreed-upon principles for financial reporting.
Of course, in reality, full convergence is not always possible. The IASB does not have the power
to require adoption of IFRS in any jurisdiction, nor is it able to supervise a country’s adoption.
There are differing local requirements and local regulatory frameworks, and there are cultural
differences in implementing the same set of standards. Partial convergence is common in
many countries. This unit considers the requirements in your local jurisdiction, and how these
requirements interact with those of the IASB.
The IASB issues regular updates on the adoption of IFRS. Currently, these standards are
required or permitted to be used in 150 countries.
Some countries have taken the approach of adopting IFRS, replacing their previous generally
accepted accounting principles (GAAP) with equivalent IFRS. For example, the European
Union has adopted this approach for the preparation of consolidated financial statements of
listed companies. Australia has largely adopted this approach with some exceptions, including
tailoring the Australian Standards for use by not-for-profit (NFP) entities and by entities that
meet the criteria for reduced disclosure requirements reporting.
Other countries have chosen to eliminate differences between their existing national GAAP and
the IFRS, where possible and practicable. Countries following this strategy include Japan, China
and India.
Companies in both Australia and the European Union have been reporting under the IFRS
regime since 2005, and companies in New Zealand since 2007. In general, the move to the
standard platform of reporting under IFRS has been successful; however, not all members of the
business community agree that the adoption of IFRS has been useful.
For an overview of the aims of the IASB, the IFRS Foundation and the standard-setting process,
consider the further reading below.
Further reading
Pacter, Paul 2017, Pocket Guide to IFRS® Standards: the global financial reporting language,
www.ifrs.org → Use around the world – Pocket Guide to IFRS Standards, accessed 13 April 2018.
To understand each of the relevant roles above, refer to the IFRS website (www.ifrs.org),
or download the ‘Who we are and what we do’ brochure (www.ifrs.org → About us → Who we
are → Who we are and what we do document).
This international approach (i.e. having separate standard setters for different sectors) differs
to the approach adopted by national jurisdictions. In Australia, the Australian Accounting
Standards Board (AASB) sets Accounting Standards for both the private and public sectors,
including NFP entities. Similarly, in New Zealand, Accounting Standards are set by the External
Reporting Board (XRB).
Drawing on the concepts set out in the Conceptual Framework, the IASB then sets and modifies
the IFRSs.
This unit will now go on to examine the foundation layer of international financial reporting as
shown in the diagram above. Specific IFRSs, as set by the IASB, are discussed in later units.
Learning outcome
1. Describe the purpose of financial reporting.
A new version of the Conceptual Framework was issued by the IASB in March 2018.
The elements and concepts defined and explained within the Conceptual Framework are
the building blocks for a set of meaningful and robust financial statements. The Conceptual
Framework acts as the foundation, defining the concepts that underpin the IFRS standards.
Before we can delve into the focus areas of this unit, we need to consider the purpose of
financial reporting, so as to better understand an entity’s reporting requirements.
Paragraph 1.2 of the Conceptual Framework states:
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and other creditors in making
decisions relating to providing resources to the entity.
Financial reports tell a story about an entity. The users need these reports to assist them in
making decisions and, as per the Conceptual Framework, these decisions rely on information
such as:
(a) the economic resources of the entity, claims against the entity and changes in those
resources and claims, and
(b) how efficiently and effectively the entity’s management and governing Board have
discharged its responsibilities to use the entity’s economic resources.
As you may recall from your university studies, general purpose financial reports are designed
to meet the needs of users who do not have the power to request reports specifically designed to
meet their own needs. These reports do not ’value’ the entity, but instead provide information
to help in users own estimations of value.
As noted above, the Conceptual Framework sets out the objective of financial reporting.
It also discusses the qualitative characteristics of useful information, and the definitions and
recognition criteria for the elements within the financial statements, and concepts of capital and
capital maintenance.
Qualitative characteristics
The Conceptual Framework para. 2.4 states:
For financial information to be useful, it must be relevant and faithfully represent what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely
and understandable.
These qualitative characteristics, along with the Conceptual Framework definitions and
recognition criteria, underpin most of the more specific principles within individual Accounting
Standards. The Conceptual Framework is not mandatory in most circumstances; however, the
concepts within form the foundation of the mandatory Accounting Standards.
The exception to this statement lies in the requirements of IAS 8 Accounting Policies, Changes in
Accounting estimates and Errors (IAS 8). Paragraphs 10 and 11 state that where the standards do
not specifically cover an issue or transaction the entity is facing, the entity should first look at
guidance from Accounting Standards covering similar or related issues, and then look at the
definitions, recognition criteria and measurement concepts in the Conceptual Framework.
It is worth reading the key aspects of the Conceptual Framework, as this should further develop
your understanding of all standards.
Required reading
The Conceptual Framework for Financial Reporting 2018.
The Conceptual Framework defines the elements of the financial statements as assets, liabilities,
equity, income and expenses. It also specifies the recognition criteria for each of these elements.
Before an item can be recognised, it is first checked against the definition set out in the
Conceptual Framework. An item that both meets this definition and satisfies the related
recognition criteria should be recognised in the financial statements.
An asset or liability is recognised only if recognition of that asset or liability and of any resulting
income, expenses or changes in equity provides users of financial statements with information
that is useful :
(a) relevant information about the asset or liability and about any resulting income, expenses or
changes in equity (see paras 5.12–5.17); and
(b) a faithful representation of the asset or liability and of any resulting income, expenses or
changes in equity (see paras 5.18–5.25).
The definition and recognition criteria are summarised in the table below. Further discussion on
each element is contained within the Conceptual Framework.
Liability A present obligation of the entity It is probable that an outflow of A present obligation of the income, expense or changes in equity Statement of
arising from past events, the resources embodying economic entity to transfer an economic provide users with useful information financial position
settlement of which is expected to benefits will result from the resource as the result of past (para. 5.7)
result in an outflow from the entity settlement of a present obligation, events (para. 4.26) What is useful information?
of resources embodying economic and the amount at which the (a) Relevant information about the
benefits (para. 4.4(b)) settlement will take place can be asset or liability (and related income,
measured reliably (para. 4.46) expense or change in equity)
Equity The residual interest in the assets Because equity is the arithmetic The residual interest in the (b) A faithful representation of the asset Statement of
of the entity after deducting all its difference between assets and assets of the entity after or liability (and related income, financial position
liabilities (para. 4.4(c)) liabilities, a separate recognition deducting all its liabilities expense or changes in equity) Statement of
criteria for equity is not needed (para. 4.63) changes in equity
The new 2018 Conceptual Framework
Income Increases in economic benefits during Increases in assets, or discusses cases where these criteria Statement of profit
the accounting period in the form of decreases in liabilities, that may not apply, that is: or loss and other
inflows or enhancements of assets or result in increases in equity, Information may not be relevant if: comprehensive
decreases of liabilities that result in other than those relating to income
(a) it is uncertain whether the asset or
increases in equity, other than those contributions from holders of
liability exists (para. 5.14), or
relating to contributions from equity equity claims (para. 4.68)
participants (para. 4.25(a)) (b) The asset or liability exists but
the probability of an inflow or
Expenses Decreases in economic benefits When a decrease in future Decreases in assets, or outflow of economic benefits is low Statement of profit
during the accounting period in the economic benefits related to a increases in liabilities, that (para. 5.12) or loss and other
form of outflows or depletions of decrease in an asset or an increase result in decreases in equity, comprehensive
assets or incurrences of liabilities that of a liability has arisen that can be other than those relating to Information may lack representational income
result in decreases in equity, other measured reliably (para. 4.49) distributions to holders of faithfulness if there is a high degree of
than those relating to distributions to equity claims (para. 4.69) measurement uncertainty (paras 5.19,
equity participants (para. 4.25(b)) 5.21 and 5.22)
Page 1-9
produce economic benefits
(para. 4.4)
Financial Accounting & Reporting
Financial Accounting & Reporting Chartered Accountants Program
Future developments
Definition of reporting entity
According to the Conceptual Framework (2018) para. 3.10,
a reporting entity is an entity that chooses, or is required, to prepare general purpose financial
statements.
A reporting entity is not necessarily a legal entity. It can comprise a portion of an entity, or two
or more entities.
At the time of writing, the IASB has not yet made the 2018 Conceptual Framework publicly
available. Check myLearning for more information. Australian candidates should note that the
IASB definition of ‘reporting entity’ differ significantly from the AASB definition. The AASB
is currently working to resolve these differences and their impact on financial reporting
in Australia.
For the purposes of this module, when referring to the international standards as a whole, the
term IFRS is used. This is consistent with the definition of IFRS in IAS 1 para. 7.
A comparison between the IASB, AASB and XRB standards is best demonstrated through
examples. Below is an example of a comparison, using a ‘new generation’ IFRS standard:
IFRS 13 Fair Value Measurement, AASB 13 Fair Value Measurement, NZ IFRS 13 Fair Value
para. 9 states, ’This IFRS defines para. 9 states, ’This standard Measurement, para. 9 states,
fair value as the price that would defines fair value as the price that ’This NZ IFRS defines fair value as the
be received to sell an asset or would be received to sell an asset price that would be received to
paid to transfer a liability in an or paid to transfer a liability in sell an asset or paid to transfer a
orderly transaction between an orderly transaction between liability in an orderly transaction
market participants at the market participants at the between market participants at
measurement date measurement date’ the measurement date’
It is clear from the above example that the paragraphs are directly comparable.
Below is an example of a comparison from an ‘older generation’ of IAS standards.
Please note that in Australia, these standards are numbered as 100 series – therefore, IAS 12 is
referred to as AASB 112. However, in New Zealand, the numbering agrees to the IASB standard
and therefore IAS 12 is referred to as NZ IAS 12.
IAS 12 Income Taxes, para. 56 AASB 112 Income Taxes, para. NZ IAS 12 Income Taxes, para.
states, ’The carrying amount 56 states, ’The carrying amount 56 states, ’The carrying amount
of a deferred tax asset shall be of a deferred tax asset shall be of a deferred tax asset shall be
reviewed at the end of each reviewed at the end of each reviewed at the end of each
reporting period…’ reporting period…’ reporting period…’
As candidates work through a given unit, we recommend referring to the related paragraphs
of the standard. While the Candidate Study Guide provides extensive guidance, a Chartered
Accountant needs to be able to access the most authoritative source of information for financial
reporting, and navigating the standards is part of your professional skill set. It is always best to
go to the source.
AU Australia-specific
The numbering system of Australian accounting pronouncements differs to the numbering
system used by the IASB, as shown below:
Correlation between Australian standard numbering and international standard numbering
systems
AASB Standards
AASB Interpretations
Interpretation 1 to 23 IFRIC 1 to 23
NZ New Zealand-specific
The numbering system of the New Zealand pronouncements is broadly the same as that
developed by the IASB, with the exception of those relating to New Zealand-specific standards.
This is further explored below:
New Zealand pronouncements Corresponding IASB pronouncements
NZ Interpretations
Learning outcome
2. Analyse the reporting requirements of an entity based on the national regulatory framework
including whether an entity is a reporting entity.
Each country has its own requirements for the preparation of financial reports. Some countries
largely draw on the international financial reporting regulatory framework, while others have
their own long-established frameworks.
In the following pages, there is a substantial amount of jurisdiction material. Candidates should
note that they are only required to study the material related to their region. Australian and
MICPA candidates should read the Australia-specific boxes. New Zealand candidates should
read the New Zealand-specific boxes.
Australia-specific AU
Australian regulatory framework
The Australian regulatory framework determines an entity’s financial reporting obligations.
This framework is overseen by statutory bodies or enshrined in legislation which establishes the
rules and regulations for financial report preparation.
The Australian financial reporting regulatory framework is depicted in the following diagram:
Financial
Financial Reporting Reporting
Regulatory Regulatory
Framework Framework (Australia)
(Australia)
Lobby groups:
CA ANZ/CPAA/IPA
ASX
ASIC
AASB AUASB
(Australian Accounting (Auditing and Assurance
Standards Board) Standards Board)
Issues: Issues:
• AASBs (Accounting Standards) • Auditing Standards
• Interpretations • Guidance statements
OUTPUT
Australian general purpose financial report1
Notes
1. A non-reporting entity may be required to prepare a financial report. Where a financial report is
prepared, the output may be a special purpose financial report.
Details on the roles and responsibilities of each regulatory body can be obtained from their
respective websites. A brief summary is also provided in the ‘Regulatory Bodies’ document,
available in the Unit 1 folder in myLearning.
Which entities are What are the main What are the rules
required to prepare a components of a financial governing how a
financial report in Australia? report in Australia? financial report is prepared?
In Australia, a large number of business entities are registered under, and governed by, the
Corporations Act.
Australian entities under the Corporations Act
The following table identifies the types of entities in Australia that you need to have an
understanding of in the FIN module. It shows how they are defined under the Corporations Act
and also includes a brief summary of the additional reporting requirements for each.
Types of Australian entities
Other types of entities that are defined under the Corporations Act are:
•• Registered schemes.
•• Companies limited by guarantee.
•• Australian financial services licence (AFSL).
Section 292 of the Act requires the following types of entities to prepare an annual financial
report, which must be lodged with the Australian Securities and Investments Commission (ASIC):
•• Disclosing entities.
•• Public companies.
•• Large proprietary companies.
•• Registered schemes.
•• Small proprietary companies (in limited circumstances only).
Large or small proprietary companies
A large proprietary company is required to prepare and lodge a financial report with ASIC,
while a small proprietary company generally is not. It is therefore important to understand the
distinction between a large and a small proprietary company.
Section 45(A) of the Corporations Act prescribes the criteria for small and large proprietary
companies, the tests of which are outlined in the table below. If a proprietary company falls
below the threshold in two or more of the tests, it is classified as a small proprietary company;
otherwise, it is classified as a large proprietary company.
Classification of proprietary limited companies – criteria
Test Threshold
2. Consolidated gross assets at the end of the financial year $12.5 million
At the time of writing, the Department of the Treasury of Australia is proposing to double the
thresholds in the table above. If approved, the new thresholds will apply for financial years
beginning on or after 1 July 2019. For the purposes of the FIN, module the existing thresholds
will be applied.
Which entities are What are the main What are the rules
required to prepare a components of a financial governing how a
financial report in Australia? report in Australia? financial report is prepared?
Directors’ declaration : AU
A requirement of Corporations Act ss 295(4) and (5), a directors’ declaration is a signed statement
on behalf of the board of directors that covers a number of assertions, including whether:
•• There are reasonable grounds to believe that the entity will be able to pay its debts as and
when they become due and payable.
•• The financial statements and notes give a true and fair view of an entity’s financial position
and performance, and comply with Accounting Standards.
The following diagram summarises the required elements for a financial report in Australia
Directors’ declaration
Financial statements
Which entities are What are the main What are the rules
required to prepare a components of a financial governing how a
financial report in Australia? report in Australia? financial report is prepared?
2016/785 Wholly owned entities may be relieved from the requirement to prepare
ASIC Corporations (Wholly and lodge audited financial statements under Chapter 2M of the
Owned Companies) Corporations Act when they enter into deeds of cross-guarantee with
Instrument their parent entity and meet certain other conditions
RG 43 Financial reports and Explains how ASIC may exercise its powers to grant relief
audit relief from the financial reporting and audit requirements of
Parts 2M.2, 2M.3 and 2M.4 (other than Division 4) of the
Corporations Act
RG 115 Audit relief for Refers to the class order relief given under2016/784. It also
proprietary indicates when ASIC will give additional relief from audit
companies requirements to individual proprietary companies on a
case-by-case basis under s. 340
RG 230 Disclosing non-IFRS Provides guidance on the use of financial information that
financial information is not presented in accordance with Accounting Standards
in financial reports and other corporate documents.
RG 247 Effective disclosure Provides guidance to listed entities and their directors on
in an operating and providing useful and meaningful information to share/unit
financial review holders when preparing an operating and financial review
in a directors’ report
SAC 1 requires the use of professional judgement to determine whether an entity is a reporting or
non-reporting entity. This means that the preparer of a financial report must consider the likely users
and their information needs. In deciding these issues, the following factors are considered:
•• The degree to which management and ownership interest is separated – for example, listed
companies have many investors who are not involved in the management of the business.
•• Political or economic interest – for example, financial reports of public sector bodies are of
interest to the public.
•• Financial characteristics – for example, very large organisations and those that employ many
people are often considered to be reporting entities.
Examples of reporting entities
In applying SAC 1:
•• some types of entities will always be reporting entities
•• other types of entities will require professional judgement to determine their reporting status.
At present, reporting entities in Australia must prepare a GPFR to comply with all relevant
Accounting Standards.
Reporting Non-reporting
Despite these application paragraphs, there is some debate as to whether preparing an SPFR
in compliance only with these Accounting Standards is sufficient to allow the presentation of a
financial report that gives a true and fair view under the Corporations Act.
To provide guidance on classifying a non-reporting entity and the financial reporting
requirements, ASIC issued Regulatory Guide 85 Reporting requirements for non-reporting
entities (RG 85). In this guide, ASIC states that, in its view, the recognition and measurement
requirements of all accounting standards must be applied in order to determine the
financial position and profit or loss of an entity reporting under the Corporations Act (RG 85
paras 2.1‑2.10). In practice, most preparers of SPFRs, if required to prepare and lodge a financial
report under the Corporations Act, follow the requirements of RG 85.
Further information
This podcast covers the issues around applying the IASB’s Revised Conceptual Framework and
solving the reporting entity and special purpose financial statement problems (commencing at
6 minutes, 30 seconds on the podcast)
Stevens, T 2018, The biggest changes in years are happening now are you ready?, podcasts,
1 June, www.accountantsdaily.com.au, accessed 29 November 2018
Summary of annual reporting requirements (current situation at November 2018 prior to proposed
AU amendments)
The requirements for annual financial reporting in Australia are summarised in the following
flowchart:
YES
Is the entity a small YES Has the entity been NO Not required to prepare
proprietary company or small directed to prepare
a financial report
company limited by guarantee? a financial report by
members or by ASIC?
NO
YES
Checkpoint
Entity should be one of the following:
• Disclosing entity Prepare a financial report
• Public company based on the standards and
• Large proprietary company interpretations to the extent
• Registered scheme directed by members or ASIC
NO
In preparing SPFR, comply with the accounting
standards necessary to give a true and fair view
Is the entity electing to NO (must include AASB 101, 107, 108, 1031, 1048 and
prepare a GPFR? 1054). Compliance with the recognition and
measurement rules of all accounting standards
may also be required
YES
NO
NO
New Zealand-specific NZ
Financial reporting regulatory framework in New Zealand
NZASB NZAuASB
(New Zealand Accounting (New Zealand Auditing and
Standards Board) Assurance Standards Board)
Issues: Key responsibilities:
• NZ IFRSs (Accounting • Professional and ethical
Standards) standards for auditors
• Interpretations in accordance • Auditing Standards
with XRB’s strategy
OUTPUT
NZ GAAP compliant general purpose financial reports
FRA 2013 and FRA 1993 sets out the requirements for the preparation and content of financial
FRA 1993 statements. The new FRA 2013 replaced FRA 1993, although the two ran in
conjunction for the period of transition, which ceased on 1 December 2016
The FRA 2013 is applicable for reporting periods beginning on or after 1 April 2014
Financial Reporting The purpose of this Act is to make amendments to other enactments in
(Amendments to other connection with the FRA 2013
Enactments) 2013 The Act effectively details all the changes to the enabling legislation of other
types of entities such as limited partnerships, companies, partnerships, building
societies, charities and retirement villages
Companies Act 1993 CA 1993 provides the administrative requirements (e.g. registration, formation,
(CA 1993) operation and cessation of a company) for companies and their members
It sets out the responsibilities of directors, and the requirements for keeping
accounting records, preparing an annual report, and appointing auditors
CA 1993 has been amended as a result of FMCA 2013 and FRA 2013
Regulatory framework NZ
In addition to the legal framework, the government and other agencies are also responsible for
monitoring and (should breaches under the legal framework occur) disciplining entities and
their members.
The following parties are involved in the regulatory process:
•• Financial Markets Authority (FMA).
•• Registrar of Companies.
•• New Zealand Stock Exchange (NZX).
Financial Markets Authority
The Financial Markets Authority Act 2011 (FMAA 2011) established the FMA as an independent
Crown entity, and sets out FMA’s main objective, which is to ‘promote and facilitate the
development of fair, efficient, and transparent financial markets’.
The FMAA 2011 also sets out FMA’s functions, which are to:
•• Promote participation of businesses, investors, and consumers in the financial markets.
•• Exercise its powers and duties under various financial markets and other legislation.
•• Monitor compliance with, investigate, and enforce financial markets legislation.
•• Monitor, inquire into and investigate matters relating to financial markets, or the activities of
financial market participants or any person involved with those markets.
•• Review the regulations and practices relating to financial markets and its participants.
•• Cooperate with other law enforcement or regulatory agencies, including overseas regulators.
In addition, the FMA also:
•• Produces policies and guidance to help professionals comply with the legislation.
•• Provides useful information and resources to help investors make better financial decisions.
•• Issues warnings and alerts to the public.
Registrar of Companies
Part 21 of CA 1993 includes a list of penalties for financial reporting offences, which could lead to
fines ranging from $5,000 to $200,000 plus prison terms for more serious offences.
Financial reporting offences in relation to the preparation, audit and registration of the financial
statements are specified in s. 207G. If convicted of a reporting offence (e.g. failing to prepare,
audit or file financial statements) a company is liable to a fine not exceeding $50,000 and each
director is liable to a penalty not exceeding the same amount (s. 374(3) CA 1993).
New Zealand Stock Exchange
The New Zealand Stock Exchange (NZX) also has a role in the regulation of entities listed on its
exchange. This involves supervising listed entities’ compliance with the NZX Listing Rules and
assisting the FMA as a co-regulator under the FMCA 2013.
The New Zealand Markets Disciplinary Tribunal (NZMDT) is an independent body charged
with hearing matters referred to it in relation to the conduct of parties who are regulated by
NZX’s market rules. NZMDT is empowered to impose penalties on parties it determined to have
engaged in conduct that breached any of the NZX rules. Disciplinary tribunal announcements
are publicly available on the NZX website.
Reporting requirements for New Zealand entities
To appropriately determine the financial reporting requirements and applicable standards for
New Zealand entities, it is important to consider the following questions:
•• Is the entity required to prepare GPFS under legislation? If not, is it opting in to prepare
general purpose financial statements?
•• Is it a public benefit entity (PBE) or a for-profit entity?
•• Which tier of reporting will it fall under?
As you can see the list of entities that will be required to report under the FMCA is extensive.
For the purpose of your studies, the most common will be (a) and (d) – entities that have issued
shares to more than 50 shareholders and listed companies on the NZX.
The financial reporting requirements for FMC reporting entities are detailed in Part 7 of the
FMCA 2013, which covers ss 450–461M. The key points to note are; ss 460–461, which requires
financial statements (or group financial statements if relevant) to be prepared within four
months of balance date; s. 461D, which requires those financial statements be audited; and
s. 461H, which requires the financial statements be lodged with the Registrar of Companies.
Large companies
When determining the reporting requirements for a large company, the first check is to make
sure it is not an FMC reporting entity as detailed above. FRA 2013 directs any entity that is an
FMC reporting entity to FMCA 2013 where its financial reporting requirements are detailed
(s. 56 (3) FRA 2013). An entity that is not an FMC reporting entity will prepare financial statements
under FRA 2013 only if it meets the size criterion in s. 45(1) FRA 2013, which states:
…an entity (other than an overseas company or a subsidiary of an overseas company) is large in respect of an
accounting period if at least 1 of the following paragraphs applies:
(a) as at the balance date of each of the 2 preceding accounting periods, the total assets of the entity and its
subsidiaries (if any) exceed $60 million;
(b) in each of the 2 preceding accounting periods, the total revenue of the entity and its subsidiaries (if any)
exceeds $30 million.
Note that the size criterion is only that either revenue or total assets meets the criterion, not
both. Additionally, the group financial statements of a large company are not required to be
prepared if it is a subsidiary of a New Zealand incorporated entity and the group prepares GAAP
group financial statements.
A large company should have its financial statements audited although there are opt-out
arrangements. At a meeting of shareholders, 95% of those entitled to vote must pass a resolution
to opt out of the audit requirement (s. 207J CA 1993).
There is no requirement for a large company to lodge its financial statements with the Registrar
unless it has significant overseas ownership (25% or more).
Note that the size criterion also applies to partnerships and limited partnerships, industrial and
provident societies, although we do not focus on these types of entities in this unit.
Overseas companies
The size criterion for an overseas-owned company to determine whether it is required to prepare
NZ
financial statements is smaller than New Zealand resident companies. Section 45(2) of the
FRA 2013 states:
…an overseas company or a subsidiary of an overseas company is large in respect of an accounting period if at
least 1 of the following paragraphs applies:
(a) as at the balance date of each of the 2 preceding accounting periods, the total assets of the entity and its
subsidiaries (if any) exceed $20 million;
(b) in each of the 2 preceding accounting periods, the total revenue of the entity and its subsidiaries (if any)
exceeds $10 million.
If this criterion is met, s. 201 CA 1993 requires the company to prepare financial statements.
These financial statements must be filed with the Registrar of Companies within five months of
balance date (ss 201 and 207E CA 1993).
A large overseas company is not required to have an audit of its financial statements or group
financial statements if its New Zealand business is not large, and under the law in force in the
country where the overseas company is incorporated or constituted, the qualifying financial
statements are required to be prepared, but are not required to be audited (s. 206(3) CA 1993).
Other reporting entities
The following entities must also prepare financial statements:
•• Retirement villages (but only if publicly listed).
•• Registered charities.
•• Large friendly societies with $30 million or more in total expenditure.
•• Maori incorporations.
•• Public sector PBEs.
Opt-in and opt-out provisions
CA 1993 provides opt-in and opt-out provisions. These permit shareholders to determine
whether a company should opt in or out of compliance with CA 1993. The key points are:
•• Companies with 10 or more shareholders can opt out of preparing financial statements,
audit requirements and annual report by a 95% majority vote. Large companies cannot take
advantage of this provision (s. 207I CA 1993).
•• Large companies can opt out of the audit requirements only by a 95% majority vote (s. 207J
CA 1993).
•• Companies with fewer than 10 shareholders can opt in to preparing financial statements,
audit requirements and annual report by written notice from shareholders of at least 5% of
voting shares (s. 207K CA 1993).
Below is a summary of the financial reporting, audit and filing requirements for companies in
New Zealand.
Category Prepare Audit Filing requirement
GPFS requirement
FMC reporting entities
Within four months of
balance date
Large overseas companies/overseas
Within five months of balance
1
overseas owned
Companies with 10 or more shareholders
No1
2 2
NZ Notes
1 Can be excused from the audit requirement if s. 206(3) CA 1993 applies.
2 Can opt out by resolution approved by not less than 95% of the votes of shareholders entitled to vote and voting on
the question.
3 Can opt in by written notice from shareholders who together hold not less than 5% of the voting shares.
The financial reporting requirements of entities other than companies are outside the scope of
the FIN module.
Learning outcome
3. Explain the interaction between the national and international financial reporting regulatory
frameworks including the relationship with their respective Accounting Standards.
AU Australia-specific
Some of the main sources of differences between the International and Australian regulatory
frameworks for financial reporting are as follows:
1. The Reporting entity concept in Australia’s SAC 1 was needed, owing to the prior lack of a
definition at international level.
2. ’Au’ requirements inserted into IFRS-equivalent standards (also known as jurisdiction-specific
requirements, usually related to Australia’s commitment to sector-neutral standards).
3. Australian standards with no international equivalent.
4. Differential reporting requirements from SAC 1 and the Corporations Act.
5. The non-adoption of IFRS for SMEs in Australia and the use of the RDR.
The Conceptual Framework and the reporting entity concept
The Australian Conceptual Framework is a slightly modified version of the IASB’s Conceptual
Framework. One of the major differences between the IASB’s Conceptual Framework and the
Australian Framework is their view on the reporting entity. Given this concept decides who
prepares GPFRs in Australia, this is a significant difference. As we can see from the table below,
the two definitions have quite a different emphasis, that is, the Australian definition is focused
on the users, while the IASB definition is focused on the actual choices of the entity in relation to
financial reporting.
Australian definition, per SAC 1 The new IASB definition, as per the IASB
Conceptual Framework 2018
AU
Reporting entities are all entities (including A reporting entity is an entity that chooses, or is
economic entities) in respect of which it is required, to prepare general purpose financial
reasonable to expect the existence of users statements
dependent on general purpose financial reports A reporting entity is not necessarily a legal entity.
for information which will be useful to them It can comprise a portion of an entity, or two or
for making and evaluating decisions about the more entities
allocation of scarce resources
As the IASB has now issued its Conceptual Framework, the Australian reporting requirements will
need to change to ensure compliance with IFRS.
Australia-specific paragraphs
For a variety of reasons there may be Australian clauses included within an AASB Standard
(indicated by the paragraph prefix ‘Aus’ within the Standard) that are not included in the
IFRS. Most of these Australian clauses are due to either specific requirements applying to NFP
entities, or Australia-specific issues. Where such clauses have been inserted, the AASB includes
an explanation of any divergences from the IFRS version of the Accounting Standard at the
beginning of each standard.
Australia aims to issue sector-neutral standards, that is, the same transaction will be treated in
the same way by different sectors. The IASB does not take this approach as IFRSs are designed
to apply to the reporting of for-profit entities. Internationally, NFP or public sector standards
are issued by different international standard-setting bodies. This is a key source of difference
between AASB standards and IFRS.
Other differences may relate to Australia-specific issues. For example, AASB 124 Related Party
Disclosures requires disclosure of the name of the ultimate controlling entity incorporated within
Australia (AASB 124 para. Aus13.1).
The AASB adopts the practice of inserting NFP-specific paragraphs within each Standard. It also
inserts Australia-specific clauses in the application paragraphs when adopting an IFRS, making
that Standard applicable to NFP entities that:
•• prepare financial reports in accordance with Part 2M.3 of the Corporations Act
•• as reporting entities, prepare a GPFR
•• prepare financial statements that are held out to be GPFRs.
Note that an NFP entity is consistently defined in several Accounting Standards, including in
AASB 102 Inventories, as one ‘whose principal objective is not the generation of profit’ (AASB 102
para. Aus6.1).
Australian standards with no international equivalent
There are also AASB standards for which there is no international equivalent. These include:
•• AASB 1004 Contributions (a NFP-specific standard).
•• AASB 1039 Concise Financial Reports.
•• AASB 1048 Interpretation of Standards.
•• AASB 1052 Disaggregated Disclosures.
•• AASB 1053 Application of Tiers of Australian Accounting Standards.
•• AASB 1054 Australian Additional Disclosures.
•• AASB 1057 Application of Australian Accounting Standards.
•• AASB 1058 Income of Not-For-Profit Entities
•• AASB 1059 Service Concession Arrangements: Grantors
Differential financial reporting
Differential reporting is the different reporting and disclosure requirements for different tiers of
entities. In Australia, these differences may arise as a result of the reporting entity concept (as per
SAC 1) and some provisions of the Corporations Act, as follows:
AU •• The reporting entity concept (application of SAC 1). As discussed earlier in this unit, SAC 1
prescribes the classification of entities as reporting entities where it is reasonable to expect
the existence of users dependent on GPFRs for information. Such entities are required to
prepare their GPFRs in accordance with full IFRS as adopted in Australia.
•• The Corporations Act prescribes differential reporting requirements on entities based on:
–– classification (as public or proprietary, disclosing or non-disclosing entities)
–– size (as a large or small proprietary company).
As a result of the current differential reporting requirements, there are a large number of entities
in Australia that are required to apply full IFRSs as adopted in Australia, but find the associated
disclosures as adopted in Australia burdensome.
Because of this differential reporting framework, the AASB decided not to adopt IFRS for SMEs.
Instead, Australia uses AASB 1053 Application of Tiers of Australian Accounting Standards to
apply two tiers of reporting, whereby Tier 2 entities may reduce their disclosures via the RDR.
These tiers of reporting are likely to change with the proposed AASB amendments.
AASB 1053 identifies two tiers of GPFR reporting requirements, as follows:
AASB 1053 tiers of reporting
Tier Includes Reporting requirements
1 •• For-profit private sector entities that have These entities are required to prepare GPFRs
public accountability using the full set of IFRSs as adopted in
•• Australian government and state, territory Australia
and local governments
2 •• For-profit private sector entities that do not Entities in Tier 2 have the option of:
have public accountability •• Preparing their GPFRs in accordance with
•• Not-for-profit private sector entities the full set of IFRSs as adopted in Australia
•• Public sector entities, whether for-profit OR
or not-for-profit, other than the Australian
•• Complying with AASB 1053, which requires
government and state, territory and local
compliance with the recognition and
governments
measurement elements of AASBs but allows
substantially reduced disclosures
•• Because this is an Australian-specific Standard, the entity applying the RDR to its financial
report cannot claim compliance with IFRS. This can be an issue where the report is presented
AU
to an overseas audience.
•• The entity applying the RDR will be complying with all IFRS recognition and measurement
requirements, but not with all of the disclosure requirements.
•• Where an entity using the RDR wishes to move to full IFRSs as adopted in Australia in the
future, it will need to apply AASB 1 First-time Adoption of Australian Accounting Standards on
transition because it is unable to make an ‘explicit and unreserved statement of such compliance
[with IFRS] in the notes’ (AASB 101 Presentation of Financial Statements, para. 16) as only some
disclosures were presented in financial statements in previous reporting periods.
Accessing RDR versions of AASB Standards and Interpretations
The RDR versions apply only when AASB 1053 is being applied. The disclosure requirements that
eligible entities are not required to comply with are clearly identified within each Standard as
shaded text.
Model illustrative RDR financial statements are prepared by some of the large accounting firms
and these can be found on their websites.
New Zealand-specific NZ
The External Reporting Board
The External Reporting Board (XRB) is the standard-setter in New Zealand. It is an independent
Crown entity established on 1 July 2011 under s. 22 FRA 1993 (now seen in s. 11 FRA 2013).
The XRB’s functions are as follows:
•• Developing and implementing an overall strategy for Financial Reporting Standards and
Auditing and Assurance Standards (including developing and implementing tiers of financial
reporting and assurance).
•• Preparing and issuing Accounting Standards.
•• Preparing and issuing Auditing and Assurance Standards, including the professional and
ethical standards that will govern the professional conduct of auditors.
•• Liaising with national and international organisations that exercise functions that correspond
with, or are similar to, those conferred on the XRB.
New Zealand generally accepted accounting practice (NZ GAAP)
There have been significant changes in the Accounting Standards framework subsequent to its
initial release in April 2012. The changes have been implemented progressively from 2012 to
2016. The new framework is based on a multi-sector, multi-tier reporting approach. Under the
new framework:
•• For-profit entities will report under Financial Reporting Standards that are different to those
for public sector and not-for-profit entities.
•• For-profit entities that are required to prepare GPFS will report using for-profit Accounting
Standards based on NZ IFRS. If there is no such statutory obligation, then it can prepare special
purpose financial statements (SPFS) for their users (e.g. Inland Revenue or its bank).
•• Public benefit entities (PBEs) will use PBE Accounting Standards based on International
Public Sector Accounting Standards (IPSAS) and are separated between public sector PBEs
and not-for-profit public benefit entities (NFP PBEs) entities.
For-Profit
Entity
No
No
Elect to be Yes
in Tier 1
anyway?
No
Tier 2
Use NZ IFRS
RDR
Source: Modified from XRB website, 1 February 2017 (no longer available).
Below is a summary of the criteria for each tier of reporting for for-profit entities:
Tier of
reporting
Criteria Accounting standards
framework
NZ
Tier 1 •• Public accountability, or NZ IFRS
•• Large for-profit public sector entity (large is defined as total
expenses > $30 million)
It is worth noting that an entity sits in Tier 1 unless it elects to report in accordance with Tier 2,
provided that it meets the criteria to be able to report under the lower tier.
Required reading (New Zealand)
Companies Act 1993, Sections 200-205, 207E-207L, 208, 211.
Financial Markets Conduct Act 2013, Part 7.
Financial Reporting Act 2013, Sections 45, 47, 56.
NFP PBE
Public
Yes Use PBE
Accountability? Tier 1
(as defined) Standard
No
Large Yes
Entity?
No
Decide to be
in Tier 1 Yes
anyway?
No
No
No
No No
Use
PBE
Tier 2 Standards
RDR
Source: Modified from XRB website, 1 February 2017 (no longer available).
NZ Below is a summary of the criteria for each tier of reporting for NFP entities:
Notes
* Public Benefit Entity Simple Format Reporting Standard – Accrual.
** If in each of the two preceding accounting periods, total operating payments are less than $125,000 (s. 46 FRA 2013).
*** Public Benefit Entity Simple Format Reporting Standard – Cash.
The flowcharts for NFP PBEs and public sector PBEs are identical and both apply PBE accounting
standards. However, there are differences between the public sector PBE accounting standards
and NFP PBE accounting standards, denoted by ‘PS’ for public sector and ‘NFP’ for the not-for-
profit sector. In addition, the public sector PBE accounting standards are applicable for reporting
periods beginning on or after 1 July 2014, whereas the NFP PBE accounting standards are
applicable for reporting periods beginning on or after 1 April 2015.
Defining public accountability
To establish whether an entity sits in Tier 1, one key definition to satisfy is that of public
accountability. An entity has public accountability if:
(a) its debt or equity instruments are traded in a public market, or it is in the process of issuing
such instruments for trading in a public market (a domestic or foreign stock exchange or an
over-the-counter market, including local and regional markets), or
(b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary
businesses. This is typically the case for banks, credit unions, insurance providers, securities
brokers/dealers, mutual funds and investment banks.
An entity is deemed to be publicly accountable in the New Zealand context if:
(a) it is an FMC reporting entity or a class of FMC reporting entities that is considered to have a
‘higher level of public accountability’ than other FMC reporting entities under section 461K
of the Financial Markets Conduct Act 2013, or
(b) it is an FMC reporting entity or a class of FMC reporting entities that is considered to have a
‘higher level of public accountability’ by a notice issued by the FMA under section 461L(1)(a)
of the FMC 2013.
NZ FRS-44 sets out the additional New Zealand specific disclosure requirements for for-profit entities
applying NZ IFRS. The disclosure requirements relate to compliance with NZ IFRS, the applicable
financial reporting standards, the reporting framework, disclosure around audit fees, imputation
credits, and reconciliation of net operating cash flows to profit (loss), prospective financial
statements and the statement of service performance.
Compliance with NZ GAAP
FRA 2013 s. 9 states that the financial statements of a reporting entity must comply with
NZ GAAP if any Act that applies to an entity provides that the financial statements must comply,
or be prepared, in accordance with GAAP. As per s. 8 FRA 2013, NZ GAAP means that financial
statements must comply with:
(a) applicable financial reporting standards, and
(b) in relation to matters for which no provision is made in applicable financial reporting
standards, an authoritative notice.
True and fair view
It is implicit that if financial statements are prepared under NZ GAAP, they will show a true and
fair view of the financial performance and position of an entity. The legislative requirements for
financial statements to give a true and fair view have been removed. Instead, the requirements in
applicable financial reporting standards (e.g. NZ IAS 1) apply.
In the previous FRA 1993, if compliance with NZ GAAP resulted in financial statements that did
not present a true and fair view, the directors of the reporting entity added such information
and explanations as to give a true and fair view of the matters. Under FRA 1993, entities were not
permitted to depart from accounting standards; however, under FRA 2013, entities can now do
so only if complying with the Standards would be so misleading as to conflict with the objective
of financial statements (para. 19 NZ IAS 1). Such situations are expected to be extremely rare
in practice.
Special purpose financial statements
As discussed earlier, certain entities (e.g. FMC reporting entities) are required to prepare GPFS in
accordance with legislation, and that such financial statements must comply with NZ GAAP.
Special purpose financial statements (SPFS) are those other than GPFS, and are tailored to the
needs of specific users. The reporting framework used in SPFS is therefore determined separately
for each set of SPFS based on the information needs of users.
SPFS do not have to comply with NZ GAAP; rather, they specify the accounting policies
according to which they have been prepared. Examples of SPFS would include those that have
been prepared for an entity that is not a reporting entity, but wishes to provide some financial
information to its shareholders, and those for which shareholders are able to specify what
information they would like to receive. Another example would be larger entities that prepare
specified financial information for banks and other finance providers (which is sometimes done
for certain companies within a group). For such cases, reports may be prepared on a special
purpose basis for specific users in addition to the annual financial statements that are prepared
for shareholders.
As discussed earlier, many small- to medium-sized companies in New Zealand no longer have
to prepare GPFS, provided that they meet certain criteria. However, they still need to prepare
SPFS that meet the need of other users (e.g. Inland Revenue minimum requirements), as part
of the amendments to the Tax Administration Act 1994. Chartered Accountants Australia and
New Zealand (through one of its predecessors, New Zealand Institute of Chartered Accountants)
recognised that the Inland Revenue minimum requirements may not provide all the necessary
information that other potential users may need, especially the larger medium-sized entities.
Therefore, it has developed an optional special purpose financial reporting framework, called
Special Purpose Financial Reporting Framework for For-Profit Entities, to provide guidance on the
preparation of SPFS.
Learning outcome
4. Explain a Chartered Accountant’s ethical requirements relating to financial reporting.
The preparation of financial information often involves the exercise of professional judgement;
for example, in assessing the useful life of an asset or determining a provision. An accountant
will face choices when preparing financial statements and will need to use their professional
judgement to determine the outcome. When using their professional judgement it is important
that the accountant understands their ethical obligations and the need to comply with those
ethical obligations.
Ethical requirements
The accounting profession is self-regulated by a code of ethics that governs professional
behaviour. The ethical principles and guidelines are set out in the Code of Ethics for Professional
Accountants (the IESBA Code), issued by the International Ethics Standards Board of
Accountants (IESBA).
A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the
public interest. Therefore, a professional accountant’s responsibility is not exclusively to satisfy the
needs of an individual client or employer. In acting in the public interest, a professional accountant
shall observe and comply with this code.
IESBA Code, s. 100.1 A1
A new version of the Code was issued by the IESBA in April 2018, which applies from 1 July 2019.
IESBA Code of ethics
Professional
Professional
Integrity Objectivity Confidentiality competence
behaviour
and due care
Self-interest Eliminate
circumstances
Self-review
Apply
Advocacy safeguards
Decline/end
Familiarity
activity
IESBA Code
The IESBA Code sets out the ethics requirements for professional accountants. The IESBA Code
is structured into three parts:
•• Part 1 – Complying with the Code, Fundamental Principles and Conceptual Framework.
•• Part 2 – Professional Accountants in Business.
•• Part 3 – Professional Accountants in Public Practice.
Part 1 establishes the fundamental principles and provides a conceptual framework that can be
applied to:
•• identify threats to independence
•• evaluate the significance of the threats identified
•• apply safeguards (when necessary) to eliminate or reduce the threats to an acceptable level.
Parts 2 and 3 describe how the conceptual framework applies in specific circumstances.
They provide examples of safeguards that may appropriately address threats to compliance
with the fundamental principles. Where no safeguard is available in a particular circumstance,
the threat must be avoided altogether. It is important to note that accountants are expected to be
guided by both the words and the spirit of the IESBA Code, using the conceptual framework.
While all sections of the IESBA Code are equally important, this unit focuses on Part 1,
sections 110 and 120; Part 2 sections 200 and 260; Part 3 sections 300 and 360.
Fundamental principles
The IESBA Code lists its five fundamental principles in para. 110.1 A1, as outlined below:
110.1 A1(a) Integrity To be straightforward and honest in all professional and business relationships
R111.1
110.1 A1(b) Objectivity Not to compromise professional or business judgments because of bias, conflict
R112.1 of interest or undue influence of others
110.1 A1(c) Professional (i) Attain and maintain professional knowledge and skill at the level required
R113.1 competence to ensure that a client or employing organization receives competent
and due care professional service, based on current technical and professional standards
and relevant legislation; and
(ii) Act diligently and in accordance with applicable technical and professional
standards
110.1 A1(d) Confidentiality To respect the confidentiality of information acquired as a result of professional
R114.1 and business relationships
110.1 A1(e) Professional To comply with relevant laws and regulations and avoid any conduct that the
R115.1 behaviour professional accountant knows or should know might discredit the profession
Each of these principles is discussed in more detail in Section 110 subsections 111-115 of the
IESBA Code.
‘Safeguards’ are actions or other measures that may eliminate threats or reduce them to an
acceptable level. There are two broad categories of safeguards:
•• Those created by the profession, legislation or regulation – for example, professional
Standards, professional or regulatory monitoring, and disciplinary procedures.
•• Those created in the workplace – for example, documented internal policies or a firm’s
quality control policies and procedures.
Further reading
IESBA Code Section 110, ss 111-115, sections 120, 200, 260, 300 and 360.
Further reading
IESBA Code remaining sections.
Australia-specific AU
Australian ethical requirements
The Accounting Professional and Ethical Standards Board (APESB) issues standards that
outline the professional conduct required by members of the professional accounting bodies.
Compliance with these standards is mandatory for all Australian Chartered Accountants.
Three key requirements of the standards are relevant to financial reporting:
1. APES 110 Code of Ethics for Professional Accountants. This replicates the fundamental ethical
principles contained within the IESBA Code.
2. APES 205 Conformity with Accounting Standards. This Australian-specific professional
standard imposes obligations on members to follow accounting standards when they
prepare, present, audit, review or compile financial statements which are either GPFR or
an SPFR.
3. APES 315 Compilation of Financial Information. This Australian-specific professional standard
is applicable to members in public practice who compile financial information. Financial
information includes financial statements. The standard sets out the format of reports that
a member must issue to accompany a GPFR or SPFR that the member has compiled at the
request of the client.
Should an Australian Chartered Accountant be disciplined for failure to comply with an ethical
principle/principles, such a breach is taken by Chartered Accountants Australia and New Zealand
(Chartered Accountants ANZ) as a breach of APES 110 rather than the IESBA Code.
Required reading (Australia)
APES 205 paras 5.1–5.6.
New Zealand-specific NZ
The IESBA has been ’trickled down’ into New Zealand via the Professional Engagement Standards
and Code of Ethics that was issued by NZICA.
New Zealand ethical requirements
New Zealand Institute of Chartered Accountants
The New Zealand Institute of Chartered Accountants (NZICA) entity retains a duty to control and
regulate the practice of the profession of accountancy by its members in New Zealand and it
cannot delegate that duty (in whole or in part) to any person under the NZICA Act 1996.
This governing body takes the form of the New Zealand Regulatory Board under the Chartered
Accountants Australia and New Zealand governance model. The New Zealand Regulatory Board:
•• prescribes the Code of Ethics
•• appoints, authorises delegations for oversees and directs the permanent bodies specified in
the NZICA Rules, and
•• carries out any other functions or responsibilities that are conferred by the Act, any
other enactment, the NZICA Rules or the Chartered Accountants Australia and New Zealand
By-Laws.
The New Zealand Regulatory Board reports to the Chartered Accountants Australia and New
Zealand Board.
NZ The NZICA Code of Ethics is binding on all New Zealand members, and mandates the
professional and ethical expectations of members. Under the NZICA Code of Ethics, all
New Zealand members shall comply with the following fundamental principles:
•• Integrity: be straightforward and honest in all professional and business relationships.
•• Objectivity: to not allow bias, conflict of interest or undue influence of others to override
professional or business judgements.
•• Professional competence and due care: maintain professional knowledge at the level
required to ensure that a client receives competent professional services.
•• Confidentiality: to respect the confidentiality of information acquired as a result of
professional and business relationships.
•• Professional behaviour: to comply with relevant laws and regulations, and avoid any action
that discredits the member’s profession.
NZICA can investigate complaints against New Zealand members. If the complaint is found to
be valid, the member may be cautioned, suspended from membership for a period of time, or
removed from the register of members. They may also be fined.
The External Reporting Board (XRB)
The New Zealand Audit and Assurance Standards Board (NZ AuASB), a sub-board of the XRB, also
sets professional and ethical standards that apply to all assurance providers adopting the XRB
Auditing and Assurance Standards.
Further reading (New Zealand)
NZICA Code of Ethics (effective from 15 July 2017).
NOCLAR
Required reading
‘Responding to Non-compliance with Laws and Regulations’, www.ifac.org → Publications →
responding to NOCLAR, accessed 30 April 2018.
Learning outcome
5. Explain contemporary issues affecting financial reporting.
There are a number of important developments relevant to broad financial reporting issues.
International level
Important contemporary financial reporting issues at the international level are outlined below.
Further reading
‘Better Communication: making disclosures more meaningful’ shows examples of improved
disclosures in real financial reports, accessed 4 Dec 2018, www.ifrs.org/-/media/project/disclosure-
initative/better-communication-making-disclosures-more-meaningful.pdf?la=en
Materiality
The principle of materiality is applied when determining whether an Accounting Standard
applies and in assessing how to apply Accounting Standards. In October 2018 the IASB made
amendments to IAS 1 and IAS 8 to clarify and align the definition of materiality in IAS 1, IAS 8,
and the Conceptual Framework, and provide guidance to improve consistency in their application.
These amendments are effective for annual reporting periods beginning on or after 1 January 2020,
however earlier application is permitted. The definition of ‘materiality’ is as follows:
Information is material if omitting, misstating, or obscuring it could reasonably be expected to influence
the decisions that the primary users of general-purpose financial statements make on the basis of those
financial statements, which provide financial information about a specific entity.
The IASB does not expect the amended definition to significantly affect how materiality
judgements are made in practice, or to significantly affect an entity’s’ financial statements.
In addition, in September 2017 the IASB also issued a practice statement on materiality entitled:
Practice Statement 2: Making materiality judgements. The statement provides guidance on how
to make materiality judgements when preparing their general purpose financial statements
in accordance with IFRS. The Practice Statement is not mandatory and it neither changes the
requirements nor introduces new ones. The aim is to drive behavioural change by supporting
preparers of financial statements with the tools to make their financial statements more useful
and concise, rather than view disclosure preparation as completing a checklist from each
relevant standard.
It recommends a four-step process in making materiality judgements:
The practice statement also provides illustrations and explanations to help preparers of financial
statements to better apply the concept when identifying appropriate disclosures.
Further reading
Better communication in financial reporting, www.ifrs.org → Project → Better communication in
financial reporting, accessed 23 November 2018.
Reducing disclosures
The issue of financial statement disclosures is topical, as many are finding the current level
of disclosures overwhelming. The key issue is that there is so much noise and distraction in
financial reports that it is difficult for users to ‘cut through’ and find the key messages.
Current discussions on the topic suggest that there is scope for entities to improve the clarity
in financial reports under existing disclosure requirements by highlighting key information,
reordering content into logical sections and removing unnecessary disclosures. As identified
in a paper published by the CA ANZ, Noise, Numbers and Cut-Through, some listed companies
in Australia and New Zealand are into their second year of ‘streamlining’ their financial
reports, and many more are expected to follow suit this reporting season. Standard-setters and
regulators have added their voice, publicly supporting the removal of immaterial disclosures.
The IASB is also considering this topic with their Disclosure Initiative project (discussed above),
which aims to improve how information is presented and disclosed in financial reports.
Further reading
CA ANZ 2015, ‘Noise, Numbers and Cut-Through’, www.charteredaccountantsanz.com → News
and analysis → Insights → Future[inc] → Archive → Noise, Numbers and Cut-Through, accessed
25 April 2018.
Sustainability reporting
The Global Reporting Initiative (GRI) is an international independent organisation that
promotes the use of sustainability reporting as a way for entities to become more sustainable
and contribute to sustainable development. Sustainability issues include issues such as climate
change, human rights and corruption.
The GRI Framework includes reporting guidelines, sector guidance and other resources.
It is supportive of integrated reporting as it develops as an important and necessary innovation
of corporate reporting.
During 2015 thought leaders in various fields were interviewed on a number of subjects
related to sustainability reporting. Articles, videos and papers based on these interviews were
disseminated to the GRI network. The final publication, ‘The Next Era of Corporate Disclosure:
Digital, Responsible, Interactive’ was issued in March 2016.
Further reading
GRI, ‘The Next Era of Corporate Disclosure: Digital, Responsible, Interactive’, www.globalreporting.org
→ Information → In the Spotlight → Sustainability and Reporting 2025, accessed 19 April 2018.
Integrated reporting
The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors,
companies, standard-setters, the accounting profession and non-government organisations. It was
formed in 2010 as part of global efforts to increase integrated business reporting.
While many companies prepare traditional financial reports and separate sustainability reports,
integrated reports attempt to serve as the reporting centrepiece to integrated thinking within
an organisation. These reports widen the traditional views of capital beyond financial capital,
to incorporate manufactured capital, human capital, social and relationship capital, intellectual
capital and natural capital.
An integrated approach argues that the interrelationships between these forms of capital act
to create short-, medium- and long-term value, and that examining the integrated whole and
embedding this in decision-making processes within an entity is key to understanding an
entity’s value creation over time.
The International Integrated Reporting Framework, (the IIR Framework) was released in
December 2013 following extensive consultation and testing by businesses and investors in
all regions of the world who participated in the IIRC Pilot Programme. The purpose of the
IIR Framework is to establish guiding principles and content elements that govern the overall
content of an integrated report, and to explain the fundamental concepts that underpin them.
The IIR Framework defines reporting boundaries, users and materiality quite differently to
traditional financial reporting, and these reports are deliberately more forward-looking.
In 2014 a new group called the Corporate Reporting Dialogue (CRD) was created. The CRD
operates under the umbrella of the IIRC and its participants include the IASB, FASB, GRI and IIRC.
The CRD is an initiative designed to respond to market calls for greater coherence, consistency
and comparability between frameworks, standards and related requirements. To assist with this,
the CRD published a corporate reporting landscape map that is intended to help stakeholders
understand the similarities and differences in the corporate reporting frameworks and standards.
Further reading
•• Integrated Reporting <IR>, ‘What? The tool for better reporting’, www.integratedreporting.org
→ What? The tool for better reporting, accessed 19 April 2018.
•• Corporate Reporting Dialogue, www.corporatereportingdialogue.com, accessed 19 April 2018.
Australia-specific AU
As discussed earlier, the IASB develops, amends and publishes IFRSs and IFRICs, which are used
in preparing financial reports in numerous countries. Therefore, many changes to financial
reporting are directed from the international level. However, significant changes may still occur
at the national level, driven by country-specific issues.
Important contemporary financial reporting issues at the national level are outlined below.
Australian Securities and Investments Commission (ASIC) – Areas of focus
Each year, ASIC announces the areas on which it will focus its reviews of financial reports of listed
entities and other entities of public interest. The current areas of focus are:
•• Estimates – impairment and asset values.
•• Accounting policy choice
–– Revenue recognition – ensuring that revenue is recognised based on the substance of
the underlying transactions.
–– Expense deferral – ensuring that expenses are only deferred when permitted to by
Accounting Standards.
–– Tax accounting.
–– Estimates and accounting policy judgements.
–– Impact of new revenue, financial instrument, lease and insurance standards.
These areas have been ASIC’s focus for a number of periods.
AASB
The AASB is currently conducting outreach sessions to clarify the future of special purpose
financial reports in light of the changes to the IASB conceptual framework
Exposure draft ED/2017/5 Accounting Policies and Accounting Estimates which proposes
amendments to IAS 8. The objective of the amendments is to better distinguish accounting
policies from accounting estimates. This is discussed further in Unit 2.
Quiz
[Available online in myLearning]
Contents
Introduction 2-3
Content of general purpose financial statements 2-4
Statement of financial position 2-4
Statement of profit or loss and other comprehensive income 2-8
Statement of changes in equity 2-12
Statement of cash flows 2-15
Disclosures 2-16
Steps in preparing financial statements under International Accounting Standards 2-21
Step 1 – Prepare the year-end adjusting entries 2-22
Step 2 – Prepare the year-end tax entries 2-22
Step 3 – Prepare the final trial balance 2-22
Step 4 – Prepare the statement of financial position, statement of profit or loss
and other comprehensive income, and statement of changes in equity 2-22
Step 5 – Prepare the statement of cash flows 2-22
Step 6 – Prepare the notes to the financial statements 2-23
Learning outcomes
At the end of this unit you will be able to:
1. Advise on the requirements for financial statements
2. Prepare, analyse and explain a complete set of financial statements.
3. Explain and account for changes in accounting policies, revisions of accounting estimates
and errors.
4. Identify and analyse related parties.
5. Explain and account for discontinued operations.
6. Explain and account for events after the reporting period.
Introduction
This unit provides an overview of the requirements for preparing financial statements, and
the content of those financial statements. It is important to work through the concepts and the
issues discussed in this unit as they are consistently referred to throughout this module.
This unit assumes that the preceding unit on financial reporting has been worked through
and understood.
While financial statements are often seen as just a set of statements and supporting notes, being
able to understand and explain how and what information is disclosed in financial statements
and notes is a very important skill for a Chartered Accountant. The career of a Chartered
Accountant is likely to involve the preparation of sets of financial statements, whether for
clients or employers.
The unit is structured in the following sections:
•• Content of general purpose financial statements.
•• Steps in preparing financial statements under International Accounting Standards.
•• Standards that impact disclosures and adjustments:
(a) Accounting policies, changes in estimates and errors (IAS 8).
(b) Related parties (IAS 24).
(c) Discontinued operations (IFRS 5).
(d) Events after reporting period (IAS 10).
Learning outcomes
1. Advise on the requirements for financial statements.
2. Prepare, analyse and explain a complete set of financial statements.
IAS 1 Presentation of Financial Statements sets out the basic structure and contents for all financial
statements, including:
•• the overall requirements for the presentation of GPFSs
•• guidelines for their structure, and
•• the minimum requirements for their content.
In preparing a complete set of financial statements, IAS 1 also states that an entity:
•• may use other titles for any one of these statements (para. 10); for example, the entity may
call the statement of financial position a balance sheet, and
•• needs to present each of the financial statements with ‘equal prominence’ (para. 11).
Each of the financial statements is discussed in turn below, as well as the basic requirements
for the face of the financial statement. Some published financial statements are also used as
examples, to illustrate the learning.
Required reading
IAS 1 (or local equivalent).
The definitions of assets, liabilities and equity were discussed in relation to the Conceptual
Framework in Unit 1.
The table below shows a simple balance sheet or statement of financial position, cross-
referenced to relevant paragraphs of IAS 1, and units in the CSG or other FIN learning elements.
(Other accounts are covered in different units throughout the module.) Further disaggregation
may be required by IAS 1 paras 77–80A; however, this would normally be shown in the notes to
the accounts.
Total assets
Total liabilities
Net assets
Shareholders equity
Total equity
no
unconditional
cash or right to defer
cash settlement
equivalent beyond
OR 12 months
OR
held
for
trading
OR
expects to held
realise within due within
for 12 months OR
12 months OR trading
normal OR expects to settle
operating within 12 months
cycle OR within normal
operating
cycle
…all other assets are non-current (IAS 1 para. 66) …all other liabilities are non-current (IAS 1 para. 69)
The only exception to this is when a presentation based on liquidity would provide users of the
financial statements with information that is reliable and more relevant. For example, financial
institutions present their statements of financial position on a liquidity basis (rather than on
a current/non-current format) as this is more reflective of how their assets are used and their
liabilities expected to be settled.
The balance sheet
STATEMENT OFbelow is an extract
FINANCIAL fromAS
POSITION theAT
Harvey Norman
30 JUNE 2018Holdings Limited’s 2018
Annual Report:
Current Assets
Cash and cash equivalents 28(a) 170,544 80,224
Trade and other receivables 7 724,690 640,686
Other financial assets 8 31,463 29,191
Inventories 9 345,287 315,968
Other assets 10 45,144 45,878
Intangible assets 11 490 486
Total current assets 1,317,618 1,112,433
Non-Current Assets
Trade and other receivables 12 78,443 78,777
Investments accounted for using equity method 37 4,497 26,355
Other financial assets 13 18,283 30,076
Property, plant and equipment 14 660,337 625,112
Investment properties 15 2,429,397 2,241,754
Intangible assets 16 69,067 75,237
Total non-current assets 3,260,024 3,077,311
Current Liabilities
Trade and other payables 17 289,986 238,628
Interest-bearing loans and borrowings 18 422,191 386,651
Income tax payable 15,608 42,541
Other liabilities 19 66,825 41,571
Provisions 20 35,354 34,034
Total current liabilities 829,964 743,425
Non-Current Liabilities
Interest-bearing loans and borrowings 21 503,203 333,858
Provisions 20 11,645 13,052
Deferred income tax liabilities 5(d) 280,735 267,219
Other liabilities 23 14,163 19,283
Total non-current liabilities 809,746 633,412
Equity
Contributed equity 24 388,381 386,309
Reserves 25 185,384 174,950
Retained profits 26 2,337,241 2,229,200
Parent entity interests 2,911,006 2,790,459
Non-controlling interests 27 26,926 22,448
TOTAL EQUITY 2,937,932 2,812,907
The above Statement of Financial Position should be read in conjunction with the accompanying notes.
IAS 1 para. 54 requires a number of line items to be included in a financial statement, but
additional line items are allowed. Similarly, paras 77–79 outline a number of disclosures and
disaggregations that are required, but these can be shown on the face of the balance sheet or in
the notes.
As previously discussed, the Standard sets out the rules for classifying current and non-current
assets and liabilities. It also states that deferred tax liabilities cannot be shown as current.
The split of equity attributable to the parent entity interests and non-controlling interests shown
in the balance sheet above is required by IAS 1 para. 54. This split will be discussed further in
the units on business combinations (Unit 15) and accounting for subsidiaries (Unit 16).
Much of the presentation of the balance sheet, such as some line items, sub totals, order
and format are not prescribed by the Standard, and it is up to the entity to decide the most
appropriate presentation method. In practice, most entities follow model financial statements
and present the statement of financial position in one of a few ’accepted’ formats.
Statement of profit or loss and other comprehensive income for the year ended 30.06.X8
Gross profit
Other income
Administrative expenses
Research and development expenses Unit 8 97, if material, show separately (on face or
notes)
Other expenses
Share of profit from associates accounted for using Unit 17 82, essential line items
the equity method of accounting
Finance income
Statement of profit or loss and other comprehensive income for the year ended 30.06.X8
Profit for the period attributable to: Units 15–16 81B, must split totals between owners/NCI
Owners of the parent entity
Non-controlling interest
Items that will not be reclassified to profit and 82A, classifications within OCI
loss
Income tax on items that are or may be reclassified 91, show OCI items either net of tax or
aggregate, split by may be reclassified/
never reclassified
Other comprehensive income for the period, net 81A, must have totals
of tax
Total comprehensive income attributable to: Units 15–16 81B, must split totals between owners/NCI
Owners of the parent entity
Non-controlling interest
Recycling OCI
When an item is classed as ’may be reclassified’, it is often referred to as ‘recycling OCI’.
This is because the item first appears in other comprehensive income, but may later be moved
to the profit and loss and ‘recycled’.
Examples of items which are recycled include the cumulative movements in the fair value of fair
value through OCI (FVTOCI) financial assets. These gains and losses are originally recognised
in a reserve account within OCI, with the reserves reclassified to the profit or loss when they are
derecognised under IFRS 9 Financial Instruments. FVTOCI financial assets are discussed in the
unit on financial instruments (Unit 9).
Further reading
IFRS 9 Appendix B para. B5.7.1A.
Below is a SPLOCI for Harvey Norman Limited for the year ended 30 June 2018. Note that:
•• Harvey Norman has chosen to present the SPLOCI as two separate statements.
•• Harvey Norman has chosen to classify expenses by function.
•• The functional presentation shows a cost of goods sold and a gross profit amount, and
groups expenses in categories such as distribution, marketing and occupancy.
•• The statement of comprehensive income shows two categories of OCI: may be reclassified
and will not be reclassified to profit or loss.
You are hopefully familiar with revaluations of property, plant and equipment from your
university studies. A revaluation on property, plant and equipment is shown here under the
heading of never to be reclassified to profit and loss. Also note that any tax relating to this
revaluation is disclosed with the OCI item. Under IAS 1 para. 90, the tax related to OCI can
either be shown on the face of the SPLOCI or in the notes.
Accounts that you may be less familiar with are the foreign currency translation reserve and
cash flow hedge reserve. We will later examine these accounts in the units on foreign exchange
(Unit 5) and financial instruments (Unit 9), respectively. For now, just note that these items are
shown as other comprehensive income under the sub-heading ’Items that may be reclassified
subsequently to profit or loss’.
Attributable to:
Owners of the parent 375,378 448,976
Non-controlling interests 4,672 3,990
380,050 452,966
Statement
The aboveof Comprehensive
Income Statement should be Income for the
read in conjunction withyear ended 30
the accompanying June 2018
notes. CONSOLIDATED
June June
2016 2015
CONSOLIDATED
$000 $000
June June
2018 2017
Profit for the year $000 351,340 $000 268,914
Other comprehensive
Other comprehensive income for
income for the
the year
year (net(net of tax)
of tax) 42,906 12,095
10,821 17,225
Total comprehensive income for the year (net of tax) 394,246 281,009
Total comprehensive income for the year (net of tax) 390,871 470,191
68comprehensive income attributable to:
Total
Total comprehensive income attributable to:
- Owners of the Parent 390,938 278,433
Owners of the parent
- Non-controlling interests 385,067 3,308 467,496 2,576
Non-controlling interests 5,804 2,695
390,871 394,246 470,191 281,009
The above Statement of Comprehensive Income should be read in conjunction with the accompanying notes.
The above Statement of Comprehensive Income should be read in conjunction with the accompanying notes.
The total amount of movement in equity is equal to the change in the entity’s net assets or
liabilities.
The statement of changes in equity separately discloses changes arising from (IAS 1 para. 106(d)):
(i) profit or loss
(ii) other comprehensive income
(iii) transactions with the owners.
Like equity on the balance sheet, the total comprehensive income must be split between owners
of the parent and the non-controlling interest (IAS 1 para. 106 (a)).
The components of equity and the movements that bring about changes to these movements are
illustrated in the following diagram:
Retrospective adjustments on
changes in accounting policies
and material errors
Below is an example of the format for a statement of changes in equity for a group where all
subsidiaries are wholly owned. This is the format that should be used in FIN module exams.
(Extract from FIN216 main exam, examiner’s feedback.)
Below is an extract from the published financial statements of Harvey Norman, showing one
year’s statement of changes in equity. Comparatives were also presented on a separate page.
Contributed Retained Asset Foreign Available for Cash Flow Employee Acquisition Non- TOTAL
Equity Profits Revaluation Currency Sale Reserve Hedge Reserve Equity Reserve controlling EQUITY
Reserve Translation Benefits Interests
Reserve Reserve
$000 $000 $000 $000 $000 $000 $000 $000 $000 $000
At 1 July 2017 386,309 2,229,200 131,304 42,374 13,732 (20) 9,611 (22,051) 22,448 2,812,907
At 30 June 2018 388,381 2,337,241 144,526 40,659 11,902 (8) 10,356 (22,051) 26,926 2,937,932
The above Statement of Changes in Equity should be read in conjunction with the accompanying notes.
Statement of changes in equity for the year ended 30 June 2018 (cont.)
HARVEY NORMAN HOLDINGS LIMITED | ANNUAL REPORT 2018 70
At 1 July 2016 385,296 2,125,186 111,199 48,021 9,682 (32) 8,995 (22,051) 22,378 2,688,674
At 30 June 2017 386,309 2,229,200 131,304 42,374 13,732 (20) 9,611 (22,051) 22,448 2,812,907
Under IFRS 9
The above Statement of Changes in Equity should be read in conjunction with the accompanying notes. In the FIN module this section
this will be net should have a heading
movement “transactions with owners
in FVTOCI recorded directly in equity,
financial assets with a sub-total
The requirements relating to the presentation and disclosures included in the statement of cash
flows are contained in IAS 7. The statement of cash flows must disclose some specific categories
of cash flows, such as interest, dividends and income tax (IAS 7 paras 31 and 35). However,
most line items in the statement of cash flows are not prescribed.
Required reading
IAS 7.
In general, the preparation of a statement of cash flows follows the following steps:
IAS 7 para. 10 requires an entity to present cash flows classified by operating, investing and
financing activities. Each classification is summarised in the diagram below. You should read
the required reading, IAS 7, for full details.
* The classification of interest paid and interest and dividends received may vary between enitities
The classification of cash flows, and ‘cash and cash equivalents’ often involves exercising
professional judgement. Classifications may differ between entities because of their differing
revenue-producing activities, but should be consistent from period to period.
Changing a cash flow classification would fall under a change of accounting policy in IAS 8.
This is discussed later in this unit.
Disclosures
The disclosure requirements of IAS 1 are spread throughout the Standard. There are disclosure
requirements under the IAS 1 heading for each financial statement. It is important to read IAS 1,
to understand the disclosures required for each financial statement in turn, and remember that
other accounting standards will add further disclosure requirements which are often more
extensive. Some disclosures must be on the face of the financial statement, however most can be
shown within the notes.
Australia-specific AU
Australia-specific disclosures
Many AASB Standards include Australia-specific requirements. Note particularly AASB 101
Presentation of Financial Statements para. Aus19.1, which precludes a departure from AASB
Standards by entities that report under Part 2M.3 of the Corporations Act, public and private
sector not-for-profit entities, and entities that report under reduced disclosure requirements.
AASB 1054 Australian Additional Disclosures contains additional disclosure requirements that
relate to financial statements that are prepared in accordance with Australian Accounting
Standards (e.g. a breakdown of audit fees required by paras 10 and 11; imputation credits
available for use in future reporting periods to frank dividends per para. 13).
The reduced disclosure requirements, described in Unit 1, affect the application of the AASB
equivalents of IAS 1, IAS 7 Statement of Cash Flow, IAS 8, IAS 10, IAS 24, IFRS 5 and IFRS 8.
Required reading
AASB 1054 paras 10–16.
Further reading
Refer to a set of model general purpose financial statements and review each of the financial
statements. These can be found on the websites of many of the large accounting firms.
An example is given below:
KPMG 2016, KPMG Example Public Company Limited: Guide to annual reports – Illustrative
disclosures 2016–17.
Australia-specific AU
Additional disclosures required under AASB 1054
In addition to the IAS 7 disclosure requirements, additional consideration that is relevant to
Australian entities is contained in AASB 1054.
AASB 1054 para. 16 requires Australian entities that use the direct method to present its
statement of cash flows (see Step 3 above) in accordance with IAS 7 para. 18(a) to provide a
reconciliation of the net cash flow from operating activities to profit/(loss) in the notes to the
financial statements.
Required reading
AASB 1054 para. 16.
New Zealand-specific NZ
Additional disclosures required under FRS-44
FRS-44 para. 10 requires New Zealand entities that use the direct method to present their
statement of cash flows in accordance with IAS 7 para. 18(a), to provide a reconciliation of the net
cash flow from operating activities to profit/(loss) in the notes to the financial statements.
Required reading
FRS-44 para. 10.
Australia also has additional requirements related to the impact of the goods and services tax
(GST).
AU Australia-specific
Impact of GST on the statement of cash flows
A further exception to the presentation of gross cash flows in Australia applies to the GST that is
payable or recoverable by an entity.
In accordance with para. 10 of Australia-specific Interpretation 1031 ‘Accounting for the Goods
and Services Tax (GST)’, cash flows are to be included in the statement of cash flows ‘on a gross
basis’. This is subject to para. 11, which requires that the ‘GST component of cash flows arising
from investing and financing activities which is recoverable from, or payable to, the taxation
authority to be classified as operating cash flows’.
Required reading
Interpretation 1031 paras 6–18.
The illustrative examples attached to the standard set out cash flow structures that are easy to
follow. In its 2016 financial statements (below), Harvey Norman prepared its operating cash
flows using the direct method, as encouraged by IAS 7 para. 19.
Statement of changes cash flows for the year ended 30 June 2018
CONSOLIDATED
June June
2018 2017
Note $000 $000
Cash and Cash Equivalents at End of the Year 28(a) 125,463 42,882
Theabove
The aboveStatement
Statement of cash
of Cash flows
Flows should
should beinread
be read in conjunction
conjunction with the accompanying
with the accompanying notes. notes.
Source: Harvey Norman, 2018 Annual Report.
(b) Reconciliation of Profit After Income Tax to Net Operating Cash Flows
Adjustments for:
Net foreign exchange gains (496) (771)
Bad and doubtful debts 46,064 21,864
Share of net profit from joint venture entities (5,792) (5,200)
Depreciation of property, plant and equipment 65,359 60,710
Amortisation 19,432 17,159
Impairment of equity-accounted investments 20,665 1,148
Impairment loss on repayment of external finance facility - 5,022
Revaluation of investment properties (51,646) (107,382)
Property revaluation increment for overseas controlled entity - (669)
Deferred lease expenses (663) (962)
Provision for onerous leases - 643
Executive remuneration expenses 4,173 4,992
Profit on disposal and sale of property, plant and equipment,
and the revaluation of listed securities (2,329) (6,849)
Reconstruction method
Many candidates are likely to be familiar with the use of the reconstruction method for the
preparation of a statement of cash flows from their tertiary studies. This method involves
reconstructing T-accounts or ledger accounts to identify and analyse events and transactions
that involved operating, investing and financing activities during the period.
Further details regarding statement of cash flows can be found in accounting textbooks.
Further reading
•• Deegan, C 2012, Australian financial accounting, Ch. 19.
•• Deegan, C and Samkin, G 2012, New Zealand financial accounting, Ch. 19.
•• Picker, R et al. 2013, Applying International Financial Reporting Standards, Ch. 19.
Learning outcome
2. Prepare, analyse and explain a complete set of financial statements.
There are a number of steps involved in the preparation of a set of financial statements and the
starting point is with an unadjusted trial balance.
Starting with this unadjusted trial balance, the steps to preparing a set of financial statements are:
Some of these adjustments, such as prepayments and accruals, were covered in your
undergraduate studies. Sources of other adjustments will be discussed in later units as we
progress through the module.
In this unit, we will discuss two areas that may result in adjustments:
•• accounting policies, changes in estimates and errors
•• events after the reporting period.
We will revisit these requirements at several points throughout the module to expand your
knowledge on how each topic area affects the appearance of the financial statements.
This unit discusses the general IAS 1 requirements related to the notes to the financial
statements, and looks at the knowledge needed to prepare the following notes:
•• Related parties.
•• Events after the reporting period.
•• Accounting policies, changes in estimates and errors.
•• Discontinued operations.
Model financial statements can be found on the websites of many of the large accounting firms.
Note: Only selected notes are prepared in this unit. Other units in this module also cover the
relevant standards’ specific requirements for disclosures of balances, transactions and events
in the notes to the financial statements.
Most of the detailed disclosure and presentation rules for preparing financial statements are
contained in individual standards that prescribe the accounting requirements for different
transactions. For instance, IFRS 16 Leases contains the disclosure requirements for leases.
However, the basic structure of the financial statements is set out in IAS 1.
Learning outcome
3. Explain and account for changes in accounting policies, revisions of accounting estimates and
errors.
If there is no such standard, IAS 8 requires management to use its judgement in developing an
accounting policy that produces information that is ‘relevant’ and ‘reliable’.
Required reading
IAS 8 (or local equivalent).
The following flow chart demonstrates the selection and application of accounting policies.
NO
Refer to:
• IFRS dealing with similar/related
Use judgement to issues
develop and apply a policy • The Conceptual Framework
(IAS 8 para. 11)
Consider:
• Recent pronouncements in other
jurisdictions
• Accounting literature
• Accepted industry practices
(Cannot conflict with IAS para. 11
sources)
(IAS 8 para. 12)
Accounting standards may allow choices of accounting methods. The application of the
Standards often involves professional judgement, taking into consideration the entity’s specific
circumstances and the accepted practices within their industry. Describing how this judgement
has been exercised provides important information to the user, especially when some users may
not be fully conversant with accounting standards.
With the increase in the number of entities streamlining or decluttering their financial statements
in line with the IASB Disclosure project, accounting policy notes are now often re-ordered, so
that all of the relevant information for a particular account is grouped together. For example, for
property, plant and equipment, the significant accounting policies may be summarised within
the property, plant and equipment note in a set of streamlined financial reports.
The consolidated entity measures the cost of equity-settled transactions with employees by reference to the fair value of the equity
instruments at the date at which they are granted.
Example(g)–Make
Accounting
good provisions
policy
This example illustrates
Provisions are recognised the
for theselection and
anticipated costs application
of future of an
restoration of leased accounting
premises. policy:
The provision includes future cost estimates
associated with dismantling and removing the assets and restoring the leased premises according to contractual arrangements. These
future cost estimates are discounted to their present value. The related carrying amounts are disclosed in Note 20.
NOTES TO THE FINANCIAL STATEMENTS
(h) Onerous lease provisions
1. STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES
The provision for onerous lease costs represents the present value of the future lease payments that the consolidated entity is presently
obligated to make in respect of onerous lease contracts under non-cancellable operating lease agreements. This obligation may be reduced
(a) the Corporate
by Information
revenue expected to be earned on the lease including estimated future sub-lease revenue, where applicable. The estimate may vary
… as a result of changes in the utilisation of the leased premises and sub-lease arrangements where applicable. The related carrying amounts
are disclosed in Note 20. Limited (the “Company”) is a for profit company limited by shares incorporated in Australia and operating in
Harvey Norman Holdings
Australia, New Zealand, Ireland, Northern Ireland, Singapore, Malaysia, Slovenia and Croatia whose shares are publicly traded on the
Australian
(iii) Securities
Investment Exchangeand
in associates (“ASX”)
jointtrading under the ASX code HVN.
ventures
(b) associate
An Basis of
is Preparation
an entity over which the consolidated entity has significant influence. Significant influence is the power to participate in the
financial and operating policy decisions of the investee, but does not control or have joint control over those policies.
The financial report has been prepared on a historical cost basis, except for investment properties, land and buildings, derivative financial
instruments,
A listed
joint venture shares
is a type of held
joint for trading andwhereby
arrangement available-for-sale
the partiesinvestments,
that have joint which have
control of been measured athave
the arrangement fair value. Thethe
rights to carrying values
net assets of
of recognised
the assets
joint venture. andcontrol
Joint liabilities that
is the are designated
contractually as hedged
agreed sharingitems in fairofvalue
of control hedges that which
an arrangement, would exists
otherwise
onlybe carried
when at amortised
decisions about the
cost are adjusted to record changes in the fair values attributable
relevant activities require unanimous consent of the parties sharing control.to the risks that are being hedged in effective hedge relationships.
The considerations
The financial report made
is presented in Australian
in determining dollarsinfluence
significant and all values are
or joint rounded
control areto the nearest
similar thousand
to those dollars
necessary ($000) unless
to determine otherwise
control over
stated under the option available to the Company under Australian Securities and Investments Commission Corporations (Rounding in
subsidiaries.
Financial/Directors’ Reports) Instrument 2016/191. The Company is an entity to which this legislative instrument applies.
The consolidated entity’s investments in its associate and joint venture are accounted for using the equity method.
The consolidated financial statements of the Company and its subsidiaries (the “consolidated entity”) for the year ended 30 June 2018 was
authorised
Under for issue
the equity in accordance
method, with a resolution
the investment of theordirectors
in an associate on 28isSeptember
joint venture 2018. at cost. The carrying amount of the
initially recognised
investment is adjusted to recognise changes in the consolidated entity’s share of net assets of the associate or joint venture since the
(c) Statement
acquisition date. of Compliance
The financial
After report
application is a equity
of the general-purpose
method, the financial report,entity
consolidated whichdetermines
has been prepared
whether in accordance
it is necessary with the requirements
to recognise of the Corporations
any impairment loss with
Act 2001,
respect toAustralian Accounting
the consolidated Standards
entity’s and Interpretations,
net investment and complies
in the associates and jointwith other requirements
ventures. of the
At each reporting law.the
date, The financial report
consolidated entity
complies with
determines Australian
whether thereAccounting
is objectiveStandards, as issued
evidence that by the Australian
the investment Accounting
in the associate Standards
or joint venture Board, and International
is impaired. Financial
If there is such evidence,
Reporting
the Standards
consolidated (IFRS),
entity as issued
calculates the by the International
amount of impairmentAccounting Standards
as the difference Board. the recoverable amount of the associate or joint
between
venture and its carrying value.
Australian Accounting Standards and Interpretations that have recently been issued or amended but are not yet effective have not been
adopted by the consolidated entity for the annual reporting period HARVEY
ended NORMAN
30 June HOLDINGS
2018. ForLIMITED | ANNUAL
details on REPORT
the impact 2018accounting 75
of future
standards, refer to page 84.
Source: Harvey Norman, 2018 Annual Report.
(d) Basis of consolidation
The consolidated financial statements comprise the financial statements of Harvey Norman Holdings Limited and its controlled entities.
Control is achieved when the consolidated entity is exposed, or has rights, to variable returns from its involvement with the investee and has
The consolidated entity re-assesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one
(a) is required bythree
or more of the anelements
IFRS; oforcontrol. Consolidation of a subsidiary begins when the consolidated entity obtains control over the
subsidiary and ceases when the consolidated entity loses control of the subsidiary.
Non-controlling interests are allocated their share of net profit after tax in the income statement and are presented within equity in the
Accountingconsolidated
for a change infinancial
statement of accounting policy
position, separately depends
from the equity of theon the
owners reason
of the for the
Parent. Losses change.
are attributed to theFor
non- example:
controlling interest even if that results in a deficit balance.
•• A change in inan
A change the accounting
ownership interest ofpolicy resulting
a subsidiary from
(without a change theis initial
in control) application
to be accounted for as an equityof an IFRS must be
transaction.
accounted
(e)
for in accordance with
Summary of Significant Accounting Policies
the specific transitional provisions in that IFRS (IAS 8
para. 19(a)). Usually, the transitional provisions require
(i) Changes in accounting policy, disclosures, standards and interpretations
any change in accounting policy to
be adjusted through retained earnings.
The accounting policies adopted are consistent with those of the previous financial year except as discussed below. The consolidated entity
•• If an IFRS does not include
pronouncements specific
do not have a material transitional
impact on the annualprovisions that
consolidated financial apply
statements toconsolidated
of the that changeentity. Theor the
applied for the first time certain standards and amendments, which are effective for annual periods beginning on or after 1 January 2017.
These new
changeconsolidated
in an accounting policy is voluntary, then the change is applied retrospectively
entity has not early adopted any other standard, interpretation or amendment that has been issued but is not yet effective.
(i.e. calculated as if the new accounting policy had always been applied (IAS 8 para. 19(b)).
Retrospective application requires an entity to adjust the opening balance of each affected
component of equity for the earliest comparative period
HARVEY presented
NORMAN HOLDINGS LIMITED |and other
ANNUAL REPORTcomparative
2018 73
amounts disclosed. This results in the current and comparative financial years being presented
as if the new accounting policy had always been applied (IAS 8 para. 22).
When it is impracticable to determine the retrospective effects of the changes in accounting
policy, the new accounting policy must be applied from the earliest date practicable (IAS 8
paras 23–25).
Paragraph 17 goes on to explain that the first time an entity chooses to:
•• revalue property, plant and equipment under IAS 16, or
•• revalue an intangible asset under IAS 38 Intangible Assets,
the revaluation is dealt with as a change in policy under IAS 16 or 38, not under IAS 8.
It is also worth noting the paragraph 30 requirements, that is, where an accounting standard
has been issued but is not yet effective, an entity must state this and assess the potential impact.
This should be disclosed by way of note to the accounts. At present, this would mean entities
would need to consider and disclose the potential impacts of IFRS 9 Financial Instruments,
IFRS 15 Revenue from Contracts with Customers, and IFRS 16 Leases to name a few (which we will
be considering in this module).
Accounting estimates
IAS 8 para. 5 defines a change in accounting estimate as:
... an adjustment of the carrying amount of an asset or a liability, or the amount of the periodic
consumption of an asset, that results from the assessment of the present status of, and expected future
benefits and obligations associated with, assets and liabilities. Changes in accounting estimates result
from new information or new developments and, accordingly, are not corrections of errors.
A change in accounting estimate results from new information or developments. This means
that the original estimates were correct at the time they were made (in contrast with ‘errors’,
which are discussed in the next section).
This reflects the fact that, by their nature, estimates cannot be measured with precision.
As listed in IAS 8 para. 32, the following examples may require accounting estimates:
•• Bad debts.
•• Inventory obsolescence.
•• Fair value of financial assets or financial liabilities.
•• Useful lives of depreciable assets.
•• Warranty obligations.
Disclosures
The disclosure requirements of IAS 8 are detailed in paras 28–30, 39–40 and 49. Generally they
include the nature of the change, impact on line items for each period, and adjustments at the
beginning of the earliest period presented.
Below is a brief summary of basic IAS 8 requirements:
Immaterial Prospective
Summary – changes
Summary −in accounting
changes policies,
in accounting changes
policies, changes in accounting
in accounting estimates and prior period errors
estimates and prior period errors
Future developments
In September 2017, the IASB issued exposure draft ED/2017/5 Accounting Policies and
Accounting Estimates which proposes amendments to IAS 8. The objective of the amendments
is to better distinguish accounting policies from accounting estimates.
The distinction is important given changes in accounting policies are generally applied
retrospectively whereas changes in accounting estimates are applied prospectively.
Learning outcome
4. Identify and analyse related parties.
Related party disclosures enable users of financial statements to fully understand the impact
that certain related party relationships and transactions may have on the profit or loss and
financial position of an entity. Therefore, identifying related parties and any related party
transactions is important to ensure that disclosures are made in accordance with IAS 24.
IAS 24 para. 2 states that this Standard is applied in:
(a) identifying related party relationships and transactions;
(b) identifying outstanding balances, including commitments, between an entity and its related parties;
(c) identifying the circumstances in which disclosure of the items in (a) and (b) is required; and
(d) determining the disclosures to be made about those items.
IAS 24 applies to consolidated and separate financial statements, as well as individual financial
statements (IAS 24 para. 3).
• A person (or close family member) who has control of the reporting entity
• A person (or close family member) who has joint control of the reporting entity
• A person (or close family member) who has significant influence over the reporting entity
• Key managers of the reporting entity
• Key managers of the parent entity
DO EXIST
• Parent entities
• Subsidiaries
• Fellow subsidiaries
• Associates or joint ventures of a parent or subsidiary
• A management entity that provides key management personnel services to the
reporting entity
ENTITY F
Mr B
ENTITY A
DIRECTORS
Mr E
ENTITY H
50%
50%
ENTITY G
JOINT VENTURE
Required reading
IAS 24 (or local equivalent).
Disclosures
The disclosure requirements of IAS 24 are detailed in paras 13–27 and include:
•• Disclosure of certain related party relationships.
•• Disclosure of related party transactions and balances.
The following disclosure meets the minimum requirements of IAS 24 paras 18–19 and 24 for
these transactions (comparatives have not been shown although would be required):
During the year ended 30 June 20X3, unsecured loans totalling $54,000 were
advanced to directors. No interest is payable on the loan and repayment in cash
is due within two years from the date the loans were made. At 30 June 20X3, the
balance outstanding was $49,000 and is included in ‘trade and other receivables’.
Discontinued operations
Learning outcome
5. Explain and account for discontinued operations.
The concept of ‘held for sale’ in respect of individual assets is discussed Units 6 and 7.
However, the table below provides the main presentation and disclosure requirements:
Statement of profit or loss and Profit or loss after tax for the period 33(a)
other comprehensive income Gain or loss after tax on remeasuring or disposal of
assets and liabilities
Statement of profit or loss and Revenue, expenses and profit before tax 33(b)
other comprehensive income Income tax expense on profit or loss for the period
or Gain or loss before tax on remeasuring or disposal of
Notes to the financial statements assets and liabilities
Income tax expense on gain or loss before tax on
remeasuring or disposal of assets and liabilities
Statement of cash flows Net cash flows – presented either in the notes or 33(c)
or financial statements, for the following activities:
Statement of profit or loss and Amount of income from continuing and discontinued 33(d)
other comprehensive income operations attributable to owners of the parent
or
Notes to the financial statements
Required reading
IFRS 5 (or local equivalent).
The rabbit food line was discontinued in August 20X5 due to disappointing sales. Fur-Mates
sold the rabbit food distribution business and made a $100,000 gain on the sale. The income tax
expense relating to the gain is $30,000.
Any assets connected with the rabbit food line were redeployed elsewhere within Fur-Mates
after the sale.
This information, concerning the discontinued business, could be presented in either of two
ways within the SPLOCI for the year ended 30 June 20X6 to comply with IFRS 5:
1. Include the detail on the face of the SPLOCI.
Discontinued operation $
Revenue 400,000)
Expenses (270,000)
2. Include summarised information on the face of the SPLOCI and present the detail in the
notes to the financial statements.
Discontinued operation $
Disclosures
Apart from the disclosure requirements outlined above, there are additional disclosures
specified by IFRS 5 that are detailed in paras 41–42.
Learning outcome
6. Explain and account for events after the reporting period.
Video resource
See the video on events after reporting period on MyLearning to assist your learning in this topic.
Timing of events
Inevitably, there is a ‘gap’ between the end of the accounting (reporting) period and completion
of the financial statements. Events that occur during this period may need to be reflected in the
financial statements for the period just ended.
IAS 10 provides guidance as to when such events should be reflected in the financial statements
and how to treat them. IAS 10 applies to events that occur after the reporting date and before
the date the financial statements are authorised for issue (IAS 10 para. 3).
Financial
End of statements
reporting authorised
period for issue
20X8 20X8
JUNE SEPTEMBER
30 15
EVENT
?
Accounting for events after the reporting period
There are two types of events that occur after the reporting period. These events are classified
as either:
•• adjusting events
•• non-adjusting events.
Events occurring
after reporting date
The difference between an ‘adjusting event’ and a ‘non-adjusting event’ is key to applying
IAS 10, and is discussed below.
Adjusting events
An adjusting event confirms the existence of a condition that existed at the end of the reporting
period, or provides more evidence about such a condition (IAS 10 para. 3(a)). Therefore, the
amounts recognised in the financial statements are adjusted to reflect adjusting events after the
reporting period (IAS 10 para. 8).
Non-adjusting events
Non-adjusting events are indicative of conditions that arose after the end of the reporting period
and therefore do not relate to a condition that existed at the reporting date (IAS 10 para. 3(b)).
The amounts recognised in the financial statements are therefore not adjusted to reflect these
events (IAS 10 para. 10).
However, material non-adjusting events could influence users of the financial statements.
Therefore, as stated in IAS 10 para. 21, the following relevant information should be disclosed:
(a) Nature of the event.
(b) Estimate of the financial effect, or a statement that such an estimate cannot be made.
Required reading
IAS 10 (or local equivalent).
Disclosures
The disclosure requirements of IAS 10 are detailed in paras 17–22.
Quiz
[Available online in myLearning]
Contents
Introduction 3-3
Accrual accounting versus cash accounting 3-3
Income versus revenue 3-4
Relevant standards and interpretations 3-4
Overview of IFRS 15 3-5
Core principle 3-5
The five-step revenue model 3-5
Step 1: Identify the contract(s) with a customer 3-8
Identifying the contract 3-8
Considering the potential combination of contracts 3-10
Step 2: Identify the separate performance obligations 3-13
Step 3: Determine the transaction price 3-17
Variable consideration 3-20
Constraining estimates of variable consideration 3-22
Existence of a significant financing component in the contract 3-24
Non-cash consideration 3-25
Consideration payable to a customer 3-25
Step 4: Allocate the transaction price 3-27
Allocation of a discount 3-28
Allocation of variable consideration 3-29
Step 5: Recognise revenue when a performance obligation is satisfied 3-30
Measuring progress towards complete satisfaction of a performance obligation 3-33
How does revenue recognition under IFRS 15 work when foreign currencies
are involved? 3-33
Disclosure 3-34
Learning outcome
At the end of this unit you will be able to:
1. Identify, measure and recognise revenue from contracts with customers.
Introduction
Revenue is a crucial number to users of financial statements in assessing a company’s
performance and prospects. Investors often focus on revenue growth and acceleration when
they analyse financial statements, because revenue is often an indication of the activity level and
capacity of an entity.
Revenue is not only one of the most important financial reporting metrics, but it is usually
also the largest item in the statement of profit or loss and other comprehensive income. It is
prominently presented in the financial statements as the very first item in the statement of profit
or loss and other comprehensive income.
Revenue (e.g. sales) has a direct impact on an entity’s financial performance (i.e. profit) and
this makes the recognition and measurement of revenue a critical issue. But how does an entity
determine when to record revenue and how much revenue should be recognised in the profit or
loss?
The sale of goods for cash is relatively simple – the revenue is recognised on the date the goods
are sold and the cash is received. But what happens if the transaction is on credit; or, if the
transaction includes a good and a service, such as a mobile phone with calls and data usage, or
a new car with a service contract? If a service is rendered over an extended period, when is the
revenue recognised?
This unit examines the principles that an entity has to apply to report ‘useful information to
users of financial statements about the nature, amount, timing and uncertainty of revenue and
cash flows arising from an entity’s contracts with a customer’ (IFRS 15 Revenue from Contracts
with Customers para. 1). It discusses the measurement and recognition of revenue and illustrates
how to measure and recognise revenue in a range of circumstances.
Income
IFRS 15 has a mandatory effective date for annual reporting periods beginning on or after
1 January 2018. Earlier application is permitted; however, if an entity applies IFRS 15 early,
it shall disclose that fact.
Required reading
Read IFRS 15 paras 5–8 now to understand the scope of IFRS 15.
Overview of IFRS 15
Core principle
The core principle of IFRS 15 is to ‘recognise revenue to depict the transfer of promised goods or
services to customers in an amount that reflects the consideration to which the entity expects to
be entitled in exchange for those goods or services’ (IFRS 5 para. 2).
As the title of IFRS 15 suggests, an entity shall only apply IFRS 15 to a contract if the
counterparty to the contract is a customer. A customer is ‘a party that has contracted with
an entity to obtain goods or services that are an output of the entity’s ordinary activities in
exchange for consideration’ (IFRS 15 para. 6). This is in line with the Framework, which states
that revenue arises in the course of the ordinary activities of an entity (para. 74).
It is important to read the paragraphs in the standard as you progress through the unit to
understand the material in detail. Candidates may also find the application guidance in IFRS 15
Appendix B helpful in exploring the key concepts.
Required reading
Read IFRS 15 paras 1–4 now to understand the objective of IFRS 15, and Appendix A to
understand key definitions.
The following simple example introduces how to apply the five-step IFRS 15 model. Each step
will be discussed in detail within the unit. Candidates can revisit the examples to test their
understanding, after reading the CSG and required readings from the standard.
Six-month service of the delivery vehicle (1,100 ÷ 22,000 × 20,000) 1,100 5 1,000
Nine-month service of the delivery vehicle (550 ÷ 22,000 × 20,000) 550 2.5 500
22,000 100.0 20,000
It is important to note that none of the steps in the five-step revenue model refers to cash
received. Therefore, the date of receipt of the cash amount has no impact on the timing of the
revenue recognition, and the date of recognition of revenue does not necessarily coincide with
the date of receipt of the related cash.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of the related cash amounts:
Date Account description Dr Cr
$ $
15.03.20X6 Trade receivables 20,000
STEP
1 Step 1: Identify the contract(s) with a customer
Step 1 consists of two parts, namely:
•• Identifying the contract.
•• Considering the potential combination of contracts.
STEP 1
Identify the Considering
Identifying
contract(s)
with a
the
contract
+ the potential
combination
of contracts
customer
Have the parties to the contract approved the contract (in writing, orally NO
or in accordance with other customary business practices) and are they
committed to perform their respective obligations?
YES
Can the entity identify each party’s rights regarding the goods or NO
services to be transferred?
YES
YES
* Probable under IFRSs is regarded as more likely than not to occur (that is, greater than 50% likelihood).
STEP
Required reading 1
Read IFRS 15 paras 9–16 now to understand how to identify a contract.
Under IFRS 15, entities apply the revenue recognition model if at the start of the contract,
it is probable that the entity will collect the consideration to which it expects to be entitled.
IFRS 15 para. 9(e) states ‘In evaluating whether collectability of an amount of consideration is
probable, an entity shall consider only the customer’s ability and intention to pay that amount
of consideration when it is due’. To this effect, entities often perform credit checks to assess
whether a potential customer would be able to settle their debt in the future. This requirement
is designed to prevent entities from applying the revenue model to problematic contracts and
recognising revenue and a large impairment loss at the same time.
STEP
1 Considering the potential combination of contracts
An entity often enters into various contracts with the same customer. Where this happens, the
entity has to assess whether these contracts with the same customer should be accounted for
individually in terms of IFRS 15 or whether they should be combined and accounted for as a
single contract.
Required reading
Read IFRS 15 para. 17 to understand when to combine contracts.
The reason for this assessment is to prevent an entity and its customer entering into a number
of legal contracts that manipulate the timing and the amount of revenue recognised. This is
demonstrated in the example below:
100,000
However, the Seatings normally sells these three products at the following prices:
Item sold Normal selling price
$
Product A 5,000
Product B 15,000
Product C 80,000
100,000
The following table outlines how revenue would be recognised in the books of Seatings under
both alternatives (i.e. individually or combined) and clearly illustrates that the three contracts
should be combined to eliminate the possible manipulation of revenue recognised:
Date of revenue Amount of revenue Amount of revenue Difference
recognition recognised – three recognised – one
separate contracts combined contract
$ $ $
The following decision tree should be used to assess whether to combine two or more contracts: STEP
1
NO
Are the contracts entered into at or near the same time?
YES
YES
NO
NO
NO
No combination of contracts
Mr and Mrs Parker have agreed to pay the total amount of $165,000 on 31 October 20X7.
To determine when and how much revenue to recognise, Beautiful Homes Builders will apply the
five-step revenue model, as follows:
Step 1 – Identify the contract(s) with a customer
Beautiful Homes Builders signed three contracts during November 20X6. As part of Step 1,
Beautiful Homes Builders has to assess whether to combine these contracts, and it should use
the decision tree to make its assessment.
STEP
1
Beautiful Homes Builders made the following assessment:
•• The three contracts are entered into at or near the same time, because they are entered into
within the same week.
•• The three contracts are entered into with the same customer (or related parties of
the customer), because Mr A D Parker and Mrs E C Parker are married and therefore
related parties.
•• The contracts are negotiated as a package with a single commercial objective, because the
three contracts all relate to the renovation of the same property at 75 Collingwood Avenue
in Hampton.
Therefore, Beautiful Homes Builders has to combine the three contracts.
Beautiful Homes Buildings would then go on the complete the remaining four steps in the five
step IFRS15 revenue recognition model. These steps are introduced briefly in this example below,
and will be examined in more detail later in the following pages.
Step 2 – Identify the separate performance obligations
According to the three signed contracts, Beautiful Homes Builders has agreed to the following
three performance obligations:
•• Renovation of kitchen.
•• Renovation of main bathroom.
•• Construction of a pool.
Step 3 – Determine the transaction price
The transaction price is $165,000.
Step 4 – Allocate the transaction price
The transaction price of $165,000 is allocated to the three performance obligations, as follows:
$
165,000
It is important to note that the combination of the three contracts is aligned to the ‘substance
over form principle’ as outlined in the Framework. If the contracts were not combined the
revenue from the three separate contracts would be recognised as follows:
$
Step 2 of the five-step revenue model requires that at the inception of contract, the entity
assesses the goods or services promised in a contract with a customer and identifies the separate
performance obligations. A performance obligation is:
STEP 2 A good or
service (or a
Identify the
bundle of goods
separate
performance
A promise
+ In a
contract + To transfer + or services) that
is distinct
obligations
OR
• A series of
distinct goods
or services
• That are
substantially
the same, and
• That have the
same pattern of
transfer to the
customer
Required reading
Read IFRS 15 paras 22–30 now to understand how to identify the separate performance
obligations.
Read the definition of performance obligation in IFRS 15 Appendix A.
STEP
2 Step 3 – Determine the transaction price
The transaction price is $1,800, which consists of the $600 joining fee and $100 per month for
12 months.
Step 4 – Allocate the transaction price
The transaction price of $1,800 is allocated to the one performance obligation.
Step 5 – Recognise revenue when a performance obligation is satisfied
The performance obligation is satisfied over the 12 months and therefore the revenue is
recognised over the 12 months.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of cash amounts, during the month of January 20X3:
Date Account description Dr Cr
$ $
Joining fee received on signing the new annual gym membership contract
The following decision tree could be used to identify separate performance obligations: STEP
2
Can the customer benefit from the good or service, whether NO
on its own, or with other readily available resources?
YES
NO
STEP
2
Example – Distinct goods or services
Stylish Equipment sells manufacturing machinery. It also installs the manufacturing machinery
for their customers. The installation of the manufacturing machinery can also be done by
registered builders.
In Step 2 of the five-step revenue model, Stylish Equipment needs to identify the separate
performance obligations. Stylish Equipment will be performing two activities – the sale and the
installation of the manufacturing machinery. Careful consideration should be given to determine
whether these two activities lead to the provision of one or two distinct goods or services to
the customer.
The customer can benefit from the manufacturing machinery on its own or with other readily
available resources, because the manufacturing machinery can also be installed by other
registered builders. In addition, the manufacturing machinery and the installation services are
not highly interdependent or highly interrelated. The sale of the manufacturing machinery and
the installation services should therefore be identified as two separate performance obligations.
STEP 3
Amount of
Determine
consideration
the
transaction
Transaction
price = the entity
expects to be
price entitled to
Entities have to consider the following in order to determine the transaction price:
•• terms of a contract (e.g. terms specified in a sales invoice)
•• the entity’s customary business practices (e.g. a settlement discount of 10% if the customer
pays within 30 days).
Required reading
Read IFRS 15 paras 46–49 now to understand determining the transaction price.
The sales revenue is calculated at the invoice price of $250,000 less the expected settlement
discount of $12,500 ($250,000 × 5%), because the transaction price is the amount of
consideration the entity expects to be entitled to. Based on past experience, Amazing Shoes
will settle its debt within 30 days and therefore the Shoe Warehouse would only be entitled to
$237,500.
Subsequently, if the amount received from Amazing shoes is higher (e.g. if the payment does not
fall within the settlement discount period), any additional revenue could be recognised.
STEP
3
Example – Refund liability
Basketball Gear sells basketball clothes and equipment to retail stores across Australia and New
Zealand. Basketball Gear does not deliver its goods to customers. Customers are required to
pay in cash or via electronic funds transfer on the day of sale, which is also the day on which the
customer picks up the goods from Basketball Gear’s warehouse.
On 12 July 20X1, Basketball Gear sells a number of basketballs, basketball hoops and clothing
to a local sports club for $50,000. The basketball club has 30 days to return any unwanted
items. If the club returns the goods within the 30 days, it will receive a full refund. Based on past
experience with this customer, Basketball Gear estimates that 15% of the goods will be returned
within the allowed 30 days.
Basketball Gear will process the following journal on 12 July 20X1 (date of cash sale and pick up
of goods) in relation to the sale:
Date Account description Dr Cr
$ $
Assume that the customer returns 15% of the goods on 31 July 20X1. Basketball Gear will process
the following journal on 31 July 20X1:
Date Account description Dr Cr
$ $
Cash 7,500
IFRS 15 para. 47 states that a transaction price excludes amount collected on behalf of third
parties. In Australia and New Zealand, this means a transaction price as defined in IFRS 15
excludes the GST collected.
STEP
3
Example – Goods and services tax (GST)
On 20 November 20X8, A-lot-of-runs Cricket Bats delivered 11 new cricket bats to Cricket
Australia. The accompanying invoice indicated that the total sales price is $110,000, including
GST of 10%. A-lot-of-runs Cricket Bats does not provide any settlement discounts to customers.
A-lot-of-runs Cricket Bats will process the following journal on 20 November 20X8 (date of
delivery) in relation to the sale of the cricket bats to Cricket Australia:
Date Account description Dr Cr
$ $
Note: this example is included to show amounts collected on behalf of third parties. GST generally is
beyond the scope of the FIN module.
The transaction price could consist of a fixed consideration, or a variable consideration, or both.
Transaction price
Fixed Variable
consideration consideration
+
OR BOTH
IFRS 15 para. 47 states that the ‘consideration promised in a contract with a customer may
include fixed amounts, variable amounts, or both’.
An entity should consider the effects of all of the following when determining the transaction
price:
Constraining
Variable estimates of
consideration variable
consideration
Existence
Consideration
of a significant
payable to a
financing
customer
component
Non-cash
consideration
STEP
3 Variable consideration
Discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses,
penalties or other similar items could impact the amount of consideration (IFRS 15 para. 50).
Consideration can also be contingent on the occurrence or non-occurrence of a future event.
Variable consideration could originate from any of the following sources (IFRS 15 para. 52):
•• Explicitly stated in the contract.
•• The customer has a valid expectation arising from an entity’s customary business
practices, published policies or specific statements that the entity will accept an amount of
consideration that is less than the price stated in the contract. The entity is expected to offer
a price concession, which could be referred to as a discount, rebate, refund or credit.
•• Other facts and circumstances indicate that the entity intends to offer a price concession to
the customer.
An entity needs to estimate the amount of variable consideration by using either of the
following two methods:
•• Expected value.
•• Most likely amount.
The method selected would depend on which of the two methods the entity expects to better
predict the amount of variable consideration.
Estimation of variable
consideration
Expected value The sum of probability-weighted amounts in An entity has a large number of
a range of possible consideration amounts contracts with similar characteristics
Most likely amount The single most likely amount in a range The contract has only two possible
of possible consideration amounts (i.e. the outcomes (e.g. an entity either achieves
single most likely outcome of the contract) or does not achieve a performance
bonus)
Required reading
Read IFRS 15 paras 50–55 now to understand variable consideration
STEP
Likely fee % probability $ 3
247,875
Master Seller will update its estimate at each reporting date. This example does not consider the
potential need to constrain the estimate of variable consideration included in the transaction
price.
Assuming this estimate meets the requirements of IFRS15 para. 56 (discussed in the following
pages), the revenue would be recognised via the following journal.
Date Account description Dr Cr
$ $
STEP
3 Constraining estimates of variable consideration
When including variable consideration in calculating a transaction price, IFRS 15 para. 56
imposes a constraint on when this variable consideration can be recognised.
The following decision tree should be used to consider the constraining estimates of variable
consideration:
NO YES
Include the fixed consideration in the Estimate the amount using the expected value
transaction price or most likely value
YES NO
* IFRS 5 Non-current Assets Held for Sale and Discontinued Operations defines ‘highly probable’ as significantly more likely
than probable. The standard does not quantify this. An entity has to consider both the likelihood and the magnitude
of the revenue reversal.
The following factors increase the likelihood or magnitude of a revenue reversal (IFRS 15
para. 57):
Constraining estimates
of variable consideration
Required reading
Read IFRS 15 paras 56–59 now to understand the constraining estimates of variable consideration.
STEP
3
Example – Right of return
The Art House sells modern art pieces to retail stores across Asia Pacific. The Art House delivers
the sold art pieces to the customers. Customers are required to either pay or return the art within
60 days. If customers return the art pieces within 60 days, they will receive a full refund.
On 5 March 20X4, The Art House sold a number of art pieces to Funky Art for $100,000. Based on
past experience with Funky Art, The Art House estimates that 30% of the goods will be returned
within the allowed 60 days.
Because the sales contract allows Funky Art to return the art pieces, the consideration is variable.
Using the expected value method, The Art House estimates that 70% of the art pieces will not
be returned.
The Art House will process the following journal on 5 March 20X4 (date of sale and delivery of
the art pieces) in relation to the sale:
Date Account description Dr Cr
$ $
Assume that Funky Art returns 30% of the goods on 15 April 20X4. The Art House will process the
following journal on 15 April 20X4:
Date Account description Dr Cr
$ $
STEP
3 Existence of a significant financing component in the contract
A significant financing component exists in a contract if the timing of the cash flows is more
than 12 months after the date of recognition of the related revenue. If a significant financing
component exists in a contract, the transaction price should be adjusted for the time value
of money.
As per IFRS 15 para. 61, the objective of adjusting the transaction price for a significant
financing component is ‘for an entity to recognise revenue at an amount that reflects the price
that a customer would have paid for the promised goods or services if the customer had
paid cash for those goods or services when (or as) they transfer to the customer (i.e. the cash
selling price)’.
The discount rate used is the rate that would be used in a separate financing transaction
between the entity and the customer. The objective of adjusting the transaction price applies to
both in advance and in arrears.
In the statement of profit or loss and other comprehensive income, an entity should present
the effects of financing (interest revenue or interest expense) separately from revenue from
contracts with customers.
Required reading
Read IFRS 15 paras 60–65 now to understand the existence of a significant component in a
contract.
Recognition of revenue on satisfaction of the single performance obligation to sell and deliver furniture
Recognition of interest revenue for the period 1 January 20X1 to 31 December 20X1
Recognition of interest revenue for the period 1 January 20X2 to 31 December 20X2
STEP
Date Account description Dr Cr 3
$ $
Non-cash consideration
If an entity provides goods or services to a customer and the customer promises consideration
in a form other than cash, the entity should measure the non-cash consideration (or promise of
non-cash consideration) at fair value. Fair value is discussed in Unit 6 and in IFRS 13 Fair Value
Measurement.
Required reading
Read IFRS 15 paras 66–69 now to understand non-cash consideration.
As the customer is paying Modern Office Furniture by providing a new delivery vehicle, the
vehicle is non-cash consideration (as discussed in IFRS 15 para. 66). The fair value of the motor
vehicle was $75,000, and this is the amount that should be recognised as revenue, rather than
the $80,000 agreed selling price.
STEP The principles to treat consideration payable to a customer are set out in IFRS 15 para. 70 and
3
are summarised below:
Required reading
Read IFRS 15 paras 70–72 now to understand consideration payable to a customer.
Once an entity has determined the transaction price under Step 3, it can move on to Step 4 to
allocate the transaction price.
STEP
4 Step 4: Allocate the transaction price
An entity should follow the following process to allocate the transaction price, as determined in
Step 3, to each performance obligation identified in Step 2:
STEP 4
Allocate the
transaction Transaction
price price
YES NO
Determine the stand-alone selling price at Estimate the stand-alone selling price using
contract inception of the distinct good or one of the following
service underlying the performance obligation • Adjusted market assessment approach
in the contract. • Expected cost plus a margin approach, or
• Residual approach (only use as a last resort).
An entity should consider the following aspects to determine the stand-alone selling price of a
good or service:
•• At what price does the entity sell the promised good or service separately to a customer?
•• At what price does the entity sell the good or service separately in similar circumstances and
to similar customers?
•• What is the contractually stated price? (This price may be, but shall not be presumed to be,
the stand-alone selling price.)
Required reading
Read IFRS 15 paras 73–80 to understand allocating the transaction price.
STEP
4 Further reading
A discussion and examples of methods to estimate stand-alone prices can be found in Unit 3 in
myLearning
100,000
In this transaction, there is an inherent discount of $20,000, which does not relate to a specific
performance obligation and is therefore allocated to all performance obligations on a relative
stand-alone selling price basis.
Allocation of a discount
In entering into a contract with a customer, an entity may provide that customer with a
discount. In order to apply the five-step revenue recognition process under IFRS 15, the
principles for dealing with discounts are discussed in IFRS 15 paras 81–83.
Allocating a discount
Required reading
Read IFRS 15 paras 81–83 to understand the allocation of a discount.
Required reading
Read IFRS 15 para. 85 to understand when to use the exception discussed in the diagram above.
STEP
5 Step 5: Recognise revenue when a performance
obligation is satisfied
In the fifth and final step of the revenue model, an entity finally determines when to recognise
revenue.
FIN fact
It should be remembered that all of the five steps are performed at inception of a contract.
Required reading
Read IFRS 15 paras 31–38 now to understand when a performance obligation is satisfied.
The timing of revenue recognition is determined based on whether the entity satisfies the
performance obligation(s) (identified in Step 2) over time or at a point in time.
An entity should start by considering whether the entity satisfies a performance obligation over
time, and if not, it is concluded that the entity satisfies the performance obligation at a point
in time.
STEP 5
Recognise
revenue
when a
performance
obligation is
satisfied
KEY QUESTION: Does the entity transfer control of the asset over time?
YES NO
The entity should recognise revenue over time, The entity should recognise revenue at a point
using a method that depicts its performance in time at which it transfers control of the good
or service to the customer
The following indicators should be considered to determine whether control of an asset has
been transferred:
•• Does the entity have a present right to payment for the asset?
•• Does the customer have legal title to the asset?
•• Has the entity transferred physical possession of the asset to the customer?
•• Does the customer have significant risks and rewards of ownership of the asset?
•• Has the customer accepted the asset?
STEP
In accordance with Step 2 of the five-step revenue model, The Great Bus Manufacturer identified 5
three separate performance obligations –the 30 seater bus, the 20-seater bus and the 10-seater
bus. In accordance with Step 5 of the five-step revenue model, The Great Bus Manufacturer will
recognise revenue at the following dates when it delivers each bus to Seaview:
•• 1 March 20X2
•• 1 May 20X3
•• 31 August 20X3.
Seaview Secondary School will obtain control of the buses at the date of the delivery of the buses.
The following decision tree should be used to determine when and how the entity transfers
control of the asset:
FALSE
The entity transfers
control over time
The entity’s performance creates or enhances an asset that the TRUE =
customer controls as the asset is created or enhanced The entity should
recognise revenue
FALSE over time, using
a method that
depicts its
The entity’s performance does NOT create an asset with performance
an alternative use to the entity TRUE
and
the entity has an enforceable right to payment
for performance completed to date
FALSE
STEP
5
Payroll Made Easy would recognise revenue from this contract as follows:
•• Financial reporting period ending on 30 April 20X4 = $1,200 [($900 × 4 quarters) × (4 months
÷ 12 months)].
•• Financial reporting period ending on 30 April 20X5 = $2,400 [($900 × 4 quarters) × (8 months
÷ 12 months)].
Example – Creates or enhances an asset that the customer controls as the asset is created
or enhanced
Good Construction enters into a contract with a customer to build a new architect-designed
home on a block of land in Sandringham. The customer purchased the block of land a few
months ago and has already demolished the original home.
In accordance with Step 2 of the five-step revenue model, Good Construction identified a single
performance obligation – the construction of a new home.
In accordance with Step 5 of the five-step revenue model, Good Construction determines that
the performance obligation is satisfied over time because Good Construction’s performance
creates or enhances an asset (property in Sandringham) that the customer controls as the asset
(the new home) is created or enhanced. The home is constructed on a block of land owned and
controlled by the customer.
Example – Creates or enhances an asset that is NOT controlled by the customer as the asset
is created or enhanced
Big Developer is developing a multi-unit residential complex in Docklands, Melbourne.
A customer enters into a binding sales contract with Big Developer for a specified unit that is
under construction. Each unit has a similar floor plan and is of a similar size, but other attributes
of the units are different (e.g. the location of the unit within the complex)
The customer pays a 10% deposit upon entering into the contract and the deposit is refundable
only if Big Developer fails to complete construction of the unit in accordance with the contract.
The remainder of the contract price is payable on completion of the contract when the
customer obtains physical possession of the unit. If the customer defaults on the contract before
completion of the unit, Big Developer has the right to retain the deposit.
In accordance with Step 5 of the five-step revenue model, at contract inception, Big Developer
determines whether its promise to construct and transfer the unit to the customer is a
performance obligation satisfied over time or a point in time.
Big Developer determines that the customer does not simultaneously receive and consume
the benefits provided by Big Developer’s performance as Big Developer performs (i.e.
construct the building), because the customer only gets physical possession of the unit on
completion of the building.
Big Developer also determines that its performance does not create or enhance an asset that
the customer controls as the asset is created or enhanced, because the customer does not own
the block of land on which the building is constructed and the customer only gets physical
possession of the unit on completion of the building.
Big Developer further determines that its performance creates an asset with an alternative
use to Big Developer, because it could sell the unit to another buyer/customer. However, Big
Developer determines that it does not have an enforceable right to payment for performance
completed to date because, until construction of the unit is complete, Big Developer only has
a right to the deposit paid by the customer. As Big Developer does not have a right to payment
for work completed to date, its performance obligation is not a performance obligation satisfied
over time. Instead, Big Developer accounts for the sale of the unit as a performance obligation
satisfied at a point in time.
Output Input
methods methods
Milestones
reached Costs incurred
Units produced
or delivered
In determining the appropriate method for measuring progress, an entity shall consider the
nature of the good or service that the entity promised to transfer to the customer.
Required reading
Read IFRS 15 paras 39–45 now to understand ways to measure progress.
Further reading
IFRIC 21 Foreign currency transactions and Advance consideration.
Disclosure
IFRS 15 requires a number of disclosures to ensure users are able to understand revenue and
cash flows arising from contracts with customers.
Revenue from contracts with customers must be disclosed separately from other sources of
revenue. Impairment losses from contracts with customers should be disclosed separately from
other impairment losses. Significant judgements made in applying IFRS 15 must be disclosed.
Required reading
Read IFRS 15 paras 110–129 now to understand disclosure requirements.
Further reading
Slater and Gordon Limited, 2018 Annual Report, Notes 3.1.1 and 3.1.2,
https://assets.slatergordon.com.au/downloads/Slater-Gordon-Annual-Report-2018.pdf
Activity 3.1
[Available online in myLearning]
Activity 3.2
[Available online in myLearning]
Quiz
[Available online in myLearning]
Working paper A
You are now ready to complete working paper A of integrated activity 4, to help you
understand how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Contents
Introduction 4-3
Tax effect accounting 4-3
Scope 4-4
Overview of IAS 12 4-4
The underlying transaction 4-5
Current tax 4-6
Methodology for calculating and accounting for current tax 4-6
Calculating the current tax liability where the entity has derived a taxable income 4-7
Determining the current tax liability 4-7
Current tax asset versus current tax liability 4-14
Deferred tax 4-15
Methodology for calculating and accounting for deferred tax 4-15
Step 1 – Calculate temporary differences at end of reporting period 4-15
Step 2 – Allocate temporary differences 4-17
Step 3 – Calculate deferred tax balances at the end of the reporting period 4-19
Step 4 – Apply recognition criteria 4-19
Step 5 – Calculate movement in deferred tax balances 4-20
Step 6 – Prepare the journal entry 4-21
Reversals of temporary differences 4-24
Complexities with deferred tax 4-25
Initial recognition exemption for DTAs and DTLs 4-26
Specific recognition exceptions concerning DTAs and DTLs 4-27
Changes in prior year taxes due to errors or estimates 4-27
Other tax effect accounting issues 4-29
Changes in tax rates and tax laws 4-29
Consolidated financial statements 4-29
Presentation 4-30
Offsetting tax balances 4-30
Presenting income tax expense 4-30
Disclosures 4-31
Income tax expense 4-31
Methodology for accounting for income tax expense recognised in profit or loss 4-31
Elements of income tax expense for separate disclosure 4-31
Other disclosure issues 4-32
APPENDIX: Determining the tax base of an asset or liability that gives rise to a temporary
difference 4-33
fin11904_csg_09
Learning outcomes
At the end of this unit you will be able to:
1. Explain the purpose of tax effect accounting.
2. Calculate and account for current tax.
3. Calculate and account for deferred tax.
4. Explain and account for changes in prior year taxes.
5. Explain and account for income tax expense.
Introduction
This unit deals with the accounting treatment of an entity’s income tax in its financial
statements (also commonly called ‘tax effect accounting’ or ‘tax accounting’), as detailed in
IAS 12 Income Taxes.
Scope
IAS 12 applies to accounting for income taxes. It does not apply to other taxes such as property
taxes and value-added taxes, or goods and services tax.
For the purposes of IAS 12, income taxes include:
•• All domestic and foreign taxes based on ‘taxable profits’.
•• Taxes (including withholding taxes) which are payable by a subsidiary, associate or joint
arrangement on distributions to the reporting entity.
Overview of IAS 12
The objective of IAS 12 is to specify the accounting treatment for income taxes. Some key
principles of IAS 12 to understand at this stage of the unit can be summarised as follows:
Time of recording tax effect •• Generally, when preparing the financial statements, tax effect entries are
journal entries recorded after all other journal entries have been recorded
•• Therefore, tax effect entries are recorded on the last day of the reporting
period
The tax liability arising from The current tax liability represents the current balance of income taxes
transactions and events payable to taxation authorities (i.e. the Australian Taxation Office (ATO) and
occurring in the current New Zealand Inland Revenue (IR)) based on the taxable income for the year
reporting period results in
the recognition of a current
tax liability
Temporary differences arise Temporary differences arise when a transaction or event is recognised in
from the expected future tax a different period in the financial statements, rather than when they are
consequences of transactions recognised for taxation purposes
and events occurring in the IAS 12 requires the related tax for a transaction or event to be recognised.
current reporting period Think of this as an accounting matching concept
From a tax viewpoint, the taxation liability occurs in a different period, which
creates a mismatch. This mismatch can be shown as follows:
Temporary differences Think of a DTA as representing income tax that has been paid in advance (like
generally result in the a prepayment of tax). The entity will recover this tax benefit (e.g. by paying a
recognition of a DTA or a DTL lower amount of income tax in a future period)
Think of a DTL as representing the receipt of a tax benefit in advance.
The entity will have to repay this tax benefit (e.g. by paying a higher amount
of income tax in a future period)
Referring to the previous diagram, a DTL would be recognised in the
first reporting period to reflect there was no tax paid on the revenue in the first
period; however, there is tax to be paid in the future when the revenue is received
Where is the underlying Which account within the Tax asset or tax liability
transaction recognised? equity section of the statement
of financial position is the tax Current tax liability DTA or DTL
effect recognised?
Note 1 – Think of income tax expense as an account that matches the tax for the period against the profit
recognised for the period. Expenses are recognised within profit or loss, therefore ‘income tax expense’
relates to the tax effect of transactions recognised in profit or loss.
Required reading
The whole of IAS 12 is required reading for this unit. At specified points, you will be directed to
read certain paragraphs to enable you to progress through this unit.
Read IAS 12 ‘Objective’ paragraph and paras 1–4 before proceeding.
The process of applying IAS 12 for the purposes of this unit is shown as follows:
Current tax
Current tax is defined in IAS 12 para. 5 as ‘the amount of income taxes payable (recoverable) in
respect of the taxable profit (tax loss) for a period’.
Required reading
Read IAS 12 paras 5–6 and 12–14 before proceeding.
Please note that as candidates studying the FIN module reside and practise in a variety of
jurisdictions, the tax treatment to be applied in the FIN module assessment material will always
be stated to avoid confusion.
Calculating the current tax liability where the entity has derived
a taxable income
The process of calculating the current tax liability can be shown as follows:
Item $ $
Taxable income
The template provides a methodical approach to recording the tax effect entry to recognise the
current tax liability. The various adjustments to the accounting profit/(loss) after tax figure are
discussed further below.
Adjustments
In many instances, the tax and accounting treatments of items will differ substantially. It is these
adjustments that give rise to the need for tax effect accounting.
The accounting treatment is based on the principles of accrual accounting and the requirements
of the International Financial Reporting Standards (IFRS), while the income tax treatment is
based on the requirements of tax legislation.
The adjustments to the accounting profit/(loss) before tax figure can be grouped into three
broad categories:
1. Non-temporary difference adjustments.
2. Temporary difference adjustments.
3. Equity or OCI adjustments affecting taxable income.
Example – Where the accounting and tax treatments of an item will never be the same
This example illustrates how to calculate current tax when there is a non-temporary difference
for an item included in the accounting profit.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Included in the profit is
$200,000 in entertainment expenses that will never be deductible for tax purposes. The taxable
income was calculated as follows:
Item $
The tax effect journal entry to record the current tax liability is:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($1.2 million × 30%)
Liabilities not tax Add back the accounting Accrued tax and Superannuation
deductible until paid (and expense, subtract the tax accounting fees for contributions (subject to
therefore the expense is deduction services to be performed meeting all other conditions
not deductible) in a future period for deductibility)
Provision for employee Provision for employee
entitlements – holiday entitlements – long
pay, long service leave, service leave, annual leave
bonuses not paid within (deductible when incurred
63 days of balance date which is usually when paid)
Asset write-downs not Add back the accounting Allowance for impairment Allowance for impairment
tax deductible until a expense, subtract the tax loss – trade receivables loss – trade receivables –
particular future event deduction – deductible only when bad debt deduction only
debt is written-off as bad when previously brought
Provision for stock to account as income and
obsolescence – only specifically written off
deductible if written as bad
down to market selling
value or realised on
disposal
Costs which are expenses Add back the accounting Expenses relating to an Initial repairs for newly
for accounting but are expense, subtract the tax asset under development acquired assets
capitalised as part of the deduction (if any)
cost of an asset for tax
purposes
Assets written-off for Add back the accounting Plant and equipment Plant and equipment with
tax and accounting at expense, subtract the tax with accelerated tax accelerated tax depreciation
different rates deduction depreciation
Costs capitalised as Add back any accounting Interest capitalised to an Certain prepayments
assets for accounting but expense recognised asset under development
deductible when paid (e.g. amortisation of the that is deductible when
for tax capitalised cost), subtract incurred
the tax deduction
Expenses capitalised as Add back the accounting Premium paid to acquire Certain borrowing costs
assets for accounting expense, subtract the tax leased land that is deductible over the life
but tax deductible over a deduction deductible over the lease of the loan or five years,
different time period period whichever is shorter
Income not yet derived Subtract the accounting Income from certain land Accrued interest income on
for tax revenue, add the tax sales that is not derived a term deposit
revenue for tax purposes until
settlement
Note: The tax treatment of temporary differences in this table is simplified and the examples are not exhaustive.
Temporary differences and their impact on deferred tax are discussed in the section on deferred tax.
Example – Where the accounting and tax treatment of an item are the same but are
recognised in different periods
This example illustrates how to calculate current tax when there is a temporary difference for an
item included in the accounting profit.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Included in the profit is
$100,000 in interest revenue that will be assessable for tax purposes when it is received in the
next reporting period. The taxable income was calculated as follows:
Item $
The tax effect journal entry to record the current tax liability is:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($900,000 × 30%)
3. Equity or OCI adjustments affecting taxable income – when the underlying
transaction is recognised outside profit or loss
Where adjustments have been accounted for outside profit or loss, the tax consequences of those
adjustments must be accounted for in the same way (i.e. the tax effect will follow the accounting
treatment) (IAS 12 para. 61A).
Required reading
Read IAS 12 para. 61A before proceeding.
3A: Equity adjustments affecting taxable income – when the underlying transaction is
recognised directly in equity
Sometimes a transaction or event is included in the calculation of taxable income; however, it is
not included in the accounting profit but is recognised in equity.
The tax relating to an underlying transaction recognised directly in equity is recorded against
that transaction (IAS 12 para. 61A(b)).
The tax effect journal entry to record the current tax liability is:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($920,000 × 30%)
Notes
1. The income tax expense is $300,000 as it is the current tax relating to the underlying transactions that
have been recognised in profit ($1 million × 30%).
2. The share capital issued during the year, net of the share issue costs and related tax effect, will be
disclosed in the statement of changes in equity as was discussed in Unit 2.
3B: OCI adjustments affecting taxable income – when the underlying transaction is disclosed
in other comprehensive income
Sometimes a transaction or event is included in the calculation of taxable income; however, it
is not included in the accounting profit but is disclosed in other comprehensive income (OCI).
In practice this is quite unusual as items disclosed in OCI generally have deferred tax
consequences rather than immediate tax consequences (as discussed in the section on
deferred taxes).
The tax relating to an underlying transaction that is disclosed in OCI is recorded against that
transaction (IAS 12 para. 61A(a)).
Example – Where the underlying transaction is disclosed in OCI and is included in taxable
income
This example illustrates how to calculate current tax when there is an item that is assessable for
tax purposes that has been disclosed in OCI.
Blackshaw recorded a $1 million profit for the year ended 30 June 20X7. Disclosed in OCI was
a $60,000 gain relating to the fair value movement on a financial asset. The gain was credited
to the fair value through OCI reserve account (see note 2 below). For tax purposes, this gain is
assessable. The taxable income was calculated as follows:
Item $
The tax effect journal entry to record the current tax liability is:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($1,060,000 × 30%)
Notes
1. The income tax expense is $300,000 as it is the current tax relating to the underlying transactions that
have been recognised in profit ($1 million × 30%).
2. The accounting treatment of assets categorised as fair value through OCI is covered in Unit 9.
3. The $60,000 movement in the fair value through OCI reserve, net of the $18,000 tax effect will be
disclosed in OCI (as was discussed in Unit 2).
FIN fact
Current tax is the current liability owing to the taxation authority in respect of income taxes.
The liability is reduced by any tax payments that have already been made (e.g. company tax
instalments or pay as you go (PAYG) instalments).
If the carryforward tax losses had not been recognised at 30 June 20X6 as a deferred tax asset:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($800,000 × 30%) including the
recoupment of a prior period loss that had not previously been recognised as a DTA
If the carryforward tax losses had been recognised at 30 June 20X6 as a deferred tax asset:
Date Account description Dr Cr
$ $
Recognition of the current tax liability for the year ended 30 June 20X7 ($800,000 × 30%) including the
recoupment of a prior period loss that had previously been recognised as a DTA
Issue 1 – Issue 2 –
liability side equity side for underlying
Does the tax impact of transaction
the underlying Determine which bucket
transaction create a to record the tax effect in
current tax liability?
Deferred tax
Deferred tax in the statement of financial position represents the future tax consequences of past
transactions or events. As discussed earlier:
•• DTA represents income tax that has been paid in advance (like a prepayment of tax). The entity
will recover this tax benefit (e.g. by paying a lower amount of income tax in a future period).
•• DTL represents receiving a tax benefit in advance. The entity will have to repay this tax
benefit (e.g. by paying a higher amount of income tax in a future period).
IAS 12 adopts what is effectively a ‘balance sheet’ approach with temporary differences.
The carrying amount of an asset or liability in the statement of financial position is compared
with its tax base to determine the future tax consequences that must be accounted for under
IAS 12. The tax base is the value that would be attributed to an asset or liability for tax purposes
if a notional ‘tax balance sheet’ was prepared.
As per IAS 12’s ‘Objective’ paragraph, it is inherent in the recognition of an asset or liability that
that asset or liability will be recovered or settled, and this recovery or settlement may give rise
to future tax consequences which should be recognised at the same time as the asset or liability.
Put more simply, if there is a future tax consequence associated with the sale of an asset or
the settlement of a liability, then that future tax must also be recognised on the balance sheet.
For example, users of the financial statements need to be informed that a future sale of asset will
result in a tax liability.
Required reading
Read IAS 12 paras 7–11, 15–18, 24–26, 46–49, 51 and 57–60 before proceeding.
Carrying amount
The carrying amount at end of reporting period is the net amount of an asset or liability that is
recorded in the accounting records of the entity, determined in accordance with the relevant
IFRS. The carrying amount is net of any accumulated depreciation/amortisation or allowances
(e.g. an allowance for impairment loss – trade receivables).
STEP Even though the carrying amount may not be apparent, deferred tax should still be accounted
1
for in respect of assets and liabilities that:
•• have a nil carrying amount (e.g. items expensed in profit or loss for accounting purposes but
that are not deductible for tax purposes until a future period), or
•• only exist for tax purposes (e.g. intangibles that are recognised for tax but expensed for
accounting purposes).
Tax base
The tax base at end of reporting period is the amount that is attributed to an asset or liability for
tax purposes by following the requirements of the tax legislation. (Think of this as amount that
would appear if a tax balance sheet was prepared by the entity). Calculation of the tax base is
one of the more challenging aspects of tax effect accounting.
In the FIN module we recommend using either of the following two approaches to determine
the tax base of an asset or liability:
Determine the value that would be recognised for Apply the appropriate formula to the asset or liability
the asset or liability if a notional tax balance sheet to determine the tax base
was prepared
You do not have to apply the same approach for each temporary difference. Use the approach
that makes more sense to you.
31 Dec 20X8
$
Machine – written down 125,000 The original purchase To calculate the tax base of
value price for the machine was the machine, we need to
$200,000 on 1 Jan 20X6 look at both the machine
The machine is depreciated and the accumulated
on a straight-line basis over depreciation using tax
its useful life of eight years depreciation rate. The tax
base of the machine is equal
to its original cost
The asset is being
depreciated for tax purposes
on a straight-line basis over
five years. The tax written
down value at 31 Dec 20X8
is $80,000
Provision for annual leave (55,000) The provision for Annual leave payments are
annual leave represents deductible for tax when they
entitlements expected to are paid
be paid in the following
12 months
The temporary differences are calculated by subtracting the tax base of the item from its STEP
1
accounting carrying amount as follows:
Calculation of temporary differences
Carrying amount Tax base Temporary difference
$ $ $
Machine – written down value 125,000 80,0001 45,000
Provision for annual leave 55,000 0 2
55,000
Further examples of the tax base of assets and liabilities are provided in IAS 12 paras 7 and 8.
FIN fact
If the accounting carrying amount and the tax base are equal, there will be no temporary
difference and, therefore, no deferred tax balance in relation to the item.
The following diagram outlines the allocation between TTDs and DTDs:
Temporary differences
STEP Once the temporary differences for each asset or liability have been calculated (from Step 1),
2
each temporary difference must be allocated as a taxable temporary difference or deductible
temporary difference using the following allocation rules:
Asset Carrying amount > TTD DTL Assets with a higher rate of depreciation for
tax base tax than for accounting
Asset Carrying amount DTD DTA Trade receivables net of an allowance for
< tax base impairment loss (as the allowance is not
recognised for tax)
Liability Carrying amount < TTD DTL Certain compound financial instruments
tax base split for accounting purposes (between
liability and equity) but not for tax purposes
Liability Carrying amount > DTD DTA Accounting provisions not deductible for tax
tax base until paid
FIN fact
To apply the deferred tax rules, we need to first determine whether we looking at an asset or
a liability.
From there, we compare the carrying amount to the tax base. This tells us which allocation
rule is relevant, and in turn, whether a DTA or DTL is the result.
Using the allocation rules, the temporary difference for the machine and the provision can be
correctly allocated as either a TTD or DTD:
•• Machine – As this is an asset, and the $125,000 carrying amount is greater than the $80,000
tax base, there is a $45,000 TTD. It is a TTD as more tax will be payable in the future when
the asset is fully depreciated for tax purposes (year 5) but continues to be depreciated for
accounting purposes for a further three years which will not be tax deductible.
•• Provision for annual leave – As this is a liability, and the $55,000 carrying amount is greater
than the $0 tax base, there is a $55,000 DTD. It is a DTD as a tax benefit will be received in
later years when the annual leave is paid in cash.
Further reading
IAS 12 para. 52 and IAS 12 Illustrative Examples – Examples of Temporary Differences.
Step 3 – Calculate deferred tax balances at the end of the reporting STEP
3
period
Calculating the deferred tax balances involves two steps:
•• Calculate the deferred tax liability (DTL) in respect of TTDs.
•• Calculate the deferred tax asset (DTA) in respect of DTDs.
The treatment to be applied to tax losses that have been incurred is covered later in the unit.
Tax rate
Applying the measurement criteria in IAS 12 paras 47–51, deferred tax balances are typically
calculated at the tax rates that are expected to apply in the reporting period when the temporary
difference is expected to reverse.
Calculating DTLs
TTD × Tax rate % = DTL
Calculating DTAs
DTD × Tax rate % = DTA
Specific recognition exceptions are explained under the heading ‘Complexities with deferred
tax’ later in this unit.
STEP
4 General recognition criteria
DTAs DTLs
A DTA relating to a DTD is only recognised to the A DTL arising from a TTD should be recognised
extent that it is probable that future taxable profit will in all cases unless a specific exception applies
be available against which the DTD can be utilised (IAS 12 para. 15)
(IAS 12 para. 24)
Points to note:
•• ‘Probable’ is not specifically defined in IAS 12, but
is defined in both IFRS 5 Non-current Assets Held
for Sale and Discontinued Operations and IAS 37
Provisions, Contingent Liabilities and Contingent
Assets as ‘more likely than not’
•• If DTDs are expected to reverse in the same
period as TTDs are expected to reverse, and the
TTDs are of greater value than the DTD, then the
DTA relating to those DTDs can be recognised.
For example, $10,000 in tax deductions (from
DTDs) are expected to arise in the same period as
when $15,000 in future income will be assessable
(from TTDs). As the $15,000 TTD is greater than
the $10,000 DTD, a $3,000 DTA relating to the
$10,000 in DTDs can be recognised as an asset
(IAS 12 para. 28)
•• In determining whether it is probable that taxable
profits will be available, an entity can take into
account any tax planning opportunities that will
create taxable profit in appropriate periods
•• Any specific tax attributes in respect of the DTA and
DTL must be considered (e.g. tax rules that may
limit the ability to recover the DTA). For example, in
Australia, capital losses can only be used to offset
capital gains. Therefore, where an asset is expected
to result in a future capital loss (as it has been
impaired), the DTA can only be recognised where
it is probable that sufficient future capital gains
(rather than revenue gains) will be available
STEP
5 Step 5 – Calculate movement in deferred tax balances
The movements in deferred tax balances since the prior period need to be calculated.
The tax effect journal entry reflects only the movements that arise in the current period in the
DTL and DTA balances, as the opening balances in these accounts recognised at the end of
the prior reporting period in the statement of financial position will have been carried forward.
The current period movement to be recorded in the journal entry is calculated as follows:
STEP
Calculation of deferred tax balances 5
FIN fact
When a temporary difference reverses, the journal entry will reduce the deferred tax balance.
For example, the reversal of a DTA will be recognised by crediting the DTA account. A negative
movement from Step 5 indicates that the deferred tax balance is reversing.
Example – Preparing the journal entry to recognise the movement in the deferred tax
balances
The tax effect journal entry to record the deferred tax asset and deferred tax liability from the
preceding example is:
Date Account description Dr Cr
$ $
Notes
1. Notice that the net movement in the deferred tax balances is recognised in income tax expense. This is
because the underlying transactions were recognised in profit, and not in other comprehensive income
or equity.
FIN fact
As DTAs and DTLs are statement of financial position items, last period’s closing balance will carry
forward. Therefore, the journal entry is simply recording the movement in the DTA and DTL to
arrive at the closing balance that will be included in the statement of financial position.
Required reading
Read IAS 12 paras 61A–65 before proceeding.
IAS 12 para. 61A requires current and deferred taxes to be recognised outside profit or
loss where these taxes relate to items that are recognised outside profit or loss (in other
comprehensive income or directly in equity). IAS 12 paras 62 and 62A outline examples of these
items including:
•• A change in carrying amount arising from the revaluation of property, plant and equipment
(see Unit 7).
•• Exchange differences arising from the translation of the financial statements of a foreign
operation (see Unit 5).
•• An adjustment to the opening balance of retained earnings resulting from either a change in
accounting policy that is applied retrospectively, or the correction of an error (see Unit 2).
The 6-step process also applies to determining the journal entry for the deferred tax when the
underlying transaction is disclosed in other comprehensive income.
The 6-steps to calculate a deferred tax balance as at 30 June 20X8 are applied in the same
way as described in the previous example. A difference arises when allocating the temporary
difference as a TTD or DTD in the worksheet. Since, this temporary difference has arisen due to
the revaluation through OCI, IAS 12 para 61A(a) requires the related tax to also be disclosed in
OCI and recognised directly against the revaluation surplus account.
As a result, when allocating the temporary difference as a TTD, it is recorded in a separate column
as a TTD (OCI). This will assist with recording the journal entry to the correct accounts and
complying with IAS 12.61A(a).
Movement 30,000
Therefore, the journal to record the deferred tax on this revaluation is as follows:
Date Account description Dr Cr
$ $
DTL 30,000
To record the DTL in relation to items recognised outside profit or loss where the movement in the
revaluation surplus (net of tax) will be disclosed in OCI
Notes
1. The debit is not taken to income tax expense as the underlying transaction was accounted for outside
profit or loss.
2. The tax relating to transactions accounted for outside profit or loss must be separately identified, as the
related tax must be separately disclosed (IAS 12 para. 81(a), (ab)).
Movement 60,000
Notes
1. The carrying amount of the share issue costs is $0 as this amount is offset against equity, and not
included as an asset or liability.
2. The tax base of the share issue costs represents the future tax deduction available of $200,000.
3. The $200,000 in future tax deductions for share issue costs will make future tax payments smaller.
Accordingly, the $200,000 is a DTD.
Therefore, the journal to record the deferred tax on the share issue costs is:
Date Account description Dr Cr
$ $
Share capital 1
60,000
To record the DTA in relation to share issue costs recognised directly in equity
Notes
1. The credit is not taken to income tax expense as the underlying transaction was accounted for outside
profit or loss. Instead, the credit relating to the future tax deductions for the share issue costs is taken to
share capital in accordance with IAS 12.61A(b).
The diagram below summarises the two key issues to consider when preparing the journal
entry to recognise deferred tax:
Two key issues to prepare the tax effect journal entry for
deferred tax
Issue 1 – Issue 2 –
asset or liability side equity side for underlying
Does the tax impact of transaction
the underlying Determine which bucket
transaction create a to record the tax effect in
deferred tax asset or
deferred tax liability?
P/L – Income
Yes, there is a tax expense
DTA
future tax impact
(temporary DTL OCI – Related tax
difference) offset against that
current year reserve
movement e.g.
revaluation surplus
account
Equity – Related tax
offset against the
equity account e.g.
share capital
account
Accounting profit/(loss)
+/– Adjustments = Tax loss
before tax
Unused tax losses can commonly be carried forward to future tax periods and be utilised
(offset) against future taxable income. For the purposes of the FIN module, assume that all
requirements of the applicable tax law have been satisfied when calculating and recognising the
carryforward tax losses.
Tax losses
The journal to recognise a DTA in respect of a current period loss is as follows:
xx.xx.xx DTA XX
Where the initial recognition exception applies, an entity does not recognise subsequent
changes in the unrecognised balance (e.g. as the asset is depreciated).
Example – A transaction where the deferred tax consequences are not recognised at the
time of initial recognition
This example illustrates accounting for a motor vehicle when Australian tax law limits the
deductible amount.
An Australian entity acquires a motor vehicle costing $75,000.
The $75,000 amount is recognised and depreciated for accounting purposes but the taxable
deductions will be limited to the luxury car limit of $57,581.
As the initial acquisition of the car affects neither accounting profit nor taxable income (because
the entry was debit car and credit cash), the deferred tax consequences of the $17,419 difference
would not be recognised.
Therefore:
•• More rigorous calculations may be performed in respect of complex transactions or events
when preparing the income tax return. This may result in the identification of different
or additional tax adjustments to those identified at the time the financial statements
were prepared.
•• Any changes in estimates or errors identified in the current tax liability calculations would
be corrected during the preparation of the tax return after the end of the reporting period.
30 12 30
In the timeline above, an error has been discovered after the accounts have been authorised
for issue. To correct this prior period error, a journal entry needs to be recorded to correct the
current tax liability (IAS 12 para. 12). Correspondingly, if the error is:
•• Immaterial – this journal entry will recognise a current year tax entry in the 30 June 20X6
financial statements.
•• Material – this journal entry will make a retrospective adjustment (usually through
opening retained earnings) that will be disclosed in the 30 June 20X5 comparative financial
statements (IAS 8 para. 42).
The journal entry to correct the error should follow the same accounting treatment as the
original underlying transaction. In practice, the most common errors you are likely to encounter
relate to the tax treatment of items recognised in profit or loss.
Neither of the underlying transactions was accounted for outside profit or loss, and they are not
material. The adjustment to the current tax liability can therefore be recognised by adjusting the
income tax expense.
Therefore, the journal entry to correct the errors is:
Date Account description Dr Cr
$ $
To record the increase in the current tax liability arising from the correction of the immaterial errors
relating to the year ended 30 June 20X5
If the errors were material, Flex-It would need to account for the errors retrospectively and adjust
the comparatives as required by IAS 8 para. 42.
If an error relates to an item that did not go through profit and loss, for example, the tax effect of
share issue costs recognised in equity, the correction follows the original underlying transaction.
Required reading
Read IAS 12 paras 38–45, 46–49 and 60 before proceeding.
Presentation
Required reading
Read IAS 12 paras 71–77 before proceeding.
There are three main issues to consider after completing the tax effect journal entries for the
year as follows:
•• Offsetting tax balances.
•• Separately presenting the income tax expense for the year.
•• Providing disclosures within the financial statements (covered in the next section).
Applying IAS 12 para. 71, current tax liabilities and assets should be offset in the statement of
financial position when:
•• The entity has a legally enforceable right to offset the recognised amounts.
•• The entity’s management intends either to settle on a net basis or to settle the liability and
realise the asset simultaneously.
An entity will normally have a legally enforceable right to set off a current tax asset against
a current tax liability when they relate to income taxes levied by the same taxation authority,
and the taxation authority permits the entity to make or receive a single net payment
(IAS 12 para. 72).
For example:
•• In Australia, the above conditions are normally satisfied for income tax payments made to
the ATO.
•• In New Zealand, the above conditions are normally satisfied for income tax payments made
to IR.
In practice, creating a journal that separately records both the DTA and the DTL is recommended.
The offset can be completed as a separate step in the calculation process. As deferred tax
balances generally relate to individual assets or liabilities; they are commonly only offset
against each other for financial statement preparation purposes.
Disclosures
Required reading
Read IAS 12 paras 79–86 before proceeding.
Current income tax expense +/– Deferred income tax expense = Income tax expense
Step 3 – Offset current income tax expense and deferred income tax expense
The sum of the current income tax expense and deferred income tax expense are added together
to give the income tax expense recognised in profit or loss.
Required reading
Read the remaining paragraphs from IAS 12.
Quiz
[Available online in myLearning]
Apply the appropriate formula to the asset or liability to determine the tax base Determine the value that would be recognised for the asset or liability if a notional tax balance
Chartered Accountants Program
sheet was prepared
Formula
Asset tax base = carrying amount – future taxable amounts1 + future deductible amounts
1
IAS 12 focuses on the future tax consequences of recovering an asset only to the extent of
its carrying amount at the reporting date. Accordingly, the future taxable amounts value is
capped at the asset’s carrying amount at the reporting date
Page 4-33
Financial Accounting & Reporting
Facts Journal entries for the accounting Formula-based approach Notional tax balance sheet
Page 4-34
transactions during the year approach
Example 1
Depreciating asset
Accounting
•• Opening balance: $120,000 (cost $150,000 – $30,000 Dr Depreciation expense $30,000 The tax base is $50,000 The tax base is $50,000
Financial Accounting & Reporting
accumulated depreciation) Cr Accumulated depreciation $30,000 = $90,000 carrying amount – $90,000 If a notional tax balance sheet was
•• Depreciation expense for the year: $30,000 future taxable amounts (capped at prepared, the depreciating asset’s
Depreciation of equipment
•• Closing balance: $90,000 the asset’s carrying amount at the $50,000 tax written down value
OR
Tax reporting date) + $50,000 in future would be recognised (cost $150,000
deductible amounts – $100,000 tax depreciation
•• Tax depreciation is deductible for tax purposes deductions claimed to date)
•• Opening tax written down value $100,000 (cost $150,000 –
$50,000 tax depreciation deductions claimed to date)
•• Tax depreciation for the year $50,000
•• Closing tax written down value $50,000 (cost $150,000 –
$100,000 tax depreciation deductions claimed to date)
Example 2
Trade receivables
Accounting
•• Opening balance: $0 Dr Trade receivables $400,000 The tax base is $400,000 The tax base is $400,000
•• Revenue recognised: $400,000 Cr Revenue $400,000 = $350,000 carrying amount – If a notional tax balance sheet was
•• Cash received from customers: $0 Sales revenue recognised $0 future taxable amounts (as the prepared:
•• Allowance for impairment loss: $50,000 recognised revenue has already been assessed OR trade receivables of $400,000 would
for tax purposes) + $50,000 in future be recognised
•• Closing balance: $350,000 (net) deductible amounts1
Dr Impairment loss expense $50,000
Tax 1
The $50,000 allowance for
Cr Accumulated impairment losses – The $50,000 allowance for impairment impairment loss would not be
•• $400,000 is assessable for tax purposes trade receivables $50,000 loss will result in a tax deduction when recognised because a tax deduction
•• The $50,000 allowance for impairment loss will only be the receivables are actually written off only arises when the receivables are
Impairment of trade receivables
deductible for tax purposes when the debt is actually actually written off
written off
Chartered Accountants Program
Formula-based approach (as per IAS 12 paras 7 and 8) Notional tax balance sheet approach (as per IAS 12 para. 5)
Apply the appropriate formula to the asset or liability to determine the tax base Determine the value that would be recognised for the asset or liability if a notional tax balance
sheet was prepared
Facts Journal entries for the accounting Formula-based approach Notional tax balance sheet
transactions during the year approach
Example 3
Provision for employee entitlements
Accounting
•• Opening balance: $200,000 Dr Expense $300,000 The tax base is $0 The tax base is $0
•• $300,000 expensed for the year Cr Provision (liability) $300,000 = $240,000 carrying amount – If a notional tax balance sheet
•• $260,000 paid during the year Employee entitlements expense $240,000 in future deductions for this OR was prepared, the liability for the
•• Closing balance: $240,000 liability when the entitlements are provision would not be recognised
paid + $0 future taxable amounts as the tax deduction will only be
Tax recognised for tax purposes when
Dr Provision (liability) $260,000
•• A tax deduction arises when employee entitlements the entitlement is paid
Cr Cash $260,000
are paid
Payment of employee entitlements
Page 4-35
Financial Accounting & Reporting
Liability
Page 4-36
Formula-based approach (as per IAS 12 paras 7 and 8) Notional tax balance sheet approach (as per IAS 12 para. 5)
Apply the appropriate formula to the asset or liability to determine the tax base Determine the value that would be recognised for the asset or liability if a notional tax balance
sheet was prepared
Formula (exception to liability rule for revenue received in advance)
Financial Accounting & Reporting
Revenue received in advance tax base = carrying amount – amount of revenue not taxable in
future periods
Facts Journal entries for the accounting Formula-based approach Notional tax balance sheet
transactions during the year approach
Example 4
Unearned income
Accounting
•• Opening balance: $0 Dr Cash $80,000 The tax base is $0 The tax base is $0
•• $80,000 received from a customer during the year but has Cr Revenue received in advance = $80,000 carrying amount – $80,000 If a notional tax balance sheet was
not yet been recognised for accounting purposes (liability) $80,000 that will not be assessable in the prepared, the liability for revenue
•• Closing balance: $80,000 Revenue received in advance future (as the $80,000 was assessable OR received in advance would not
Tax that cannot yet be recognised for for tax purposes when received) be recognised as the amount
accounting purposes has already been assessed for
•• The revenue is assessable when received tax purposes
•• [In a later reporting period when the revenue is recognised
for accounting purposes, there will be no further taxation
of the $80,000 as it was assessed for tax purposes
when received]
Chartered Accountants Program
Contents
Introduction 5-3
Accounting for foreign currency 5-3
Functional currency 5-4
Presentation currency 5-4
Foreign currency transactions and balances 5-5
Understanding key terms 5-5
Initial recognition of foreign currency transactions 5-5
Reporting at subsequent reporting dates 5-5
Recognising exchange differences 5-6
Translation of financial statements 5-8
Determining the functional currency 5-8
Translating from the functional to the presentation currency 5-9
Disclosures 5-13
fin11905_csg_07
Learning outcomes
At the end of this unit you will be able to:
1 Explain and account for foreign currency transactions and balances.
2. Determine the functional currency.
3. Explain and account for the translation of financial statements of an entity from its
functional currency to its presentation currency.
Introduction
It is quite common for entities to conduct their business activities in foreign currencies or
in foreign locations. With the revenues generated, assets purchased and investments made
overseas, entities have an increased exposure to foreign currencies and are increasingly affected
by fluctuating foreign exchange (FX) rates.
IAS 21 The Effects of Changes in Foreign Exchange Rates outlines how to account for foreign
currency transactions and balances, and discusses how to determine an entity’s functional
currency and translate financial statements into an entity’s presentation currency.
This unit examines the application of IAS 21.
Functional currency
A foreign currency transaction is initially recorded by an entity in its functional currency.
The functional currency is the currency of the primary economic environment in which the
entity operates, normally where it primarily generates and expends cash. Determining an
entity’s functional currency is discussed later in this unit.
Presentation currency
An entity may present its financial statements in any currency (IAS 21 para. 38). In practice, for
many entities the local currency is the presentation currency. An entity’s presentation currency
may be prescribed by local regulatory requirements.
Transactions Translations
e.g. buy inventory from our supplier in Italy e.g. translate the financial report of our
French subsidiary from euros €
Pay in euros €, record transaction in our
ledger in dollars $ into dollars $
Accounting: Accounting:
Gain or loss to P&L Balancing figure to FCTR
DO NOT USE FCTR (Equity, OCI)
IAS 21 paras 23-24 IAS 21 paras 38-47
Learning outcome
1. Explain and account for foreign currency transactions and balances.
Monetary items
‘assets and liabilities to be received or paid in a fixed
Non-monetary items
or determinable number of units of currency’
IAS 21 para. 8
The following table summarises how to translate foreign currency denominated items at each
reporting date (IAS 21 para. 23).
Foreign currency monetary items Use the closing rate (the spot exchange rate at the end
of the reporting period)
Non-monetary items that are measured in terms of Use the exchange rate at the date of the transaction
historical cost in a foreign currency
Non-monetary items that are measured at fair value in Use the exchange rates at the date when the fair value
a foreign currency was measured
•• On the settlement of monetary items Recognise in profit or loss in the period in which
OR they arise
•• On translating monetary items at rates different
from those at which they were translated on initial
recognition during the period or in a previous
financial report
Dates A$ US$
Payables 13,333,333
To record entering into the contract for the acquisition of the machine
As the machine is to be paid for in instalments, exchange differences are likely to arise when
the payments are made. IAS 21 para. 28 covers the treatment of exchange differences arising on
the settlement of monetary items.
The second journal entry is to recognise the payment of US$6 million on completion of the first
milestone on 30 September 20X3 (US$6 million ÷ 0.92), and reduction of the payable as the first
half of the liability is being settled (13,333,333 ÷ 2). The difference of A$144,928 between these
two amounts (A$6,666,667 – A$6,521,739) is a foreign exchange gain recognised in profit or loss.
Date Account description Dr Cr
A$ A$
Cash 6,521,739
The third journal entry is to recognise the final payment of US$6 million on completion of the
second milestone on 31 December 20X3 (US$6 million ÷ 0.93), and reduction of the payable as
the second half of the liability is being settled (A$13,333,333 ÷ 2). The difference of A$215,053
between these two amounts (A$6,666,666 – A$6,451,613) is a foreign exchange gain recognised
in profit or loss. The payable has not been restated since its initial recognition as this only occurs
at reporting dates.
Date Account description Dr Cr
A$ A$
Cash 6,451,613
The last journal entry transfers the capital WIP to property, plant and equipment (PPE) at
31 December 20X3, as the machine is now installed and ready for use. As the capital WIP is a
non‑monetary item, it is not restated at the year end.
Date Account description Dr Cr
$ $
Required reading
IAS 21 (or local equivalent).
Learning outcomes
2. Determine the functional currency.
3. Explain and account for the translation of financial statements of an entity from its functional
currency to its presentation currency.
While an entity must record its foreign currency items in its functional currency, it must present
its financial statements in a single currency, known as the ‘presentation currency’.
Foreign operations, such as subsidiaries and branches, often have to translate their financial
statements from their functional currency into the presentation currency of the reporting entity
to facilitate the preparation of consolidated financial statements.
IAS 21 para. 39 specifies the method for translating financial statements from the functional
currency into the presentation currency, which is covered later in this unit.
•• The currency that mainly influences sales prices for the entity’s goods and services (this will often be the
currency in which sales prices are denominated and settled) (IAS 21 para. 9(a)(i))
•• The currency of the country whose competitive forces and regulations mainly determine the sales price of
the entity’s goods and services (IAS 21 para. 9(a)(ii))
•• The currency that mainly influences labour, material and other costs of providing goods and services (this
will often be the currency in which the costs are denominated and settled) (IAS 21 para. 9(b))
•• The currency in which funds from financing activities (i.e. issuing debt and equity instruments) are
generated (IAS 21 para. 10(a))
•• The currency in which receipts from operating activities are usually retained (IAS 21 para. 10(b))
•• Whether the activities of the foreign operation are conducted as an extension of the reporting entity or
autonomously (IAS 21 para. 11(a))
•• Whether transactions with the reporting entity are a high or low proportion of the foreign operation’s
activities (IAS 21 para. 11(b))
•• Whether cash flows from the foreign operation directly affect the cash flows of the reporting entity and are
readily available for remittance to it (IAS 21 para. 11(c))
•• Whether cash flows from the foreign operation are sufficient to service existing and normally expected debt
obligations without funds from the reporting entity (IAS 21 para. 11(d))
There may be instances where the indicative factors are mixed and the functional currency
is not obvious. In such cases, management uses its judgement to determine the functional
currency that best represents the economic effects of the underlying transactions, events and
circumstances. Management must give priority to the primary indicators, because the secondary
and additional indicators are not linked to the primary economic environment in which the
entity operates and only provide supporting evidence (IAS 21 para. 12).
As an entity’s functional currency reflects its underlying transactions, events, and conditions; it is
not changed unless there is a change in those transactions, events or conditions (IAS 21 para. 13).
Assets and liabilities Closing rate (spot exchange rate at reporting date)
Share capital
Reserves
Retained earnings
Entities will often recognise foreign exchange translation differences in a foreign currency
translation reserve in the financial statements.
As noted in IAS 21 para. 47, any goodwill arising on the acquisition of a foreign operation and
any fair value adjustments arising from the acquisition are treated as assets and liabilities of
the foreign operation, and are expressed in the functional currency of the foreign operation.
They are translated in the manner set out above. Accounting for the acquisition of an entity
is discussed in the unit on business combinations.
Example – Applying foreign currency transaction and financial statement translation rules
This example illustrates how and when the foreign currency transaction and financial statement
translation rules under IAS 21 are applied.
Dinkum Limited (Dinkum) is an Australian subsidiary of a United Kingdom group, Union Jack
Limited. Dinkum was incorporated on 1 July 20X4. Its functional currency is Australian dollars
and its presentation currency is pounds sterling.
Exchange rates during the year ended 30 June 20X5 were as follows:
Exchange rates
Average rate for the year ended 30 June 20X5 1 1.06 0.50
Assets – current A$ A$
Assets – current £ £
Activity 5.2: Translating from the functional currency to the presentation currency
[Available online in myLearning]
Disclosures
The disclosure requirements of IAS 21 are detailed in paras 51–57.
An entity is required to disclose the value of exchange differences recognised (para. 52) and
narrative notes related to the functional/presentation currency (paras 53–57).
An entity also has to clearly disclose the presentation currency in accordance with IAS 1
Presentation of Financial Statements para. 51 (d).
Quiz
[Available online in myLearning]
Now that you have completed Units 1–5, you are ready to integrate these topics and attempt the
first integrated activity. These activities help to prepare you for professional practice and the
FIN Module exam.
Integrated activity 1
The integrated activity is available online in myLearning.
Working paper B
You are now ready to complete working paper B of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Contents
Introduction 6-3
Why is IFRS 13 needed? 6-3
Purpose of this unit 6-3
Scope of IFRS 13 6-4
Measuring fair value 6-4
Definition 6-4
Step 1 – Determine the asset or liability to be measured 6-4
Step 2 – Measure fair value using an exit price 6-5
Step 3 – In the principal (or most advantageous) market 6-6
Step 4 – Between market participants 6-8
Step 5 – Based on the highest and best use for non-financial assets 6-9
Step 6 – Using an appropriate valuation technique 6-11
Step 7 – Based on inputs from the fair value hierarchy 6-13
Step 8 – To arrive at a fair value measurement 6-15
Considerations specific to liabilities and an entity’s own equity instruments 6-16
Liabilities 6-16
An entity’s own equity instruments 6-16
Measuring fair value for liabilities and own equity 6-16
Preparing IFRS 13 disclosures 6-17
fin11906_csg_04
Learning outcome
At the end of this unit you will be able to:
1. Explain and identify the key principles of fair value measurement, along with the related
disclosure requirements.
Introduction
IFRS 13 Fair Value Measurement establishes a single framework or hierarchy for measuring fair
value. This unit outlines the principles of fair value measurement and their general application.
For example, under IFRS 3, when a parent acquires a subsidiary, most assets and liabilities
of the acquired entity are required to be measured at fair value at the acquisition date. When
a standard requires or permits a fair value measurement, that standard relies on IFRS 13 for
its measurement.
Scope of IFRS 13
Not all fair value accounting under IFRS is covered by IFRS 13. For example, the requirements
of IFRS 13 do not apply to:
•• Measurement and disclosure requirements under:
–– IFRS 2 Share-based Payment.
–– IFRS 16 Leases.
–– Standards that utilise a similar basis to fair value but that are not fair value, such
as IAS 2 Inventories (when net realisable value is applied) and IAS 36 (in relation to
recoverable amount determined using value in use).
Required reading
IFRS 13 (or local equivalent).
Definition
IFRS 13 para. 9 defines ‘fair value’ as ‘the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the measurement
date’. The definition is therefore based on a hypothetical transaction.
The process of measuring fair value under the Standard can be performed in eight steps, as
shown in the following diagram:
STEP
1
Step 1 – Determine the asset or liability to be measured
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 STEP 7 STEP 8
Determine Measure In the Between Based on Using an Based on To arrive at a
the asset fair value principal market the highest appropriate inputs fair value
or liability using an (or most participants and best valuation from the measurement
to be exit price advantageous) use for technique fair value
measured market non-financial hierarchy
assets
A fair value measurement is for a particular asset or liability (IFRS 13 para. 11). This draws out
two key points when considering an orderly transaction between market participants:
1. What the particular item is, is dependent on its unit of account.
2. Factoring in any characteristics of the asset or liability that market participants would
consider when pricing the item.
Fundamental to the standard is an ‘exit price’ approach to measuring fair value. In this
approach, the entity is looking at the valuation from a market participant perspective, an
outsider’s view, and not from within the entity.
Entity-specific view
The fair value definition refers to an exchange in an orderly transaction. Therefore, this exit
price must be based on what would occur in an orderly transaction.
For a transaction to be orderly it must:
•• assume exposure to the market for a period before the measurement date to allow for
marketing activities that are usual and customary for transactions involving such assets or
liabilities, and
•• be based on market participants who are motivated, but not forced or otherwise compelled,
to transact for the asset or liability.
STEP
3 Step 3 – In the principal (or most advantageous) market
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 STEP 7 STEP 8
Determine Measure In the Between Based on Using an Based on To arrive at a
the asset fair value principal market the highest appropriate inputs fair value
or liability using an (or most participants and best valuation from the measurement
to be exit price advantageous) use for technique fair value
measured market non-financial hierarchy
assets
A key principle of IFRS 13 is the concept of measuring the fair value in the principal market or,
in the absence of a principal market, in the most advantageous market. An exhaustive search of
all possible markets is not necessary, but the entity should take into account all information that
is reasonably available.
Asset Liability
Identify potential markets Identify potential markets
• The most advantageous • The most advantageous
market maximises the market minimises the
amount received to sell amount that would be
the asset paid to settle the
• Subtract transport costs liability
• Subtract transaction • Add transaction costs
costs
Identify which is the most
advantageous market
STEP
3
Example – Identifying the most advantageous market for an asset
This example illustrates how to identify the most advantageous market for an asset. An entity
would only follow these steps when there is no principal market for the asset.
Company X is measuring the fair value of a particular asset and has determined there is no
principal market for it.
It has identified two possible markets:
Market A Market B
$ $
Market A is the most advantageous market as the amount received to sell the asset is maximised
after factoring in transaction and transport costs ($86,000 is higher than $80,000).
The measurement of the fair value of this asset is covered in a later example in this unit.
STEP
4 Step 4 – Between market participants
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5 STEP 6 STEP 7 STEP 8
Determine Measure In the Between Based on Using an Based on To arrive at a
the asset fair value principal market the highest appropriate inputs fair value
or liability using an (or most participants and best valuation from the measurement
to be exit price advantageous) use for technique fair value
measured market non-financial hierarchy
assets
A fair value measurement should be based on the assumptions of market participants (i.e. it is
not an entity-specific measurement). Market participants are buyers and sellers in the principal
(or the most advantageous) market for the asset or liability.
Market participants are:
•• Independent of each other (not related parties).
•• Knowledgeable, having a reasonable understanding of the asset or liability and the
transaction using all available information, including information that might be obtained
through due diligence efforts that are usual and customary.
•• Able to enter into a transaction for the asset or liability.
•• Willing to enter into a transaction for the asset or liability (i.e. they are motivated but not
forced or otherwise compelled to do so)
STEP
4
Example – Assumptions of market participants in measuring fair value
This example illustrates how the assumptions of market participants are relevant when
measuring fair value.
Company X is measuring the fair value of an investment property. It acquired the property as it is
confident that a new rail station will be built in the area in the future, which will convert it into a
vibrant business hub.
Despite its confidence, Company X should factor in the assumptions that market participants
would make when pricing the property. For example, in applying a suitable valuation technique,
a market participant would factor in the risk that the rail station will not be built in the coming
years when measuring the property’s fair value.
STEP
Step 5 – Based on the highest and best use for non-financial assets 5
The valuation premise for a non-financial asset is based on its highest and best use from a
market participant’s perspective, which may differ from its current use within the entity.
This means that the entity’s own intentions (e.g. to develop an asset) are not relevant when
measuring fair value.
It is assumed that market participants would maximise the value of the asset or group of assets,
either by using the asset in its highest and best use or by selling it to another market participant
that would use the asset in its highest and best use (IFRS 13 para. 27).
Appendix A to IFRS 13 defines the highest and best use as:
The use of a non-financial asset by market participants that would maximise the value of the asset or the
group of assets and liabilities (e.g. a business) within which the asset would be used.
The highest and best use of an asset must be a use that market participants would consider:
•• physically possible (e.g. building a car manufacturing plant on a small piece of land would
not be physically possible)
•• legally permissible (e.g. zoning restrictions prevent a nightclub being developed on a
particular site)
•• financially feasible (e.g. building a luxury hotel in a remote location may not be
economically sound).
When considering a use that is financially feasible, market participants take into account
whether the use of an asset that is physically possible and legally permissible would generate
a satisfactory investment return after taking into account the costs of converting the asset to
that use.
An entity’s current use of a non-financial asset is presumed to be its highest and best use unless
market or other factors suggest that a different use by market participants would maximise the
asset’s value (IFRS 13 para. 29).
STEP
5
Highest and best use for non-financial assets
Existing use
The entity needs to determine whether the highest and best use of the asset provides maximum
value to market participants either:
•• on a stand-alone basis (e.g. freehold land), and therefore the fair value measurement will be
calculated at the individual asset level, or
•• in combination with other complementary assets (e.g. a specialised piece of machinery used
on a production line that operates in conjunction with other assets), and therefore the fair
value measurement will be calculated on a combined asset basis.
STEP
5
Example – Determining the highest and best use for a non-financial asset
This example illustrates how to identify the highest and best use for a non-financial asset.
Company X owns a plane that is used to operate charter services for large corporations. The
plane is carried at value in its financial statements.
Company X has two feasible options for the plane:
1. Continue to use the plane for charter flights.
When used for charter services, the value of the plane is $4 million at the reporting date.
2. Refurbish the cabin as a luxury plane.
Refurbishment is estimated to cost $1 million. The plane would then have a value of $6
million. There is strong global demand from celebrities and business tycoons who are keen
to own their own luxury plane.
Company X has not commenced any planning to refurbish the plane by the reporting date, but is
giving this option careful consideration and has consulted with a US company that specialises in
such refurbishments.
As option 2 is feasible, the plane’s existing use value is not the only basis considered when
determining the value.
Fair value of the plane based on its highest and best use
$4,000,000 $5,000,000
From a market participant’s perspective, the plane’s highest and best use is if it were refurbished.
Source: Adapted from IFRS 13 Fair Value Measurement Illustrative Examples, January 2012, accessed on 9 April 2018
STEP
Step 6 – Using an appropriate valuation technique 6
In bringing together these concepts, the standard explains that when a price for an identical
asset or liability is not observable, an entity measures fair value using another valuation
technique (IFRS 13 para. 3).
The Standard does not specify the use of a particular valuation technique as it is a matter of
professional judgement; however, para. 61 requires an entity to apply a valuation technique:
•• that is appropriate in the circumstances
•• for which sufficient data is available
•• for which the use of relevant observable inputs is maximised
•• for which the use of unobservable inputs is minimised.
STEP Three widely used valuation techniques are outlined in IFRS 13, para. 62. However, these
6
techniques are more of an overall approach, whereas practitioners will apply specific valuation
methods. The three valuation techniques are as follows:
Market A valuation technique The fair value and yield to For example, •• Real estate
approach that uses prices and other maturity on a corporate matrix pricing •• Financial
relevant information bond that is frequently and market instruments
generated by market traded on an active pricing based such as swaps,
transactions involving market that has a similar on recent debt securities
identical or comparable credit quality to the transactions and equity
(i.e. similar) assets, instrument being valued instruments
liabilities or a group of
•• Certain
assets and liabilities, such
intangible
as a business
assets where
there is
an active
market for a
homogenous
asset (e.g. a taxi
licence)
Cost A valuation technique Estimated costs using For example, •• Tangible assets
approach that reflects the amount quantity surveyors and depreciated such as plant
that would be required builders, remaining useful replacement cost and equipment
currently to replace the life estimates reflecting method •• Infrastructure
service capacity of an physical and economic/ assets
asset (often referred to as technological factors (e.g. bridges)
current replacement cost)
Income Valuation techniques that Discount rate, income For example, •• A cash-
approach convert future amounts stream (e.g. rentals, discounted cash generating unit
(e.g. cash flows or income royalties, sales, remaining flow method •• Intangible
and expenses) to a single economic life) and multi-period assets that
current (i.e. discounted) For a financial excess earnings generate an
amount. The fair value instrument, inputs may Black-Scholes- income stream
measurement is include current share Merton option (e.g. royalties)
determined on the basis price, risk-free interest pricing model
of the value indicated rate, time until option
by current market expiration and option
expectations about those strike price
future amounts
As indicated in the table above, inputs are used in applying a particular valuation technique. STEP
6
These inputs effectively represent the assumptions that market participants would use to make
pricing decisions, including assumptions about risk. Inputs may also include price information,
volatility factors, specific and broad credit data, liquidity statistics, and all other factors that
have more than an insignificant effect on the fair value measurement.
IFRS 13 distinguishes between observable inputs, which are based on market data obtained
from sources independent of the entity, and unobservable inputs, which reflect the entity’s own
view of the assumptions market participants would apply.
The Standard specifies that regardless of which valuation technique is being applied by
an entity for measuring fair value, it should maximise observable inputs and minimise
unobservable inputs.
STEP
Step 7 – Based on inputs from the fair value hierarchy 7
The fair value hierarchy categorises the inputs used in a valuation technique into three levels.
The most reliable evidence of fair value is a quoted price (unadjusted) in an active market for
identical assets and liabilities (Level 1). When this price is available, the hierarchy specifies that
it must be used without adjustment, except in certain specified (and limited) circumstances
(IFRS 13 para. 77).
When a quoted price in an active market is not available, entities need to use a valuation
technique to measure fair value that is appropriate in the circumstances, maximises the use of
relevant observable inputs (Level 2) and minimises the use of unobservable inputs (Level 3)
(IFRS 13 para. 67).
STEP The classification of inputs within the fair value hierarchy is shown below:
7
Classification of inputs within the fair value hierarchy
Level 1 input
Is there a
quoted (Quoted prices (unadjusted) in
No Has the No
price for an active markets for identical assets
price been or liabilities that the entity can access
identical item adjusted?
Yes Yes at the measurement date)
in an active
market? Examples:
• Quoted prices for shares listed on
the New Zealand Stock Exchange
• Commodities such as gold and
crude oil
Level 2 input
(Inputs other than quoted prices
included within Level 1 that are
Are there any observable for the asset or liability,
No
significant either directly or indirectly)
unobservable Examples:
inputs? Yes
• Interest rates
• Valuation multiples
• Price per square metre
Level 3 input
(Unobservable inputs for the asset or
liability)
Examples:
• Forcast cash flows
• Estimated useful life of an asset
Source: Adapted from KPMG 2011, ‘First Impressions: Fair value measurement’, available at www.kpmg.com/Global/en/
IssuesAndInsights/ArticlesPublications/first-impressions/Documents/First-impressions-fair-value-measurement.pdf,
accessed 16 April 2018.
In some cases, the inputs used to measure fair value may be categorised within different levels
of the fair value hierarchy. In such instances, the fair value measurement is categorised in its
entirety, based on the lowest level input that is significant to the measurement. This is relevant
for certain disclosures required by IFRS 13.
The time value of money based on a Level 2 As the intervals of the yield curve can
yield curve observable at commonly be corroborated by observable market
quoted intervals for listed fixed-rate data (borrowings quoted on active
borrowings markets are the market evidence), it is
a Level 2 input
STEP
Item Category of input Reason 7
Credit risk of Company X Level 3 The input cannot be corroborated
by market evidence and is based on
management’s assumptions on the
entity’s own credit risk and therefore it
is a Level 3 input
Source: Adapted from: PWC 2015, ‘In depth – A look at current financial reporting issues’, www.pwc.co.za/
en/assets/pdf/indepth-ifrs-13-questions-and-answers-march-2015.pdf, accessed 16 April 2018.
STEP
Step 8 – To arrive at a fair value measurement 8
The final step is arriving at the dollar value for the item being measured at fair value.
Whether a complex valuation technique is applied or a more straightforward measurement
technique is used, IFRS 13 para. 24 states that:
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction in the principal (or most advantageous) market at the measurement date under current
market conditions (i.e. an exit price) regardless of whether that price is directly observable or estimated
using another valuation technique.
In measuring this exit price from a market participant’s perspective, IFRS 13 specifies the
treatment for certain costs:
Transport costs Included They are relevant to fair value where location, for
example, is a characteristic of an asset (IFRS 13
para. 26)
Transaction costs Excluded They are entity-specific and can differ depending on
how a transaction is structured. They are a feature of
the transaction rather than a characteristic of the asset
or liability being measured (IFRS 13 para. 25)
STEP
8
Example – Measuring fair value
This example illustrates how to measure fair value for an asset and extends on the earlier
example that looked at the situation when there is no principal market for an asset.
Company X is measuring the fair value of a particular asset and has determined that there
is no principal market for it. It has identified two possible markets:
Column 1 Market A Market B*
$ $
Market A is identified as the most advantageous market as the amount received to sell the
asset is maximised after factoring in transaction and transport costs.
However, when measuring fair value within Market A (the most advantageous market),
transaction costs are ignored. Accordingly the fair value is $96,000 ($100,000 – $4,000).
* The fact that the corresponding value in Market B of $105,000 ($110,000 – $5,000) is higher than the
$96,000 fair value in Market A is irrelevant. Market B was not identified as the most advantageous market
for the asset. Consequently, fair value is not measured in that market.
Liabilities
The definition of fair value as it relates to liabilities is based on the liability being transferred
rather than settled. Therefore, IFRS 13 requires the assumption that the liability will be
transferred to a market participant at the measurement date. Its fair value must also reflect non-
performance risk – the risk that the entity will not fulfil an obligation, including (but not limited
to) the entity’s own credit risk.
the transaction and requires the fair value to be measured from the perspective of a market
participant that holds the identical item as an asset.
The valuation perspective under IFRS 13 of a liability or an entity’s own equity measurement
can be explained as follows:
NO
Identical instruments
held as an asset by
another party?
YES NO
NO
Source: Adapted from KPMG June 2011, First impressions: Fair value measurement, p. 15, accessed 16 April 2018,
www.kpmg.com, search for ‘fair value measurement’.
In addition, para. 91(b) requires disclosure of the effect of the measurement for the
reporting period on profit or loss or other comprehensive income where recurring fair value
measurements use significant Level 3 inputs.
For items measured in the statement of financial position at fair value after initial recognition,
para. 93(b) requires an entity to disclose, by class of asset or liability, the level in the fair value
hierarchy at which the fair value measurement is categorised. Professional judgement may need
to be exercised to determine the significance of the inputs to the fair value measurement.
The level of the fair value hierarchy in which the valuation falls*
For non-financial assets where highest and best use differs from current
use, an explanation of why this is the case
* Disclosure also required for assets and liabilities not measured at fair value but for which fair value is disclosed in
the financial statements
Adapted from: Grant Thornton, IFRS News, October 2011, Grant Thornton website, accessed 16 April 2018,
www.grantthornton.com.au/globalassets/1.-member-firms/australian-website/technical-publications/ifrs/gtil_2011_ifrs-
mews-ifrs-13-special-edition.pdf accessed 16 April 2018.
30 June 20X3
Recurring fair value measurements at the end of the reporting
period using:
Assets
Liabilities
In making these disclosures, the preparer would have given consideration to assets and liabilities
with inputs in multiple levels of the fair value hierarchy where those inputs were significant
to the item’s fair value. An item is classified in the hierarchy based on the level of the lowest
significant input. Focusing on the disclosure of the two investment properties, assume that:
•• The fair value of the unit in the high-rise apartment block involved the use of a Level 3
input to allow for a specific characteristic such as a custom-designed kitchen. A Level 2
input involved the use of observable prices for similar properties recently sold in the same
building. Overall, this property has been categorised as a Level 2 input, as this level is more
significant in measuring its fair value under a valuation technique using the market approach
than the Level 3 input.
•• The factory is classified separately (IFRS 13 para. 94) from the high-rise apartment block
unit, due to its different nature, characteristics and risk. It is being held for rental returns
and long-term capital appreciation, and therefore a valuation technique using an income
approach is appropriate in measuring fair value. A Level 2 input in measuring its fair value is
market rent per square metre for similar industrial properties in a similar location. However,
Level 3 inputs, such as cash flow forecasts using the company’s own data and yields based
on management’s expectations, are more significant in arriving at fair value. Therefore, the
factory is categorised as a Level 3 input in the table.
Quiz
[Available online in myLearning]
Contents
Introduction 7-3
Defining property, plant and equipment 7-4
Scope exclusions 7-4
Differentiating PPE classes 7-4
Recognition of items as PPE 7-5
Accounting for PPE during its useful life 7-6
Measurement at recognition 7-6
Measurement of cost 7-8
Subsequent costs 7-10
Measurement after initial recognition 7-11
Depreciation 7-16
Impairment 7-17
Compensation for impairment/loss of an asset 7-17
Derecognition 7-17
Non-current assets held for sale and discontinued operations 7-18
Disclosures for PPE, borrowing costs and non-current assets held for sale 7-19
Disclosures for PPE 7-19
Disclosures for borrowing costs 7-19
Disclosures for non-current assets held for sale 7-20
fin11907_csg_04
Learning outcomes
At the end of this unit you will be able to:
1. Describe the nature of property, plant and equipment.
2. Explain and account for property, plant and equipment during its useful life.
3. Explain and account for borrowing costs in relation to a qualifying asset.
Introduction
Regardless of the industry sector in which an entity operates, it most likely will have property,
plant and equipment (PPE). PPE is non-financial tangible assets that are used in an entity’s
business operations during more than one period.
The amount to be recognised for the asset and the impact on profit or loss via depreciation
charges or impairment charges over the life of the asset and on disposal/derecognition need to
be correctly determined to accurately reflect the asset’s use in the business over its useful life.
This unit considers the recognition, measurement, classification, derecognition and disclosure
requirements for non-current assets recognised by an entity as PPE.
A current asset is defined in IAS 1 Presentation of Financial Statements para. 66 as follows:
An entity shall classify an asset as current when:
(a) it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
(b) it holds the asset primarily for the purpose of trading;
(c) it expects to realise the asset within twelve months after the reporting period; or
(d) the asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is restricted from being
exchanged or used to settle a liability for at least twelve months after the reporting period.
Paragraph 66 further states that all other assets shall be classified as non-current.
In this unit, unless stated to the contrary, PPE are considered to be classified as non-current assets.
The unit also covers situations where borrowing costs can be capitalised as part of the cost of
a non-current asset, and addresses the implications of non-current assets that are held for sale.
Since a standard may require or permit an asset to be measured at fair value, the calculation
and disclosure requirements for fair value measurement, as applicable to non-financial tangible
assets, is also covered.
This unit examines the application of the following standards:
•• IAS 16 Property, Plant and Equipment.
•• IAS 23 Borrowing Costs.
•• IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations.
•• IFRS 13 Fair Value Measurement.
Learning outcome
1. Describe the nature of property, plant and equipment.
PPE does not include assets that are classified as investment properties in accordance with
IAS 40 Investment Property. Investment properties are discrete assets that are independent of
an entity’s principal business activities. Their unique characteristics make them different from
PPE assets, which have a distinct connection to, and are an essential element of, an entity’s
business activities.
IAS 40 prescribes specific accounting and disclosure requirements for certain types of property
held for investment, as opposed to property held for resale or occupied by the owner.
IAS 40 para. 5 defines an 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, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
This unit does not consider non-current assets classified as investment property.
Scope exclusions
IAS 16 deals with the accounting and disclosure requirements for most non-financial tangible
assets. The exclusions that are covered in other standards are identified in IAS 16 para. 3:
This Standard does not apply to:
(a) property, plant and equipment classified as held for sale in accordance with IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations;
(b) biological assets related to agricultural activity (see IAS 41 Agriculture);
(c) the recognition and measurement of exploration and evaluation assets (see IFRS 6 Exploration for
and Evaluation of Mineral Resources); or
(d) mineral rights and mineral reserves such as oil, natural gas and similar non-regenerative resources
However, this Standard applies to property, plant and equipment used to develop or maintain the
assets described in (b)–(d).
Plant
The automated production line
Equipment
The forklift
An entity is required to use judgement when applying the recognition criteria for PPE.
For example, para. 8 identifies that items such as spare parts and servicing equipment usually
do not meet the criteria for recognition as PPE, and so are usually classified as inventory
(e.g. spare parts inventory) and expensed as consumed. However, it is possible for major spare
parts to qualify as PPE when an entity expects to use them for more than one period. Similarly,
if the spare parts relate specifically to an asset held by the entity, the costs of those parts are
accounted for as PPE.
IAS 16 does not specify what constitutes an item of PPE, and judgement is required in
applying the recognition criteria to an entity’s specific circumstances (para. 9). For example,
should an aircraft be classified as a single asset or should the components be recognised
separately? To answer this question, an analysis of what will happen to that asset in the future
is required. If the asset has a number of distinct components with different useful lives, then the
components will need to be accounted for separately to record correctly the pattern of benefits
consumed. In the case of an aircraft, the separate components may consist of the engines, the
fuselage of the aircraft and the internal fittings.
Required reading
IAS 16 (or local equivalent).
Learning outcomes
2. Explain and account for property, plant and equipment during its useful life.
3. Explain and account for borrowing costs in relation to a qualifying asset.
Measurement at recognition
Where an asset can be recognised, IAS 16 para. 15 requires it to be initially measured at cost.
Paragraph 6 defines cost as:
… the amount of cash or cash equivalents paid or the fair value of the other consideration given to
acquire an asset at the time of its acquisition or construction or, where applicable, the amount attributed
to that asset when initially recognised in accordance with the specific requirements of other IFRSs,
e.g. IFRS 2 Share-based Payment.
Elements of cost
IAS 16 para. 16 states that the cost of an item of PPE comprises:
•• Its purchase price, including any import duties and non-refundable purchase taxes
(e.g. GST) incurred, after deducting any trade discounts or rebates.
•• Directly attributable costs.
•• An initial estimate of the costs of dismantling and removing the asset and restoring the site.
Directly attributable costs are costs that are needed to bring an asset to the location and
condition necessary so that it can operate in the manner intended by management.
If the purchase price and any directly attributable costs are denominated in a foreign currency,
then they are recorded by translating the foreign currency amount using the spot exchange rate
at the date of the transaction, in accordance with the requirements of IAS 21 The Effect of Changes
in Foreign Exchange Rates. This is classified as a foreign currency transaction and is covered in the
unit on foreign exchange. The asset needs to be recorded in the functional currency of the entity.
The initial estimate of the costs of dismantling and removing the asset and restoring the
site is determined under IAS 37 Provisions, Contingent Liabilities and Contingent Assets and is
included in the cost of the asset, in accordance with IAS 16. IAS 37 essentially requires that
these estimated costs be discounted back to present value at the time of initial recognition of the
PPE. The change over time in the value of the provision resulting from unwinding the discount
is discussed further in the unit on accounting for provisions. It does not impact the amount
recognised in PPE.
Example – Situations where the costs of dismantling and removing an asset or restoring a
site must be capitalised as part of the original cost of an item of PPE
This example illustrates when the cost of an asset needs to include a dismantling/restoration
provision.
The construction of an
offshore oil platform, where
the law requires the platform
to be removed at the end of
the oil extraction.
Note that IAS 23 requires that borrowing costs (which include interest) be capitalised as part of
the cost of a qualifying asset, as discussed later in this unit.
Expenditure on the following is not to be included in the cost of PPE (IAS 16 paras 19 and 20):
•• Costs of opening a new facility.
•• Costs of introducing a new product or service (including costs of advertising and
promotional activities).
•• Costs of conducting business in a new location or with a new class of customer (including
costs of staff training).
•• Administration and other general overhead costs.
•• Costs incurred while an item capable of operating in the manner intended by management
has yet to be brought into use or is operated at less than full capacity.
•• Initial operating losses, such as those incurred while demand for the item’s output builds up.
•• Costs of relocating or reorganising part or all of an entity’s operations.
Measurement of cost
Once the elements of the cost of an item of PPE have been identified, these amounts need to be
measured. In most situations this will be simple to determine; however, deferred payment of
the consideration and asset trade-ins can complicate the calculation.
IAS 16 para. 23 states that the cost of an item of PPE is the cash price equivalent at the
recognition date.
Specific matters to consider are:
•• Deferred payment of the consideration – if payment is deferred beyond normal credit terms,
interest will need to be recognised in profit or loss unless it can be capitalised in accordance
with IAS 23 (i.e. only where the asset is a qualifying asset as defined by IAS 23).
•• A non-monetary asset, or a combination of non-monetary and monetary assets, may be
exchanged to acquire an item of PPE. For example, an old asset may be traded in as part of
the consideration to acquire a replacement PPE asset, as often applies with motor vehicles.
Paragraphs 24–25 specify how to measure the cost in this situation.
•• The value of PPE acquired under a finance lease is measured in accordance with IFRS 16
Leases. This is discussed further in Unit 12.
•• A government grant may reduce the amount recognised for PPE under IAS 20 Accounting
for Government Grants and Disclosure of Government Assistance.
Paragraph 7 provides further guidance as to what types of assets may be regarded as qualifying
assets, and makes clear that qualifying assets do not include those that are ready for their
intended use or sale at the time of acquisition.
Borrowing costs are defined in para. 5 as ‘interest and other costs that an entity incurs in
connection with the borrowing of funds’. Paragraph 6 clarifies that ‘interest’ is the interest
expense calculated using the effective interest rate method (discussed further in the unit on
financial instruments) and what ‘other costs’ constitute borrowing costs.
Paragraph 8 requires that borrowing costs, to the extent that they are directly attributable to the
acquisition, production or construction of a qualifying asset, are capitalised. Only borrowing
costs that would have been avoided had the expenditure on the qualifying asset not been made
are able to be capitalised under this standard.
IAS 23 outlines two types of borrowing costs eligible for capitalisation:
•• Funds borrowed specifically for the purpose of obtaining a qualifying asset (para. 12).
•• Funds borrowed generally and used for the purpose of obtaining a qualifying asset
(para. 14).
•• Is suspended when active development of a qualifying asset is halted for extended periods
(para. 20).
•• Ceases when substantially all of the activities necessary to prepare the qualifying asset for
its intended use or sale are complete (para. 22).
Period Calculation $
1. Although the total expenditure on the plant at 1 January 20X3 is $2,700,000 ($600,000 on signing the
contract + $2,100,000 on delivery), only $2,000,000 of this has been financed by the loan.
Required reading
IAS 23 (or local equivalent).
Certain
exclusions
from cost
(IAS 16 paras 19
and 20)
Subsequent costs
The need to repair or replace an item of PPE may require an entity to consider how to account
for subsequent expenditure on PPE. IAS 16 para. 12 refers to the recognition principle set out
in para. 7 to assess whether subsequent costs should be capitalised or expensed. Day-to-day
servicing costs are generally expensed as repair and maintenance expenses. Further guidance
about when to capitalise versus when to expense is provided in paras 13 and 14.
One approach is to capitalise subsequent costs when they either:
•• Extend the useful life of an asset.
•• Improve the asset’s quality of output.
•• Reduce the operating costs associated with the use of the asset.
Cost model
IAS 16 para. 30 requires that all items of PPE measured under the cost model be carried at cost
less any accumulated depreciation and any accumulated impairment losses.
Revaluation model
In many cases, the calculation of an asset’s carrying amount by reference to its cost may not be
a true reflection of the current value of the asset. Therefore, IAS 16 provides entities with the
option of adopting the revaluation model for classes of PPE. Under the revaluation model, items
of PPE are revalued to fair value.
For the revaluation model to be adopted, IAS 16 para. 31 requires that the fair values of the
assets in question can be measured reliably.
IAS 16 para. 6 defines fair value as:
... the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
This definition is consistent with the definition of fair value in IFRS 13. All accounting standards
defer to IFRS 13 for fair value measurement issues, as discussed in the unit on fair value
measurement.
Where the revaluation model is used to measure a class of PPE, IAS 16 para. 31 requires that
revaluations be made with sufficient regularity to ensure that the carrying amount of each
asset in the class does not differ materially from its fair value at the reporting date. Therefore,
there may be no requirement for annual revaluations to be made. The frequency of revaluations
depends on the changes in fair value and is discussed in more detail in para. 34.
IAS 16 paras 39 and 40 contain the principles for applying the revaluation model. These
paragraphs refer to individual items of PPE. Therefore, even though the revaluation model is
applied to classes of assets, the accounting under the model is applied on an asset-by-asset basis.
PPE XXX
* Disclosed in OCI.
Revaluation decrement with no previous revaluation increment
On 1 May 20X3 an item of PPE is revalued for the first time. Its carrying amount after the
elimination of depreciation (as per step 1) is $100,000. The fair value of the asset is $70,000.
The journal entry to record the revaluation decrement and tax is as follows:
Date Account description Dr Cr
$ $
PPE 30,000
Being the revaluation increment for PPE with a previous revaluation decrement
On 1 May 20X3 an item of PPE is revalued. Its carrying amount after the elimination of
depreciation (as per step 1) is $100,000. The fair value of the asset is $160,000. A revaluation
decrement of $50,000 had previously been recognised in profit or loss in relation to this asset
and it had been assessed that realisation of the resulting DTA was probable.
Being the revaluation increment for PPE with a previous revaluation decrement
* Disclosed in OCI.
Revaluation decrement with previous revaluation increment
On 1 May 20X3 an item of PPE is revalued. Its carrying amount after the elimination of
depreciation (as per step 1) is $100,000. The fair value of the asset is $70,000. A revaluation
increment of $40,000 had previously been recognised in relation to this asset.
Date Account description Dr Cr
$ $
PPE 30,000
Being the revaluation decrement for PPE with a previous revaluation increment
On 1 May 20X3 an item of PPE is revalued. Its carrying amount after the elimination of
depreciation (as per step 1) is $100,000. The fair value of the asset is $70,000. A revaluation
increment of $20,000 had previously been recognised in relation to this asset.
Date Account description Dr Cr
$ $
PPE 30,000
Being the revaluation decrement for PPE with a previous revaluation increment
Required reading
IFRS 13 para. 9.
Pro forma journal entries for revaluation of property, plant and equipment
Revaluation increment
Disclose in other comprehensive income (disclosure Recognise in profit or loss to the extent that it reverses
purposes only) and accumulate in revaluation surplus a decrement previously recognised in profit or loss
account (IAS 16 para. 39) (IAS 16 para. 39)
Revaluation decrement
Recognise in profit or loss (IAS 16 para. 40) Disclose in other comprehensive income (disclosure
purposes only) to the extent that it reverses a previous
revaluation surplus amount (IAS 16 para. 40)
XX.XX.XX DTA 1
XXX XX.XX.XX DTL XXX
Depreciation
Depreciation is defined in IAS 16 para. 6 as:
... the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciation is expensed in profit or loss unless it is included in the carrying amount of another
asset. For example, where machinery is used on a production line, the machinery depreciation
will be part of the cost of inventory and will be capitalised in the cost of inventory to the
extent that the inventory is still on hand at period end. The entry to record this would be:
DR Inventory WIP; CR Accumulated depreciation.
Depreciation is allocated over an asset’s useful life, which is defined in IAS 16 para. 6 as:
(a) The period over which an asset is expected to be available for use by an entity; or
(b) The number of production or similar units expected to be obtained from the asset by an entity.
Depreciation commences when an asset is available for use by the entity (i.e. when it is in the
location and condition necessary for it to be capable of operating in the manner intended by
management), and ceases at the earlier of the date when the asset is:
•• Reclassified as being held for sale under IFRS 5.
•• Derecognised (e.g. sold or scrapped).
Depreciation does not cease when an asset becomes idle or is retired from active use unless the
asset is fully depreciated. However, the depreciation charge can be zero where the depreciation
method is based on usage during periods of non-production (IAS 16 para. 55).
Depreciation is calculated on the depreciable amount, which is defined in para. 6 as ‘the cost of
an asset, or other amount substituted for cost, less its residual value’. This definition means that
a class of PPE measured at fair value is still subject to depreciation.
Depreciation method
Each entity is required to select the method, on an asset-by-asset basis, that most closely reflects
the expected pattern of consumption of benefits (IAS 16 para. 60). A variety of depreciation
methods can be used and IAS 16 para. 62 identifies the following depreciation methods:
•• Straight-line method – this results in a constant charge over the asset’s useful life (provided
that the residual value does not change).
•• Diminishing balance method – this results in a decreasing charge over the asset’s useful life.
•• Units of production (usage) method – this results in a charge based on the expected use
or output.
IAS 16 para. 61 requires a review of the depreciation methods applied to all assets to be
conducted at the end of the annual reporting period (as a minimum). If there is a significant
variation in the asset’s pattern of consumption, the method of depreciation must be adjusted
to reflect this change.
Where an annual review results in a change of depreciation rate, depreciation method, or
useful life, the effect must be accounted for as a change in an accounting estimate. Under IAS 8,
changes in accounting estimates are recognised prospectively, meaning that the effect of the
change is included in profit or loss in the:
•• Period of the change, if it only affects the current period.
•• Current and future years, if the change affects both the current and future years.
Summary of depreciation
Depreciation commences when the asset is in the location and condition necessary for it to
operate in the manner intended by management; it is allocated over the asset’s useful life to the
entity; it ceases at the earlier of reclassification as held for sale or when the asset is derecognised
(IAS 16 para. 55).
Determine the useful life by assessing the asset’s expected utility to the entity and
consider the:
• Expected usage of the asset.
• Expected physical wear and tear.
• Technical or commercial obsolescence.
• Legal restrictions (IAS 16 paras 56−57).
The depreciation method applied should reflect the expected pattern of benefits that will
be enjoyed by the entity from using the asset (IAS 16 paras 60 and 62). Common methods
include straight-line, diminishing balance and units of production.
Prepare the depreciation journal entry to recognise depreciation in profit or loss unless
it is included in the carrying amount of another asset (IAS 16 para. 48).
Review residual values, useful lives and depreciation methods at least annually at each
year end. Any change is accounted for as a change in an accounting estimate in
accordance with IAS 8 (IAS 16 paras 51 and 61).
Impairment
The requirements of IAS 36 Impairment of Assets, as discussed in the unit on impairment of
assets, should be applied in determining and accounting for impairment of an asset. PPE cannot
have a carrying amount higher than the asset’s recoverable amount.
Derecognition
Under IAS 16 para. 67, an item of PPE should be derecognised from the statement of financial
position when:
•• it is disposed of
•• no future economic benefits are expected from its use or disposal.
Any balance in relation to the asset recorded in the revaluation surplus account may be
transferred to retained earnings upon derecognition of that item of PPE. However, transfers
from the revaluation surplus to retained earnings are not made through profit or loss
(IAS 16 para. 41).
IFRS 5 provides guidance on the recognition of impairment losses and reversals, and the
accounting implications where there is a change to a plan of sale.
Required reading
IFRS 5 (or local equivalent).
Required reading
IFRS 13 para. 91.
Further reading
ITL Limited and Controlled Entities 2015, 2015 Annual Report, Consolidated balance sheet (p. 22)
and Note 12 (for disclosures concerning assets held for sale, p. 45).
Quiz
[Available online in myLearning]
Working paper C
You are now ready to complete working paper C of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Contents
Introduction 8-3
Identifying key characteristics of intangible assets 8-3
Defining an intangible asset 8-3
Recognition of intangible assets 8-4
Measurement, amortisation and derecognition of intangible assets 8-5
Initial measurement of cost for intangible assets 8-5
Internally generated intangible assets prohibited from recognition 8-8
Accounting for intangible assets after initial recognition 8-8
Amortisation of intangible assets 8-13
Derecognition 8-14
Summary - intangible assets 8-15
Disclosures 8-16
fin11908_csg_03
Learning outcomes
At the end of this unit you will be able to:
1. Identify and explain the key characteristics of an intangible asset, including whether it can
be recognised for financial reporting purposes.
2. Explain and account for an intangible asset.
Introduction
Intangible assets are similar to tangible assets (e.g. property, plant and equipment) in that
they contribute to an entity’s operations in current and future accounting periods. However,
intangible assets are non-monetary assets without physical substance and do not possess
concrete features like other assets, but they can demonstrate specific characteristics such as
control (i.e. by denying other parties access) and economic benefits through their use.
IAS 38 Intangible Assets prescribes the accounting and disclosure requirements for intangible
assets.
The definition of an intangible asset is quite broad and captures intangible assets ranging
from intellectual property (e.g. registered patents) to franchising agreements acquired from
external parties. Some intangible assets may be contained in or on a physical substance such
as a compact disc (e.g. computer software), legal documentation or film. Therefore, an entity
may need to exercise judgement to determine if an asset that incorporates both intangible and
tangible elements should be treated as a tangible asset under another accounting standard
(e.g. IAS 16 Property, Plant and Equipment) or as an intangible asset under IAS 38. An entity
may acquire different types of intangible assets either separately or as part of the acquisition of
other businesses.
Some intangible assets are not governed by IAS 38 as they are covered by other standards.
These include intangible assets held for sale in the ordinary course of business (IAS 2 Inventories
and IAS 11 Construction Contracts), financial assets (IAS 32 Financial Instruments: Presentation)
and goodwill acquired in a business combination (IFRS 3 Business Combinations).
Learning outcome
1. Identify and explain the key characteristics of an intangible asset, including whether it can be
recognised for financial reporting purposes.
Identifiability
An intangible asset must be identifiable to distinguish it from goodwill. IAS 38 para. 12 states
that an asset is identifiable if it either:
(a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred,
licensed, rented or exchanged, either individually or together with a related contract, identifiable
asset or liability, regardless of whether the entity intends to do so; or
(b) arises from contractual or other legal rights, regardless of whether those rights are transferable or
separable from the entity or from other rights and obligations.
Control
Like other assets, an intangible asset must be controlled by the entity. IAS 38 para. 13 defines
this concept as the power to obtain the future economic benefits flowing from the underlying
resource and to restrict the access of others to those benefits.
Usually this characteristic will flow from legal rights. In the absence of legal rights it is difficult
to demonstrate control.
These recognition criteria mirror the recognition criteria for an asset from the Conceptual
Framework for Financial Reporting para. 4.44.
The ‘probable’ concept is assessed by management based on internal/external evidence and
their best estimates of the future economic benefits arising from the intangible asset over its
useful life.
For separately acquired intangible assets, the ‘probable’ recognition criterion is always
considered to be satisfied (IAS 38 para. 25). In most cases, where consideration is in the form of
cash or other monetary assets, the cost of separately acquired intangible assets can be measured
reliably (IAS 38 para. 26).
Required reading
IAS 38 (or local equivalent).
Learning outcome
2. Explain and account for an intangible asset.
The following diagram presents an overview of the initial measurement of cost for separately
acquired intangible assets.
Research phase
Research is defined in IAS 38 para. 8 as ‘original and planned investigation undertaken with the
prospect of gaining new scientific or technical knowledge and understanding’.
IAS 38 para. 56 provides the following examples of research activities:
(a) activities aimed at obtaining new knowledge;
(b) the search for, evaluation and final selection of, applications of research findings or other
knowledge;
(c) the search for alternatives for materials, devices, products, processes, systems or services;
and
(d) the formulation, design, evaluation and final selection of possible alternatives for new or improved
materials, devices, products, processes, systems or services.
An intangible asset is not recognised as the view is that an entity cannot demonstrate that an
identifiable intangible asset exists that will generate future economic benefits. Expenditure on
the research phase must be expensed when it is incurred (IAS 38 para. 54).
Development phase
Development is defined in IAS 38 para. 8 as:
… the application of research findings or other knowledge to a plan or design for the production of new
or substantially improved materials, devices, products, processes, systems or services before the start of
commercial production or use.
IAS 38 para. 57 states that an intangible asset arising from the development phase can be
recognised if, and only if, an entity is able to demonstrate all of the following:
(a) the technical feasibility of completing the intangible asset so that it will be available for use or sale;
(b) its intention to complete the intangible asset and use or sell it;
(c) its ability to use or sell the intangible asset;
(d) how the intangible asset will generate probable future economic benefits. Among other things,
the entity can demonstrate the existence of a market for the output of the intangible asset or the
intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset;
(e) the availability of adequate technical, financial and other resources to complete the development
and to use or sell the intangible asset; and
(f) its ability to measure reliably the expenditure attributable to the intangible asset during its
development.
Where an entity demonstrates that all of the above criteria are met, an intangible asset is
recognised, as these criteria indicate that there are probable future economic benefits and that
the cost can be measured reliably.
Required reading
SIC-32 paras 1–10.
The factors that need to be considered when determining fair value are discussed in the unit on
fair value measurement.
It is difficult to apply the requirements of the fair value definition to most intangible assets due to
their unique nature and thin market conditions. IAS 38 acknowledges this issue and states that an
active market could exist for selected intangible assets such as for freely transferable taxi licences,
fishing licences or production quotas (IAS 38 para. 78), but cannot exist for intangible assets such
as brands or trademarks, as each asset is unique. Consequently, IAS 38 requires the following:
•• An intangible asset is carried at cost less accumulated amortisation and impairment losses if
no active market exists for the intangible asset and the class of intangible assets to which it
belongs has adopted the revaluation model (IAS 38 para. 81).
•• If an active market no longer exists, the carrying amount of the intangible asset is its most
recent revaluation by reference to the active market less any subsequent accumulated
amortisation and impairment losses (IAS 38 para. 82).
•• If the fair value of an intangible asset can be measured by reference to an active market
at a subsequent measurement date, the revaluation model is applied from that date
(IAS 38 para. 84).
Elimination of accumulated amortisation against the gross carrying amount on the revaluation of the
intangible asset
Being the revaluation decrement for intangible asset – fishing quota recognised in profit or loss
* Recognised to the extent that realisation is probable.
Being the revaluation increment for intangible asset – fishing quota with a previous revaluation
decrement
On 1 May 20X4 PM revalued its gemfish fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1 in applying the revaluation model) is $150,000. Fair value of the asset is
$240,000. A revaluation decrement of $75,000 had previously been recognised in profit or loss in
relation to this asset and it had been assessed that realisation of the resulting DTA was probable.
Date Account description Dr Cr
$ $
Being the revaluation increment for intangible asset – fishing quota with a previous revaluation
decrement
* Disclosed in OCI.
Being the revaluation decrement for intangible asset – fishing quota with a previous revaluation
increment
* Disclosed in OCI.
On 1 May 20X4 PM revalued its red cod fishing quota. Its carrying amount after the elimination of
amortisation (as per step 1 in applying the revaluation model) is $100,000. Fair value of the asset
is $70,000. A revaluation increment of $20,000 had previously been recognised in relation to this
asset.
Date Account description Dr Cr
$ $
Being the revaluation decrement for intangible asset – fishing quota with a previous revaluation
increment
* Disclosed in OCI.
** Recognised to the extent that realisation is probable.
The revaluations should be made with such regularity so that the book value is not materially
different to the fair value at the end of the reporting period (IAS 38 para. 75).
Disclose in other comprehensive income (disclosure Recognise in profit or loss to the extent that it reverses
purposes only) and accumulate in revaluation surplus a decrement previously recognised in profit or loss
account (IAS 38 para. 85) (IAS 38 para. 85)
Revaluation increment for intangible asset XX.XX.XX Income tax expense XXX
1. Net of related tax on the amount recognised in other XX.XX.XX Revaluation surplus3 XXX
comprehensive income
XX.XX.XX DTL XXX
Revaluation decrement
Recognise in profit or loss (IAS 38 para. 86) Disclose in other comprehensive income (disclosure
purposes only) to the extent that it reverses a previous
revaluation surplus amount (IAS 38 para. 86)
Revaluation decrement for intangible asset XX.XX.XX Income tax expense XXX
Term Definition
Amortisation Systematic allocation of the depreciable amount of an intangible asset over its
useful life (IAS 38 para. 8)
Depreciable amount Cost of an asset, or other amount substituted for cost, less its residual value (IAS 38
para. 8)
Residual value 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 (IAS 38 para. 8)
Residual value of an intangible asset with a finite useful life is assumed to be
zero unless:
•• there is an active market for the asset
•• the residual value can be determined by reference to that market, and
•• it is probable that such a market will exist at the end of the asset’s useful life
Alternatively, a residual value can arise when there is a commitment by a third
party to purchase the asset at the end of its useful life (IAS 38 para. 100)
Useful life Period over which an asset is expected to be available for use by an entity, or the
number of production or similar units expected to be obtained from the asset by
an entity (IAS 38 para. 8)
When an intangible asset arises from contractual or legal rights, useful life cannot
exceed the period of the contractual or legal rights, including renewal periods only
if the renewal does not involve significant cost, but may be shorter depending on
the period over which the entity expects to use the asset (IAS 38 para. 94)
The process for amortisation of an intangible asset with a finite life, including key
considerations is shown in the following flow chart.
Commence amortisation when the intangible asset is in the location and condition
necessary for it to operate in the manner intended by management. It ceases at the
earlier of: the date when the intangible asset is reclassified as held for sale and the date
when the intangible asset is derecognised (IAS 38 para. 97).
Determine the depreciable amount of the intangible asset and decide how it will be
allocated on a systematic basis over its useful life (IAS 38 para. 97).
Ensure the amortisation method applied reflects the expected pattern of benefits that
will be enjoyed by the entity from using the intangible asset. Choose from straight-line,
diminishing balance, and unit of production methods (IAS 38 para. 98). If a pattern of
benefits cannot be determined, use the straight-line method (IAS 38 para. 97).
Review the amortisation period and amortisation method at least at each financial year
end. Any changes are accounted for as a change in an accounting estimate in accordance
with IAS 8 (IAS 38 para. 104).
Prepare the journal entry to recognise amortisation in profit or loss unless it is included in
the carrying amount of another asset (IAS 38 para. 99).
Derecognition
The carrying amount of an intangible asset is derecognised when:
•• it is disposed, or
•• no future economic benefits are expected from its use or disposal (IAS 38 para. 112).
Any related gain or loss is recognised in profit or loss at the time of derecognition (not classified
as revenue) (IAS 38 para. 113) and is calculated as the difference between net disposal proceeds,
if any, and the carrying amount of the intangible asset (IAS 38 para. 113). The consideration
receivable on disposal is recognised initially at its fair value. If payment for the intangible asset
is deferred, the consideration is recognised initially at the cash price equivalent. The difference
between the nominal amount of the consideration and the cash price equivalent is recognised
as interest revenue in accordance with IFRS 9.
If the revaluation model has been adopted, the cumulative amount in revaluation surplus for
the intangible asset may be transferred to retained earnings (not through profit or loss):
•• when the asset is derecognised, or
•• as the asset is used by the entity during its useful life subject to specific calculations (IAS 38
para. 87).
• As a separate acquisition
• Identifiable • As an acquisition as part of a business combination
• Non-monetary • Internally
• Without physical substance • As an acquisition by way of a government grant
IAS 38 para. 8 • By exchange of assets
Initial Subsequent
Recognise at cost Accounting policy choice (class by
IAS 38 para. 24 class basis)
IAS 38 para. 72
ACCOUNTING
Cost Revaluation
MODEL
Finite Indefinite
USEFUL LIFE
Disclosures
The key disclosure requirements of IAS 38 are detailed in paras 118–128.
The disclosure requirements of IAS 38 are necessary so users of financial statements can
understand an entity’s exposure to and accounting for its intangible assets during a particular
accounting period.
In summary, an entity must disclose the following:
1. General information for each class of intangible assets, distinguishing between internally
generated and other intangible assets (IAS 38 paras 118–123), with details of:
–– useful life information
–– amortisation methods used
–– carrying amount movements
–– a reconciliation of the carrying amount at the beginning and end of the period.
2. For intangible assets measured using the revaluation model (IAS 38 paras 124–125), with
details of:
–– valuation information including fair value assumptions and date of revaluation
–– carrying amount of revalued intangible assets and the carrying amount that would have
been recognised if the cost method had been applied
–– revaluation surplus movements.
3. Research and development expenditure recognised as an expense during the period (IAS 38
paras 126–127).
Quiz
[Available online in myLearning]
Contents
Part A 9-3
Introduction 9-3
IFRS 9 Financial Instruments 9-4
Common terms and concepts 9-5
Navigating this unit 9-6
Financial instruments 9-6
Financial instruments: meeting the definition 9-8
Derivatives 9-12
Distinguishing financial liabilities from equity 9-13
Compound financial instruments 9-15
Measurement of financial instruments 9-18
Initial recognition 9-18
Initial measurement 9-18
Subsequent measurement 9-19
Treatment of gains, losses, dividends and interest arising from financial instruments 9-21
Classification of financial instruments 9-23
Classification of financial liabilities 9-24
Amortised cost 9-24
Fair value through profit or loss 9-24
Classification of financial assets 9-25
Contractual cash flow characteristics of the financial asset (the SPPI test) 9-26
The business model used for managing financial assets 9-28
Designation at FVTPL 9-30
Equity investments 9-30
Summary – measurement of financial assets and liabilities 9-31
Interest recognition 9-32
Derecognition and reclassification 9-35
Derecognition of a financial liability 9-35
Derecognition of a financial asset 9-35
Reclassification of financial instruments 9-37
Part B 9-39
Hedge accounting 9-39
The hedged item, hedged risk and the hedging instrument 9-40
Overview of hedge accounting 9-41
Types of hedging relationship 9-42
Hedge accounting process 9-44
Fair value hedges 9-49
Cash flow hedges 9-51
Impairment of financial assets 9-59
Expected credit losses 9-60
The general approach to impairment 9-61
The simplified approach to impairment 9-62
Purchased or originated credit-impaired approach 9-62
Low credit risk operational simplification 9-63
Significant increase in credit risk 9-66
Recognition of ECLs in the financial statements 9-67
Disclosure 9-69
Overview of requirements 9-69
Classes of financial instruments for disclosure purposes 9-69
Learning outcomes
At the end of this unit you will be able to:
1. Explain and identify financial instruments and the principles for classifying them as
financial assets, financial liabilities or equity instruments of the issuer.
2. Account for financial assets, financial liabilities and equity instruments of the issuer
(including derivatives).
3. Explain and account for basic cash flow and fair value hedges.
4. Explain and account for impairment of financial assets.
5. Explain and account for the derecognition of financial assets and financial liabilities.
This unit has been split into two sections for ease of
candidate study. Part A covers definitions, classification,
measurement and derecognition of financial instruments.
Part B covers hedging, impairment and disclosure of
financial instruments.
Part A
Introduction
Financial instruments are held by most entities, for example, in the form of cash, trade
receivables, trade payables, loans or more complex financing structures. Understanding how to
identify and account for financial instruments is crucial to your role as a Chartered Accountant.
Although International Accounting Standards on financial instruments have existed since 1995,
Accounting Standards in Australia were only introduced in 2004, as the usage of more complex
financial instruments increased.
There are now a number of standards that apply to financial instruments, as follows:
Standard Description
IAS 32 Financial instruments: Presentation Defines financial instruments and contains principles for classifying
and presenting financial instruments
IAS 39 Financial Instruments: Recognition Contains the principles for recognising and measuring financial
and Measurement instruments. Also contains the rules for hedge accounting
IFRS 7 Financial Instruments: Disclosures Contains the principles for disclosure of financial instruments,
and explains the significance of financial instruments for an
entity’s financial position and performance. Also explains the risks
associated with those instruments
IFRS 9 Financial Instruments Replaces IAS 39, effective for reporting periods beginning on
or after 1 January 2018. Contains principles for recognising and
measuring financial assets and liabilities. Also contains principles
for impairment, hedge accounting and derecognition
IFRS 13 Fair Value Measurement Defines fair value and provides a framework for determining fair
value when another Standard requires or permits the use of fair
value measurement
The majority of the Chartered Accountants Program studies in financial instruments concentrate
on the requirements of IFRS 9. The first part of this unit will focus on the requirements of
IFRS 9 to classify, measure and account for financial instruments. The second part will focus on
hedging and impairment of financial instruments. At the end of the unit we will briefly examine
the disclosure requirements of IFRS 7. The fair value standard, IFRS 13, is covered in Unit 6.
Due to its principles-based approach, significantly more judgement is required to apply the
requirements of IFRS 9 compared to IAS 39. This unit will focus primarily on the requirements
of IFRS 9 and IAS 32, with a small section on IFRS 7.
IFRS 9 and IAS 32 apply to all types of financial instruments entered into by all entities, apart
from the following exceptions:
IFRS 9 IAS 32
•• Interests in subsidiaries, associates and joint •• Interests in subsidiaries, associates and joint
ventures accounted for under IFRS 10 Consolidated ventures accounted for under IFRS 10 Consolidated
Financial Statements, IAS 27 Separate Financial Financial Statements, IAS 27 Separate Financial
Statements or IAS 28 Investments in Associates and Statements or IAS 28 Investments in Associates and
Joint Ventures Joint Ventures
•• Employers’ rights and obligations under employee •• Employers’ rights and obligations under employee
benefit plans to which IAS 19 Employee Benefits benefit plans to which IAS 19 Employee Benefits
applies applies
•• Rights and obligations under an insurance •• Rights and obligations under an insurance
contract as defined in IFRS 4 Insurance Contracts, contract as defined in IFRS 4 Insurance Contracts,
except when the rights and obligations meet except when the rights and obligations meet
the definition of a financial guarantee contract, the definition of a financial guarantee contract,
although there are elections available as to which although there are elections available as to which
accounting standard applies accounting standard applies
•• Financial instruments, contracts and obligations •• Financial instruments, contracts and obligations
under share-based payment transactions to which under share-based payment transactions to which
IFRS 2 Share-based Payments applies IFRS 2 Share-based Payments applies
Required reading
IFRS 9 Appendix A Defined terms.
Financial instruments
Learning outcome
1. Explain and identify financial instruments and the principles for classifying them as financial
assets, financial liabilities or equity instruments of the issuer.
A financial instrument is defined in IAS 32 para. 11 as ‘any contract that gives rise to a
financial asset of one entity and a financial liability or equity instrument of another entity’.
As per the definition, a financial instrument is made up of a number of components, as follows:
•• a contract (i.e. an agreement between two or more parties)
•• a financial asset, and
•• a financial liability or equity instrument.
Required reading
IAS 32 paras 11, 15–16, 28 and 35–40.
A financial asset is a contractual right arising from a past transaction that provides future
economic benefit to an entity and results in a financial liability or equity of another entity. The
following are financial assets as defined in IAS 32:
Contractual right to receive cash or another financial Trade receivables, or investments in bonds or
asset convertible notes
Contractual right to exchange financial instruments Purchased call or put options, which an entity would
under potentially favourable conditions only exercise if conditions were in their favour
Contract that may or will be settled in the entity’s own These types of financial assets are not covered in the
equity instruments and is: FIN module
(i) a non-derivative for which the entity is or may
be obliged to receive a variable number of the
entity’s own equity instruments
(ii) a derivative that will or may be settled other than
by the exchange of either a fixed amount of cash
or another financial asset for a fixed number of
the entity’s own equity instruments
A financial liability is a type of contractual obligation arising from a past event that is expected
to result in an outflow of economic benefits and results in a financial asset of another entity.
The following are financial liabilities as defined in IAS 32:
Contractual obligation to deliver cash or another Trade payables, borrowings, financial guarantees or
financial asset to another entity issuance of bonds
Contractual obligation to exchange financial assets Written call or put options, which another entity
or financial liabilities under potentially unfavourable would exercise under conditions favourable to them
conditions (i.e. unfavourable to you)
Contract that will or may be settled in the entity’s own Issue of a convertible note by an entity that converts
equity instruments and is: to a fixed value of shares of the entity (e.g. $5,000
(i) a non-derivative for which the entity is or may worth of ordinary shares). The number of shares
be obliged to deliver a variable number of the received will, however, vary (e.g. if the share price is
entity’s own equity instruments $2 the holder will receive 2,500 shares; if the share
price is $1.60 the holder will receive 3,125 shares)
(ii) a derivative that will or may be settled other than
by the exchange of either a fixed amount of cash
or another financial asset for a fixed number of
the entity’s own equity instruments
An equity instrument is any contract that evidences a residual interest in the assets of an entity
after deducting all of its liabilities. Shares issued by a company will be an equity instrument of
that company.
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Contract for Chopsters Limited (Chopsters) enters into a contract to purchase inventory from a
purchase of supplier, Big Smoke Limited (Big Smoke). The inventory has been delivered, which
inventory on credit results in inventory being recognised on Chopsters’ statement of financial position
as well as trade payables (being the amount owing for the inventory). Big Smoke
has recognised trade receivables (being the amount owing by Chopsters for the
inventory) and sales
Loan issued by a Chopsters is in the process of expanding its business and part-funds the expansion
bank with a loan from Safe Bank. Chopsters recognises the loan with Safe Bank as a
liability as well as the cash received in the bank account it holds with Safe Bank.
Safe Bank recognises the loan it has made to Chopsters as well as the bank account
Chopsters holds with it
Loan from Safe Bank – financial liability Loan to Chopsters – financial asset
Cash – financial asset Borrowings – financial liability
Shares issued by a Chopsters raises the remainder of the funds it needs for the expansion of its
company business by conducting a rights issue to its existing shareholders. Wealthy
Superfund is one of the investors who takes up its entitlement under the rights
issue and recognises the additional investment in its statement of financial
position
It is important to note in the example above that the inventory contract itself is not a financial
instrument as it does not result in a right or obligation of either party to receive, deliver or
exchange a financial asset. It is the resulting impacts on trade payables and trade receivables
that are financial instruments.
Below is an extract from the Woolworths 2016 Annual Report, which shows clearly each of the
financial instruments it holds as at 26 June 2016.
Financial asset
}
Not a financial asset
Financial liability
Financial liability
Only a financial liability if it arises
from a contract e.g. rent accrual
} Equity instruments
Cash at bank Yes Cash at bank is a financial asset – a contractual right to obtain
cash from the bank and a corresponding financial liability of
the bank
Trade receivables Yes These are contractual rights to receive cash from another
entity. There will be a corresponding financial liability in the
other entity’s books
Fair value of hedging Yes The fair value of a contract that will result in the receipt or
derivatives payment of cash or another financial asset with another entity
Deferred tax assets No These are not a contractual right to receive a financial asset,
but rather relate to a statutory obligation imposed by the
Government, and accordingly, these are not a financial asset
Trade payables Yes These are a contractual obligation to deliver cash to another
entity and accordingly is a financial liability
Provisions for employee No Provisions are a constructive obligation (i.e. one that arises out
benefits of an entity’s actions) rather than a contractual obligation and
may be settled through the delivery of services rather than a
financial asset (e.g. permitting staff not to work for a period
of time whilst still paying them). Accordingly, these are not a
financial liability
Derivatives
A derivative ‘derives’ its value from underlying financial instruments, commodities, prices or
an index. They are widely used by entities to manage financial risk. Key features of a derivative
are that:
•• Its value changes based on changes in value of an agreed underlying asset.
•• It requires little or no net initial investment.
•• It is settled at a future date.
Appendix 2 to this unit contains further information and examples of common derivative
financial instruments.
Answer
Contract Financial Derivative? Explanation
instrument?
Interest rate swap Yes Yes The value of an interest rate swap is based on an
underlying notional value and the relevant interest
rates in the contract. It has no initial net investment
Futures contract Yes Yes The value of the futures contract is based on an
to buy USD in amount of currency to be purchased in the future.
three months’ There is minimal initial net investment, although
time movements in the value of the contract are settled
daily
Futures contract No No This is effectively the same as the contract to buy jet
to buy jet fuel in fuel as described above, just transacted via a futures
six months’ time exchange rather than direct with a supplier (so not a
with physical financial instrument or derivative for the same reasons
delivery as above). However, if the contract was habitually
settled net in cash, an entity shall apply IFRS 9 to it and
may designate it as a derivative
Call option over Yes Yes This is a contract with a small initial investment whose
interest rates value is derived from an underlying notional amount
and interest rate
The only derivatives Fly-by-day needs to be concerned about with regard to the application of IFRS 9
are those that are also financial instruments as IFRS 9 does not apply to derivatives that are not financial
instruments
The critical feature in distinguishing between the two is the existence of a contractual obligation
of the issuer of the financial instrument to the holder to:
•• deliver cash
•• deliver another financial instrument, or
•• exchange another financial instrument with the holder under conditions potentially
unfavourable to the issuer.
Where such a contractual obligation exists, the financial instrument is likely to be a financial
liability.
The key factor for classification is the discretion of the issuer to make payments to the holder.
If the issuer has a contractual obligation to make payments to the holder, it is likely that the
financial instrument is a liability not equity.
Preference shares While many preference shares receive a ‘fixed’ dividend, it is still likely that
this is entirely at the discretion of the company and, accordingly, is not a
contractual obligation (even if ordinary share dividends cannot be paid
until preference share dividends are paid). However, some features may
lead preference shares to be classified as financial liabilities. These include
mandatory dividend payments, redemption at the holder’s request and
conversion at the holder’s option to a fixed value (variable number) of ordinary
shares (a condition potentially unfavourable to the issuer)
Answer
Bank loan
Fly-by-day has a contractual obligation to make principal and interest payments to the bank.
It has no discretion over this obligation and accordingly, the bank loan would be classified as a
financial liability.
Preference shares
There is no contractual obligation on the part of Fly-by-day to make a dividend payment each
year. The only obligations regarding dividends are that:
•• The dividend is at a specified rate.
•• If a dividend is declared, Fly-by-day has to pay the dividend to preference shareholders
before it pays dividends to ordinary shareholders.
•• If no dividend is declared, these payments have to be ‘caught up’ before payments can be
made to ordinary shareholders.
In addition, the shares have no maturity date, so there is no contractual obligation to repay the
principal amount invested by holders. Accordingly, these preference shares will be classified
as equity as they are not a financial liability.
Under IAS 32, compound financial instruments must be classified separately into their liability
and equity components, and accounted for separately by the issuer. The issuer is required to
determine the fair value of the financial liability at the date of its initial recognition. The amount
allocated to the equity component is the residual amount of the compound instrument. These
initial values of each component may not be subsequently revised.
The following figure illustrates how the fair value of a compound instrument is allocated into
its components:
FIN fact
Only the issuer accounts for the instrument as a compound financial instrument. The investor
will recognise a financial asset (and there is no split accounting).
These components are then separately accounted for as per the normal requirements for liability
or equity instruments. This is often termed ‘split accounting’. The liability will be accounted for
under IFRS 9 and the equity component under IAS 32.
Date Description Dr Cr
$ $
The liability component will then be accounted for under IFRS 9. In this case, it will be classified
as measured at amortised cost covered later in the unit. The equity component is recognised on
the statement of financial position in equity.
On the day of potential note conversion, the value of the liability component will have reached
$20 million. The accounting treatment would depend on whether the holder elected to convert
to shares or receive cash. If shares were issued, the relevant amount of the liability would be
derecognised and the amount of equity increased by the same amount. If the holder elected to
receive cash the liability would be derecognised against a reduction in cash. The amount in the
equity reserve remains in equity. The relevant journals would be as follows:
Shares issued on conversion date
Date Description Dr Cr
$ $
Equity 2,388,519
Being recognition of the issuance of shares on conversion of the convertible notes and transfer of the
reserve to equity
Cash 20,000,000
Learning outcome
2. Account for financial assets, financial liabilities and equity instruments of the issuer (including
derivatives).
Before reviewing how financial instruments are classified, it is helpful to understand how they
are measured under IFRS 9.
Required reading
IFRS 9 paras 3.1.1, 5.1–5.4.1 and 5.7.1–5.7.3
Initial recognition
IFRS 9 provides that an entity shall recognise a financial asset or liability on its statement of
financial position when, and only when, it becomes a party to the contractual provisions of
the instrument.
Initial measurement
IFRS 9 para. 5.1.1 specifies that financial assets and financial liabilities shall be initially
measured at fair value plus or minus transaction costs, unless they have been classified as a
financial asset or financial liability at fair value through profit or loss (FVTPL), in which case,
transaction costs are expensed.
Generally, the fair value is the cost or consideration given or received for the asset or liability.
Transaction costs are costs directly attributable to the acquisition, issue or disposal of a financial
asset or liability (e.g. fees and commissions payable to brokers), but do not include financing or
internal administrative costs.
FIN fact
Remember when recognising financial liabilities at amortised cost, the liability recognised on
the statement of financial position will be reduced by the amount of transaction costs.
Subsequent measurement
Under IFRS 9 the two bases under which financial assets and financial liabilities can be
measured after initial recognition are fair value and amortised cost.
The price that would be received to sell an asset or Calculated as the initial amount recognised:
paid to transfer a liability in an orderly transaction minus any principal repayments
between market participants at the measurement
date plus or minus cumulative amortisation (interest)
using the effective interest method
The change in fair value is recognised either in other
comprehensive income or profit or loss depending on minus any write-down for impairment or
the classification of the instrument (see below) uncollectability (financial assets only)
Fair value
The fair value of financial assets and liabilities is determined in accordance with IFRS 13.
The price used to measure financial assets and liabilities may be directly observable, as in an
active market with quoted prices, or may be determined using valuation techniques if no active
market exists.
Transaction costs associated with transferring the financial asset or liability are not to be included
in the subsequent measurement of fair value as they are not a characteristic of the asset or
liability, but are specific to the transaction itself. This topic is discussed in more detail in Unit 6.
Amortised cost
IFRS 9 requires that interest on financial assets and liabilities shall be measured using the
effective interest method (EIM). The effective interest rate is the internal rate of return of
the financial asset or liability, that is, it is the rate that exactly discounts the estimated future
cash flows through the expected life of the instrument to the net carrying amount at initial
recognition.
Excel formula =
dates)
Please note that in the FIN module assessment, the effective interest rate will be provided
and candidates will not be required to calculate it. The table above is provided only for your
information and further understanding.
The effective interest rate is applied to a financial asset or liability to calculate the amounts that
should be recognised on the statement of financial position.
The amount that will be recognised each year as the loan balance in the statement of financial
position will be the closing loan balance. The interest expense recognised in the statement of
profit or loss and other comprehensive income (SPLOCI) will be the interest accrued using EIM
rather than the actual interest payment of $60,000. Journal entries are as follows:
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Item Treatment
Dividends or interest Recognised as income in profit or loss in the hands of the holder of the financial
received on owned asset
instruments
Dividends or interest paid If instrument classified as a financial liability, recognised as an expense in profit
on issued instruments or loss. If instrument classified as an equity instrument, recognised as a change
in equity
Transaction costs Recognised as a deduction from equity to the extent they are directly attributable
on issuing equity to the equity transaction that otherwise would have been avoided
instruments
Transaction costs on Allocated to the liability and equity components of the instrument in proportion to
issuing compound the allocation of proceeds
instruments
Gains and losses Generally follows the classification of the financial instrument. (There are a number
of exceptions to this that will be discussed throughout this unit)
From a profit or loss perspective, the primary difference between amortised cost and fair value is
the timing of recognition of transaction costs (ignoring the impact of fair value changes). If the
loan is classified as FVTPL, transaction costs are recognised initially as an expense. If the loan is
classified as amortised cost, transaction costs are recognised over the life of the loan, so the total
expense is the same under each classification.
Learning outcome
1. Explain and identify financial instruments and the principles for classifying them as financial
assets, financial liabilities or equity instruments of the issuer.
IFRS 9 uses a principles-based approach for classifying financial assets, instead of the rules-
based approach adopted by IAS 39. Compared to IAS 39, the most significant differences arise
in relation to financial assets. The classification of financial liabilities is largely the same in
IFRS 9 as in IAS 39.
For all financial assets and liabilities, there are three main categories of classification:
•• Fair value through profit or loss (FVTPL).
•• Fair value through other comprehensive income (FVTOCI).
•• Amortised cost.
The following summarises the measurement and classification criteria for each. These criteria
will be explained further in the following material:
Cash flows not Initial designation Held for trading Initial designation
SPPI*
OR
Business model to
sell financial asset
Required reading
IFRS 9 paras 4.1–4.2, 5.7.5, 5.7.7 and 5.7.10–5.7.11
Amortised cost
The default position for financial liabilities is to categorise them as amortised cost. Liabilities
in this category are initially recognised at fair value less transaction costs and subsequently
measured at amortised cost using the EIM.
Interest measured using the EIM is recognised as an expense. Any gains or losses shall be
recognised in profit or loss when the financial liability is derecognised and through the
amortisation process. Foreign exchange gains and losses (if the liability is a monetary item
under IAS 21 The Effects of Changes in Foreign Exchange Rates) are recognised in profit or loss.
Financial liabilities classified as FVTPL are initially and subsequently recognised at fair value.
Changes in fair value are recognised as follows:
•• For HFT financial liabilities, gains or losses on changes in fair value are recognised in profit
or loss in the period in which they occur.
•• For financial liabilities initially designated as FVTPL, the change in the fair value of the
liability attributable to changes in the issuer’s credit risk is taken to other comprehensive
income (OCI). The remaining amount of the change in the fair value of the liability is
recognised in profit or loss in the period in which it occurs. The recognition of changes in
credit risk in OCI may seem a little counter-intuitive. A reduction in an issuer/borrower’s
creditworthiness will reduce the fair value of financial instruments issued by them. This
provision in IFRS 9 ensures the resulting gain is recognised in OCI rather than profit or loss.
It is useful to note that one of the reasons for designating financial liabilities as FVTPL is to
reduce an accounting mismatch. If taking the change in credit risk in OCI enlarges or creates
an accounting mismatch, then these gains or losses should be taken to profit or loss rather
than OCI.
The following flow chart illustrates the process for determining the category of a financial asset.
Choose to designate at
Designation FVTPL to eliminate
as FVTPL accounting mismatch? FVTPL
NO YES
FVTPL
YES NO
NO YES
Objective to collect
contractual cash flows and
sell financial assets
YES NO
It can be seen from the flowchart that the characteristics of an asset’s cash flows (i.e. whether
they are principal and interest payments or not) and how a business manages those assets
(i.e. whether the objective is to receive cash flows, sell the assets for profit or both) are extremely
important in determining how they will be classified and accounted for.
In particular, these two criteria will determine:
•• how the assets are measured following initial recognition (fair value or amortised cost), and
•• for assets measured at fair value, where revaluation gains and losses are recognised (profit
or loss or OCI).
As discussed earlier, under IFRS 9 the category of a financial asset is determined using a
principles-based rather than a rules-based approach. To this end, there are two primary criteria
for determining how financial assets should be classified (and therefore whether they will be
measured at either amortised cost or fair value):
•• The contractual cash flow characteristics of the financial asset.
•• The entity’s business model for managing financial assets.
In assessing financial instruments, the focus should be on what the interest is compensating for,
rather than on how much it is.
Some instruments do not legally bear interest, for example, trade receivables. In these cases, the
SPPI test is still met as the principal is the amount resulting from the sales transaction, and there
is no significant financing component, so the interest is deemed to be zero.
The SPPI test is applied on an instrument-by-instrument basis in the currency in which the
financial asset is denominated.
Most basic lending arrangements having features that represent payments of principal and
interest will pass the SPPI test and accordingly are measured at amortised cost.
However, some financial assets have cash flows that may not represent payments of principal
and interest. Examples are:
AUD bank bills Yes These are contracts that require the investment of a
discounted amount (e.g. $95) and the repayment of the face
value of the bill (e.g. $100) on maturity, which represents the
principal and interest thereon
Deposits with banks Yes These are contractual obligations requiring repayment from
a bank of principal and the interest on the principal at an
agreed interest rate
Options on Australian No Options are derivatives that fail the SPPI test as cash flows
Government bonds do not represent payments of principal and interest on the
principal outstanding
Bonds convertible into a No Since the amount received on maturity is variable (based on
fixed number of ordinary the share price at the time), the cash flows do not represent
shares of the issuer at solely payments of principal and interest on the principal
maturity amount outstanding
New Zealand Government Yes These give rise to cash flows on specified dates that are solely
short-term bonds principal and interest on the principal amount outstanding
Those financial instruments that fail the SPPI test will be classified as FVTPL (unless an election for FVTOCI
for equity investments is available, which is discussed later in this unit). This means any subsequent
movements in fair value will be recognised in profit or loss. The instruments that pass the SPPI test can
then be assessed to determine their classification under the business model test. Depending on this, they
will be classified at amortised cost, FVTOCI or FVTPL
If the entity manages its financial assets solely to collect contractual cash flows, the assets may
be measured at amortised cost (assuming other criteria are met).
If the entity has a business objective of realising fair value changes in financial assets from the
sale of the assets before their contractual maturity rather than collecting contractual cash flows,
the financial assets cannot be held at amortised cost.
An entity’s business model is determined at a level that reflects how groups of financial assets
are managed together to achieve a particular business objective. An entity may have more than
one business model for managing its financial instruments and so this assessment does not need
to occur at the entity level.
The business model used by an entity is a matter of fact that can be observed in the way an
entity is managed and in the information provided to management. It is not a matter of choice
or assessment. Evidence can be obtained from:
•• How the performance of the business model and the financial assets within it are evaluated
and reported.
•• The risks that impact performance of the business model and how those risks are managed.
•• How the managers of the business are compensated.
Business models are likely to remain unchanged for extended periods of time. A change in
the method of generating cash flows from an asset does not impact on the classification of the
financial asset. However, when evaluating a new financial asset, an entity will have regard to
how cash flows were realised in the past.
Designation at FVTPL
An entity may, at initial recognition, choose to designate a financial asset as measured at FVTPL
if doing so eliminates or significantly reduces a measurement or recognition inconsistency
(often referred to as an ’accounting mismatch’) that would otherwise arise from measuring
assets and liabilities on different bases.
Equity investments
Investments in shares in another entity are generally classified as FVTPL as they fail the SPPI
test. However, as long as the investment is not held for trading, an entity may make an election
on initial recognition to present subsequent changes in fair value in OCI. This is an irrevocable
election by an entity and is made on an instrument-by-instrument basis.
Dividend revenue on the financial asset is still recognised in profit or loss. All gains and losses
(including those relating to foreign exchange) are recognised in an account in OCI and remain
there permanently even when the asset is derecognised.
Financial Amortised cost Fair value + Amortised cost + Profit or loss Use EIM to
asset transaction impairment test only when asset recognise
costs derecognised interest
revenue in
profit or loss
Financial Amortised cost Fair value – Amortised cost Profit or loss only Use EIM to
liability transaction when liability recognise
costs derecognised interest
expense in
profit or loss
Interest recognition
For interest-bearing financial instruments, interest should be accrued to appropriately reflect
the amount earned or owed for the relevant reporting period. The fair value of an interest-
bearing financial instrument measured at FVTOCI or FVTPL will include interest accrued but as
yet unpaid.
Paragraph 5.7.11 of IFRS 9 requires that the amounts recognised in profit or loss are the same
for FVTOCI assets as if they were measured at amortised cost. This means that interest revenue
will be recognised under the EIM for instruments measured at amortised cost and instruments
measured at FVTOCI.
Accordingly, the change in fair value for FVTOCI instruments recognised in OCI at each reporting
date will reflect the change in fair value, excluding interest earned or accrued on the instrument.
IFRS 9 does not provide specific guidance on the treatment of interest on financial instruments
measured at FVTPL. For instruments of this nature, changes in fair value (which includes accrual
of interest) are recognised in profit or loss. Accordingly, there is no requirement for interest to
be calculated or recognised separately from gains or losses in fair value. For the purposes of the
FIN module, interest on FVTPL instruments should be recognised based on the interest coupon
of the instrument. Interest should be recognised in the same account as changes in fair value.
Notes
1. Assume that the current year transactions all occurred on 30 June 20X7 for the purposes of recording journal entries.
2. Includes $40,000 current year change in fair value of securities sold during the year.
3. These securities were originally acquired for $3,000,000 in the prior reporting period, resulting overall in a $200,000
cumulative gain when sold at fair value for $3,200,000.
$ $ $ $ $
You will now need to prepare the journal entries for these transactions so you can check them
against the general ledger.
Answer
Bank loan (financial liability)
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Being recognition of the transaction costs associated with the bank loan
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Being recognition of interest expense and payment on the bank loan for the year ended 30 June 20X7,
calculated using the EIM [$3,940,000 × 5.832% EIR = $229,781 interest expense; $4,000,000 × 5% coupon =
$200,000 interest coupon paid]
Being revaluation of the option to acquire an equity investment at 30 June 20X7 to fair value
Being interest revenue calculated using the EIM on the short-term debt securities portfolio for the year ended
30 June 20X7 and the coupon receipt of $750,000
Date Description Dr Cr
$ $
Being revaluation of the short-term debt securities portfolio to fair value at 30 June 20X7, recognised in OCI
Date Description Dr Cr
$ $
Date Description Dr Cr
$ $
Being reclassification of the cumulative gain on the securities that were sold during the year ended 30 June
20X7 ($3,200,000 disposal proceeds less $3,000,000 cost of acquisition)
Learning outcome
5. Explain and account for the derecognition of financial assets and financial liabilities.
Required reading
IFRS 9 paras 3.2.1–3.2.6, 3.3.1–3.3.4 and 5.6
IFRS 9 contains a decision tree that steps through the process for derecognising financial assets.
This shows that the tests are applied in a hierarchy, so that the control tests are only applied when
the entity has neither transferred nor retained substantially all risks and rewards or ownership.
In summary, after some preliminary steps there are three main questions:
Preliminary
Steps Have rights Have risks Has
expired or and rewards control been
been been retained?
transferred? transferred?
In order for derecognition to be available for a financial asset, all the following criteria need to
be fulfilled:
•• The rights to receive cash flows from the asset have expired (e.g. at the end of a loan term)
or been transferred (e.g. by sale or assignment).
•• Substantially all the risks and rewards of ownership of the asset have been transferred.
•• The entity no longer has control of the asset (i.e. no practical ability to make a unilateral
decision to sell the asset to a third party).
Most financial assets are derecognised because they are disposed of, or because they expire at
the end of their life. There are some more complex arrangements that an entity may enter into
(e.g. securitisation) where meeting the criteria can be the subject of much judgement. These
arrangements will not be explored further in this unit.
NO
NO
NO
NO
YES
Adapted from IFRS 9 Financial Instruments para. B3.2.1, July 2014, accessed on 26 April 2018, www.aasb.gov.au/admin/
file/content105/c9/IFRS9_BC_7-14.pdf
Being recognition of the gain on reclassification of short-term investments from amortised cost to FVTOCI
Working paper D
You are now ready to complete working paper D of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Part B
Hedge accounting
Learning outcome
3. Explain and account for basic cash flow and fair value hedges.
Most organisations are subject to financial risks that may impact on the profit or loss their
business generates.
Changing
commodity
prices impact
the amount paid
for inventory
Changing Changing
interest raes FX rates impact
impact interest the amount paid
expense on a for a piece of
floating rate imported
loan ORGANISATION equipment
These risks may be managed by various means, including the use of financial instruments to
reduce the risk. Derivatives are the primary tool entities use to hedge financial risks such as
interest rate risk, foreign exchange risk and commodity price risk. In this section, a risk will be
referred to as a hedged risk.
Recognised asset USD-denominated trade receivables Foreign exchange risk – the risk
that receivables will decrease in
value in AUD due to movements in
exchange rates
Recognised liability An AUD floating rate loan Interest rate risk – the risk that
interest payments will increase due
to increases in interest rates
Unrecognised firm An order has been received to Commodity price risk – the risk that
commitment deliver 10,000 tonnes of iron ore to the price of iron ore will fall prior to
an offshore customer at the iron ore the delivery date
price on the delivery date.
Highly probable forecast An Australian company forecasts Foreign exchange risk – the risk
transaction €1 million in inventory purchases for that the inventory will cost more
the next six months. in AUD due to movements in
exchange rates
Economic relationship between the hedged item and the hedging instrument
Hedging is a strategy that an entity may use to manage a specific risk.
IFRS 9 requires there to be an economic relationship between the hedged item and the hedging
instrument with the expectation that the value of the hedging instrument and the value of
the hedged item would move in the opposite direction because of the same risk, which is the
hedged risk.
The diagram below shows an example of a hedging strategy:
W
Gain e pur heat
h cha
on t ative a ses
at v che re Lo
Wheases deri dging ) (hedaper on ss
r c h (he ment der the
pu more ru
g
item ed ivat
are nsive inst ) (h iv
e
exp dged inst edging e
rum
(he m) ent)
ite
FIN fact
Hedge accounting is optional. Subject to satisfying certain requirements, an entity can
choose to designate a hedging relationship between a hedging instrument and a hedged
item for the hedged risk.
In general,
•• Hedge accounting can only be applied if certain eligibility and qualification criteria are satisfied.
•• The accounting for the hedged item and hedging instrument in a designated hedge
relationship is recorded in a different way to the normal classification and measurement
rules for financial instruments.
–– The accounting modifies the normal basis for recognising gains and losses (or revenues
and expenses) on associated hedging instruments and hedged items, so that both are
recognised in the statement of profit or loss and other comprehensive income in the
same reporting period.
–– Hedge accounting effectively matches the hedged item with the hedging instrument
to reflect the economic relationship, and eliminates or reduces the volatility in the
statement of profit or loss and other comprehensive income.
•• Without hedge accounting, all derivatives are classified as FVTPL and all revaluation gains and
losses are recognised in profit or loss.
Required Reading
IFRS 9 paras 6.1.1–6.1.2, 6.2.1–6.2.3 and 6.3.1–6.5.12
In a fair value hedge, the risk being hedged is the change in the value of the hedged item.
A fair value hedge can be designated in respect of the following hedged items:
Value of an FX risk of an
Value of a Value of a
unrecognised unrecognised
recognised asset recognised liability
firm commitment firm commitment
In a cash flow hedge, the entity does not hedge the asset, the liability or the highly probable
forecast transaction itself, but rather the potential variable cash flows that any of those items
might generate, provided that they ultimately impact on profit or loss.
A cash flow hedge can be designated in respect of the following hedged items:
Cash flows of a
FX risk of an
Cash flows of a Cash flows of a highly probably
unrecognised firm
recognised asset recognised liability forecast
commitment
transaction
NO Rebalancing/
Step Is the hedge
4 effective? discontinuation
YES
A failure to document this information at the inception of the hedging relationship means that
hedge accounting under IFRS 9 cannot be applied (IFRS 9 para. 6.4.1(b)).
In contrast, the risk management objective is set at the level of the individual hedging
relationships and will specify how a particular hedging instrument will be used to hedge
a particular exposure that has been designated as a hedged item. This will also include
consideration of whether the hedge is a cash flow or fair value hedge. Accordingly, a
risk management strategy may involve many different hedging relationships whose risk
management objective relate to executing the overall risk management strategy.
•• Interest rate risk on a $3 million floating rate Interest rate swap that pays fixed and receives
AUD denominated bank loan – policy indicates floating interest rates for $1.5 million notional
that 50% of debt should be fixed rate principal
Answer
$3 million floating rate loan
The exposure here is to the adverse changes in AUD interest rates. Derivative instruments
are permissible under IFRS 9 to be used to hedge this interest rate exposure – so an interest
rate swap will qualify under IFRS 9. In addition, it is permissible to hedge only part of the total
exposure. So an interest rate swap that covers the risk of $1.5 million of the $3 million loan will
hedge 50% of the interest rate risk, which will enable the company to comply with its policy.
Hedge effectiveness
A hedging relationship qualifies for hedge accounting only if it meets all of the following hedge
effectiveness requirements:
•• There is an economic relationship between the hedged item and the hedging instrument.
•• The effect of credit risk does not dominate the value changes that result from that economic
relationship.
•• The hedge ratio satisfies certain requirements. Hedge ratio is explained further below.
Hedge effectiveness is the extent to which changes in the fair value or cash flows of the hedging
instrument offset changes in the fair value or cash flows of the hedged item.
Hedge ineffectiveness, however, is the extent to which the changes in the fair value or cash
flows of the hedging instrument are greater or less than those on the hedged item.
It is common for there to be some hedge ineffectiveness from an accounting perspective while
still satisfying the principles of the hedge effectiveness assessment. Accounting for fair value
and cash flow hedges under Step 5 illustrates this.
Economic relationship
As explained earlier, it is generally expected that the values of the hedged item and the
hedging instrument will move in opposite directions because of the hedged risk. Accordingly,
it would be expected that the underlying risks of the hedged item and hedging instrument are
economically related.
Hedge ratio
The hedge ratio is the ratio between the quantity of the hedged item and the quantity of the
hedging instrument. The ratio documented for hedge accounting purposes is established by
looking at the amount of the hedging instrument actually used to economically hedge the
required amount of the hedged item. The ratio is set to maximise the effectiveness of the hedge
and is often 1:1, but may not always be.
Assessments of hedge effectiveness should be made at the inception of the hedge and on an
ongoing basis (at least at every reporting date). Effectiveness cannot be assumed just because
critical terms match. The assessment relates to expectations of hedge effectiveness and therefore
is only forward-looking.
Accordingly, any hedge ineffectiveness is automatically presented in profit or loss (as the net
debit or credit from recognising the fair value movement on both the hedged item and hedging
instrument).
Designated fair Fair value movements Fair value movements on To the extent that the
value hedge on the hedged item the hedging instrument hedge is ineffective, there
relationship are recognised in profit (derivative) are recognised will be a net difference
or loss (including fair in profit or loss recognised in profit or
value movements on loss (e.g. if a gain on the
an unrecognised firm hedged item exceeded
commitment – e.g. a a loss on the hedging
purchase order) instrument)
Example An $80,000 gain on the A $70,000 loss on the A net $10,000 gain is
fair value movement on a fair value movement on recognised in profit or loss
purchase order the derivative hedging (hedge ineffectiveness)
instrument
To appreciate the impact of designating a fair value hedge relationship, it is helpful to consider
the accounting treatment if an entity did not choose to apply hedge accounting. Assume a
derivative was entered into to manage the risk on the specific item
If hedge accounting •• If the hedged item is Fair value movements on There would be volatility
is not applied a recognised asset or the hedging instrument in profit or loss due to
liability then only those (derivative) are recognised the differing accounting
classified as FVTPL will in profit or loss treatment for the hedged
have changes in fair item and the hedging
value recognised in profit instrument
or loss (e.g. if recognised
at amortised cost then no
fair value movements are
recognised)
•• If the item is an
unrecognised firm
commitment (e.g. a
purchase order), no
changes in its fair
value are recognised
as the unrecognised
firm commitment itself
would not yet qualify
for recognition in the
financial statements
The process for accounting for a fair value hedge can be broken down into the following steps:
Step 1 Step 3
Determine the fair value of the hedging Determine the gain or loss on the hedged
instrument at the reporting date item that is attributable to the hedged risk
Step 2 Step 4
Recognise the change in fair value in Adjust the carrying amount of the hedged
profit or loss since the last reporting date: item and recognise any gain or loss in
Dr/Cr Hedging instrument profit or loss:
ging Hed
Hed ment g
Item ed
Hedged Hedging t r u
Ins 50
Item Instrument 40 He
ged Inst dging
50 50 Hed rum
Item e
50 60 nt
For an item being hedged If the fair value change of the If the fair value change of the
that moves by 50, a hedging hedging instrument (derivative) hedging instrument (derivative) is
instrument (derivative) that is less (e.g. 40), this is less more (e.g. 60), then the additional
changes in fair value by the same economically effective, but no change compared to the change in
amount (i.e. 50) perfectly offsets amount will be recognised in fair value of the hedged item (i.e. 10)
the fair value change of the item profit or loss will be recognised in profit or loss.
being hedged Think of this as being over-hedged
* This is because the change in value of the hedging instrument is greater than the amount recognised in the CFHR – the
difference is recognised in P&L
FIN fact
Correctly applying the ‘lower of’ test is critical to correctly accounting for a cash flow hedge.
When applying the test, you must interpret the information provided to calculate the
cumulative values since the inception of the hedge rather than just the movement since the
last reporting date.
When the hedged item affects profit or loss (i.e. when When the hedged item is a forecast transaction that
the hedged item is sold, settled or otherwise realised) results in the recognition of a non-financial asset (e.g.
inventory) or a non-financial liability.
29.05.X7 0 0
* These values are provided and cannot be derived from the other information in the table.
Journal entries to be recognised over the life of the hedging relationship:
29 May 20X7
Hedged item
Step 1 – The fair value of the firm commitment is $3,603,604. There is no entry to be recognised
as the firm commitment does not result in the recognition of a transaction in the financial
statements.
Hedging instrument
Step 1 – When the FX forward contract was entered into on 29 May 20X7, it had a fair value of
zero and accordingly, there is no transaction to be recognised.
30 June 20X7
Hedged item
Step 1 – the fair value of the firm commitment is $3,508,772. There is no entry to recognise
Hedging instrument
Date Description Dr Cr
$ $
To measure the FX forward contract asset at fair value. The effective portion of the hedge is recognised in the
CFHR (disclosed in OCI); the ineffective portion in profit or loss
*Disclosed in OCI
Step 1 – the FX forward contract is a derivative and must be measured at fair value, which at
30 June 20X7 is a $104,000 asset.
Step 2 – the cumulative change in fair value of the cash flow being hedged since inception of the
hedge is $94,832 (being $3,508,772 – $3,603,604, and also provided in the table). The cumulative
change in fair value of the FX forward since its inception is $104,000 (being the fair value of
$104,000 – $0).
Step 3 –
Amount to be recognised in the CFHR at 30 June 20X7
$94,832 $104,000
Step 4 – since the last reporting date, the change in value of the FX forward is $104,000 Dr
(since this is the first period of the hedge, this is the same as its cumulative change in value
since inception).
The balance in the CFHR at the last reporting date is zero. The balance it needs to be at 30 June
20X7 is $94,832 Cr (from Step 3 – a credit because the value of the FX forward is a debit), so the
change in value required is $94,832 Cr.
Step 5 – the journal entry is therefore to Dr the FX forward by $104,000 and Cr the CFHR
by $94,832.
Does the journal entry balance at this stage? No. There is a debit of $104,000 and a credit of
$94,832. This means there is hedge ineffectiveness, so the difference of $9,168 Cr must be
recognised in P&L.
Step 6 – the cash flow being hedged has not yet been recognised in P&L, so no further journal
entries are required.
15 July 20X7
Hedged item
Step 1 – the hedged item transaction is now recognised and impacts P&L (sales revenue).
Date Description Dr Cr
$ $
Being recognition of sale and receipt of cash from Singapore customer at the FX spot rate (SGD4,000,000 ÷ 1.18)
Hedging instrument
Date Description Dr Cr
$ $
To measure the FX forward contract asset at fair value. The effective portion of the hedge is recognised in the
CFHR (disclosed in OCI); the ineffective portion in profit or loss
*Disclosed in OCI
Step 1 – the FX forward contract is a derivative and must be measured at fair value, which at
15 July 20X7 is a $213,773 asset.
Step 2 – the cumulative change in fair value of the cash flow being hedged since inception
of the hedge is $213,773 (being $3,389,831 – $3,603,604, and also provided in the table).
The cumulative change in fair value of the FX forward since its inception is also $213,773 (being
the fair value of $213,773 – $0).
Step 3 –
$213,773 $213,773
Step 4 – since the last reporting date (30 June 20X7), the change in value of the FX forward is
$109,773 Dr (since the asset has increased in value from $104,000 to $213,773).
The balance at 30 June 20X7 (the last reporting date) in the CFHR is $94,832 Cr (from the journal
entry above at 30 June 20X7). The balance it needs to be at 15 July 20X7 is $213,773 Cr (from
Step 3), so the change in value required is $118,941 Cr.
Step 5 – the journal entry is therefore to Dr the FX forward by $109,773 and Cr the CFHR
by $118,941.
Does the journal entry balance at this stage? No. There is a debit of $109,773 and a credit of
$118,941. This means there is hedge ineffectiveness, so the difference of $9,168 Dr must be
recognised in P&L.
Step 6 – the cash flow being hedged has been recognised in P&L in the current period as sales
revenue (ie on 15 July 20X7).
Step 7 – the FX forward contract was an asset and will be settled on 15 July 20X7 by May-Son
receiving cash of $213,773.
Date Description Dr Cr
$ $
The hedging relationship has now finished, so the accumulated amount in the CFHR
($213,773 Cr) needs to be reclassified to P&L since the cash flow being hedged was recognised
in P&L. IFRS 9 para 6.5.11(d)(ii) requires the reclassification of the CFHR balance to profit or loss
to correspond with the timing of the profit or loss impact of the hedged cash flow from the
customer, that is, when the sale is recognised.
Date Description Dr Cr
$ $
Being reclassification of CFHR balance on settlement of the hedge from equity to profit or loss
Worked example 9.2: Hedge accounting for a cash flow and fair value hedge
[Available online in myLearning]
Learning outcome
4. Explain and account for impairment of financial assets.
In changing the methodology for recognising impairment of financial assets, the IASB has
sought to address a key concern that arose during the global financial crisis. During the
financial crisis, the recognition of credit losses on financial assets was delayed due to the
application of the IAS 39 impairment model based on incurred losses (i.e. credit losses were
recognised only when a credit event had occurred). This resulted in a mismatch between the
recognition of income from the financial asset (spread evenly over the life of the asset) and the
recognition of impairment losses, which generally were recognised at a later date.
IFRS 9 incorporates a forward-looking expected loss model into its requirements in an effort
to overcome the shortcomings of impairment under IAS 39. IFRS 9 anticipates that credit
losses will be recognised prior to a financial asset becoming credit-impaired or an actual
default occurring.
Required Reading
IFRS 9 para. 5.5.
A credit loss occurs when an entity receives lower cash flows than the amount that is
contractually due to it.
IFRS 9 requires an entity to recognise a loss allowance in the statement of financial position for
expected credit losses on:
•• Financial assets measured at amortised cost or FVTOCI in accordance with para. 4.1.2
or 4.1.2A of IFRS 9.
•• Lease receivables.
•• Contract assets – under IFRS 15 Revenue from Contracts with Customers contract assets are
defined as an entity’s right to consideration in exchange for goods or services that the entity
has transferred to a customer when that right is conditional on something other than the
passage of time (e.g. the entity’s future performance).
•• Loan commitments that are not measured at FVTPL.
•• Financial guarantee contracts that are not measured at FVTPL.
An impairment gain or loss will be recognised in profit or loss for the amount of the expected
credit loss that is required to adjust the loss allowance at the reporting date to the amount
required under IFRS 9.
The effect of the impairment provisions of IFRS 9 is to ensure changes in expected credit losses
are recognised in profit or loss.
FIN fact
For financial assets measured at FVTPL, the market’s expectations of the impact of expected
credit losses on future cash flows is already recognised in profit or loss, and accordingly,
a separate loss allowance is not required.
In measuring ECLs, entities may use practical expedients such as a provision matrix for trade
receivables.
Lifetime ECLs are the expected credit losses that result from all possible default events over the
expected life of a financial asset. This means that an entity needs to estimate the probability of
default occurring over the contractual life of the financial asset.
Twelve-month ECLs are a portion of lifetime ECLs. They represent only the loss arising from
possible default events for the next 12 months after the reporting date.
In applying the IFRS 9 requirements, an entity can use one of the following approaches,
as applicable:
•• The general approach – applied to most loans and debt securities.
•• The simplified approach – applied to most trade receivables.
•• The purchased or originated credit-impaired approach.
•• Low credit risk operational simplification.
Adapted from Deloitte IFRS e-learning module IFRS 9 (4) Impairment, accessed on 26 April 2018,
www.deloitteifrslearning.com/description.asp?id=ifrs94_v15&mod=ifrs
Under the general approach there are a number of stages in recognising expected credit losses:
•• Initial recognition of the financial asset. No loss allowance for expected credit losses
recognised as the asset is initially recognised at fair value, thereby incorporating the credit
risk of the asset.
•• Each reporting date:
–– Stage 1: If there is no significant increase in credit risk since initial recognition, entities
provide for expected credit losses that may result from default events possible within
the next 12 months (i.e. ’12-month expected credit losses’).
–– Stage 2: If there has been a significant increase in credit risk since initial recognition,
entities provide for expected credit losses that may result from default events possible
over the entire expected life of the financial instrument (i.e. ‘lifetime expected
credit losses’).
Under the general approach, an entity recognises a loss allowance based on either 12-month
ECL or lifetime ECL, depending on whether there has been a significant increase in credit risk
since initial recognition. Accordingly, an entity is required to monitor the change in credit
risk of financial assets at each reporting date.
In stages 1 and 2, interest recognition and impairment are de-coupled as interest recognition
is based on the gross carrying value of the financial asset despite the fact that the asset has
been impaired.
In Stage 3, interest recognition is re-coupled with the asset impairment and is based on
the amortised cost of the financial asset, which is the gross carrying value adjusted for any
loss allowance.
FIN fact
A contract asset is the right to consideration in exchange for goods or services that
is conditional on something other than the passage of time (i.e. performance of
another obligation). This is unlike a trade receivable which is an unconditional right to
receive consideration.
A financial asset is not considered to carry low credit risk merely due to the existence of
collateral, or because a borrower has a lower risk of default than the risk inherent in an entity’s
other financial assets or lower than the credit risk of the jurisdiction in which the entity operates.
The following flowchart illustrates the application on a reporting date of the impairment
requirements combining all three approaches:
NO
AND
Calculate
interest
revenue on
gross carrying
amount
(Stage 2)
Adapted from IFRS 9 Financial Instruments Illustrative Examples, July 2014, accessed on 24 April 2018
www.aasb.gov.au/admin/file/content105/c9/IFRS9_IE_7-14.pdf
Cash at bank Yes General approach This is an asset held at amortised cost since cash
with low credit flows (the balance of the account and interest on
risk operational the account) are solely principal and interest on the
simplification principal, and it is held in order to collect contractual
cash flows (repayment of the balance or a portion
of it when required). Accordingly, the impairment
provisions of IFRS 9 apply. As our primary bank
is rated AA+, it has a very low risk of default, and
we have a strong expectation that, going forward,
the bank would be able to meet any withdrawals
we made. This means we can apply the low credit
risk operational simplification and we just have to
calculate the 12-month ECL. Given our confidence in
our bank, we could assume this to be zero
Cash Yes General approach These assets are held at FVTOCI and accordingly the
portfolio potentially with impairment provisions of IFRS 9 apply. The approach
low credit risk we adopt will depend on the quality of assets
operational held. If high quality (investment grade) we could
simplification adopt the low credit risk approach (as with cash at
bank), which means we just have to calculate the
12-month ECL. If not high quality, we would need
to adopt the general approach. This would require
an initial calculation of 12-month ECL, but also
ongoing monitoring to determine if there has been
a significant increase in credit risk and lifetime ECL is
required to be calculated
The 12-month ECL calculation (under either
approach) will require us to determine a probability
of default in the next 12 months together with a
lifetime loss given that default for each investment
asset we hold
Trade Yes Simplified Trade receivables are held at amortised cost and
receivables approach IFRS 9 permits us to adopt a simplified approach
in applying the impairment provisions. This means
we are not required to track credit risk of the trade
debtor and can just recognise lifetime ECL. Since our
trade receivables are all due within 90 days, lifetime
is only 90 days anyway. In addition, we can use a
provision matrix based on our historical experience
of credit losses
External Changed
market external
indicators credit rating
•• The assessment may be made on a collective basis or at the level of the counterparty.
Lifetime credit losses are generally expected to be recognised before a financial instrument
becomes past due as credit risk has likely increased significantly prior to that date.
However, an entity may not be able to identify changes in credit risk for individual financial
instruments and may choose to recognise lifetime ECLs on a collective basis. To do this,
an entity can group financial instruments on the basis of shared credit risk characteristics
(e.g. instrument type, credit risk ratings, collateral type, industry, geographical location).
A significant increase in credit risk relates to the change in probability of default rather than to
the absolute probability of default. At any given moment in time, two financial assets may have
the same absolute probability of default but one may have increased or decreased significantly
since initial recognition whereas the other may not have.
The probability of default tends to be higher the longer the expected life of a financial asset.
For example, the risk of default in relation to a 10-year AAA rated bond is higher than that of a
5-year AAA rated bond.
These two concepts link together when considering how the probability of default for a
financial asset changes over time. If the probability of default remains constant over time, it is
likely that the credit risk has increased as it would be expected that the probability of default
would reduce as an instrument gets nearer to maturity.
The probability of default may also be impacted by the timing of payments. If there are
significant payment obligations close to maturity (e.g. for a corporate bond) the risk of default
may not necessarily decrease over time.
Profit or loss Expected credit loss Expected credit loss Expected credit loss
recognised as impairment recognised as impairment recognised as impairment
gain/loss gain/loss gain/loss
Balance sheet Loss allowance included in Fair value already reflects Loss allowance recognised
amortised cost expected credit losses as a provision
At each reporting date, an entity recognises the movement in the loss allowance as an
impairment gain or loss in the SPLOCI.
The carrying amount of financial assets measured at amortised cost includes the loss allowance
relating to that asset.
Assets measured at FVTOCI are recognised at fair value with changes in fair value recognised
in OCI. Changes in fair value include a number of factors, including the change in credit risk of
the asset. At reporting date, the amount relating to the change in credit risk is transferred from
OCI to profit or loss.
For financial assets that are unrecognised (e.g. loan commitments yet to be drawn, financial
guarantees), a provision for loss allowance is created in the statement of financial position to
recognise the loss allowance.
Being recognition of the change in fair value of the financial asset at 31 December 20X6
Date Description Dr Cr
$ $
Being recognition of the loss allowance for the financial asset at 31 December 20X6
Disclosure
Required reading
IFRS 7 paras 6–42
Overview of requirements
IFRS 7 disclosures encompass two broad areas. Under IFRS 7 entities are required to disclose
information that enables users to understand and evaluate:
•• The significance of financial instruments to an entity’s financial position and performance.
•• The nature and extent of risks arising from financial instruments to which the entity is
exposed, and how these are managed.
Broadly, IFRS 7 achieves the first of these by mandating the specific disclosure of information
that is based on accounting records and classifications. These disclosures are detailed but
relatively straightforward.
As to the second, IFRS 7 attempts to provide users with an ‘inside view’ of the risks to which an
entity is exposed. This requires the entity’s management to disclose information based on how it
views these financial risks, with a minimum standard of information being required by IFRS 7.
Because there are many different ways to view and report risk, and much of this information is
not directly available in the accounting system, providing these IFRS 7 disclosures can be quite
challenging for entities.
In addition, IFRS 13 requires disclosure of the valuations techniques and inputs used to measure
the fair value of financial instruments, as well as the effect of fair value measurements using
Level 3 inputs on profit or loss or other comprehensive income for the period.
Further reading
The preparation of disclosures relating to financial instruments is beyond the scope of this unit.
An example of financial instrument is contained in the Woolworths 2016 annual report, available at
wow2016ar.qreports.com.au/xresources/pdf/wow16ar-financial-report.pdf, accessed 26 April 2018.
Working paper E
You are now ready to complete working paper E of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Bank bills A short-term money market security with maturities generally ranging from 30 to
180 days. Generally offered at a discount to its expected value when it matures
Bonds Debt securities that are issued for a period greater than one year (and up to
30 years) for the purpose of raising capital. The most common bonds are those
issued by governments and corporations. Bonds involve a repayment of principal
amount (sometimes called face value) at the maturity date, and (usually) payments
of interest at a fixed rate (sometimes called coupons) over the term of the bond
The interest rate on a bond is determined by the perceived repayment ability of the
borrower. The fair value of a bond may also change based on market interest rates
and inflation in an inverse relationship (i.e. higher market interest rates compared to
the interest rate on the bond and inflation lead to lower bond prices)
Cash and cash ‘Cash and cash equivalents’ is an accounting concept that includes cash on hand,
equivalents demand deposits and short-term, highly liquid investments that are readily
convertible to known amounts of cash and subject to an insignificant risk of
changes in value
Convertible bonds or Types of corporate bonds that can be converted into ordinary or preference shares
notes of the issuer at some point in the future, usually at the option of the holder
Debt securities At their most basic, debt securities are written promises to repay debts on specified
terms. Sometimes called interest-bearing securities, they come in a variety of
forms, two of the most common being bonds and notes. They are generally
tradeable securities
Forward rate agreement A financial instrument used to hedge interest rate risk, and is based on a
(FRA) notional principal amount. In that sense, it is similar to an interest rate swap.
FRAs are relatively simple, short-term (up to one year) OTC instruments with one
settlement date
Loans Advances of money from lenders to borrowers over a period of time, with
repayment of the principal amount either at intervals during the loan period or at
the end of the loan. Interest rates that apply to loans may be fixed or variable. In
contrast to debt securities, loans are not tradeable
Notes Short-term to medium-term debt securities, usually maturing within five years or
less. Interest rates that apply to notes may be fixed or variable
Options A contract conveying to the option holder the right (not the obligation) to buy or
sell a specified asset at a fixed price before or at a future expiration date. The price
of an option is called a premium
There are two types of options:
•• A call option confers on the holder the right to buy (i.e. call) the underlying asset
at a fixed price
•• A put option confers on the holder the right to sell (i.e. put) the underlying asset
at a fixed price
A European option is exercisable only on the option’s expiry date. An American
option is exercisable at any time up to the option’s expiry date
Ordinary shares Residual ownership in a company. Ordinary shares give the holder an entitlement
to a share of any dividends issued by the company, and the right to vote in its
annual general meetings. Shares may be traded either privately or on an exchange
(if the company is listed), and the value determined by market forces
Preference shares A form of shares issued by a company where, depending on the terms of the share
issue, the holders are usually entitled to a fixed dividend before dividends are paid
to ordinary shareholders, but do not usually have voting rights. In the event of a
company winding up, preference shares rank above ordinary shares
Swaps An OTC contract between two parties to exchange multiple payments over periods
greater than one year (and up to 15 years) based on a notional principal amount
The most common form of swap is an interest rate swap. This involves the exchange
of fixed and floating interest payments based on a notional principal amount and is
generally entered into as a hedge against interest rate risk
Swaps may also be cross-currency, which involves an exchange of interest
payments in one currency for interest payments in another currency based on the
respective notional principal amounts
Trade payables Amounts owing by an entity for goods and services it has received on credit.
Also referred to as accounts payable
Trade receivables Amounts that are due to an entity from another entity for goods and services it
supplied on credit. Also referred to as accounts receivable
Bank bill swap rate The rate at which banks in Australia commonly lend to each other. It is derived from
(BBSW) a compilation and average of market rates of bank bills supplied daily by Australian
banks for specific maturities up to six months
Basis risk The risk that two different financial instruments in a hedging strategy will not
experience exactly offsetting price or rate movements
Bid price The price that a buyer is willing to pay for shares
Dividends or distributions Portion of an entity’s earnings that is distributed to its shareholders (or a class
thereof ). Often expressed in terms of an amount per share
Interest Charge exacted on money that is borrowed, or income received for money that
is lent. Usually expressed as an annual percentage of the principal or notional
amount. In accounting terms, interest is treated separately from any gain or loss
Net settlement In relation to a derivative, a payment settlement system within a contract where
only the net differential is transferred between the two parties to conclude the
contract
Nominal value Stated value of an issued security, sometimes known as face value or par value. The
nominal value of a security remains fixed for the duration of its life, in contrast to
its market value, which varies. For example, a bond may have a nominal value of
$1,000 (being the amount repaid at maturity), but will be issued, and traded, at a
different market value based on its terms, market interest rates, inflation, and so on
Notional value Total value of a leveraged position’s assets at the current price. (Leverage is the use
of financial instruments or borrowings to increase the exposure to an investment,
increasing the potential risk and return on the investment.) Often used in the
derivatives markets because a very small amount of money can be used to control
a large position. As an example, one S&P 500 Index* futures contract obligates the
buyer to purchase 250 units of the S&P 500 Index (or settle in cash). If the index
is trading at $1,000, the futures contract equates to an investment of $250,000
(250 × $1,000). Therefore, $250,000 is the notional value underlying the futures
contract, as compared to its actual value, which would be substantially lower
Offer price The price that a seller is willing to accept for shares. Also referred to as ask price
Settlement date The date that an asset is delivered to or by an entity. Generally, financial instruments
‘settle’ within a few days of the trade date
Spot price The current price at which a particular item can be bought or sold
Trade date The date that an entity commits itself to purchase or sell an asset
Transaction costs Under IFRS 9, transaction costs are incremental costs that are directly attributable
to the acquisition, issue or disposal of a financial asset or liability
An incremental cost is one that would not have been incurred if the entity had not
acquired, issued, or disposed of the financial instrument
Underlying item In derivatives, the index, security or other asset – such as shares or commodities –
on which the contract is based
* Standard & Poor’s 500, which is a stock market index of the top 500 US companies
Term Definition
Amortised cost The amount at which the financial asset of liability is measured at initial recognition
minus principal amount repayments, plus or minus the cumulative amortisation
(using the effective interest rate method) of any difference between that initial
amount and the maturity amount minus (for financial assets) any reduction for
impairment or uncollectability
Compound financial A financial instrument that contains both a financial liability and an equity
instrument component from the issuer’s perspective
Credit loss The difference between all contractual cash flows that are due to an entity in
accordance with the contract and all the cash flows that the entity expects to
receive (i.e. all cash shortfalls), discounted at the original effective interest rate
Credit risk The risk that one party to a financial instrument will cause a financial loss for the
other party by failing to discharge an obligation
Term Definition
Effective interest rate The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument or, when
appropriate, through a shorter period to the net carrying amount of the financial
asset or liability
Effective interest rate A method of calculating amortised cost and interest income or interest expense
method (EIM) using the effective interest rate of a financial asset or financial liability (or group of
financial assets or financial liabilities)
Embedded derivative A feature within a host non-derivative contract such that the cash flows associated
with that feature behave in a similar fashion to a stand-alone derivative. An
embedded derivative causes some or all of the cash flows that otherwise would
be required by the contract to be modified based on a specified interest rate,
security price, commodity price, foreign exchange rate, index of prices or rates, or
other variable
In the same way that derivatives must be accounted for at fair value in the
statement of financial position with changes recognised in the statement of
comprehensive income, so too must some embedded derivatives. IFRS 9 requires
that an embedded derivative be separated from its host contract and accounted for
as a derivative in certain prescribed circumstances
Equity instrument Any contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities
Fair value The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date
Financial guarantee A contract that requires the issuer to make specified payments to reimburse the
contract 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
Financial instrument Any contract that gives rise to both a financial asset of one entity and a financial
liability or equity instrument of another entity
Term Definition
Hybrid contract A contract that includes a non-derivative host and an embedded derivative. An
example is a convertible debt instrument which combines an interest-bearing debt
instrument (a non-derivative) with an option on equity shares (a derivative)
Insurance contract A contract under which one party (the insurer) accepts significant insurance risk
from another party (the policyholder) by agreeing to compensate the policyholder
if a specified uncertain future event (the insured event) adversely affects the
policyholder
Past due A financial asset is past due when a counterparty has failed to make a payment
when that payment was contractually due
Regular way contracts Contracts for the purchase or sale of financial assets that require delivery of the
assets within the time frame generally established by regulation or convention in
the marketplace concerned
Appendix 2 – Derivatives
Derivatives ‘derive’ their value from underlying financial instruments, commodities, prices or
an index and are widely used by entities to manage risk.
Examples of common derivatives are in the following table:
Common derivatives
Forward rate A contract that places an obligation on one party to buy a financial instrument,
contract commodity or currency, and another party to sell that instrument, commodity or currency
at a specified future date. Also called a ‘forward’. Forwards are OTC financial instruments,
whereby the terms of the contract are determined by the buyer and seller
As a forward involves an obligation to make an exchange, the value of the contract may be
either positive or negative to the holder if the price of the underlying item changes during
the term of the forward
Futures These are a form of forward contract traded on a formal exchange. As such, futures have
standardised terms to facilitate trading. They are often ‘closed’ by making an offsetting
trade on the exchange, or settled in cash without taking or making delivery of goods
Option A contract that gives the buyer/holder the right, but not the obligation, to buy or sell a
specified quantity of a commodity or other instrument at a specific price (exercise price
or strike price) at or within a specific period of time, regardless of the market price of that
instrument. There are many different types of options, but the two most common are put
options and call options (see below)
The seller/writer of the option is in the opposite position to the buyer, in that they have
the obligation to deliver or purchase the underlying item (or settle in cash) if the option is
‘exercised’ by the buyer
Unlike many other derivatives, for the buyer there is an initial price (or premium) for
purchasing the option. The buyer’s potential loss is limited to this amount, because if
the movement in the value of the underlying item is unfavourable from the buyer’s
perspective, they simply will not exercise the option and it will ‘expire’. Therefore, for the
option holder, the value of the option cannot be less than zero. For the seller, the potential
loss is unlimited and the value of the option may be negative
Call option An instrument that gives the buyer/holder the option to buy an underlying item at a
specific price (exercise or strike price). The option becomes more valuable to the buyer/
holder as the market price of the underlying item goes up, and less valuable as the price
goes down. When the market price is above the exercise price, it is said to be ‘in the money’.
For example, if the market price of a security is $7, the holder of a call option on that
security with a strike price of $5 could exercise the option and buy the security from the
option writer for $5, being $2 below the current market value
If the market price is below $5, the option is ‘ out of the money’ and would not be exercised
by the holder as it would be cheaper to buy the security on the market
Put option An instrument that gives the buyer/holder the option to sell the underlying item at a
specific price (exercise or strike price). The option becomes more valuable as the price of
the underlying item falls, and less valuable as the price goes up. When the market price is
below the exercise price, it is said to be ‘in the money’. For example, if the market price of
a security is $7, the holder of a put option on that security with a strike price of $9 could
exercise the option and sell the security to the option writer for $9, being $2 above the
current market value
If the market price is above $9, the option is ‘out of the money’ and would not be exercised
by the holder as they would be better off selling the security on the market
Swap Exchange of streams of payments over time according to specified terms. The most
common types of swaps are interest rate swaps and currency swaps (see below)
Common derivatives
Interest rate swap Swap in which the two counterparties agree to exchange interest rate flows over a period,
but without any principal being exchanged. Typically, one party agrees to pay a fixed
interest rate on a specified principal amount (notional principal) on a specified series of
payment dates, and the other party pays a floating rate on the notional principal based on
a market benchmark interest rate on those payment dates. The value of the swap to both
parties will change depending on the movement in the market benchmark interest rate
after the swap commences. For example, if the market benchmark interest rate goes up,
the swap party paying the fixed rate of interest will be better off as they will receive higher
interest payments going forward, while their obligations will not change – for them, the
swap will have positive value. In contrast, the swap will have negative value to the party
paying the floating rate. Often, interest rate swaps are net settled
Currency (foreign Swap that involves the exchange of a series of cash flows in one currency (e.g. US dollars)
exchange (FX)) for a series of cash flows in another currency (e.g. Japanese yen) on a specified schedule of
swap dates between two parties
The value of the swap will change depending on the movement in the relative values of
the currencies, and can be either positive or negative for either party at any given time
Under IFRS 9, derivatives are held for trading financial instruments and are measured at fair
value through profit or loss, unless they are designated hedging instruments in a hedging
relationship.
They are used predominantly as a means of managing financial risk that entities become
exposed to through their day-to-day operations.
Example – Derivative
George Miller grows wheat. He is concerned about the price he will obtain for this year’s crop.
The current price of wheat is $5.50 per bushel and the standard contract size in the futures
market is 5,000 bushels. George hopes the price will rise by the time he wants to sell his wheat
crop in six months. He has 500,000 bushels to sell. The market expects the price of wheat to be
$6.00 per bushel in six months.
George could take no action now and just hope the price increases by the time he comes to sell
his wheat. Another option is to hedge his price risk by selling the wheat forward in the futures
market so that he locks in a selling price of $6.00 per bushel. To do this he would sell 100 futures
contracts for delivery at $6.00 per bushel in six months’ time.
In six months, the price may fall lower than $6.00 per bushel. In this case, George has made more
on his wheat than if he hadn’t hedged his price risk. On the other hand, the price may rise to
above $6.00 per bushel. George would have been better off if he hadn’t hedged, but he thinks
the cost of the certainty he has created through hedging is worth paying to ensure he does not
receive less than $6.00 per bushel.
Net settling
If an entity enters into contracts to buy or sell non-financial items for the purpose of receipt
or delivery of those items in accordance with the entity’s normal business requirements, these
contracts are outside the scope of IFRS 9.
However, if the contracts can be settled net in cash or another financial instrument, an entity
may designate the contract as a derivative and IFRS 9 shall apply to it. The ability to settle net in
cash may not be explicit in the terms of the contract, but an entity may have a practice of settling
similar contracts net in cash. This may be done by entering into offsetting contracts or by selling
the contract before its exercise or lapse.
Embedded derivatives
An embedded derivative is a component of a hybrid contract that also includes a non-derivative
host. The effect is that some of the cash flows of the contract vary in a way similar to a stand-
alone derivative.
Examples of embedded derivatives are provided below.
•• A lease contract contains a provision for rentals to increase each year in line with inflation.
The entire lease contract is a hybrid contract containing a lease contract host and an
embedded derivative of the adjustment for inflation
•• A company in Australia sells iron ore in USD to a company in China with a functional
currency of Renminbi. The hybrid contract is the entire sale contract. The host contract is the
sales contract and the embedded derivative is the foreign exchange USD/CNY forward rate
implicit in the contract.
Contents
Introduction 10-3
Scope of IAS 36 10-3
Key concepts 10-4
What is an impairment loss 10-4
Impairment loss rules may be applied to an individual asset or to a cash generating
unit (CGU) 10-4
When to undertake impairment testing under IAS 36 10-5
Determining whether there is any indication that an asset may be impaired 10-5
Determining the recoverable amount 10-6
Determining whether to assess impairment at an individual asset level or at a CGU level 10-7
Accounting for an impairment loss under IAS 36 – individual assets 10-8
Determining and accounting for impairment losses under IAS 36 – CGUs and goodwill 10-9
Identifying a CGU 10-10
Consistency in determining the carrying amount and recoverable amount for a CGU 10-10
Complications with CGUs 10-12
Reversal of an impairment loss under IAS 36 10-15
Reversal of an impairment loss for an individual assets 10-16
Reversal of an impairment loss in a CGU 10-19
Other complications 10-20
Interim financial reporting and impairment 10-20
Existence of a non-controlling interest and the impact on goodwill impairment 10-20
Disclosures 10-20
fin11910_csg_03
Learning outcomes
At the end of this unit you will be able to:
1. Explain and account for an impairment loss for an individual asset.
2. Identify, explain and account for an impairment loss for a cash-generating unit (CGU)
including impairment of goodwill.
3. Explain and account for reversals of impairment losses.
Introduction
The value of an entity’s assets may fluctuate, particularly in challenging economic times.
Because of the risk of overstatement of assets, corporate regulators, including the Australian
Securities and Investments Commission (ASIC), often focus on compliance with IAS 36
Impairment of Assets. As per ASIC’s media release:
The recoverability of the carrying amounts of assets such as goodwill, other intangibles and property, plant
and equipment continues to be an important area of focus.
(Source: ASIC 2017, (Attachment to 16-428MR: ASIC calls on directors to apply realism and clarity to
financial reports), media release, December, accessed 16 April 2018, http://asic.gov.au/about-asic/media-
centre/find-a-media-release/2016-releases/16-428mr-asic-calls-on-preparers-to-focus-on-useful-and-
meaningful-financial-reports/)
The main purpose of IAS 36 is to ensure that the carrying amount of an asset does not exceed its
recoverable amount in the statement of financial position. The standard requires the recognition
of an impairment loss when this occurs.
Scope of IAS 36
Paragraphs 2–5 of IAS 36 identify the scope of the standard, which can be summarised
as follows:
FIN fact
An impairment loss is never allocated to a liability. Only assets can be impaired.
Required reading
IAS 36.
Key concepts
This section outlines some key concepts from IAS 36 that are critical to calculating and
accounting for an impairment loss.
Higher of*
* It is not always necessary to determine both an asset’s fair value less costs of disposal and its value in use.
If either of these amounts exceeds the asset’s carrying amount, the asset is not impaired and it is not
necessary to estimate the other amount (IAS 36 para 19).
The limousine is an individual asset that The factory is a CGU as the factory assets work
generates cash inflows from being hired together to generage cash inflows
Yes No
From these sources of information, the entity needs to consider the following when assessing
whether there is any indication of impairment:
•• Significant decline in the market value of an asset •• Evidence of obsolescence or physical damage
•• Significant changes that adversely affect the entity of an asset
in the technological, market, economic or legal •• Significant change in the use of an asset that
environment in which it operates adversely affects the entity
•• Increases in market interest rates or other market •• Declining economic performance, which might be
rates of return that are likely to affect the discount indicated by larger than expected maintenance
rate used to assess the present value of the future costs or lower than expected profits, from the use
cash flows from the asset of an asset
•• When the carrying amount of the entity’s net assets
exceeds the market capitalisation of the entity
Note that although IAS 36 paras 18–57 set out the requirements for measuring recoverable
amount for ‘an asset’, these provisions apply equally to an individual asset or CGU.
Any projections based on budgets or forecasts should ‘cover a maximum period of five years,
unless a longer period can be justified’. Projections for periods beyond the budgets or forecasts
are extrapolated using ‘steady or declining growth’ rates for subsequent years, unless another
rate can be justified (IAS 36 para. 33).
Further reading
IAS 36 Appendix A.
Yes No
Determine the recoverable amount for the Determine the recoverable amount at the
individual asset (IAS 36 para. 22) CGU level (IAS 36 paras 65–103) unless
This unit will look first at accounting for an impairment loss for an individual asset and then
look at how the rules are applied for assets within a CGU.
Learning outcome
1. Explain and account for an impairment loss for an individual asset.
The process for recognising an impairment loss calculated for an individual asset is shown
as follows:
No Yes
No Yes
Refer to Units 7 and 8 for the journal entry to recognise a revaluation decrement for an asset
measured on a revaluation basis.
Subsequent depreciation/amortisation
‘After the recognition of an impairment loss, the depreciation (amortisation) charge for the
asset shall be adjusted in future periods to allocate the asset’s revised carrying amount, less its
residual value (if any), on a systematic basis over its remaining useful life’ (IAS 36 para. 63).
As the carrying value of the asset has been reduced, future depreciation/amortisation charges
will be lower. This applies to assets measured at cost or on a revaluation basis. Accounting
for a change in depreciation/amortisation is discussed in Units 7 and 8.
Learning outcome
2. Identify, explain and account for an impairment loss for a cash-generating unit (CGU)
including impairment of goodwill.
It is common to have some assets that, while necessary to run a business, do not individually
generate cash inflows. For instance, in a manufacturing environment, the machinery used to
produce the inventory may be directly linked to the cash that is generated from the sale of
the manufactured goods. However, some items of machinery may work in conjunction with
other assets to produce the inventory. This machinery does not of itself generate a direct cash
inflow. Similarly, the head office of a manufacturing operation would not individually generate
cash inflows.
IAS 36 para. 66 requires that when it is not possible to identify an individual asset’s recoverable
amount, its recoverable amount must be determined in the context of the CGU to which the
asset belongs.
Recall that the definition of a CGU from IAS 36 para. 6 is:
… the smallest identifiable group of assets that generates cash inflows that are largely independent
of the cash inflows from other assets or groups of assets.
Accordingly, an impairment loss is generally calculated at the CGU level rather than for
individual assets within the CGU.
The accounting for an impairment loss calculated for a CGU can be shown as follows:
The CGU impairment loss is allocated to the relevant individual assets within the CGU (following IAS 36 rules)
The impairment loss journal entry reduces the carrying amount of the individual assets
within the CGU by the appropriate amount
Identifying a CGU
The following are key to identifying a CGU:
•• The requirement to identify the ‘smallest identifiable group of assets’ – for example, this
may mean drilling down below divisional management reporting lines to determine cash
inflows at a specific product or service level.
•• The generation of cash inflows rather than requiring the CGU to produce a net cash inflow.
You will find guidelines for, and useful examples of, the identification of CGUs in IAS 36
paras 67–73 and in IAS 36 Illustrative Example 1.
These guidelines and examples are a useful reference; however, the identification of a CGU
still requires professional judgement. In practice, management should document the factors
and internal management reporting structure that support how the entity’s CGUs have
been identified.
The focus in the FIN module is on the calculation and recognition of an impairment loss for
a CGU rather than the identification of an entity’s CGUs.
To ensure consistency in determining if there is an impairment loss, you will need to consider
how to calculate the carrying amount of the CGU based on the information provided for the
CGU’s recoverable amount.
Consistency can be demonstrated by considering the following examples.
Example – Applying consistency when determining the carrying amount and recoverable
amount for a CGU
This example illustrates how consistency is needed when determining the carrying amount and
recoverable amount for a CGU.
Stellar has two CGUs, Meteor and Comet, both of which are being tested for impairment.
Meteor– the recoverable amount has been determined on a VIU basis
The VIU for Meteor was determined by including the present value of the future cash flows
relating to Meteor’s:
•• assets within the scope of IAS 36
•• trade receivables
•• inventory
•• less trade payables.
The carrying amount of the Meteor CGU will be calculated by including the carrying amount
of the Meteor’s:
•• assets within the scope of IAS 36
•• trade receivables
•• inventory
•• less trade payables.
The VIU and carrying amount of the Meteor CGU are consistent when the two values are
compared to determine if there is an impairment loss for the Meteor CGU.
Comet– the recoverable amount has been determined by calculating its FVLCOD
The FVLCOD for Comet was determined by including the fair value of its inventory as
management assessed that a purchaser would buy Comet’s inventory as well as its other assets.
Therefore, the FVLCOD was measured as Comet’s:
•• assets within the scope of IAS 36
•• inventory.
The carrying amount of the Comet CGU will be calculated by including the carrying amount
of Comet’s:
•• assets within the scope of IAS 36
•• inventory.
The FVLCOD and carrying amount of the Comet CGU are consistent when the two values are
compared to determine if there is an impairment loss for Comet.
The impairment loss for the CGU can only be applied to assets within the scope
of IAS 36
Despite the fact that the recoverable amount and carrying amount of a CGU may include values
for balance sheet items such trade receivables, inventory and trade payables, an impairment loss
for a CGU can only be allocated to assets within the scope of IAS 36. Therefore, the following
items cannot be impaired under IAS 36:
Item Reason
Trade receivables Expected credit losses on trade receivables are recognised under IFRS 9
Trade receivables cannot be impaired under IAS 36 as they are outside the scope of IAS 36
Inventory Inventory is carried at the lower of cost and net realisable value under IAS 2
Inventory cannot be impaired under IAS 36 as it is outside the scope of IAS 36
Trade payables Trade payables are a financial liability. Liabilities are not impaired and cannot have
impairment losses allocated to them
IAS 36 only applies to those assets within its scope
FIN fact
A CGU’s carrying amount and recoverable amount should be calculated on the same basis,
with the same inclusions and exclusions. Consistency of the two calculations is the key issue.
2. Corporate assets
Corporate assets are assets other than goodwill that do not independently generate cash inflows
but are integral to the cash flows generated by a CGU, along with those of other CGUs. An
example of a corporate asset is a company’s head office.
When testing a CGU for impairment, IAS 36 para. 102(a) requires that corporate assets, or a
relevant portion thereof, be allocated to the CGU under review on ‘a reasonable and consistent
basis’. Where an allocation cannot be made on such a basis, IAS 36 para. 102(b) provides
appropriate guidance.
40% of the head office’s carrying amount is allocated to the plastics division CGU
when determining the impairment loss for the plastics division CGU
A portion of the impairment loss for the plastics There is no impairment loss in respect of the
division CGU is allocated to the head office asset head office relating to its 60% support for the
because of its 40% support to this division paper division CGU, as that CGU is not impaired
FIN fact
IAS 36 para. 105 specifies a floor for an impairment loss allocated to an individual asset
within a CGU. The asset cannot be written down below this floor.
Worked example 10.3: Accounting for impairment for a CGU with goodwill
[Available online in myLearning]
Learning outcome
3. Explain and account for reversals of impairment losses.
An entity which has recorded an impairment loss may find that the indicators that initially
required the asset or CGU to be impaired have reversed in a subsequent reporting period.
Therefore, IAS 36 para. 110 requires that:
An entity shall assess at the end of each reporting period whether there is any indication that an
impairment loss recognised in prior periods for an asset other than goodwill may no longer exist
or may have decreased.
Watch out for the need to reverse an impairment loss in a later reporting period
An
IAS 36 para. 111 requires an entity to consider external and impairment
internal sources of information that indicate that an impairment loss for goodwill
loss recognised in prior periods (either for an individual asset or cannot be
a CGU) may no longer exist or may have decreased reversed (IAS 36
para. 124)
Has the situation changed during the current reporting period? Consider…
The conditions for reversing an impairment loss are restrictive with IAS 36 para. 114,
specifying that:
An impairment loss recognised in prior periods for an asset other than goodwill shall be reversed if,
and only if, there has been a change in the estimates used to determine the asset’s recoverable amount
since the last impairment loss was recognised. If this is the case, the carrying amount of the asset shall,
except as described in paragraph 117, be increased to its recoverable amount. That increase is a reversal
of an impairment loss.
The amount of an impairment loss reversal is restricted by the requirements of IAS 36 (which
are explained below).
No Yes
Yes
Yes
No Yes
Calculation of the
Would the allocated reversal of the impairment ceiling value: the
loss cause the new carrying amount of any asset’s notional
individual asset to exceed the lower of that asset’s: carrying amount at the
1. recoverable amount, and end of the reporting
2. carrying amount (after depreciation/ period (after
amortisation), had no impairment loss been depreciation/
Yes
initially recognised (‘the ceiling’)? amortisation) as if
there had been no
No Yes impairment loss
Recognise the impairment loss reversal in profit or • Limit the allocation of the impairment reversal
loss for the individual asset for that individual asset to the lower of 1. and 2.
• Allocate the excess that would otherwise have
been allocated to the asset on a pro rata basis
to the other assets of the CGU so that no
individual asset exceeds the ‘ceiling’
Activity 10.1: Accounting for impairment and subsequent reversal for a CGU
[Available online in myLearning]
FIN fact
IAS 36 specifies a ceiling for an impairment loss reversal for individual assets (para. 117) and
assets within a CGU (para. 123). The reversal cannot result in the individual asset be written
up above a specified value.
Other complications
Further reading
IAS 36 Illustrative Example 4.
IFRIC 10 paras 3–9.
Disclosures
The disclosure requirements of IAS 36 are located in paras 126–137.
Required reading
IAS 36 Illustrative Example 9.
Quiz
[Available online in myLearning]
Learning outcomes
At the end of this unit you will be able to:
1. Explain and account for a provision.
2. Identify and explain a contingent liability.
3. Identify and explain a contingent asset.
Introduction
IAS 37 Provisions, Contingent Liabilities and Contingent Assets prescribes the accounting and
disclosure requirements for provisions and provides guidance on when and how to disclose
contingent liabilities and contingent assets.
Some provisions are not governed by IAS 37, as they fall under other standards. These include
employee benefits, including termination benefits, which are covered by IAS 19 Employee Benefits.
All provisions, however, have one thing in common: they are based on estimates of future cash
flows and, therefore, their measurement and recognition are subject to significant professional
judgement.
As a result, they are susceptible to over-optimism, over-cautiousness or error. Common
problems that may arise with provisions include:
•• Using provisions for profit smoothing (i.e. debiting or crediting a provision, with
a corresponding credit or debit to profit, to achieve the profit outcome desired by
management).
•• Increasing provisions to cover any possible future liability.
•• Creating ‘big bath’ provisions – a term used to describe the practice of recognising certain
expenses immediately (i.e. debit expense, credit provision) and thus making future profits
appear stronger.
Learning outcome
1. Explain and account for a provision.
Recognising provisions
A provision exists and must be recognised when all of the following criteria are met:
(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision shall be recognised (IAS 37 para. 14).
Critical to the recognition of a provision is the requirement for there to be a present obligation.
A past event that leads to a present obligation is called an obligating event. An obligating event
is an event that creates a legal or constructive obligation, and therefore the entity has no realistic
alternative to settling the obligation created by the event. This is the case only:
•• where the settlement of the obligation can be enforced by law, or
•• in the case of a constructive obligation, where the event (which may be an action of
the entity) creates valid expectations in other parties that the entity will discharge
the obligation.
A constructive obligation arises if past practice creates a valid expectation on the part of a third
party, for example, a retail store that has a long-standing policy of allowing customers to return
goods within a specified period.
The fact that an entity is under a legal obligation to do something in the future does not create a
present obligation. For example, a realistic alternative for an entity may be for it to dispose of an
asset before the legal obligation relating to the asset arises. Examples 6, 11A & 11B in Part C of
the guidance on implementing IAS 37 provides further illustration of this point.
Required reading
IAS 37 (or local equivalent).
Measuring provisions
Having determined that a provision should be recognised, the next step is to measure it.
In practice, this can be one of the most difficult and contentious areas of financial reporting for
the entity.
The amount recognised must be the best estimate of the expenditure required to settle present
obligations at the reporting date, taking into account the risks and uncertainties that surround
the events and circumstances affecting the provision. It should reflect the amount that an entity
would rationally be required to pay to settle the obligation at the reporting date, or to transfer to
a third party at that time (IAS 37 paras 36 and 37).
The amount of the provision is estimated using the judgement of management, supplemented
by experience of similar transactions and, in some cases, reports from independent experts.
Events after the reporting date should also be considered (IAS 37 para. 38).
If settlement is expected to occur after more than one year, and the effect of the time value of
money is material, the amount should be discounted using a pre-tax rate specific to the liability.
The discount rate is not adjusted for risks that have already been taken into account in the cash
flow estimates (IAS 37 paras 45–47).
Note that gains from the expected disposal of assets are not included in the measurement of the
provision (IAS 37 para. 51).
At each reporting date, the provision needs to be remeasured and adjusted to reflect the current
best estimate. If the provision is measured using discounted cash flows, the carrying amount of
the provision will increase each year to reflect the passage of time and, hence, the unwinding of
the discount. This increase is recognised as a borrowing cost and treated as an expense (IAS 37
paras 59 and 60).
Onerous contracts
As per IAS 37 para. 10:
An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.
An onerous contract meets the three criteria for recognising a provision and, therefore,
a provision should be recognised for the unavoidable costs under the contract. The unavoidable
costs reflect the least net cost of exiting the contract, which is the lower of the cost of fulfilling
it and any compensation or penalties arising from failure to fulfil it (IAS 37 paras 66 and 68).
Restructuring provisions
Restructuring is a program, planned and controlled by management, which materially changes
the scope of a business undertaken by an entity or the manner in which that business is
conducted (IAS 37 para. 10).
As per IAS 37 para. 70, restructuring may occur due to:
•• the sale or termination of a portion of the entity’s business
•• a relocation of business activities from one country or region to another
•• a change in management structure.
A provision for restructuring costs can only be recognised where the three recognition criteria
are met (IAS 37 para. 71).
A constructive obligation to restructure only arises where management has developed a formal
plan for the restructure and has communicated that plan to those affected. The mere intention
of management to carry out such a plan is not enough for a provision to be recognised (IAS 37
para. 72).
A restructuring provision shall only include expenditure that is necessarily entailed by the
restructuring. As per IAS 37 paras 80–83, a restructuring provision does not include any items
which are associated with the ongoing activities of the entity, such as:
•• Retraining or relocating continuing staff.
•• Marketing.
•• Investment in new systems and distribution networks.
•• Identifiable future operating losses up to the date of restructure.
•• Gains on the expected disposal of assets.
In relation to item (c) above, IFRIC 1 para. 8 requires the effect of the unwinding of the discount
to be recognised in profit or loss as a finance cost, as it occurs regardless of the model used to
account for property, plant and equipment.
Many entities account for property, plant and equipment using the cost model, whereby an
increase in the provision arising under (a) and (b) above is capitalised as part of the cost of the
related asset and depreciated over the remaining life. A decrease in the provision is deducted
from the cost of the asset but is restricted to the asset’s carrying value; any excess is recognised
immediately in profit or loss.
Where entities account for property, plant and equipment using the revaluation model (fair
value), a change in the liability arising under (a) or (b) above does not affect the valuation of the
item for accounting purposes. The effect of the change in the liability is treated consistently with
the revaluation surplus or deficit previously recognised on that asset, where:
•• An increase in the liability is recognised as an expense in profit or loss, except to the extent
of a revaluation surplus relating to that asset, when it will reduce the revaluation surplus.
•• A decrease in the liability is recognised as an increase in the revaluation surplus relating to
the asset, except to the extent that it reverses a revaluation deficit that has previously been
recognised in profit or loss.
•• A decrease in the liability that exceeds the carrying amount that would have been
recognised had the asset been carried under the cost module, the excess is recognised
immediately as income in profit or loss.
Required reading
IFRIC 1 paras 1–8.
Employee benefits
Employee benefits are defined in IAS 19 para. 8 as:
… all forms of consideration given by an entity in exchange for service rendered by employees or for
the termination of employment.
IAS 19 does not provide a definition of the term ‘employee’; however, it specifies that
employees include ‘directors and other management personnel’ and that an employee may
provide services to an entity on a full-time, part-time, permanent, casual or temporary basis
(para. 7). In practice, it can be difficult to distinguish employees from contractors, and this is
an issue where there are related regulations (e.g. pay-as-you-go (PAYG) withholding tax in
Australia, or pay as you earn (PAYE) obligations in New Zealand).
The following table shows the different types of employee benefits.
Termination benefits (IAS 19 para. 159) •• The entity’s decision to terminate an employee’s employment
before the normal retirement date
•• An employee’s decision to accept voluntary redundancy
As these benefits are due within 12 months of the reporting date, they are measured on an
undiscounted (nominal) basis and recognised as both a liability (net of any amount already
paid) and an expense (unless permitted to be recognised in the cost of an asset) (IAS 19
para. 11).
The expected cost of an accumulating paid absence is recognised when the employee performs a
service that increases their right to future paid absences. This rule applies regardless of whether
the entitlement is vesting or non-vesting. However, a non-vesting entitlement is only included
as a liability at reporting date if it is probable the entity will be required to pay the employee for
the entitlement in the future.
The expected cost of a non-accumulating paid absence is recognised when the absences occur
(IAS 19 para.13).
The following decision tree can be applied to determine when a short-term paid absence should
be recognised.
Accumulating benefit
Yes No
An issue that arises on the measurement of employee benefits relates to the ‘on-costs’ associated
with employment. On-costs can include superannuation or KiwiSaver obligations, payroll tax
and workers’ compensation premiums. The compensated absences should be recognised based
on the expected cost to the entity, which therefore includes the on-costs related to the payment.
Annual leave Annual leave is an accumulating absence. Recognition occurs when the employee
renders the service that increases their entitlement to future compensated
absences (IAS 19 para. 13). The benefit is measured at the expected cost of the leave
entitlement (IAS 19 para. 16)
If the entity does not expect an employee to take their leave entitlement within
12 months, then the entity measures the leave entitlement by applying the rules for
long-term liabilities
Profit-sharing and bonus A liability is recognised for profit-sharing and bonus plans in accordance with IAS 19
plans para. 19 when:
•• The entity has a present legal or constructive obligation (i.e. established by
past practice) or otherwise has no realistic alternative but to settle the liability
as a result of past events, and
•• A reliable estimate of the obligation can be made
A reliable estimate can be made when at least one of the following conditions
is met (IAS 19 para. 22):
•• There are formal terms in the plan for determining the amount of the benefit
•• The entity determines the amounts to be paid before the financial statements
are signed off
•• Past practice gives clear evidence of the amount of the entity’s obligation
If the profit-sharing and bonus payments are not due wholly within 12 months
after the end of the reporting period, they are accounted for as ‘other long-term
employee benefits’ (IAS 19 para. 24)
Non-monetary benefits IAS 19 is unclear as to how the costs of non-monetary benefits (e.g. interest-free
loans, discounts on products purchased from the employer, or use of motor
vehicles) should be measured. One approach is to measure the expense based on
the net cost to the employer. For example, when a manufacturing company sells
goods to employees at less than cost, an expense should be recognised equal to the
difference between the selling price and the marginal production cost. Given the
lack of guidance, other approaches may be considered by entities accounting for
these non-cash forms of remuneration
The expectation for the year ended 30 June 20X4 is that 180 employees will take 10 or less
days of sick leave. The remaining 20 employees will take an average of 12 days of sick leave for
the year.
Based on these facts, the liability for sick leave would be calculated as:
•• Zero for the 180 employees who are expected to take 10 or less days per year.
•• 20 × (12 – 10) = 40 days for the 20 employees whose entitlement of two days carried forward
will be used in the year ended 30 June 20X4.
Therefore, a liability that should be recognised at 30 June 20X3 for 40 days, which is the sick
leave in excess of the annual entitlement that employees are expected to utilise in the following
period.
The liability will be measured by reference to the expected cost.
Required reading
IAS 19 paras 8–24 (Definitions of employee benefits only in para. 8).
Australia
A 2015 research commissioned by the Group of 100 and Actuaries Australia, and conducted by
actuarial firm Milliman Australia (Milliman), concluded that Australia now has a sufficiently
deep market in high quality corporate bonds and so corporate bond rates should be used
to discount long-term employee obligations. To support the report, Milliman will regularly
publish periodic yield curves that will be available for use in valuing employee liabilities.
Further reading
CA ANZ 2015, ‘Employee discount rates and AASB 119’, Accounting and Assurance News Today,
www.charteredaccountants.com.au → News & media → Newsletter → Archive → 05 June 2015.
New Zealand
It is generally agreed that New Zealand does not have a sufficiently active and liquid market
for high-quality corporate bonds, and so the market yield on the appropriate government
bonds is used to discount amounts denominated in New Zealand currency. The bonds must be
consistent with the currency that the liability is to be settled in, and the estimated term of the
liability (IAS 19 para. 83). The Treasury of New Zealand publishes a table of risk-free discount
rates that can be used.
Please note that for the purposes of the FIN module only, candidates will be provided with the
appropriate rates in a given scenario when answering a question.
Step 4: Multiply the cash flow by the probability that Ms D will receive her LSL benefit (i.e. will still be
employed when her LSL becomes payable) to calculate the LSL liability
Ms D’s LSL benefit is therefore:
$7,364 × 30% = $2,209
In accordance with IAS 19 para. 156, when recognising an expense to record the LSL obligation,
the total expense must be allocated between:
•• Service cost.
•• Net interest.
•• Remeasurement of the liability.
Net interest is the movement in benefit due to the unwinding of discount factors applied to
previous periods (i.e. the previous year’s liability multiplied by the discount rate).
Remeasurement of the liability may include actuarial gains and losses arising from a change
in assumptions in relation to discount rates, retention rates, expected salary increases and the
like. For example, if the probability of an employee receiving their LSL benefit changed from
30% to 25% then part of the movement in the liability would not be due to current service
but to changes in the actuarial assumptions, and would be disclosed as a remeasurement of
the liability.
Required reading
IAS 19 paras 156–171.
Termination benefits
Another common employee benefit arises when employee services are terminated. This type of
employee benefit differs from those considered previously: it is the termination, rather than the
service by the employee that gives rise to the obligation.
The requirements for recognising and measuring a termination benefit liability are provided in
IAS 19 paras 165–170. IAS 19 is used rather than IAS 37, which deals with other costs incurred
in a restructure.
Further guidance on the date at which the entity can no longer withdraw the offer of benefits is
provided in IAS 19 paras 166–167.
on the nominal value of benefits in the same way as other short-term benefits. If payment
is expected to be more than 12 months from the reporting date, the liability is calculated by
discounting the estimated cash flows in the same way as other long-term benefits.
Where voluntary redundancies are offered, the measurement of the termination benefits will
also require an estimation of the number of employees expected to accept the offer. However,
where uncertainty exists regarding the number of employees who may accept voluntary
redundancy, a contingent liability may exist, disclosure of which may be required under IAS 37
para. 28 (discussed later in this unit).
Contingent liabilities
Learning outcome
2. Identify and explain a contingent liability.
Para. 10(a) – possible obligation not There is no present obligation; Where an entity is jointly and
wholly within control of the entity however, a future event may create severally liable for an obligation,
an obligation for the entity such as in a partnership between
two parties shared on a 60:40
basis. The 40% obligation that is
The future event must not be expected to be met by the other
wholly within the control of the partner is an example of a possible
entity obligation to the 60% partner
Para. 10(b)(i) – present obligation There is a present obligation A legal claim against an entity in
arising from a past event where resulting from an earlier event, but which the entity concludes that it is
settlement is not probable the probability of an outflow is 50% liable but it is likely to successfully
or lower defend the case
Para. 10(b)(ii) – present obligation There is a present obligation An entity is being sued and it is
arising from a past event where resulting from an earlier event; unsure whether it will be able to
the amount cannot be reliably however, estimates of the outflow successfully defend the case. If it
measured required to settle the obligation are is unsuccessful, the amount of any
difficult to measure damages are uncertain
(Note that these situations are
considered to be rare)
Unit 15 discusses the importance of the distinction between the sub-categories of contingent
liabilities. Certain contingent liabilities are recognised when performing the accounting for a
business combination.
Contingent assets
Learning outcome
3. Identify and explain a contingent asset.
A contingent asset arises where the entity may receive an inflow of economic benefits. As per
IAS 37 paras 31–34, if the inflow is:
•• Virtually certain, then the asset is not contingent and should be recognised, normally
as a receivable.
•• Probable, then a contingent asset is disclosed.
•• Possible, but not probable, then no disclosure is required.
Disclosures
The key disclosure requirements of IAS 37 are located in the following paragraphs:
•• Provisions: paras 84, 85, 87 and 88.
•• Contingent liabilities: paras 86, 87, 88 and 91.
•• Contingent assets: paras 89, 90 and 91.
IAS 37 para. 92 provides some relief from compliance with the disclosure requirements where:
... some or all of the information … can be expected to prejudice seriously the position of the entity in a
dispute with other parties on the subject matter of the provision, contingent liability or contingent asset.
Where this exemption is applicable, the general nature of the dispute, together with the fact and
reason why the information has not been disclosed, must be stated in the financial report.
IAS 19 does not require specific disclosures for short or long-term employee benefits or
termination benefits; however, other Standards may require further disclosures.
Quiz
[Available online in myLearning]
Working paper F
You are now ready to complete working paper F of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Contents
Introduction 12-3
Background of IFRS 16 12-4
IFRS 16 overview 12-5
Scope of IFRS 16 12-6
Navigating IFRS 16 12-6
Identifying a lease 12-7
Understanding the characteristics of a lease 12-7
Does the contract contain a lease? 12-7
Lessee accounting 12-8
Recognition of the lease 12-9
Initial measurement of the lease liability 12-9
Initial measurement of right-of-use asset 12-11
Subsequent measurement 12-12
Other issues for lessees 12-13
Recognition exemptions for certain leases 12-14
Complex issues for lessees 12-15
Presentation and disclosure for lessees 12-16
Lessor accounting 12-16
Classifying a lease as an operating or a finance lease 12-17
Accounting for a finance lease 12-19
Accounting for operating lease 12-20
Presentation and disclosure for lessors 12-21
Sale and leaseback transactions 12-21
Tax effect implications of leases 12-24
fin11912_csg_09
Learning outcomes
At the end of this unit you will be able to:
1. Discuss the characteristics of a lease.
2. Explain and account for lease transactions (for lessees).
3. Explain and account for lease transactions (for lessors).
4. Explain and account for sale and leaseback transactions.
Introduction
Leasing is a common way for entities to obtain the use of assets without having to purchase the
assets outright. It is therefore an important source of medium- and long-term finance. For the
purposes of the FIN module, this unit will cover the accounting for lease contracts but will not
extend to cover the accounting for subleases and lease modifications.
IFRS 16 Leases prescribes the accounting and disclosure requirements for leases for both lessees
and lessors. IFRS 16 replaces the current treatment of accounting for leases under the existing
Accounting Standard IAS 17 Leases. The application of IFRS 16 to an entity with a 30 June
annual reporting year end is as follows:
An entity can adopt IFRS 16 early; however, if it does it must also apply IFRS 15 Revenue from
Contracts with Customers on or before it adopts IFRS 16.
Transitioning to IFRS 16 has major implications for lessees, as it permits a lessee to choose
between two approaches when first applying IFRS 16:
1 July 2018 30 June 2019 30 June 2020 1 July 2018 30 June 2019 30 June 2020
The FIN module will not examine the IFRS 16 transition approaches.
Background of IFRS 16
One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet.
Sir David Tweedie, Former Chairman of the IASB, April 2008, accessed 16 April 2018,
www.pwc.com/gx/en/communications/pdf/communications-review-april-2017.pdf
The IFRS 16 project was started as a joint project between the International Accounting
Standards Board (IASB) and the US Financial Accounting Standards Board. It was the boards’
original intention to develop a fully converged Standard; however, ultimately the two boards
chose different models. It took the IASB 10 years to develop and finalise IFRS 16.
Reason Explanation
A significant source of finance In 2014 the estimate of ‘off balance sheet’ lease commitments
was not recognised on the approximated US$3 trillion for listed companies reporting under IFRS or US
statement of financial position Generally Accepted Accounting Principles (GAAP)
An analysis by region revealed long-term lease liabilities were understated
by 32% of entities in Asia/Pacific, 26% in Europe and 22% in North America
Source: IFRS Foundation 2016, IFRS 16 Leases – Project Summary and Feedback
Statement, accessed 16 April 2018, www.ifrs.org
Reason Explanation
Lack of comparability in financial The accounting for a lease by lessees under IAS 17 differed between
statements entities and often by industry or region
Compound this difference in accounting treatment with the accounting
treatment that applies when an entity borrows funds to purchase an asset
outright. In that situation, the asset and liability are both recognised on the
statement of financial position. Ultimately, an entity is gaining economic
benefits from the use of an underlying asset. The accounting treatment
should not vary significantly when finance is used to obtain the benefits
from the use of an asset
As a result, market analysts and investors were not able to properly
compare entities that borrow to buy assets with those that lease assets
without having to make adjustments that involve significant estimates
This lack of comparability is in contrast with one of the IFRS Foundation’s
objectives in their mission statement, which states:
IFRS Standards bring transparency by enhancing the international
comparability and quality of financial information, enabling investors and
other market participants to make informed economic decisions
(Source: IFRS Foundation, www.ifrs.org)
IFRS 16 adopts a balance sheet approach, whereas the accounting treatment for a lessee under
IAS 17 was based on categorising the lease either as a finance lease (recognised on balance
sheet) or an operating lease (not recognised on balance sheet). This lease categorisation
required the exercise of significant professional judgement, with varying approaches taken
in practice and resulted in significantly different accounting treatment for the lessee as
explained below:
Finance lease A lease that transfers substantially A leased asset and lease liability are
all the risks and rewards of recognised on the statement of financial
ownership position
Interest expense and depreciation of the
leased asset are recognised in profit or loss
Operating lease Any other lease Operating lease expenses are expensed when
incurred over the life of the lease
IFRS 16 overview
IFRS 16 was developed to address the problems of off–balance sheet financing and lack of
comparability in financial statements. The treatment for most leases under IFRS 16 is that the
lessee must now recognise a right-of-use asset and lease liability on the statement of financial
position. The impact of this accounting treatment extends beyond journal entries. Applying this
accounting methodology has implications for an entity in areas such as:
•• Financial ratios and performance metrics (e.g. gearing ratios, return on capital employed,
and earnings before interest, tax, depreciation and amortisation (EBITDA)).
•• Loan covenants, as adverse movements in financial ratios may cause an entity’s loan
covenant to be breached. Loan covenants would need to be renegotiated with lenders to
prevent adverse impacts, such as higher interest rates and the potential for borrowings to be
immediately repaid.
•• Employee incentive (bonus) schemes and share-based payment arrangements, which could
be adversely impacted by reductions in profit.
Interestingly, lessor accounting under IFRS 16 is largely consistent with that under IAS 17, that
is, by accounting for a lease as either an operating or a finance lease.
The focus in this unit is on accounting for new lease transactions under IFRS 16 rather than how
an entity applies the transitional provisions of IFRS 16 for existing leases as it moves from the
IAS 17 accounting requirements.
Required reading
Read IFRS 16 paras 1–4 and 9–21 before proceeding.
Scope of IFRS 16
IFRS 16 applies to most common types of leases; however, there are various exclusions from its
scope, including:
•• Rights held by a lessee under a licensing agreement (e.g. for the use of a patent or copyright
accounted for under IAS 38 Intangible Assets).
•• Licenses for the use of intellectual property granted by a lessor (e.g. use of software, music
and trademarks accounted for under IFRS 15 Revenue from Contracts with Customers).
•• Leases to explore for or use minerals, oil and natural gas.
Navigating IFRS 16
The table below maps the key parts of IFRS 16 that will be covered in this unit. It also outlines
the paragraphs that details lease accounting, which should be read as you progress through
this unit:
Definitions Appendix A
Lessee accounting
•• Recognition and measurement Paras 22–46
•• Presentation and disclosure Paras 47–60
Lessor accounting
•• Classification of leases Paras 61–66
•• Finance leases – recognition and measurement Paras 67–80
•• Operating leases – recognition and measurement Paras 81–87
•• Presentation and disclosure Paras 88–97
Candidates may also find the application guidance in IFRS 16 Appendix B helpful in exploring
the key concepts.
Identifying a lease
Typically, the lessor has legal title of the asset, and the lease agreement will:
•• assign the right to use an asset for a specified time
•• specify payment amounts and dates
•• specify whether legal ownership will pass to the lessee at the end of the lease
•• specify other contractual obligations, including responsibility for maintenance and
insurance of the asset.
Yes
Yes
Neither
No
No
Yes
The contract contains a lease The contract does not contain a lease
Further reading
IFRS 16 Appendix B – Application guidance paras B9–B31.
Lessee accounting
Lessee accounting has changed significantly with the introduction of IFRS 16. This diagram
provides an overview of the key aspects a lessee will consider when accounting for a lease.
Analyse
the lease
contract
Does a
recognition No Recognise the lease on the Apply appropriate
exemption statement of financial position accounting
apply? treatment
Exemption — short-term Prepare
asset lease appropriate
Yes OR presentation
Exemption — low-value and
asset lease disclosures
A lessee entering into a lease contract for the use of an underlying asset will analyse the lease
agreement, which will determine its accounting treatment. The general accounting treatment for
a lessee reflects that, at the start of a lease, the lessee obtains both a right-of-use asset and a lease
liability. Later in this unit, we will consider exemptions from this general accounting treatment.
Required reading
Read the definitions of the following terms from IFRS 16 before proceeding:
• Commencement date of the lease.
• Economic life.
• Fixed payments.
• Inception date of the lease.
• Initial direct costs.
• Interest rate implicit in the lease.
• Lease incentives.
• Lease payments.
• Lease term.
• Lessee’s incremental borrowing rate.
• Residual value guarantee.
• Unguaranteed residual value.
Required reading
Read IFRS 16 paras 22–38 before proceeding.
Adapted from: Grant Thornton 2016, Major reforms to global lease accounting, accessed 16 April 2018,
www.grantthornton.ie/globalassets/1.-member-firms/ireland/insights/publications/grant-thornton---ifrs-16-leases-
special-edition.pdf.
Example – Identifying the interest rate to apply when measuring the lease liability
This example illustrates how to identify the interest rate that a lessee should apply to determine
the lease liability at the commencement date of the lease.
Re-read the definitions of ‘interest rate implicit in the lease’ and the ‘lessee’s incremental
borrowing rate’ to assist in understanding this scenario.
Boaty-Mac Limited is a lessee that enters into a lease arrangement for a ship from Deep Pockets
Limited.
The lease contract does not specify the interest rate implicit in the lease and Boaty-Mac does not
know the initial direct costs that Deep Pockets incurred in entering into the lease.
Boaty-Mac has to estimate its own incremental borrowing rate and does so by calculating an
interest rate that reflects:
•• the interest rate that would be charged if Boaty-Mac was to borrow over a similar term for an
asset of a similar value to the right-of-use asset embodied in the ship
•• the security it would need to provide to obtain such a borrowing
•• a similar economic environment
Boaty-Mac determines its incremental borrowing rate to be 8% and uses this when calculating
the lease liability at the commencement date and the interest expense on the lease liability.
[In the FIN module the interest rate implicit in the lease and/or the lessee’s incremental
borrowing rate will be stated. You will not have to perform these calculations.]
Example of items to be included in the initial measurement of the lease liability at the
commencement date:
Item Included? Explanation
Yes or No
Monthly lease payments under a three-year lease term Yes This is a fixed payment
Lease payments that will increase in line with increases in Yes This is a variable lease payment
the consumer price index that is based on an index
A fixed final payment that will result in the transfer of the Yes This is a purchase option which
legal ownership of the underlying asset at the end of the the lessee is reasonably certain
lease. The payment is considerably lower than the estimated to exercise
value of the underlying asset at the end of the lease term
and the lessee is intending to make this payment
Reimbursement of agent's commission to be made by the Yes This is a lease incentive receivable
lessor to a lessee relating to a premises under a lease
Substantial penalties to be paid for early termination No The lessee intends to use the
of a lease; however, the lessee intends to complete the underlying asset for the lease
lease term term and therefore termination
penalties would not apply
Legal costs incurred by the lessee for reviewing a No These will be included in the initial
lease contract measurement of the right-of-use
asset but are not included in the
lease liability
Compensation to be paid by a lessee to the lessor if the Yes This is a residual value guarantee
value of the underlying asset is below a specified amount at
the end of the lease†
†
It expects it will pay this compensation based on how it has used similar assets in the past.
5 30 June 20X8* –
* Note: The $15,000 optional payment is excluded from the lease liability calculation at the commencement
date as Alpha is not reasonably certain to exercise the purchase option.
Estimated costs
Lease liability to dismantle/ Lease
(amount Prepaid lease Initial
remove/ incentives
initially payments direct costs
restore (link to received
measured) Unit 11)
Adapted from: Grant Thornton 2016, Major reforms to global lease accounting, accessed 16 April 2018,
www.grantthornton.ie/globalassets/1.-member-firms/ireland/insights/publications/grant-thornton---ifrs-16-leases-
special-edition.pdf.
Subsequent measurement
Lease liability
Calculating the lease liability is very similar to amortised cost calculations for financial
instruments (covered in Unit 9):
Lease liability – subsequent measurement
Right-of-use asset
The subsequent measurement of the right-of-use asset can be shown as follows:
Right-of-use asset – subsequent measurement
Three options for measurement
1 2 3
Recognise any
impairment losses under IAS 36
Impairment of Assets
Depreciation
Ownership will transfer/ Other situations
purchase option will
be exercised
Based on an index or rate Based on any other variable In-substance fixed payments
(IFRS 16 paras 27(b) and 28) (IFRS 16 para. 38(b)) (IFRS 16 para. 27(a) and B 42)
• Included in the • Not included in the • Included in the
measurement of the measurement of the measurement of the
lease liability lease liability lease liability because
• The payments are • Recognised in profit or in substance they are
unavoidable as uncertainty loss when the event or unavoidable
relates to the measurement condition that triggers
of the liability rather than that event occurs
to its existence
Note that remeasurement of For example, the lessee has
the lease liability is beyond the choice to either exercise a
the scope of the FIN module purchase option to acquire
the underlying asset or extend
the lease term. The lower of
For example, variable lease For example, variable lease the discounted cash outflows
payments that are based on a payments that are based on a is the in-substance fixed
benchmark market interest percentage of sales revenue, payment as one of the
rate or market rental rate output or asset usage two options will be taken
Required reading
Read IFRS 16 paras 5–8 before proceeding.
Short-term lease
The lease has a term of 12 months or less from the commencement date. A purchase option in
the lease agreement excludes the use of this exemption.
This exemption is an accounting policy choice which must be applied for each class of
underlying asset.
Low-value assets
The assessment of whether an asset is low value applies to when the asset was new. According
to the IASB, it was thinking of an asset with a new value of under US$5,000 at the time of
reaching its decisions on this exemption (Basis of Conclusions para. 100). Typically this
exemption applies to items such as computers, phones and office equipment.
This exemption is an accounting policy choice, which can be made on a lease-by-lease basis.
Required reading
Read IFRS 16 paras 39–46 before proceeding.
Reassessing the lease liability The lease liability may need to be re-calculated if there is a change, including a
change to the:
•• lease term
•• future lease payments (e.g. changes made based on a market rent review)
•• intention to exercise a purchase option
Lease modifications The modification may need to be accounted for as a separate lease.
For example, when the modification adds the right to use an additional
underlying asset along with the use of the asset specified in the original
lease contract
The presentation and disclosure requirements of IFRS 16 for lessees are extensive. Key
requirements include:
•• Depreciation and interest expense (interest expense can be disclosed within finance costs).
•• Expense relating to short-term leases.
•• Expense relating to low-value assets.
•• Right-of-use assets (disclosed separately from other assets, either in the statement of
financial position or notes).
•• Lease liabilities (disclosed separately from other liabilities, either in the statement of
financial position or notes).
•• Statement of cash flows disclosures for the principal component of the lease liability, interest
on the lease liability and short-term lease payments, and payments for low-value assets.
Further reading
IASB 2016, IFRS 16 Leases – Effects Analysis, Appendix C Effects on a company’s financial statements:
illustrative examples, accessed 16 April 2018, www.ifrs.org/Current-Projects/IASB-Projects/Leases/
Documents/IFRS_16_effects_analysis.pdf
Lessor accounting
Accounting for a contract that is identified as a lease under IFRS 16 is essentially the same as
that under the existing IAS 17. Leases are classified as either operating leases or finance leases,
in accordance with their substance rather than their legal form.
This diagram provides an overview of the key aspects a lessor will consider when accounting
for a lease.
Required reading
Read the definitions of the following terms from IFRS 16 before proceeding:
• Fair value.
• Finance lease.
• Gross investment in the lease.
• Net investment in the lease.
• Operating lease.
• Lease term.
• Lessee’s incremental borrowing rate.
Required reading
Read IFRS 16 paras 61–87 before proceeding.
The classification of a lease is based on the substance of the transaction rather than the legal
form of the contract. The classification determines its accounting treatment (IFRS 16 para. 63).
When classifying a lease, ask this question:
Where do the risks and rewards incidental to ownership of the underlying asset
substantially reside?
The risks and rewards incidental to ownership of an underlying asset must be considered when
establishing the substance of the lease and therefore its classification, as shown in the table.
Risks and rewards incidental to ownership of an underlying asset (IFRS 16 Appendix B para. B53)
Risks Rewards
Possibility of losses from idle capacity Expectation of profitable operation over the economic
Possibility of losses from technological obsolescence life of the underlying asset
Variations in returns caused by changing economic Expectation of gain from an appreciation in value or
conditions realisation of a residual value
The following table summarises typical situations and indicators to look for when classifying
a lease:
Normally leads to finance lease classification May lead to finance lease classification
The above situations and indicators are not always conclusive. If it is clear from other features of
the lease that it does not transfer substantially all the risks and rewards incidental to ownership,
then classify the lease as an operating lease (IFRS 16 para. 65).
The accounting treatment for a lessor under IFRS 16 can be summarised as follows:
The classification between operating and finance lease does not apply to the lessee. The lessee
will apply the appropriate accounting explained earlier in this unit (e.g. recognise a right-of-use
asset and lease liability, short-term lease accounting, or low-value asset accounting)
Initial recognition
The lease receivable recognised by the lessor as an asset at the commencement of the lease is
determined by first calculating the gross investment in the lease. The calculation of the asset to
be recognised in the statement of financial position can be shown as follows:
Gross investment
in the lease
Lease payments
receivable by the
lessor
Discounted
The value of the
using the The net
lease receivable
interest rate investment
recognised in
implicit in the in the lease
the statement
lease
Unguaranteed of financial
residual value position at the
accruing to the commencement
lessor date
Notice how the lease payments receivable by the lessor are equivalent to the lease payments
payable by the lessee covered earlier in the unit.
Subsequent measurement
A lessor will account for lease payments under a finance lease as follows:
Lease payments are split between
Finance income on the lease receivable Reduction in the lease receivable (reduces the
recognised based on a constant periodic rate of principal of the asset balance)
return (using the interest rate implicit in the lease)
The calculations are very similar to those for financial assets categorised and measured
at amortised cost that were covered in Unit 9
• The underlying asset • Initial direct costs incurred • Recognise lease payments
subject to the operating by a lessor are added to the as income
lease is classified by its carrying amount of the • Recognise on a straight-line
nature in the statement of underlying asset basis over the lease term,
financial position • These costs are expensed unless another systematic
• Depreciate the asset over the lease term on basis is more appropriate
consistent with the the same basis as the
depreciation applied to lease income
similar assets of the entity
To record the operating lease payment received from Regi-Star for May 20X6
Note that Regi-Star would recognise a right-of-use asset and lease liability in respect of the lease
contract.
The presentation and disclosure requirements of IFRS 16 for lessors are extensive. Key
requirements include:
•• Finance income on the net investment in a lease.
•• A maturity analysis of the lease receivable for finance leases.
•• A maturity analysis of future lease payments to be received for operating leases.
•• Lease income for operating leases.
Required reading
Read IFRS 16 paras 98–103 before proceeding.
Sale
– transfer Asset
of ownership
for the Cash
Seller-lessee underlying asset Buyer-lessor
Leaseback
Lease payments – lease contract
The accounting treatment of sale and leaseback transactions under IFRS 16 can be summarised
as follows:
Sale and leaseback accounting
Transfer of the asset is a sale under IFRS 15 Transfer of the asset is not a sale
A challenging aspect of sale and leaseback accounting is determining the values of the right-
of-use asset and the gain or loss to be recognised (items 3 and 4 in the diagram above) for the
seller-lessee where the transfer is a sale.
Example – Determining the values for the initial accounting for the lessee where the
transfer is a sale
This example illustrates how to determine the values of the right-of-use asset and the gain or loss
to be recognised (items 3 and 4 in the preceding diagram) for the seller-lessee where the transfer
is a sale.
Facts
Carrying amount of asset before sale: $1.5 million
Sale consideration (at fair value): $2 million
Lease liability: $1.8 million
Portion of the gain not recognised Portion of the gain recognised (the balance)
Lease liability Sale consideration
Notional gain ×
______________________
at
fair value − lease liability
Sale consideration at fair value
Notional gain × _____________________________
Sale consideration at fair value
$1.8 million
$2 million
__________
$500,000 ×
$2 million − $1.8 million
___________________
$500,000 ×
$2 million
= $450,000
= $50,000 gain on sale
This portion of the gain cannot be recognised because
it reflects the rights that have been retained by the This portion of the gain is recognised because it reflects
seller-lessee the rights that have been transferred to the buyer-lessee
Asset 1,500,000
(Recording sale of asset, entering into the leaseback transaction and gain recognised in profit or loss)
Integrated activity 2
The integrated activity is available online in myLearning.
Quiz
[Available online in myLearning]
Working paper G
You are now ready to complete working paper G of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Contents
Introduction 13-3
Earnings per share 13-3
Importance of EPS 13-3
Scope of IAS 33 13-4
Basic and diluted EPS 13-4
Calculating EPS 13-4
Basic EPS 13-4
Diluted EPS 13-11
EPS for continuing and discontinued operations 13-17
Summary – calculating EPS 13-18
Disclosures 13-20
EPS presentation and disclosure requirements 13-20
Summary – disclosing EPS 13-21
fin11913_csg_03
Learning outcomes
At the end of this unit you will be able to:
1. Explain the requirements for disclosing earnings per share (EPS) information, including
which entities need to include EPS information.
2. Calculate basic and diluted EPS for continuing and discontinued operations.
Introduction
Earnings per share (EPS) is an indicator that measures an entity’s profitability relative to the
number of issued shares of that entity.
As a component of the price/earnings ratio, it is used for business valuation and as an indicator
of whether shares are expensive or cheap. It allows comparisons of relative profitability
between different entities in the same reporting period, and between different reporting periods
for the same entity.
IAS 33 Earnings per Share prescribes the principles for the determination and presentation of
EPS. It recognises that EPS data may have limitations due to the different accounting policies
being applied in the calculation of earnings (i.e. the numerator in the EPS calculation); however,
it focuses on the number of issued shares (i.e. the denominator in the EPS calculation) on the
basis that a consistently determined denominator enhances financial reporting.
In your role as a Chartered Accountant, it is likely you will be required to calculate EPS
and present EPS information as part of preparing financial statements, and/or apply your
understanding of EPS to interpret an entity’s performance.
Learning outcome
1. Explain the requirements for disclosing earnings per share (EPS) information, including which
entities need to include EPS information.
Importance of EPS
EPS is considered to be one of the most important indicators of profitability and is widely
used in the investment community. One of the reasons for its prominence is that it measures
profitability from an investor’s perspective. EPS is also used to calculate the price/earnings ratio,
a key indicator of both profitability and share price.
While EPS is useful in comparing a company’s profitability between different financial periods,
and to other companies in the same reporting period, it does have some limitations.
EPS does not take into account the capital contribution of ordinary shareholders; that is, the
amount a company receives in issuing the ordinary shares on issue. For example, if Company A
and Company B both earn profits of $1.5 million each and both have one million ordinary
shares outstanding during the financial period, each company would have the same EPS of
$1.50 per share. However, if Company A issued its shares at $1 each and Company B at $0.50
each, then clearly Company B has produced a better return on the capital from ordinary
shareholders.
Scope of IAS 33
IAS 33 applies to the following entities:
•• Entities that have their ordinary shares (or potential ordinary shares) traded in a public market.
•• Entities that file, or are in the process of filing, financial statements with a securities
commission for the purpose of issuing ordinary shares in a public market (IAS 33 para. 2).
Where consolidated and separate financial statements are prepared and presented together, EPS
is only required to be presented for the consolidated information (IAS 33 para. 4).
Any other entities that choose to disclose EPS must apply IAS 33 (IAS 33 para. 3).
Required reading
IAS 33 (or local equivalent).
Calculating EPS
Learning outcome
2. Calculate basic and diluted EPS for continuing and discontinued operations.
An ordinary share is defined in IAS 33 para. 5 as ‘an equity instrument that is subordinate to all
other classes of equity instruments’. On this basis, it is the substance of an equity instrument,
not its description that characterises it as an ordinary share for the purposes of the EPS
calculation.
Basic EPS
Basic EPS is calculated by dividing profit (or loss) attributable to ordinary equity holders of the
parent entity (the numerator) by the weighted average number of ordinary shares outstanding
(the denominator) during the period (IAS 33 para. 10), as follows:
Earnings
The ‘earnings’ used as the numerator in calculating EPS is the profit or loss attributable to the
parent entity.
As the EPS calculation relates to ordinary shareholders, earnings are adjusted for the effects of
any preference shares classified as equity.
Under IAS 33 para. 12, the numerator is determined after adjusting profit or loss attributable
to the parent entity for the following items after tax regarding preference shares classified
as equity:
•• Preference share dividends.
•• Differences arising on the settlement of preference shares.
•• Other effects of preference shares.
The profit after tax is adjusted for the preference share dividend, as it would be accounted for as
a dividend in accordance with IAS 32 para. 35.
There is no adjustment to basic earnings for the preference share dividend as it would be
accounted for as an expense (i.e. it has already been deducted in calculating profit after tax).
Item $
Fair value of ordinary shares issuable under original terms (100,000 × 2 × $2.50) (500,000
Loss deducted from profit or loss for the purposes of calculating EPS 250,000
Number of shares
Having discussed the numerator for basic EPS, the denominator is now considered.
An entity might issue or buy back ordinary shares during a financial period, or holders of
convertible instruments may convert those instruments to ordinary shares. For this reason, EPS
is calculated using a weighted average of the number of ordinary shares outstanding during
the financial period to provide a more accurate measure of the profit earned for each share
(IAS 33 para. 19).
The weighted average number of ordinary shares outstanding during the period is the number
of ordinary shares outstanding at the beginning of the period, adjusted by the number of
ordinary shares bought back or issued during the period multiplied by a time-weighting factor
(IAS 33 para. 20).
Time-weighting factor
The time-weighting factor is based on the number of days that the shares are outstanding as a
proportion of the total number of days in the period (usually 365).
Examples of dates for inclusion in the weighted average number of ordinary shares
In place of interest or principal on other financial instruments Date that interest ceases to accrue
As consideration for the acquisition of a non-cash asset Date when the acquisition is recognised
The following is an example of how the time-weighting factor is used to calculate the weighted
average ordinary shares outstanding.
365 2,495,8901
Note
1. 2,000,000 × 184 ÷ 365
The weighted average number of ordinary shares to be used in the EPS calculation is 2,495,890.
Refer to IAS 33 Illustrative examples – Example 2 for another example of calculating the weighted
average number of ordinary shares.
However, certain types of share issues do not result in a corresponding change in resources.
For example:
•• A capitalisation (dividend reinvestment) or bonus issue.
•• A rights issue with a bonus element.
•• A share split.
•• A reverse share split (share consolidation – IAS 33 para. 27).
This means that the weighted average number of ordinary shares would be adjusted for the
bonus element of a share issue that does not result in a corresponding change in resources,
as if those shares had always been on issue. This is done so that EPS is not distorted from period
to period for issues that do not result in additional resources.
At beginning 4*
01.07.X1–31.03.X2 274 4,800,000 4,800,000 4,804,384
of period 3
Bonus issue 01.04.X2–30.06.X2 91 1,600,000** 6,400,000 1,595,616
365 6,400,000
(1 + 3) = 4
* Bonus adjustment factor = 3 3
= 1
** Bonus issue 4,=
800, 000 # 3 1, 600, 000
Note: The resulting weighted average number of shares outstanding could be derived by simply
adding the original shares on issue to the bonus issue (4,800,000 + 1,600,000), as IAS 33 para. 28
requires the number of ordinary shares before the bonus issue to be adjusted as if the bonus
issue had always existed. However, calculating the adjustment factor is important when taking
into account other changes in ordinary shares during the period.
Refer to IAS 33 Illustrative examples – Example 3 for another example of calculating for bonus
issues.
Worked example 13.1: Calculating basic EPS including a bonus share issue
[Available online in myLearning]
Rights issues
In a rights issue, the entity offers existing shareholders additional shares in proportion to their
holdings, usually at a discount to the current market value. When offered at a discount to the
current market value, a rights issue has a bonus element.
The shares outstanding immediately before the rights issue are adjusted to reflect this bonus
element as if those shares had always been on issue. This is done as follows:
To adjust EPS for the current period, the weighted average number of ordinary shares before
the rights issue is multiplied by the adjustment factor, increasing the weighted average number
of shares on issue. This has the effect of decreasing EPS.
Conversely, to adjust EPS for prior periods, the EPS previously calculated should be divided by
the adjustment factor. This also has the effect of decreasing EPS.
The weighted average number of shares outstanding for the year ended 30 June 20X2 is
calculated as follows:
Weighted average number of shares outstanding for the year ended 30 June 20X2
365 25,108,932
Refer to IAS 33 Illustrative examples – Example 4 for another example of calculating EPS where
there has been a rights issue.
Required reading
IAS 33 Appendix A paras A1-A2, A15.
IAS 32 para. 35.
Diluted EPS
Defining diluted EPS
Diluted EPS is a measure of earnings per share taking into account the effects of all dilutive
potential ordinary shares (IAS 33 para. 32). However, before discussing how to calculate diluted
EPS there are some key terms to consider:
Potential ordinary shares are only used in the diluted EPS calculation if they are ‘dilutive’. This
means potential ordinary shares that are ‘anti-dilutive’ are ignored.
Change in earnings due to conversion Basic EPS/ (loss per share) from
Increase in number of ordinary shares on conversion 1 continuing operations
When determining whether particular potential ordinary shares are dilutive, each issue is
considered separately. Each type of potential ordinary share is considered in sequence from the
most dilutive (i.e. lowest earning per incremental share) to the least dilutive (i.e. highest earning
per incremental share), as the sequence may affect whether or not the potential ordinary shares
are dilutive. This is considered in more detail below.
Therefore, when calculating diluted EPS (as per IAS 33 para. 33), the earnings is the amount
used in the basic EPS, adjusted for the after-tax effect of the following:
•• Dividends or other items relating to dilutive potential ordinary shares that have been
deducted in arriving at the profit or loss attributable to ordinary equity holders of the
parent entity for the purposes of determining basic EPS.
•• Any interest recognised in the period relating to dilutive potential ordinary shares.
•• Any other changes in income or expenses resulting from the conversion of dilutive potential
ordinary shares.
The diluted EPS implications of a number of common types of potential ordinary shares will
now be considered:
Convertible debt
Convertible debt is a financial instrument that may be settled in cash or redeemed for a
specified number of ordinary shares. The conversion terms often vary depending on a range
of factors, including the timing of conversion and the share price.
Profit or loss attributable to ordinary equity holders Add back interest charged (net of tax) in respect of the
liability component of the convertible debt
7,000,000
$1,590,000 ÷ = $0.23
(5,000,000 + (1,000,000 × 2))
Diluted earnings is basic earnings adjusted by adding the interest on the convertible notes.
The weighted average number of shares used to calculate the diluted EPS is the weighted
average number of ordinary shares adjusted for the impact of the convertible notes.
Note: The convertible notes are ‘dilutive’ because their impact reduces the basic EPS.
Options/warrants exercised
2,250,000
$1,200,000 ÷ = $0.53
(2,000,000 + 250,000)
Note: Options are always dilutive because there is no corresponding impact on the profit.
Share-based payments
Share-based payment arrangements relate to the exchange of goods or services for shares or
options, including employee share options, and are governed by IFRS 2 Share-Based Payments.
This is covered in more detail in Unit 14.
An equity-settled share-based payment (e.g. an option), can be a potential ordinary share which
would need to be included when calculating diluted EPS.
As discussed above, contingently issuable ordinary shares are excluded from the calculation
of basic EPS until all conditions have been met. They are then included from the date the
conditions were met.
However, contingently issuable ordinary shares are included in the calculation of diluted EPS
from the beginning of the period or, if later, from the date of the contingent share agreement.
Where conditions have not been satisfied, the number of contingently issuable shares must
be calculated based on the number of shares that would be issuable if the end of the financial
period were the end of the contingency period (IAS 33 para. 52).
Two examples of circumstances where the issue of shares is dependent on conditions being met
in future periods follow:
•• If the share issue depends on meeting future profit targets, calculate the number of shares
that would be issued if profit at period end has met the required profit (IAS 33 para. 53).
•• If the share issue depends on future share prices, calculate the number of shares that would
be issued if the share price at period end is the contingency price (IAS 33 para. 54).
The examples above assume the contingently issuable ordinary shares are dilutive.
The following diagram summarises the treatment of contingently issuable shares:
YES
NO
Required reading
IAS 33 Appendix A paras A3–A9 and A16, Illustrative examples – Example 9.
When results are segmented between continuing and discontinued operations, there may be a
profit in continuing operations and a loss in discontinued operations, or vice versa. In this case,
there will be positive and negative EPS amounts presented (IAS 33 para. 69).
Use profit or loss attributable to the Use the number of shares outstanding at
parent entity for: the beginning of the period adjusted by
• Continuing operations the number of ordinary shares bought
• Discontinued operations back or issued during the period
• Continuing and discontinued (IAS 33 para. 20)
operations
Basic earnings adjusted for the effects of Weighted average number of ordinary
all dilutive potential ordinary shares
(IAS 33 para. 31) ÷ shares adjusted for the effects of all
dilutive potential ordinary shares
(IAS 33 para. 31)
Worked example 13.3: Calculating basic and diluted EPS for continuing and discontinued
operations
[Available online in myLearning]
Disclosures
Presentation
•• In the statement of profit or loss and other comprehensive income:
–– Basic EPS for continuing operations.
–– Diluted EPS for continuing operations.
–– Basic EPS for profit or loss attributable to the parent entity.
–– Diluted EPS for profit or loss attributable to the parent entity.
•• Basic and diluted EPS are to be given equal prominence.
•• Diluted EPS is to be provided for all periods if it is reported for at least one period, even if it
is the same as basic EPS (IAS 33 para. 67).
•• The statement of profit or loss and other comprehensive income, or the notes must include:
–– Basic EPS for each discontinued operation.
–– Diluted EPS for each discontinued operation (IAS 33 para. 68).
•• The basic and diluted EPS are to be presented even if the amounts are negative (IAS 33
para. 69).
Disclosures
•• Numerators for basic EPS and diluted EPS calculations, together with a reconciliation to
profit or loss attributable to the parent entity (IAS 33 para. 70(a)).
•• The weighted average number of shares used as the denominator in the basic EPS and
diluted EPS calculations, together with a reconciliation to each other (IAS 33 para. 70(b)).
•• Instruments that were not included in the EPS calculations because they are presently
antidilutive, but which could potentially dilute earnings per share in the future (IAS 33
para. 70(c)).
•• A description of ordinary share or potential ordinary share transactions that occurred
after the end of the reporting period that would have significantly changed the number
of outstanding shares (IAS 33 para. 70(d)).
Either in the statement of profit or loss and other comprehensive income or notes to the
financial statements for each discontinued operation (IAS 33 para. 68)
Quiz
[Available online in myLearning]
Contents
Introduction 14-3
Share-based payments 14-3
Share-based payment transactions 14-3
Identifying SBP transactions 14-3
Accounting for SBP transactions 14-4
Disclosures for SBP transactions 14-15
fin11914_csg_04
Learning outcome
At the end of this unit you will be able to:
1. Identify and account for share-based payments.
Introduction
Share-based payments
A share-based payment (SBP) is an arrangement whereby an entity settles a transaction with
shares, share options, or a cash figure linked to the value of shares. Share plans and share option
schemes often form part of employee remuneration packages, and some entities also use such
schemes to pay suppliers for goods and/or services.
An example of such an arrangement is one that existed between the social networking utility
Facebook and David Choe, the American graffiti artist who decorated the walls of Facebook’s
original headquarters in 2005. He was offered a cash payment of US$60,000 for his work but
instead opted to take shares in Facebook. It has been reported that these shares were worth
between US$200 million and US$500 million when Facebook made its initial public offering
(IPO) in May 2012.
Difficulties with accounting for such schemes include valuing the SBP and establishing when
it should be recognised in an entity’s financial statements.
IFRS 2 Share-based Payment provides guidance on the recognition and measurement of SBP
transactions.
An entity shall apply IFRS 2 in accounting for all SBP transactions.
Learning outcome
1. Identify and account for share-based payments.
Scope of IFRS 2
IFRS 2 applies in accounting for SBP transactions, including those that are settled by another group
entity on behalf of the entity receiving or acquiring the goods or services (IFRS 2 para. 3A).
IFRS 2 does not apply to transactions:
•• with an employee (or other party) in their capacity as a holder of equity instruments of the
entity (IFRS 2 para. 4)
•• in which the entity acquires goods as part of the net assets acquired in a business
combination, as defined by IFRS 3 Business Combinations, or the contribution of a business
on the formation of a joint venture, as defined by IFRS 11 Joint Arrangements (IFRS 2 para. 5)
•• in which the entity receives or acquires goods or services under a contract within the scope
of IAS 32 Financial Instruments: Presentation or IFRS 9 Financial Instruments (IFRS 2 para. 6).
IFRS 2 uses the term ‘fair value’ differently from the way in which it is defined in IFRS 13 Fair
Value Measurement, and therefore, when accounting for SBP transactions, the measurement
prescribed in IFRS 2 should be used.
Required reading
IFRS 2 (or local equivalent) and Appendix A – Defined terms.
The pro forma journal entry to record an equity-settled SBP transaction is as follows:
xx.xx.xx Expense/asset* xx
Equity* xx
* Account descriptions should be adapted to suit each specific equity-settled SBP transaction.
The issues associated with recording this journal in the financial statements are:
•• How should the expense or asset be measured?
•• When should the expense or asset be recognised?
For the remainder of this unit it is assumed that an equity-settled SBP is granted to employees
with the debit side of the transaction recognised in profit or loss as an expense.
Vesting period
(vesting conditions attached)
Vesting conditions
The diagram below shows the different types of vesting conditions:
Vesting conditions
Provided the executive satisfies the service condition, the remuneration expense for the three
years and the amounts accumulated in equity would be as follows:
Year end date Calculation Remuneration Equity balance
expense for period
$ $
The remuneration expense is recognised regardless of whether the market condition (i.e. the
achievement of the share price target) is achieved at 30 June 20X6 (IFRS 2 para. 21).
The journal entry to recognise the remuneration expense for the year ended 30 June 20X4 is:
Date Account description Dr Cr
$ $
Equity1 20,000
To record the remuneration expense relating to issuing 20,000 share options after one year of the
three‑year vesting period
1. IFRS 2 is not prescriptive on the accounting for the credit to equity in respect of an equity-settled share-based
payment. One common approach in practice is to put the credit to a share-based payment reserve until the award has
been settled and then make a transfer to share capital (although this is not permitted in some countries due to local
legislation), other reserves or retained earnings.
Adapted from: IFRS 2 Implementation guidance IG Example 5.
Non-market conditions (e.g. target earnings per share (EPS)) are not related to the market
price of an entity’s equity instruments. Non-market conditions are not taken into account when
estimating the fair value per equity instrument at measurement date (grant date). The fair value
per equity instrument at grant date is recognised as an expense over the vesting period based
on the best available estimate of the number of equity instruments expected to vest. The number
expected to vest is revised at each period end as necessary (IFRS 2 paras 19–20).
The calculation of remuneration expense for the year ended 30 June 20X4 is as follows:
Year Calculation Remuneration Equity balance
expense for period
$ $
20X5
At 30 June 20X5 Coco’s earnings had increased by 13% over the previous year. Four employees
left during the year.
At 30 June 20X5 Coco’s management expects that earnings will increase enough in the next year
so that the shares will vest on 30 June 20X6. Management also expects that an additional two
employees will resign during the year ending 30 June 20X6.
The calculation of remuneration expense for the year ended 30 June 20X5 is as follows:
Year Calculation Remuneration Equity balance
expense for period
$ $
20X6
Another three employees left during the year ended 30 June 20X6 and Coco’s earnings increased
by 9%.
The average increase in earnings over the 20X4–20X6 years is 13% ((17% + 13% + 9%)/3) and
therefore achieves the required minimum of 12%. Accordingly, the shares vest at 30 June 20X6.
Year Calculation Remuneration Equity balance
expense for period
$ $
Required reading
IFRS 2 Implementation guidance IG Examples 1A, 2 and 5.
xx.xx.xx Expense/asset* xx
Liability* xx
* Account descriptions should be adapted to suit each specific cash-settled SBP transaction.
Again, the issues associated with recording this journal in the financial statements are:
•• How should the expense or asset be measured?
•• When should the expense or asset be recognised?
Relevant details at the end of each of the three years of the vesting period are provided in the
following table:
Spitfire’s cash-settled SBP scheme period end details
Year end date Share price Number of employees who Number of employees
$ have left during the year expected to leave in the
future
30.06.X3 6.50 2 4
30.06.X4 7.25 3 1
30.06.X5 7.50 0 –
The liability is remeasured at each period end until it is settled. The liability is calculated as the
number of employees expected to remain in employment until the bonus is paid multiplied
by the number of shares on which the bonus is based multiplied by the fair value of the shares.
This is spread over the three-year vesting period.
Recognition of cash-settled SBP scheme
Required reading
IFRS 2 Implementation guidance IG Example 12.
Equity-settled Cash-settled
(IFRS 2 para. 30)
TRANSACTION
Remeasured to fair
REMEASUREMENT
Equity-settled Cash-settled
Do vesting Do vesting
conditions exist? conditions exist?
NO YES NO YES
VESTING CONDITIONS
Market Non-market
conditions conditions
(IFRS 2 para. 14) vesting period vesting period (IFRS 2 para. 32) vesting period
irrespective of based on best at fair value
whether market estimate of the to recognise the
condition is number of equity services received
satisfied instruments (IFRS 2
(IFRS 2 para. 21) expected to vest paras 32–33)
(IFRS 2 para. 19)
01.07.X4 3.75
30.06.X5 4.00
30.06.X6 4.10
30.06.X7 4.25
Harboard estimates that the fair value of the share alternative at grant date is $3.60 per share.
At grant date, the fair value of the share alternative is $72,000 ($3.60 × 20,000). The fair value of
the cash alternative is $67,500 ($3.75 × 18,000). Therefore, the fair value of the equity component
of the compound instrument is $4,500 ($72,000 – $67,500).
The equity component is recognised through profit or loss over the three-year vesting period
($4,500 ÷ 3 = $1,500 per annum).
The liability component based on the 18,000 shares is remeasured to fair value at each
period end.
Choice of settlement
YES NO
TREATMENT
The accounting treatment of employee share options depends on the terms of the options, as
detailed in the following table:
Treat the same as other options – even though they Treat the same as contingently issuable shares
may be contingent on vesting
Include the employee share options in the weighted Include the employee share options in the weighted
average number of ordinary shares outstanding from average number of ordinary shares outstanding from
the date the options were granted the date the options were granted
Include in the calculation of diluted EPS if dilutive Include in the calculation of diluted EPS if dilutive and
if the conditions in the contract would be met if the
period end were the contract period end
Adjust the weighted average number of ordinary Adjust the weighted average number of ordinary
shares outstanding during the period by the number shares outstanding during the period by the number
of actual shares to be issued, less the number of shares of ordinary shares that would be issued for free, if
that would have been issued for the same proceeds at the period end conditions were the contract end
the average market price for the period conditions
Required reading
IFRS 2 Implementation guidance IG Example 13.
Quiz
[Available online in myLearning]
Learning outcome
At the end of this introduction you will be able to:
1. Identify the appropriate classification for investments as subsidiaries, associates or joint
arrangements.
Introduction
Investment in another entity can be undertaken for a variety of reasons: to take advantage of
synergies, to diversify, for growth, or to eliminate competition. For example, South African
retailer Woolworths Holdings Limited acquired 100% of the Australian retailer David Jones
Limited in a $2.2 billion takeover. The combined business accelerated the implementation
of Woolworths’ strategies, and the resulting synergies have resulted in significant earnings
growth.
When acquiring 100% of an entity, the position of control is obvious, and the two sets of
accounts are consolidated under IFRS 10 Consolidated Financial Statements. However, in many
situations, determining control, joint control or significant influence requires considerable
professional judgement. These decisions are vital to the financial reports, as decisions about
control lead to different accounting and reporting requirements. Units 15–17 aim to help
candidates navigate situations where such decisions are required, and account for the various
investments.
As a Chartered Accountant working in a business environment that is becoming more global,
you will need to understand how to account for different levels of power an entity has over
another.
Classification of investments
We have previously covered accounting for relatively minor investments in ordinary shares in
Unit 9. This included ‘Fair value through OCI’ financial assets, which are accounted for under
IFRS 9 Financial Instruments.
Units 15–17 will cover the accounting treatment where the investment is more significant,
giving rise to:
•• Control (investment in subsidiaries).
•• Joint control (joint ventures or joint operations).
•• Significant influence (investment in associates).
fin11915-17csg_intro_03
It helps to have a clear vision of the flow of concepts covered in the upcoming units. The
thought process to be applied to determine the appropriate accounting treatment based on the
classification of the investment can be represented as follows:
Classify
Classify
thethe
investment
I(nvestmentbased
based
on on
thethe
level
level
of power
of power
Accounting
Classify thetreatment
I(nvestment is determined
based on the
by
the classification
level ofofpower
the investment
A simple summary of the accounting method associated with various levels of power is shown
below.
Investment
Accounting for
a financial asset,
IFRS 9
U9
Significant influence
Equity accounting, IAS 28
r
we
po
U17
sed
rea
Joint control
Inc
Control
Consolidation – IFRS 10
U16
The following detailed flow chart sets out the process of classifying investments for financial
reporting purposes and the accounting method to use for each classification. The relevant CSG
units and Accounting Standards are also noted.
More detail on each accounting requirement is given in the relevant unit.
combina
ess ti
in U15
on
s
Bu
s
Does the investor gain
control in the business
combination?
IFRS 3 Business
for subs
ing id
Combinations
nt U16 YES
ou
iar NO
Acc
Consolidation ies
nts and investments
in accordance
eme
with IFRS 10
g U17
in a
Disclosures per ran sso
IFRS 12 t ar cia
n te
oi Does the investor have joint control?
s
J
nt
Fin
s
Classify the joint arrangement Does the investor have Account for
in accordance with IFRS 11 significant influence over the NO the investment in
investee? accordance with
IFRS 9
IAS 28 Investments in
JOINT Associates and Joint Ventures Disclosures per
OPERATION IFRS 7
Account for assets, YES
liabilities, revenue
and expenses in JOINT INVESTMENT
accordance with VENTURE IN ASSOCIATE
IFRS 11
Disclosures per
IFRS 12
Equity accounting in
accordance with IAS 28
Disclosures per IFRS 12
Notice how the degree of power is mutually exclusive; for example, there cannot be both control
and significant influence exerted by an investor over another entity.
Term Explanation
Control An investor controls an investee when the investor is exposed, or has rights, to
variable returns from its involvement with the investee, and has the ability to affect
those returns through its power over the investee
Joint arrangement An arrangement over which two or more parties have joint control
Joint control The contractually agreed sharing of control of an arrangement, which exists only when
decisions about the relevant activities require the unanimous consent of the parties
sharing control
Joint operation A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the assets and obligations for the liabilities relating to the arrangement
Joint venture A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the net assets of the arrangement
Significant influence The power to participate in the financial and operating policy decisions of the
investee. It is not, however, control or joint control of those policies
As you progress through the last three units of the CSG, please remember to revisit these
diagrams to help you determine the correct accounting treatment.
Contents
Introduction 15-3
Links to other units 15-3
Identifying a business combination 15-4
What is a business combination? 15-4
Parent controls a subsidiary 15-5
Determining control and accounting for a business combination in the books of the acquirer 15-5
Acquisition method 15-5
Application of IFRS 10 in determining whether control exists 15-6
Definition of control 15-6
Analyse the facts to determine whether control exists 15-7
Explanation of terms in the flow chart 15-9
Acting as principal or agent 15-10
If control under IFRS 10 cannot be determined 15-11
Tax effect implications of business combination adjustments 15-17
Deferred or contingent consideration 15-18
Gain from a bargain purchase 15-22
Accounting subsequent to the initial accounting 15-22
Measurement period adjustments 15-23
Adjustments after the measurement period 15-24
Other accounting issues subsequent to the business combination 15-24
Contingent liabilities 15-24
Contingent consideration 15-25
Summary - acquisition method of accounting for business combinations 15-27
Disclosures 15-28
fin11915_csg_04
Learning outcomes
At the end of this unit you will be able to:
1. Identify a business combination.
2. Explain the concept of control.
3. Explain and account for a business combination in the books of the acquirer.
4. Account for subsequent adjustments to the initial accounting for a business combination.
Introduction
It is common for an entity to obtain control of another business. This transaction is known as
a business combination. IFRS 3 Business Combinations prescribes the accounting and disclosure
requirements for business combinations.
A business combination can be a complex transaction and it is critical that it is accounted for
correctly, as users of a financial report are likely to find this information important. They will be
particularly interested to know the value of the purchase consideration and the amount of any
goodwill paid for the acquired entity.
The focus in this unit is where one entity (the acquirer) obtains control of another entity
(the acquiree) by acquiring all or some of its equity, which results in a parent–subsidiary
relationship. This unit goes through the accounting requirements for a business combination
step by step.
Unit 15
• A business combination requires
one entity to control another
• The key focus is on calculating
the goodwill or gain from a bargain
purchase in a business combination
(IFRS 3 Business Combinations)
(IFRS 10 Consolidated Financial
Statements)
Unit 6 Unit 16
Many of the inputs to the business The goodwill or gain from a
combination accounting under IFRS 3 bargain purchase is recognised in the
are required to be measured at fair value consolidated financial statements
(IFRS 13 Fair Value Measurement) (IFRS 10 Consolidated Financial Statements)
Learning outcome
1. Identify a business combination.
This definition is dependent on the three elements that make up a business – input, process and
output. As explained in IFRS 3 Appendix B, input is the economic resource (e.g. assets) to which
a process is applied (e.g. an operational process) to provide output (e.g. a dividend) to benefit
stakeholders.
A ‘business combination’ arises where an ‘acquirer obtains control of one or more businesses’
(IFRS 3 Appendix A). IFRS 3 is applied when accounting for business combinations.
The following are examples of business combinations:
•• One entity purchasing another entity by acquiring its equity.
•• One entity purchasing a business from another entity by acquiring all or some of the net
assets.
•• The merger of two previously unrelated entities.
•• The establishment of a new entity to control previously unrelated entities.
Required reading
IFRS 3 paras 2–3, Appendix A Defined terms and Appendix B Application guidance para. B7.
Further reading
Evans S 2018, ‘I-MED Radiology eyes more acquisitions after 1.25b sale to Permira’, Australian
Financial Review, available at www.afr.com/business/banking-and-finance/private-equity/
imed-radiology-eyes-more-acquisitions-after-125b-sale-to-permira-20180128-h0pf5z, accessed
26 April 2018.
Learning outcomes
2. Explain the concept of control.
3. Explain and account for a business combination in the books of the acquirer.
Acquisition method
The acquisition method of accounting for business combinations as prescribed by IFRS 3 is
applied to a business combination. This method can be worked through as a series of steps, as
outlined below:
To identify the acquirer in a business combination, IFRS 3 requires there to be control, which is
determined under IFRS 10 Consolidated Financial Statements (IFRS 10). The linkages between the
two Standards in determining control can be shown as follows:
Definition of control
IFRS 10 para. 5 states:
An investor, regardless of the nature of its involvement with an entity (the investee), shall determine
whether it is a parent by assessing whether it controls the investee.
FIN fact
An investor that holds ≥ 50% of voting rights, in the absence of any other factors, controls the
investee.
This definition can be broken down into three key elements (IFRS 10 para. 7), as illustrated in
the diagram below:
Elements of control
An investor controls an investee if and only if the investor has all the following:
Control
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
Typically the investee is a separate entity (and that is our focus in this module).
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
Where it is not clear whether control of an investee is held through voting rights, a critical step
is identifying the relevant activities of the investee. Relevant activities are defined in IFRS 10
Appendix A as ‘activities of the investee that significantly affect the investee’s returns’.
Decisions affecting returns include those that relate to key strategic aspects of an investee’s
operations, such as operating, financial and capital policies, and appointing or terminating key
management personnel and determining their remuneration.
Step 1(c) – Determine whether the investor has power over the investee
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
Flow chart: How to determine whether an investor has power over an investee
Determine whether the investor’s rights provide ability to direct relevant activities
Does the investor own >50% YES YES Does the investor have
of substantive voting rights? power over structured entity?
NO NO
YES
Is there de facto control?
NO
NO
Power
Do other contractual
agreements, or some
combination of contracts, Unclear Consider factors in
voting rights and potential IFRS 10 paras B18−B20
voting rights provide
controlling power?
NO
No power
Term Explanation
Investor rights Different types of rights, either individually or in combination, can give an investor power
to direct the relevant activities, including:
•• Direction by voting rights – both current and potential (e.g. through options held)
•• Direction by other rights (including by contract) – typically arises from contractual
arrangements that may involve a structured entity (outside the scope of this module)
De facto control An entity can control another entity with less than a majority of the voting rights. Factors
to consider when determining whether an entity has de facto control include:
•• Size of the holding relative to the size, dispersion and voting pattern of other vote
holders
•• Potential voting rights
•• Other contractual rights
•• Any other facts that may indicate whether the investor has the current ability to
direct the investee’s relevant activities
Step 1(d) – Determine whether the investor has exposure, or rights, to variable returns from the
investee
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
This sub-step reflects the second element of control, which analyses the variability of returns.
A return may still be considered variable even if it is fixed under a contract – for example, fixed
performance fees for managing an investee’s assets are still considered variable as the investor
is exposed to the investee’s risk of non-performance (IFRS 10 para. B56).
Returns may be positive, negative, or both positive and negative. Examples include dividends
or other distributions, tax benefits, residual interests in the investee’s assets and liabilities,
and an investor’s ability to use the investee’s assets in combination with its own to achieve
economies of scale.
Step 1(e) – Determine whether the investor has the ability to use its power over the investee to
affect its own returns
STEP 1(a) STEP 1(b) STEP 1(c) STEP 1(d) STEP 1(e)
Identify the Identify the Determine Determine Determine
investee relevant whether the whether the whether the
activities of investor has investor has investor has the
the investee power over exposure, or ability to use its
the investee rights, to variable power over the
returns from investee to affect
the investee its own returns
The link between power over an investee and exposure to variable returns from involvement
with the investee is essential to having control. An investor that has power over an investee,
but cannot benefit from that power, does not control that investee.
Returns are often an indicator of control: the greater an investor’s exposure to the variability
of returns from its involvement with an investee, the greater the incentive for the investor to
obtain rights that give the investor power.
Principal Agent
(can control) (cannot control)
Decision-maker
The investor (decision-maker)
has the ability to use
its power to affect the amount
of its returns
If a single party holds kick-out rights that can remove a decision-maker without cause, then the
decision-maker is acting as an agent and not a principal (IFRS 10 para. B65).
Required reading
IFRS 10 paras 5–18, Appendix A Defined terms, Appendix B Application guidance paras B5–B28,
B34–B50, B55–B61 and B64–B67.
IFRS 3 paras 4–7; Appendix B Application guidance paras B13–B18.
JUPITER
100%
ordinary shares
PLUTO
100%
preference shares
SATURN
Jupiter Limited (Jupiter) purchased 100% of the ordinary share capital of Saturn Limited
(Saturn) from Pluto Limited (Pluto) and replaced Pluto’s directors with its own. Saturn operates a
profitable transport business that complements Jupiter’s medical equipment business, achieving
cost savings for Jupiter.
Pluto retains its preference shares in Saturn. These preference shares, which are all owned by
Pluto, give it the right to a fixed dividend each year before any dividends can be declared on
Jupiter’s ordinary shares. The preference shares do not have voting rights except on matters that
directly affect their rights.
Applying the five sub-steps to determine whether there is control:
1. Saturn is the investee.
2. The relevant activities are those involved in Saturn’s transport business.
3. Jupiter has power over Saturn because it controls all of the substantive voting rights in the
investee. The voting rights on the preference shares held by Pluto are not substantive as their
voting rights cannot direct the relevant activities of Saturn.
4. Jupiter is exposed to variable returns from Saturn, such as dividends on the ordinary shares.
5. Jupiter, acting as the principal, can use its power to direct Saturn, which will affect its own
returns.
Therefore, Jupiter is the acquirer in the business combination because it controls Saturn.
Having determined that an acquirer has gained control in a business combination, the
remainder of the acquisition method under IFRS 3 is applied.
The determination of the acquisition date is important as it impacts the amount of goodwill or gain
from a bargain purchase. To correctly calculate the amount of goodwill or gain from a bargain
purchase, the items listed below must be recognised and measured at the acquisition date:
•• Consideration transferred.
•• Identifiable assets acquired and liabilities assumed.
•• Any NCI.
•• Any previously held equity interest owned by the acquirer in the acquiree (for a business
combination that is achieved in stages).
The acquisition date is the date the acquirer gains control of the acquiree. This is generally when
the consideration is legally transferred in return for acquiring the assets and assuming any
liabilities of the acquiree.
The acquisition date is 15 February 20X5 – the date on which Bombe first obtained the power to
govern Alaska’s financial and operating policies through its ability to remove and appoint all of
the members of Alaska’s board. Accordingly, Bombe’s journal entry to record the 100,000 share
issue on 1 May 20X5 will value the shares at the acquisition date fair value of $5.20 per share.
Adapted from: IFRS Foundation: Training Material for the IFRS® for SMEs (version 2013-05)
Required reading
IFRS 3 paras 8–10 and 18.
Step 3 – Recognise and measure at acquisition date the identifiable assets acquired and the
liabilities assumed, as well as any NCI in the acquiree
IFRS 3 sets out the recognition and measurement principles relating to the acquiree’s
identifiable assets acquired, liabilities assumed and any NCI in a business combination.
Keep in mind that the acquisition method results in recognising a value for goodwill. It is only
when there is a business combination that goodwill can be recognised as an asset, as IAS 38
Intangible Assets prohibits the recognition of internally generated goodwill (covered in Unit 8).
Goodwill is defined in IFRS 3 Appendix A as:
An asset representing the future economic benefits arising from other assets acquired in a business
combination that are not individually identified and separately recognised.
FIN fact
There may be assets such as brand names that are recognised when calculating the amount
of goodwill acquired in a business combination. This is even though a particular Accounting
Standard may prohibit the acquiree from recognising the asset in its own financial statements.
When an acquirer does not obtain ownership of all of the equity of the acquiree, the equity that
was not acquired is an NCI. For example, when 80% of a subsidiary is acquired, the 20% not
acquired by the parent is recognised as the NCI. IFRS 3 requires an acquisition-date value to be
placed on the NCI in order to calculate the goodwill acquired.
At the acquisition date the acquirer recognises separately from goodwill, these items of the acquiree
(IFRS 3 paras 10–14)
Assets acquired and liabilities assumed must meet the definitions of For each business combination,
‘assets’ and ‘liabilities’ in the Conceptual Framework an acquirer can choose to value
any NCI (IFRS 3 para. 19 and
E.g. expected future costs such as restructuring costs cannot be
Appendix B paras B44–B45) at:
included in the calculation of liabilities assumed
• fair value (used in the full
goodwill method)
General measurement rule OR
Identifiable assets acquired and liabilities assumed are measured at fair • the NCI’s share of the
value at the acquisition date (IFRS 3 para. 18) acquiree’s fair value of
identifiable net assets (used in
the partial goodwill method)
Specific recognition rule for Specific recognition rule for
intangible assets contingent liabilities
Recognise identifiable intangible Even though the acquiree
assets acquired intangible assets would never recognise a
at fair value (IFRS 3 para. 13 and contingent liability in its own
IAS 38 paras 33–34) financial statements under
IAS 37, the accounting for a
business combination is
Examples of intangible assets different
recognised in a business Where a contingent liability of
combination (even if acquiree the acquiree is a present
had previously expensed obligation arising from a past
these costs) event that can be reliably
Brand names, trademarks, measured, its fair value is
customer lists, recognised, e.g. in relation to a
royalty agreements, patented law suit against the acquiree
technology and computer (IFRS 3 paras 22–23)
software (IFRS 3 Appendix B The fair value reflects market
paras B31–B34) participant expectations about
all possible cash flows, rather
than simply the likely or
expected maximum or
minimum cash flows
When applying IFRS 3 to calculate goodwill, the consolidated financial statements will
recognise:
•• Inventory of $400,000.
•• Plant and equipment of $2,900,000.
Explanation
IAS 2 Inventories requires inventory to be measured at the lower of cost and net realisable value;
however, IFRS 3 overrules this when accounting for a business combination.
[Unit 16 will explain that a consolidation journal entry will be recorded to recognise these fair
value adjustments in the consolidated financial statements. Later in this unit an acquisition
analysis will illustrate how these fair value adjustments are treated when goodwill is calculated.]
Required reading
IFRS 3 paras 10–14, 18–19, 21–26, 51–52, Appendix B ‘Application guidance’ paras B31–B34,
B44–B45.
IAS 12 para. 19.
IAS 38 paras 33–34.
The consideration transferred to gain control of the acquiree is not limited to cash paid. IFRS 3
identifies that there can be three different components to the consideration transferred as
shown below:
Consideration transferred
Measured under IFRS 3 para. 37 as the aggregate of the fair values of:
FIN fact
Acquisition related costs are not included within the consideration transferred. They are expensed
(IFRS 3 para. 53).
For the purposes of the FIN module, deferred and/or contingent consideration is confined
to situations that give rise to a liability. In order to measure the appropriate fair value, the
following rules are applied:
Typically the acquirer’s incremental As this can be complex, the fair value of
borrowing rate is used as the contingent consideration will be
discount factor provided in the FIN module
Required reading
IFRS 3 paras 37–40, 53.
IAS 32 para. 35.
IFRS 9 Appendix A (definition of transaction costs).
Step 5 – Recognise and measure the goodwill or gain from a bargain purchase
This is the final step in applying the acquisition method. The diagram below summarises some
of the key concepts covered so far:
Item Neptune
$
Neptune’s identifiable assets acquired and liabilities assumed were recorded at fair value except
for the following items:
Item Carrying amount at Fair value at
acquisition date acquisition date
$ $
Item $ $
FIN fact
Always include a value for the NCI at the acquisition date as part of the goodwill calculation when
a partly owned subsidiary is acquired.
•• If the NCI is measured at fair value, the full goodwill method is being used.
•• If the NCI is calculated as its share of the FVINA, the partial goodwill method is being used.
Worked example 15.2: Calculate goodwill when a partly owned subsidiary is acquired
in a business combination
[Available online in myLearning]
This process of re-examining the calculation could possibly identify an asset impairment when
reassessing asset fair values. Assuming this re-examination identified that an asset of the acquiree
needed to be written down, this will revise the initial calculation of the gain from a bargain purchase
Required reading
IFRS 3 paras 32–36.
Learning outcome
4. Account for subsequent adjustments to the initial accounting for a business combination.
IFRS 3 sets out rules for the accounting of certain issues after the acquisition date. Several of the
important matters are covered in this section. The emphasis is on how the goodwill calculation
may be impacted; however, the discussion could equally apply to a gain from a bargain
purchase.
The diagram below explains the accounting treatment of measurement period adjustments:
Goodwill is calculated at
the acquisition date as
per Step 5 (known as the
provisional calculation
when considering
measurement period
adjustments)
No, new facts/circumstances
during the measurement period
FIN fact
The amount of goodwill calculated at the acquisition date might change in the 12 months after
the acquisition date … if there is a measurement period adjustment.
Required reading
IFRS 3 paras 45–50.
Contingent liabilities
For the purposes of the FIN module, a contingent liability recognised in a business combination
is remeasured at each reporting date to the best estimate of the expenditure required to settle
the present obligation under IAS 37 para. 36.
•• Where the reporting date falls within the measurement period, this will result in the
goodwill being adjusted (as explained in the diagram on measurement period adjustments).
•• Where the reporting date falls after the measurement period ends, this will result in the
subsequent adjustment being recognised in profit or loss.
Contingent consideration
If additional information is obtained about facts and circumstances relating to contingent
consideration that existed at acquisition date, these are accounted for as measurement period
adjustments where they fall within the measurement period (as explained in the diagram on
measurement period adjustments).
However, events that occur after the acquisition date – for example, meeting an earnings target
or reaching a specified share price – are not measurement period adjustments. Changes in
the fair value of contingent consideration that are not measurement period adjustments are
accounted for as follows:
Cash 1,000,000
Cash 500,000
To record the payment of the additional consideration due to PeeWee achieving the profit target, with
the $100,000 expense recognised in profit or loss
1. IFRS 3 para. 58(b)(i) does not specify the account within profit or loss to use for this debit entry; however, this account
description is used in practice.
To derecognise the liability for the contingent consideration as the profit target was not achieved, with
the gain recognised in profit or loss
Required reading
IFRS 3 paras 54, 56 and 58.
Step 1
Control determined under IFRS 10 Consolidated Financial Statements
Identify the acquirer
Step 2
The date the acquirer gains control of the acquiree
Determine the
acquisition date
Step 3 Assets and liabilities of the acquiree are generally measured at fair value
NCI measured for each business combination at fair value (full goodwill method) or
Recognise and measure, proportionate share of fair value of identifiable net assets (partial goodwill method)
at acquisition date,
the identifiable assets Special rules set by IFRS 3 Business Combinations:
acquired and the liabilities
assumed, as well as any Recognition rule
non-controlling interest Contingent liabilities
(NCI) in the acquiree
Subsequent • The measurement period ends as soon as the acquirer receives the information it was seeking or
measurement obtains more information that was previously not obtainable. The measurement period cannot exceed
and accounting one year from the acquisition date
• Measurement period adjustments alter goodwill/gain from a bargain purchase when it subsequently
becomes known that: the cost of acquisition needs adjusting; assets or liabilities in existence at the
date of acquisition were not recognised; and assets or liabilities in existence at the date of acquisition
were recognised at values other than the measurement basis specified in IFRS 3
• Special rules for the subsequent accounting, which do not alter goodwill/gain from a bargain purchase,
are: contingent liabilities and contingent consideration
Disclosures
Due to the significance of a business combination to the economic entity, both at acquisition and
because of the anticipated long-term benefits, disclosures are extensive.
The information disclosed enables users of the financial statements to:
... evaluate the nature and financial effect of a business combination that occurs either:
(a) during the current reporting period; or
(b) after the end of the reporting period but before the financial statements are authorised for issue
(IFRS 3 para. 59).
Required reading
IFRS 3 paras 59–63 and Appendix B Application guidance paras B64–B67.
Quiz
[Available online in myLearning]
Contents
Introduction 16-3
Extra support with this unit 16-4
1. Integrated activity 16-4
2. Adaptive learning lesson 16-4
Tax effect implications of consolidated accounting 16-4
What is consolidation? 16-5
Consolidation process 16-8
Step 1 – Determine whether control exists 16-8
Preparing consolidated financial statements 16-8
Step 2 – Determine whether consolidated financial statements need to be presented 16-8
Step 3 – Ensure that the subsidiary’s accounting policies, reporting date and
presentation currency are consistent with the parent’s 16-9
Step 4 – Prepare all necessary consolidation eliminations and adjustments 16-10
Step 4(a) – Perform an acquisition analysis 16-11
Step 4(b) – Prepare any business combination valuation reserve entries 16-12
Step 4(c) – Eliminate the investment asset 16-17
Step 4(d) – Eliminate intragroup transactions and balances 16-18
Step 4(e) – Prepare the NCI allocations 16-23
Step 4(e)(i) – Calculate the NCI percentage 16-24
Step 4(e)(ii) – Calculate the NCI allocation 16-24
Step 4(e)(iii) – Record the NCI allocation 16-26
Step 5 – Prepare the consolidated financial statements 16-26
Separate financial statements 16-27
Assessing goodwill for impairment for partly owned subsidiaries 16-27
Consolidating a foreign subsidiary 16-30
Accounting for movements in investments 16-32
Acquisition of additional investment (step acquisition) 16-32
New issue of shares by a subsidiary 16-32
Disclosures 16-33
Learning outcomes
At the end of this unit you will be able to:
1. Explain how a business combination is accounted for in the books of the acquiree.
2. Explain and account for a consolidation for a wholly-owned subsidiary.
3. Explain and account for a consolidation for a partly-owned subsidiary.
4. Account for movements in the parent’s interest in a subsidiary
Introduction
When a parent entity has control over another entity, that entity is a subsidiary. The
consolidated financial statements of the parent and its subsidiaries (the group) are presented
as those of a single economic entity. Whether a Chartered Accountant is the preparer, auditor
or interpreter of consolidated financial statements, knowledge of accounting for subsidiaries is
critical to understanding and explaining the financial results and position of a group.
This unit explains the ongoing accounting requirements when a parent controls one or more
subsidiaries. It outlines the necessary steps to account for subsidiaries and prepare consolidated
financial statements. It follows on from the unit on business combinations; therefore, it is
recommended that you complete that unit first.
1. Integrated activity
Integrated activity 3 is based on a relatively straightforward scenario and provides an
opportunity for candidates to ‘dip in and dip out’ with their learning as they proceed through
the consolidation process outlined in this unit. It is not necessary to wait until the end of this
unit to attempt this integrated activity and, for some people, it might be a refresher from
university studies.
Integrated activity 3
The integrated activity is available online in myLearning.
What is consolidation?
Learning outcomes
1. Explain how a business combination is accounted for in the books of the acquiree.
2. Explain and account for a consolidation for a wholly-owned subsidiary.
3. Explain and account for a consolidation for a partly-owned subsidiary.
Consolidation is the process of presenting the financial statements of all entities within a group
as those of a single economic entity.
A summary of the key principles of consolidation is tabled below. It would be helpful for
candidates to have a basic understanding of the principles before proceeding with their study of
the consolidation process.
Owner is called ‘the The parent is the entity that has gained control in the business combination
parent’
Acquired entity is called The subsidiary may be wholly owned or partly owned by the parent
‘the subsidiary’ If the subsidiary is partly owned, a non-controlling interest (NCI) will need to be
recognised in the consolidated financial statements
Journal Dr Cr Journal
$ $ ref. $ $ ref. $
Statement
of profit or
loss
Consolidation entries are Consolidation journal entries are recorded on the consolidation worksheet and
made to many different may be made to accounts within the statement of financial position and the
accounts statement of profit or loss and other comprehensive income
Consolidation journal entries do not alter the general ledger of the parent or
the subsidiary. Rather, they must be posted into the consolidation worksheet at
each reporting period. This means that consolidation journal entries do not carry
forward to the next accounting period (unlike asset and liability balances within
the general ledger that do). As such, a current year consolidation journal entry
may need to reflect a transaction or an event that happened in an earlier year
For example, three years of amortisation for an asset recognised in a business
combination where the business combination occurred several years ago. The
consolidation journal entry would record the prior two years’ amortisation expense
against the opening retained earnings account while the current year’s charge
would be recorded to amortisation expense within the statement of profit or loss
and other comprehensive income
Goodwill of the subsidiary Goodwill is calculated by performing an acquisition analysis (which is covered in
acquired in the business the unit on business combinations)
combination is recognised The goodwill is not separately shown in the general ledger of the parent. It is
as an asset only through a consolidation entry that the goodwill asset is recognised in the
consolidated financial statements
The parent’s investment As the consolidated financial statements show the economic entity as one entity,
asset in the subsidiary is the parent’s investment asset in the subsidiary would be an internal investment, so
eliminated it must be eliminated
This is achieved through a consolidation journal entry, using the values from the
acquisition analysis that calculated the goodwill from the business combination
Video resource
The consolidation journal entry also has the effect of removing the parent’s share
of the subsidiary’s pre-acquisition earnings and reserves, as the net assets of the
subsidiary are included in the consolidated financial statements
Refer to the Unit 16 page on myLearning for a video demonstration of why
eliminating the investment asset avoids double counting
An NCI is recognised if The NCI is part of the economic entity and is considered to be a contributor of
the parent does not own equity. It is shown in the equity section of the statement of financial position
100% of the subsidiary within the consolidated financial statements
It may help to think that the economic entity (group) can include 100% of the
subsidiary’s net assets in the consolidated financial statements, despite only partly
owning the subsidiary, because it recognises an NCI within equity
Subsidiary’s equity in consolidated
financial statements
Parent’s share
75%
NCI
25%
Intragroup transactions If transactions occur within the economic entity, they must be eliminated through
are eliminated consolidation journal entries to avoid double-counting
FIN fact
Consolidation journal entries do not alter the general ledger of the parent or the subsidiary.
Therefore, consolidation journal entries do not carry forward to the next accounting period.
As such, a current year consolidation journal entry may need to reflect a transaction or an event
that happened in an earlier year.
One of the key effects of the consolidation journal entries is that the parent’s share of post-
acquisition earnings and reserves remain in the consolidated financial statements. Remember
that the shareholders of the parent will be particularly interested to know how a subsidiary has
performed since the parent gained control of it.
The diagram below is an example of a group structure which we will use to briefly apply some
of the key principles tabled above.
MIC ENT
O NO IT
Y
EC IM
RO
PR
S
E
60%
Acquisition
date 1 July 20X5
NCI
40%
C
S
A
RL
ET
Other
shareholders
40% NCI
Applying the principles of consolidation to the diagram above, we can determine that:
•• Primrose is the parent.
•• Scarlet is the subsidiary.
•• There is a 40% NCI in Scarlet. We do not need to know detailed information about the
NCI. It could be one shareholder owning 40% of Scarlet, or multiple shareholders whose
ownership interests total 40%.
•• The economic entity/group comprises Primrose, Scarlet and the 40% NCI.
•• Therefore, the consolidated financial statements will:
–– show 100% of post-acquisition earnings and reserves that Primrose has earned from
Scarlet since it gained control of the subsidiary on 1 July 20X5 and allocate 40% of them
to the NCI
–– recognise within equity that there is a 40% NCI in Scarlet.
Required reading
IFRS 10 Appendix A ‘Defined terms’ and Appendix B para. B86.
Consolidation process
The consolidation process can be worked through as a series of steps, as outlined below:
STEP
1 Step 1 – Determine whether control exists
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5
Determine Determine Ensure that the Prepare all Prepare the
whether control whether subsidiary’s necessary consolidated
exists consolidated accounting consolidation financial
financial policies, eliminations and statements
statements need reporting date adjustments
to be presented and presentation
currency are
consistent with
the parent’s
The process of determining whether control exists (Step 1) was covered in Unit 15 on business
combinations, where it was established that a business combination required the parent entity
to have gained control of the subsidiary in an acquisition. IFRS 10 defines ‘control’ and specifies
the three elements that must be present for control to exist (IFRS 10 para. 7).
Required reading
IFRS 10 paras 7–8.
Consolidated financial statements are prepared when there is control. Therefore, control is
not only required when the business combination occurs but also needs to be assessed on an
ongoing basis. It must also be reassessed if there is any indication of a change to any of the three
key elements of control (IFRS 10 para. 8).
STEP
2 Step 2 – Determine whether consolidated financial statements need
to be presented
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5
Determine Determine Ensure that the Prepare all Prepare the
whether control whether subsidiary’s necessary consolidated
exists consolidated accounting consolidation financial
financial policies, eliminations and statements
statements need reporting date adjustments
to be presented and presentation
currency are
consistent with
the parent’s
Once it has been established that the investor has control (and is therefore a parent), it must STEP
2
be determined whether consolidated financial statements should be presented or if an
exemption applies.
Australia-specific
According to AASB 10 Consolidated Financial Statements para. Aus4.2, there is no exemption
available for the ultimate Australian parent company if either the parent or the group (or both)
are reporting entities.
Required reading
IFRS 10 para. 4.
A parent that is required to prepare consolidated financial statements may need to make certain
adjustments as part of the consolidation process to ensure the subsidiary’s accounting policies
and presentation currency are consistent with its own financial statements. It may also need to
adjust the subsidiary’s reporting date to align it with that of its own.
Accounting policies
Consolidated financial statements should be prepared using uniform accounting policies for
like transactions and other events with similar circumstances (e.g. where an overseas subsidiary
adopts a different inventory valuation method that is not permitted under IFRS), requiring
consolidation adjustments to achieve uniformity among the entities in the group.
STEP An analysis of the subsidiary’s revenue recognition under both methods reveals:
3
Subsidiary’s revenue recognition
Ignoring tax, the consolidation entry required to achieve uniform accounting policies is:
Date Account description Dr Cr
$ $
To achieve a uniform accounting policy by applying the IAS 18 revenue recognition basis to the subsidiary
Notes
1. Last year’s revenue is reduced by $10,000 on consolidation, lowering that year’s consolidated profit.
2. By debiting revenue, the current year profit is reduced by $20,000 as required.
3. Deferred revenue of $30,000 should be recognised as a liability at 30 June 20X6, as the cash received to date
of $180,000 exceeds the $150,000 revenue recognised to date under IFRS 15 by $30,000.
Presentation currency
If an entity’s functional currency differs from the group’s presentation currency, the entity’s
financial statements need to be translated into the group’s presentation currency to enable
consolidation. Translation of financial statements from the functional currency to the
presentation currency is discussed in the unit on foreign exchange.
Reporting date
The reporting dates of subsidiaries should generally be aligned with those of the parent. In the
event that the reporting date of a subsidiary is different from that of its parent, the subsidiary
must make adjustments to its reporting cycle to enable consolidation.
Required reading
IFRS 10 paras 19–20, Appendix B Application guidance paras B87 and B92–B93.
STEP
4 Step 4 – Prepare all necessary consolidation eliminations and
adjustments
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5
Determine Determine Ensure that the Prepare all Prepare the
whether control whether subsidiary’s necessary consolidated
exists consolidated accounting consolidation financial
financial policies, eliminations and statements
statements need reporting date adjustments
to be presented and presentation
currency are
consistent with
the parent’s
Step 4 includes the identification, calculation and preparation of the consolidation entries. STEP
4
This step is usually the most complicated step in the preparation of consolidated financial
statements; however, identifying the issues that consolidation journal entries need to address
should make this step easier. To achieve this, Step 4 can be broken down into five sub-steps.
STEP
Step 4(a) – Perform an acquisition analysis 4a
STEP 4(a) STEP 4(b) STEP 4(c) STEP 4(d) STEP 4(e)
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
Acquisition date fair value BCVR entry to recognise the acquisition date fair value Step 4(b)
adjustments adjustments
Depreciation or amortisation entries after the acquisition date Step 4(b)
relating to these fair value adjustments
Consideration transferred Elimination of the investment asset entry as the consideration Step 4(c)
transferred is recognised within this asset
Gain from a bargain Elimination of the investment asset entry to enable the gain Step 4(c)
purchase to be recognised
STEP
4b Step 4(b) – Prepare any business combination valuation reserve
entries
STEP 4(a) STEP 4(b) STEP 4(c) STEP 4(d) STEP 4(e)
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
IFRS 3 generally requires identifiable assets acquired and liabilities assumed to be recorded at
fair value at the acquisition date. Depending on the circumstances, these adjustments will be
recognised in the subsidiary’s general ledger or as a consolidation entry. In the FIN module, the
approach taken to recording these fair value adjustments via a consolidation entry is to use a
BCVR account. Candidates may have been taught a different approach in their university studies,
but provided the same end result is achieved, various methods are accepted in the exam.
Think of the BCVR account as a consolidation suspense account that is used to process certain
fair value adjustments arising prior to the acquisition date. After processing all consolidation
entries, the balance in the BCVR should always be $0 because this account can never contain
post-acquisition movements.
FIN fact
Acquisition-date fair value adjustments to assets that are depreciated or amortised will also
require consolidation entries (including tax effect entries) for depreciation/amortisation.
A timeline will help you to calculate the depreciation/amortisation expense.
FIN fact
Think of the BCVR account as a consolidation suspense account that is used to process certain fair
value adjustments arising prior to the acquisition date.
The following diagram explains how acquisition-date fair value adjustments are recorded. STEP
4b
Acquisition-date fair value adjustments
Use the revaluation surplus account Use the business combination valuation
Recognise the fair value adjustment in the reserve (BCVR) account
subsidiary’s revaluation surplus account (net of tax) – Recognise the fair value adjustment in a
For example, Dr Plant and equipment, Cr Deferred consolidation entry to the BCVR (net of tax)
tax liability, Cr Revaluation surplus – For example, Dr Brand name, Cr Deferred tax
liability, Cr BCVR
Pre-acquisition revaluation surplus must be eliminated Pre-acquisition BCVR must be eliminated every year
every year
– Elimination of the investment asset Step 4(c) –
– Elimination of the investment asset Step 4(c) – eliminate the parent’s share of the BCVR
eliminate the parent’s share of the revaluation surplus
– Allocate to the NCI Step 4(e) – allocate the NCI’s share
– Allocate to the NCI Step 4(e) – allocate the NCI’s share of the BCVR
of the revaluation surplus
STEP
4b
Recognition of goodwill/gain from a bargain purchase
Goodwill/gain from a bargain purchase is calculated in the acquisition analysis.
Goodwill
The table below summarises how goodwill is recognised in the consolidated financial statements:
Wholly owned Not applicable Goodwill = The goodwill Goodwill is one No impact as
subsidiary as the Consideration asset is line within the there is no NCI
subsidiary is transferred less recognised elimination of
wholly owned FVINA within the the investment
elimination of the entry
investment entry
Partly owned
subsidiary
(i) Full goodwill The NCI is Goodwill = The goodwill The parent’s The NCI’s share
method measured at (Consideration asset is share of of the BCVR
fair value transferred + fair recognised in a the BCVR is is debited in
value of NCI) separate entry debited in the the NCI entry
less DR Goodwill elimination of (effectively
the investment allocates to the
FVINA CR BCVR entry NCI its share of
(The goodwill (The goodwill the goodwill)
asset recognised asset includes an
is higher than amount relating
that under the to the parent
partial method and an amount
as it includes an relating to the
amount that NCI)
relates to the NCI)
(ii) Partial The NCI is Goodwill = The goodwill Goodwill is one No impact as
goodwill measured at its (Consideration asset is line within the no goodwill is
method proportionate transferred + recognised elimination of allocated to the
share of the NCI’s % share of within the the investment NCI
subsidiary’s FVINA) elimination of entry
fair value of less the investment
identifiable net entry
assets (FVINA) FVINA
(The goodwill
(The goodwill asset is all
asset recognised attributable to
is the proportion the parent)
attributable to
the parent only)
FIN fact
Any goodwill acquired in a business combination will be recognised in the statement of financial
position every time consolidated financial statements are prepared.
Full Partial
goodwill goodwill
A gain from a bargain purchase is recognised as a credit within the elimination of the
investment asset entry (see Step 4(c)). In future reporting periods the gain is credited to opening
retained earnings as part of the elimination of investment asset entry.
STEP
4b
Example – Recognising a gain from a bargain purchase
This example illustrates how to recognise a gain from a bargain purchase that has been
calculated in an acquisition analysis.
On 1 July 20X4, Jupiter Limited purchased 100% of the ordinary issued shares of Pluto Limited for
a cash consideration of $580,000. Pluto’s business was in a declining market and its shareholders
were willing to accept Jupiter’s offer at a $20,000 discount to its net asset value. Any impairment
losses have been recognised in Pluto’s financial statements.
At the acquisition date the fair value of the recorded net assets of Pluto were:
Net assets at 1 July 20X4
Item $
Item $
When Jupiter’s consolidated financial statements are prepared at 30 June 20X5, the elimination
of investment asset entry will recognise this gain in profit or loss as the acquisition occurred
during the current year.
Date Account description Dr Cr
$ $
To eliminate Jupiter’s share of the pre-acquisition equities of Pluto, which are reflected in the cost of the
investment
FIN fact
A gain from a bargain purchase is recognised in the consolidated profit in the year of acquisition.
The gain will be recognised as a credit to opening retained earnings when future years’
consolidated financial statements are prepared.
STEP 4(a) STEP 4(b) STEP 4(c) STEP 4(d) STEP 4(e)
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
The parent’s statement of financial position will include an asset, being the investment in
the subsidiary.
Appendix B para. B86 of IFRS 10 requires both the carrying amount of the parent’s investment
in each subsidiary and the parent’s portion of equity of each subsidiary, to be eliminated.
Elimination of the investment asset through a consolidation journal entry is required because:
•• The consolidated financial figures represent the group, comprising a parent and its
subsidiaries. As it is not possible for an entity to show an investment in itself, the investment
asset in the parent’s records must be eliminated on consolidation.
•• When a parent acquires shares in a subsidiary, it is effectively gaining access to its relevant
share of the identifiable net assets of that subsidiary – hence the line-by-line inclusion of all
assets and liabilities of the subsidiary in the consolidation worksheet. The pre-acquisition
equity balances in the subsidiary’s records represent the other side of the net assets equation
and thus must be removed to avoid double counting.
•• Eliminating the parent’s share of pre-acquisition equities means that the parent’s share of
post-acquisition earnings and reserves remains in the consolidated financial statements.
•• Depending on the goodwill method applied, this consolidation entry recognises the
goodwill from the business combination as an asset.
FIN fact
The balance in the investment in subsidiary account should always be $0 after processing all
consolidation entries.
FIN fact
The acquisition analysis is reflected in the elimination of investment asset entry. This entry is
prepared every time consolidated financial statements are prepared.
Required reading
IFRS 10 Appendix B Application guidance paras B86 and B88.
Worked example 16.1: Recording entries to the BCVR account to recognise a fair value
adjustment for an asset
[Available online in myLearning]
Worked example 16.2: Eliminating the investment asset at the acquisition date
[Available online in myLearning]
Worked example 16.3: Preparing consolidation journal entries after the acquisition date
[Available online in myLearning]
STEP
4d Step 4(d) – Eliminate intragroup transactions and balances
STEP 4(a) STEP 4(b) STEP 4(c) STEP 4(d) STEP 4(e)
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
All intragroup assets, liabilities, equity, income, expenses and cash flows must be eliminated
in full in the consolidated financial statements. Profits or losses resulting from intragroup
transactions that are recognised in assets, such as inventory and fixed assets, must also be
eliminated in full.
IFRS 10 requires the elimination of intragroup transactions to be made in full as the NCI is
recognised in the consolidated financial statements as being part of the economic entity. The NCI
is adjusted to reflect its share of unrealised profits or losses on eliminated intragroup transactions
(this is covered in Step 4(e)).
Where there is an elimination adjustment required on a profit or loss arising from an intragroup
transaction, IAS 12 is applied to recognise any temporary difference.
FIN fact
When you alter profit on consolidation, a tax effect consolidation entry is generally required.
A visual representation of the relevant consolidation issues for each of these intragroup
transactions is presented in the five diagrams following.
For the purpose of these illustrations:
•• P is the parent.
•• S is the subsidiary.
•• P holds a 60% interest in S.
•• The year end is 30 June.
•• Any tax and NCI impacts are not considered.
These transactions are illustrated in the diagram below, including the consolidation journal STEP
4d
entries (shown to the right):
Group Consolidation journal entries
Loan of $100,000 at
10% interest per annum
Date Account description Dr Cr
advanced on 01.01.X3 $ $
P
30.06.X3 Loan payable 100,000
$5,000 interest due
on 30.06.X3 Loan receivable 100,000
$5,000 60% ownership $100,000
interest loan Being elimination of intragroup loan
As the loan and resultant interest are transactions that take place between entities within a
group, they are required to be eliminated when preparing consolidated financial statements.
FIN fact
The balance in the intragroup receivables and payables should always be $0 after processing all
consolidation entries.
As the sales and resultant purchases are transactions that take place between entities within a
group, they are required to be eliminated when preparing consolidated financial statements.
Note here that the direction of sale does not matter as the elimination entry simply totals
the sales and eliminates the whole of the intragroup transaction from the consolidated
financial statements.
This consolidation journal entry is recorded on the assumption that the inventory that was
transferred internally via the intragroup sales, has all been sold outside the group by year end.
If some of this inventory is still on hand at year end, an additional consolidation journal entry
will be required to eliminate any unrealised profit.
STEP
4d
Unrealised profit/loss on inventory transfer
From a consolidation perspective, profits and losses are not realised until there has been a
transaction (i.e. sale) to an entity outside the group, or the asset is consumed within the group.
For example, consider a scenario in which S purchases inventory from an external supplier for
$50 on 1 May 20X2. S then sells that inventory to P on 15 June 20X2 for $80, generating a profit
of $30 (i.e. $80 – $50). P subsequently sells the inventory to an external party on 1 August 20X2
for $140, generating a profit of $60 (i.e. $140 – $80).
These transactions are illustrated in the diagram below:
Group
1 Inventory cost S
$50 in 20X2
This transaction will have an impact on the consolidation process in both the 20X2 and 20X3 years.
First, consider its impact on the 20X2 consolidation process. At 30 June 20X2, the inventory is
still held by the group. As a result of this intragroup sale, the carrying amount of inventory
and profit are both overstated by $30 from the group’s perspective. The inventory is currently
recorded by P at $80, but the cost of the inventory to the group was $50. The profit of $30
generated by S on the sale to P is considered unrealised profit from the group’s perspective at
30 June 20X2. A consolidation adjustment is required at 30 June 20X2 to eliminate the unrealised
profit and reduce the carrying amount of the inventory. The consolidation journal entry for the
unrealised profit is as follows:
Inventory 30
Now consider the impact of the transaction on the 20X3 consolidation process. The inventory
is sold to an external party during the 20X3 financial year, and as a result the profit that was
considered to be unrealised in 20X2 from the group’s perspective has now been realised.
The total profit from the group’s perspective in relation to this sale is $90 (being $140 – $50).
As the amount of profit recognised by P on the sale to the external party is $60, a consolidation
adjustment is required in 20X3 to increase profit by $30. There will be a corresponding
adjustment required to opening retained earnings to reflect the fact that the profit was
unrealised at 30 June 20X2. The consolidation journal entry to recognise that the unrealised
profit has now been realised is as follows:
Cost of sales 30
Being elimination of unrealised profit in opening inventory that was sold during the year
1 Original cost of
asset is $120 on
S
01.07.X1
Useful life assessed
at six years
This transaction will have an effect on the consolidation process over a number of years,
commencing in 20X3 and continuing over the remaining useful life of the asset.
First, consider the impact on the 20X3 consolidation process. As a result of the intragroup sale,
the carrying amount of the depreciable asset and profit are both overstated from the group’s
perspective. The depreciable asset was initially recorded by P at $160, but the carrying amount
from the group’s perspective at the date of sale was $100. The profit of $60 generated by S on
the sale to P is considered unrealised profit from the group’s perspective at 30 June 20X3.
STEP A consolidation adjustment is required at 30 June 20X3 to eliminate the unrealised profit and
4d
reduce the carrying amount of the depreciable asset, as follows:
Asset 40
Being elimination of unrealised profit on depreciable asset sale and reinstate the original accumulated
depreciation
A further consolidation adjustment will be required at 30 June 20X3 to adjust the depreciation
expense that P has recognised. P will record a depreciation expense of $32 ($160 ÷ 5) for the
20X3 year. From the group’s perspective, the depreciation expense should be $20 ($120 ÷ 6)
based on the initial cost and useful life of the asset to the group. Therefore, a consolidation
adjustment is required at 30 June 20X3 to reduce the depreciation expense by $12, as follows:
Depreciation expense 12
For the remaining useful life of the asset, consolidation adjustments will be required to carry
forward the entry, to eliminate the original unrealised profit and adjust for the cumulative effect
of depreciation.
Intragroup dividends
Parent entities often receive dividends from subsidiaries, which must be eliminated on
consolidation. The amount eliminated is calculated by reference to the ownership interest of the
immediate parent of the subsidiary paying the dividend.
For example, consider a scenario in which S declared and paid a dividend of $10,000 during the
year ended 30 June 20X3. Of this dividend, $6,000 was paid to P.
P
Subsidiary declared and
paid a $10,000 dividend
$6,000 60% ownership
dividend
paid
A consolidation adjustment will be required at 30 June 20X3 to eliminate the $6,000 dividend
revenue in P’s accounting records and the corresponding $6,000 dividend paid in S’s accounting
records, as follows:
If a dividend has not been paid by the reporting date, the intragroup receivable and payable
relating to the dividend will also require elimination.
It is assumed that there is no tax effect resulting from the elimination of dividends due to
intragroup dividends being exempt from assessability under the prevailing tax laws.
Required reading
IFRS 10 Appendix B Application guidance para. B86(c).
STEP 4(a) STEP 4(b) STEP 4(c) STEP 4(d) STEP 4(e)
Perform an Prepare any Eliminate the Eliminate Prepare the
acquisition business investment intragroup NCI allocations
analysis combination asset transactions
valuation and balances
reserve entries
STEP NCI is the equity in a subsidiary that is not attributable, directly or indirectly, to the parent.
4e
As 100% of a subsidiary’s assets, liabilities, income and expenses are included in the
consolidated financial statements under the line-by-line consolidation process, in instances
where the group does not wholly own a subsidiary, the NCI is recognised within equity to
reflect the economic substance of the subsidiary’s ownership.
The NCI can be shown diagrammatically as follows:
Company A
80%
20%
Company B NCI
Required reading
IFRS 10 para. 22 and Appendix B Application guidance paras B94–B95.
The preparation of the NCI allocations can be broken down into three sub-steps, as illustrated
below:
The NCI is considered to be a contributor of capital to the economic entity. To the extent
that the equity of a subsidiary is not attributable to the parent, this will represent the NCI’s
ownership interest. Referring to the previous example of Companies A and B, there is a 20%
NCI percentage.
The NCI’s allocation of equity can be calculated as shown in the table below:
Component NCI
Under IFRS 10, 100% of a subsidiary’s equity (comprising both pre-acquisition and post-
acquisition balances) is initially included in the consolidation worksheet on a line-by-line basis.
Through a combination of the pre-acquisition investment asset elimination entry and the NCI
allocation, the remaining equity balances reflect the parent’s entitlement to each subsidiary’s
post-acquisition retained earnings and reserves. This method will therefore show what the
subsidiary has contributed to the group since control was obtained.
N OMIC ENT
IT
E CO Y
60%
Parent
NCI
Adjust NCI (and tax effect) for. . . Don’t adjust NCI for. . .
• Depreciation and amortisation re • Intragroup revenue/expenses
fair value adjustment at eliminated on consolidation with
DO acquisition of subsidiary DON’T
no unrealised profit impact
• The group sold an asset or (e.g. interest)
settled a liability of a subsidiary • Impairment of goodwill
that was the subject of a fair (partial goodwill method)
value adjustment on acquisition
• Impairment of goodwill
(full goodwill method)
Video resource
See the video on unrealised profits on inventory sales on myLearning.
STEP
4e Step 4(e)(iii) – Record the NCI allocation
STEP 4(e)(i) STEP 4(e)(ii) STEP 4(e)(iii)
Calculate Calculate the Record the NCI
the NCI NCI allocation allocation
percentage
The NCI is shown as a single line item in the equity section of the consolidated statement of
financial position.
FIN fact
The balance in the BCVR should always be $0 after processing all consolidation entries because
this account can never contain post-acquisition movements.
FIN fact
The balance in the share capital account should only be the parent’s own share capital after
processing all consolidation entries. The parent’s share of the subsidiary’s share capital must be
eliminated and the amount, if any, that belongs to an NCI is allocated to the NCI.
STEP
5 Step 5 – Prepare the consolidated financial statements
STEP 1 STEP 2 STEP 3 STEP 4 STEP 5
Determine Determine Ensure that the Prepare all Prepare the
whether control whether subsidiary’s necessary consolidated
exists consolidated accounting consolidation financial
financial policies, eliminations and statements
statements need reporting date adjustments
to be presented and presentation
currency are
consistent with
the parent’s
The consolidated statement of profit or loss and other comprehensive income, statement of
financial position and statement of changes in equity are prepared based on the output from the
consolidation worksheet.
Key statements from the Harvey Norman Holdings Limited’s 2016 Annual report were
displayed in Unit 2. Refer to these now to identify that they are consolidated financial
statements. For example, you will notice that there is a non-controlling interest in the equity
section of the statement of financial position.
Further reading
KPMG 2017, ‘KPMG Example Public Company Limited: Guide to annual reports – Illustrative
disclosures 2016–17’.
Review the layout of the key consolidated statements in this example report.
Australia-specific
Where a parent of a consolidated group that prepares consolidated financial statements does
not prepare separate financial statements for the parent entity, reg. 2M.3.01 of the Corporations
Regulations 2001 requires consolidated financial statements to include certain disclosures about
the parent, including:
•• Profit or loss.
•• Total comprehensive income.
•• Equity separated between issued capital and individual reserve balances.
•• Current assets, total assets, current liabilities and total liabilities.
•• Guarantees provided in support of a subsidiary’s debts.
•• Contingent liabilities.
•• Contractual commitments for the acquisition of property, plant and equipment.
•• Comparative information for the previous period.
The goodwill that arises from each business combinations relates only to that particular
subsidiary, rather than benefiting other entities in the Peacock group.
Assume that the only identifiable assets of each subsidiary are plant and equipment with
carrying amounts as follows:
Carrying amount of identifiable assets at 30 June 20X8
Alzir 700,000
Beid 800,000
For the purposes of the annual impairment testing of goodwill, the value in use for each CGU has
been determined as follows:
Value in use at 30 June 20X8
CGU $
Alzir 300,000
Beid 1,300,000
A fair value less costs of disposal cannot be measured for each CGU. Accordingly, the recoverable
amount for each CGU is its value in use.
To determine the carrying amount of each CGU, the carrying amount of the goodwill is added to
the carrying amount of identifiable assets for each subsidiary. The impairment loss can then be
determined as follows:
Carrying amount of each CGU at 30 June 20X8
Note 1 – As the partial goodwill method had been used for the business combination accounting for Beid,
the carrying amount of goodwill in Beid must be grossed up to reflect 100% of goodwill: $420,000 ÷ 70%
= $600,000. This adds $180,000 to the goodwill arising on the acquisition, effectively attributing a value for
goodwill to the 30% NCI.
This grossing up is a notional calculation, so that there is matching of like for like. The plant and equipment
value is a 100% amount; however, the goodwill value under the partial goodwill method is calculated as
belonging only to the parent and is therefore a 70% value.
It may seem there would be no impairment loss for the Beid CGU if the calculation were
performed without grossing up the goodwill. The carrying amount of the Beid CGU would be
$1,220,000 (i.e. $420,000 goodwill and $800,000 plant and equipment). With a recoverable
amount of $1,300,000 being higher than this carrying amount, this would suggest there is no
impairment loss. However, this approach is not in accordance with IAS 36 as it is not comparing
the grossed up value with the recoverable amount.
The impairment loss for each CGU, as correctly calculated in the table above, is first allocated to
that CGU’s goodwill and then, if there is a remaining impairment loss, it is allocated to the other
assets in the CGU (in this case plant and equipment) on a pro rata basis in accordance with IAS 36
para. 104. The impairment loss allocation for the Alzir CGU is as follows:
Alzir – allocation of impairment loss
The $100,000 impairment loss allocation for the Beid CGU is performed differently. Only $70,000
of this impairment loss for goodwill is actually recognised because the $100,000 impairment
loss calculated was based on 100% values using a notional grossed up value for goodwill. The
$30,000 difference ($100,000 – $70,000) is not allocated to Beid’s plant and equipment as it
results only from this notional calculation required by IAS 36.
The CGU impairment losses are recognised through consolidation journal entries as the goodwill
is only recognised as a separate asset when the consolidated financial statements are being
prepared (as explained in Step 4 of the consolidation process).
Date Description Dr Cr
$ $
To recognise the impairment loss for the Alzir CGU to reduce the goodwill to a revised carrying amount of
$0 and the plant and equipment to a carrying amount of $300,000
Date Description Dr Cr
$ $
To recognise the impairment loss for the Beid CGU to reduce the goodwill to a revised carrying amount of
$350,000
FIN fact
The goodwill acquired from a business combination involving the acquisition of a foreign
subsidiary is treated as an asset of the foreign subsidiary. The goodwill must be translated at the
spot rate at reporting date whenever consolidated financial statements are prepared.
Perform an acquisition analysis, prepare any BCVR entries and eliminate the
investment asset (Steps 4(a)–(c))
One fundamental issue when accounting for a foreign subsidiary is the treatment of goodwill
and fair value adjustments arising on acquisition.
IAS 21 para. 47 requires any goodwill arising on the acquisition of a foreign operation, and any
fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition
of that foreign operation, to be treated as assets and liabilities of the foreign operation. Such
balances are therefore expressed in the functional currency of the foreign operation and are
subject to translation into the group’s presentation currency each period. Assuming that
exchange rates move from what they were at the acquisition date, when preparing a later
consolidation this will mean:
•• There will be a foreign currency translation reserve (FCTR) balance within a fair value
adjustment entry because the BCVR is translated at the historical rate, while the asset,
accumulated depreciation and deferred tax balances are translated at the spot rate at the
reporting date.
•• Subsequent depreciation or amortisation adjustments arising from fair value adjustments
also have an FCTR balance because the depreciation or amortisation, being an expense, is
translated at the average exchange rate for the period, while the accumulated depreciation
or amortisation is translated at the closing rate at the reporting date.
•• There will be an FCTR balance within the elimination of investment entry, because parts of
the entry are translated at the historical rate while any goodwill, being considered an asset
of the subsidiary, is translated at the spot rate at the reporting date.
Required reading
IAS 21 para. 47.
•• Unrealised profits or losses on inventory and other asset transfers are eliminated using
the exchange rate applicable at the transaction date. There is no further requirement to
re‑translate any asset or liability components of this consolidation journal entry to the
period end rate.
•• Dividends declared are eliminated using the exchange rate applicable at the declaration date.
•• Intragroup payables and receivables are eliminated using the closing rate.
Tax-effect entries are calculated using the tax rate of the country holding the asset, rather than
the rate applicable to the entity that recognised the unrealised profit. This is because IAS 12
requires the recognition of a temporary difference since the tax base of the asset is different
from its carrying amount.
Further reading
Consolidating a foreign subsidiary
Learning outcome
4. Account for movements in the parent’s interest in a subsidiary.
This section covers two types of movements in a parent’s interest in a controlled entity:
•• The acquisition of an additional investment whereby an associate becomes a subsidiary
(a step acquisition).
•• The new issue of shares by a subsidiary.
Required reading
IFRS 3 paras 41–42.
Further reading
Accounting for movements in investments – step acquisitions
Required reading
IFRS 10 para. 23 and Appendix B Application guidance para. B96.
Disclosures
The disclosures concerning a consolidated group are found in IFRS 12. This Standard also
applies to disclosures for interests in joint arrangements and associates, which are covered
in Unit 17. While IFRS 12 also applies to interests in unconsolidated structured entities, these
disclosures are beyond the scope of this unit.
There are two main types of disclosures for interests in subsidiaries, as outlined in the
table below:
Significant judgements and An explanation of the significant judgements and assumptions made in
assumptions determining whether the entity controls another entity
Required reading
IFRS 12 paras 7–9, 10–13, 18–19.
Quiz
[Available online in myLearning]
Contents
Introduction 17-3
Differences between the equity method and the consolidation method 17-4
Applying the equity method 17-5
Complexities with equity accounting 17-14
Changes in ownership interests 17-14
Consolidating a foreign associate or joint venture 17-14
Recognising the tax effect of the equity carrying amount of the investment 17-14
Impairment of the investment in associate or joint venture 17-14
Discontinuing equity accounting 17-14
Significant influence and joint control 17-16
Identifying associates: significant influence 17-16
Establishing when joint control exists 17-17
Disclosures – interests in joint arrangements and investments in associates 17-18
fin11917_csg_05
Learning outcomes
At the end of this unit you will be able to:
1. Explain and account for an investment using the equity method.
2. Explain the concepts of significant influence and joint control.
Introduction
The diagram below is from the Introduction to Units 15-17. Now that you have covered
business combinations, it is worth reviewing the connections between the different units and
different Accounting Standards.
combina
ess ti
in U15
on
s
Bu
s
Does the investor gain
control in the business
combination?
IFRS 3 Business
for subs
ing id
Combinations
nt U16 YES
ou
iar
NO
Acc
ies
Consolidation
nt
Fin
s
Classify the joint arrangement Does the investor have Account for
in accordance with IFRS 11 significant influence over the NO the investment in
investee? accordance with
IFRS 9
IAS 28 Investments in
JOINT Associates and Joint Ventures Disclosures per
OPERATION IFRS 7
Account for assets, YES
liabilities, revenue
and expenses in JOINT INVESTMENT
accordance with VENTURE IN ASSOCIATE
IFRS 11
Disclosures per
IFRS 12
Equity accounting in
accordance with IAS 28
Disclosures per IFRS 12
Unit 9 discussed investments that fell under IFRS 9 Financial Instruments. Units 15 and 16 looked
at situations where control was established under IFRS 3 Business combinations, and consolidated
financial statements were prepared in accordance with IFRS 10 Consolidated Financial Statements.
This unit examines equity accounting. Equity accounting is applied in two different situations:
1. Investments in associates, where significant influence is established under
IAS 28 Investments in associates and Joint Ventures.
2. Joint ventures, where joint control is established under IFRS 11 Joint Arrangements.
The unit will start by examining how to apply the equity method of accounting, first by
introducing the differences between equity accounting and consolidations, and then by walking
through the equity method step-by-step.
Later sections discuss why you need to apply the equity method, and analyse the factors that
need to be considered when establishing significant influence under IAS 28 and joint control
under IFRS 11.
Key differences between the equity method and the consolidation method
Proportion of investee’s The investor’s share of the associate or 100% of a subsidiary’s balances
balances recognised joint venture’s post-acquisition earnings are included in the consolidated
and reserves are recognised and financial statements and 100%
generally the investor’s share of inter- of inter-entity transactions are
entity transactions are eliminated eliminated, with appropriate
adjustments to reflect any non-
controlling interest
View the video on myLearning for a more detailed explanation of the similarities and
differences between the equity method of accounting and consolidations.
Required reading
IAS 28 paras 10–11, 16 and 27.
IFRS 11 paras 24–25.
IAS 28 para. 35 requires the investor’s financial statements to be prepared using uniform
accounting policies for like transactions and other events in similar circumstances. If an
associate or joint venture uses accounting policies other than those adopted by the investor,
appropriate adjustments must be made when using that entity’s financial statements
(IAS 28 para. 36).
In the event that the reporting date of the associate or joint venture is different to that of the
investor, adjustment for significant transactions or events to align the financial statements with
those of the investor should be made. If this is impractical, a maximum difference of three
months between the end of reporting periods is permissible (IAS 28 para. 34).
Required reading
IAS 28 paras 33–36.
It is important to determine where to record the equity method journal entries and to identify
whether there are further accounting requirements in respect of the investment in the associate
or joint venture under IAS 27 Separate Financial Statements.
Accounts prepared by Where is the equity Nature of the equity Does IAS 27 also apply?
the investor method applied? journal entries
The investor prepares In the consolidated Equity journal entries are If the parent entity itself
consolidated financial financial statements notional (i.e. recorded holds the investment
statements as it is a in the consolidation in the associate or joint
parent entity in a group worksheet only) venture, then it applies
IAS 27 in its separate
financial statements.
In the parent’s separate
financial statements,
the investment can be
accounted for:
•• at cost, or
•• in accordance with
IFRS 9 Financial
Instruments, or
•• by applying the equity
accounting method in
accordance with IAS 28
The investor does not In the investor’s own Equity journal entries are No
prepare consolidated separate financial permanent (i.e. recorded
financial statements as it statements in the general ledger)
is not a parent entity in
a group
The activity for this unit assumes that the investor is a parent entity; that is, it prepares
consolidated financial statements. Therefore, the equity journal entries are recorded through the
consolidation worksheet as notional entries. The journal entries will need to reflect current year
movements in retained earnings and reserves as well as post-acquisition movements of prior
years, given that these notional entries do not carry forward from previous years.
Required reading
IAS 28 paras 2, 4 and 44.
IAS 27 para. 10.
Negative Investor’s share of the net Yes The negative goodwill is recognised
goodwill fair value of the investee’s as income in the determination of
identifiable assets and liabilities the entity’s share of the associate’s
less or joint venture’s profit or loss in the
year of acquisition. A corresponding
Investment cost adjustment is made to the equity
carrying amount
Item $
Timid’s identifiable assets acquired and liabilities assumed were recorded at fair value except
for an unrecorded brand name which had a fair value of $100,000 and an estimated remaining
useful life of five years.
(i) If Brave paid $250,000 for the investment
Calculation of goodwill
Goodwill acquired in Timid at 1 July 20X4
Item $ $
Assets acquired
The $46,000 in goodwill is included in the cost of the investment in Timid and does not
require an equity accounting journal entry to be recorded.
(ii) If Brave paid $150,000 for the investment
Calculation of negative goodwill
Negative goodwill on the acquisition of Timid at 1 July 20X4
Item $ $
Assets acquired
The ($54,000) in negative goodwill is included in the cost of the investment in Timid.
When the equity accounting entries are recorded for the first reporting period, the ($54,000)
will be recognised as income in the determination of the entity’s share of the associate’s
profit or loss (IAS 28 para. 32(b)).
Date Account description Dr Cr
$ $
To recognise the negative goodwill as income in the year that Brave acquired its interest in Timid
Required reading
IAS 28 para. 32
Sub-step 3a – Record the investor’s share of current year profits or losses of the associate
or joint venture
The investor recognises its share of the investee’s profit/(loss) for the financial period.
IAS 1 Presentation of Financial Statements para. 82(c) requires the share of the profit or loss
of associates and joint ventures accounted for using the equity method to be disclosed as
a separate line item in the statement of profit or loss and other comprehensive income.
To facilitate ease of disclosure, the equity journal entry to record this share of profit or loss may
be made to an account called ‘share of associate’s/joint venture’s profit after tax’.
Required reading
IAS 1 para. 82(c).
FIN fact
The equity carrying amount of the investment is increased or decreased to recognise the
investor’s share of post-acquisition profits and post-acquisition reserve movements.
Required reading
IAS 1 para. 82A.
IAS 28 para.10.
Sub-step 3c – Eliminate the effect of current year dividends paid or declared by the associate
or joint venture
Dividends distributed by an investee and recognised as income by the investor in the current
period must be eliminated to avoid double-counting, as the dividend amount has effectively
been included through the equity journal entries recorded in sub-steps 3a and/or 3b above.
FIN fact
The equity accounting method includes the investor’s share of post-acquisition closing retained
earnings in the equity carrying amount of the investment. As dividends are paid from profits
included within closing retained earnings, they must be subtracted – otherwise we would be
double-counting these profits.
Sub-step 3d – Record adjustments to the share of associate’s or joint venture’s profits or losses
as required
In recognising the investor’s share of the associate’s current year results and post-acquisition
movements in opening retained earnings, it may be necessary to make the following adjustments:
1. Negative goodwill on acquisition.
If, on acquisition of the associate or joint venture there is negative goodwill, the amount
is recognised as income in the year the investment was acquired in determining the share
of the investee’s profit or loss with a corresponding adjustment to the investment carrying
amount (refer to earlier example).
2. Fair value and depreciation adjustments.
A depreciation or amortisation adjustment is required if a fair value adjustment to depreciable
or intangible assets forms part of the acquisition analysis in the associate or joint venture.
If the carrying amount of an asset is less than its fair value at acquisition date, a notional
adjustment to the asset must be made as part of the acquisition analysis. In addition, if
the carrying amount has not subsequently been revalued or recognised in the books of
the associate or joint venture, any depreciation or amortisation on the asset is understated
from the point of view of the investor. In this case, an adjustment is needed to recognise
additional depreciation or amortisation, which will result in a reduction in the investor’s
share of the associate’s or joint venture’s profits.
If the carrying amount of an asset is more than its fair value at acquisition date, a notional
adjustment to the asset will be required in the acquisition analysis. If an impairment has
not been recognised in the books of the associate or joint venture, an adjustment will be
required to reduce the depreciation or amortisation, which will result in an increase in the
investor’s share of the associate’s or joint venture’s profits.
3. Elimination of unrealised profits and losses on transactions between the investor and the
associate or joint venture.
IAS 28 para. 28 requires that adjustments must be made to eliminate unrealised profits and
losses on transactions between the associate or joint venture and the investor.
Bossy Boots
45% Significant
ownership influence
Agreeable
Bossy Boots
45% Upstream
ownership sale
Agreeable
During the year, Agreeable sold running shoes to Bossy Boots. This is an upstream sale. The cost
to Agreeable was $200,000 and the selling price was $280,000, resulting in $80,000 profit. Bossy
Boots has not sold any of this inventory by 30 June 20X8. Under the equity accounting method
of accounting, this profit is unrealised and cannot be recognised by Bossy Boots until the shoes
are sold to an unrelated party.
The simplest way to eliminate the unrealised profit existing at 30 June 20X8 is when calculating
the investor’s share of the associate’s profit for the year.
Item Calculation
If Bossy Boots had sold all of the running shoes, it would recognise $360,000 ($800,000 × 45%)
as its share of the associate’s profit for the year. However, as the running shoes are still owned
by Bossy Boots, only $334,800 can be recognised, which would be recorded in this equity
accounting journal entry:
Date Account description Dr Cr
$ $
To record Bossy Boots’ share of Agreeable’s profit for the year ended 30 June 20X8
Bossy Boots
45% Downstream
ownership sale
Agreeable
During the year, Bossy Boots sold boots to Agreeable. This is a downstream sale. The cost to Bossy
Boots was $400,000 and the selling price was $520,000, resulting in a $120,000 profit. Agreeable
has not sold any of this inventory by 30 June 20X8.
In this situation, it is Bossy Boots’ profit, not Agreeable’s profit, which needs to be adjusted. This is
because Bossy Boots has recognised 100% of the profit on the sale of boots in its general ledger.
IAS 28 only permits the profit to be recognised to the extent of the unrelated interest, which in
this case is 55% (1 – 45%). Therefore, 45% of the $120,000 profit must be eliminated and can only
be recognised when the boots are sold by Agreeable to an unrelated party.
Included in Bossy Boots’ $2,000,000 profit after tax is a profit after tax of $84,000 (($120,000 ×
(1 – 30%)) on the sale of the boots to Agreeable. Because the sale was made by the investor to
the associate, $37,800 (45% of the $84,000 profit) is unrealised and needs to be eliminated as an
equity accounting adjustment. Under the equity method of accounting the downstream profit is
eliminated by adjusting the relevant accounts of the investor line by line, as follows:
Date Account description Dr Cr
$ $
To record the adjustment for the transfer of inventory from Bossy Boots to
Agreeable, being the current year downstream unrealised profit
This journal entry will be reversed in the next reporting period, assuming Agreeable sells the
boots in that period.
Notes
1. $520,000 × 45% = $234,000. Bossy Boots’ revenue is overstated, as 45% of the $520,000 transfer made to Agreeable is
considered unrealised (as it is still unsold) and therefore needs to be eliminated.
2. $400,000 × 45% = $180,000. Bossy Boots’ cost of sales is also overstated and requires an equivalent adjustment.
3. ($234,000 – $180,000) × 30% = $16,200. As the profit before tax has been reduced by $54,000, a corresponding
reduction in income tax expense is required.
4. ($234,000 – $180,000) × (1 – 30%) = $37,800. The net effect of these adjustments reduces the carrying amount of
Bossy Boots’ investment in Agreeable.
FIN fact
When there is an unrealised profit, draw a diagram to determine who made the sale.
The unrealised profit is captured in the seller’s profit. Then apply the appropriate equity
accounting treatment depending on whether it is an upstream or a downstream unrealised profit.
Required reading
IAS 28 paras 26 and 28–31.
Activity 17.1: Accounting for an investment in an associate under the equity method of
accounting
[Available online in myLearning]
2. The investor’s share of the investee’s losses reduces the carrying amount of the
investment to below $0.
In this situation, the equity method must be discontinued and the investment recorded as
$0 (IAS 28 para. 38). A liability for additional losses is recognised by the investor only in
limited circumstances. When the investor resumes the application of equity accounting,
it must not recognise its share of profits until these offset its share of losses not recognised
(IAS 28 para. 39).
Required reading
IAS 28 paras 22, 25 and 38–43.
YES
YES
Accounting for underlying
JOINT assets and liabilities applied
OPERATION by joint operator
under (IFRS 11 para. 20)
Is the arrangement a joint
operation or a joint venture?
Equity method of accounting
JOINT is applied under IAS 28 unless
VENTURE there is scope exclusion
(IFRS 11 para. 24)
Note: If an investor has control over an entity, then IFRS 10 Consolidated Financial Statements is applied.
Learning outcome
2. Explain the concepts of significant influence and joint control.
The principles around the requirements of joint control or significant influence within each
standard must be satisfied, prior to applying equity accounting.
IAS 28 para. 5
20% or more voting
power of investee =
IAS 28 para. 3
presume significant
ASSOCIATE: ‘an entity
influence
over which the investor
has significant influence’
IAS 28 para. 6
notes indicators of
significant influence
IAS 28 para. 7
potential voting rights
must be considered in
deciding if there is
significant influence
Required reading
IAS 28 paras 3 and 5–9.
YES
* Relevant activities are described in IFRS 10, Appendix A as activities that significantly affect the
Unit 17 – Corereturns
contentof the entity (for IFRS 11 purposes this means the arrangement). Page 17-17
Financial Accounting & Reporting Chartered Accountants Program
In practice, once joint control is established, the arrangement is then classified as a joint
operation, or joint venture, using the flow chart in IFRS 11 para. B33.
Accounting for joint operations, and distinguishing between joint ventures and joint operations,
is beyond the scope of the FIN module.
Required reading
IFRS 11 paras 4–5, Appendix A Defined terms and Appendix B, Application guidance paras B2–B4.
Further reading
IFRS 11 Illustrative examples 1 and 2 for situations that distinguish a joint venture from a joint
operation.
FIN fact
The investment in the associate/JV is initially measured at cost.
Required reading
IFRS 12 paras 7, 20–23 and Appendix B Application guidance paras B12–B20.
IAS 1 paras 82(c) and 82A.
Quiz
[Available online in myLearning]
Working paper H
You are now ready to complete working paper H of integrated activity 4, to understand
how this topic relates to the financial reports. You can complete this activity
progressively as you do each topic, or as a comprehensive exam preparation activity.
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 1.0100 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1100 1.1200 1.1300 1.1400 1.1500 1.1600 1.2000 1
2 1.0201 1.0404 1.0609 1.0816 1.1025 1.1236 1.1449 1.1664 1.1881 1.2100 1.2321 1.2544 1.2769 1.2996 1.3225 1.3456 1.4400 2
Financial tables
3 1.0303 1.0612 1.0927 1.1249 1.1576 1.1910 1.2250 1.2597 1.2950 1.3310 1.3676 1.4049 1.4429 1.4815 1.5209 1.5609 1.7280 3
4 1.0406 1.0824 1.1255 1.1699 1.2155 1.2625 1.3108 1.3605 1.4116 1.4641 1.5181 1.5735 1.6305 1.6890 1.7490 1.8106 2.0736 4
5 1.0510 1.1041 1.1593 1.2167 1.2763 1.3382 1.4026 1.4693 1.5386 1.6105 1.6851 1.7623 1.8424 1.9254 2.0114 2.1003 2.4883 5
Chartered Accountants Program
6 1.0615 1.1262 1.1941 1.2653 1.3401 1.4185 1.5007 1.5869 1.6771 1.7716 1.8704 1.9738 2.0820 2.1950 2.3131 2.4364 2.9860 6
7 1.0721 1.1487 1.2299 1.3159 1.4071 1.5036 1.6058 1.7138 1.8280 1.9487 2.0762 2.2107 2.3526 2.5023 2.6600 2.8262 3.5832 7
8 1.0829 1.1717 1.2668 1.3686 1.4775 1.5938 1.7182 1.8509 1.9926 2.1436 2.3045 2.4760 2.6584 2.8526 3.0590 3.2784 4.2998 8
9 1.0937 1.1951 1.3048 1.4233 1.5513 1.6895 1.8385 1.9990 2.1719 2.3579 2.5580 2.7731 3.0040 3.2519 3.5179 3.8030 5.1598 9
10 1.1046 1.2190 1.3439 1.4802 1.6289 1.7908 1.9672 2.1589 2.3674 2.5937 2.8394 3.1058 3.3946 3.7072 4.0456 4.4114 6.1917 10
Present and future value tables
11 1.1157 1.2434 1.3842 1.5395 1.7103 1.8983 2.1049 2.3316 2.5804 2.8531 3.1518 3.4785 3.8359 4.2262 4.6524 5.1173 7.4301 11
12 1.1268 1.2682 1.4258 1.6010 1.7959 2.0122 2.2522 2.5182 2.8127 3.1384 3.4985 3.8960 4.3345 4.8179 5.3503 5.9360 8.9161 12
13 1.1381 1.2936 1.4685 1.6651 1.8856 2.1329 2.4098 2.7196 3.0658 3.4523 3.8833 4.3635 4.8980 5.4924 6.1528 6.8858 10.699 13
14 1.1495 1.3195 1.5126 1.7317 1.9799 2.2609 2.5785 2.9372 3.3417 3.7975 4.3104 4.8871 5.5348 6.2613 7.0757 7.9875 12.839 14
15 1.1610 1.3459 1.5580 1.8009 2.0789 2.3966 2.7590 3.1722 3.6425 4.1772 4.7846 5.4736 6.2543 7.1379 8.1371 9.2655 15.407 15
16 1.1726 1.3728 1.6047 1.8730 2.1829 2.5404 2.9522 3.4259 3.9703 4.5950 5.3109 6.1304 7.0673 8.1372 9.3576 10.748 18.488 16
17 1.1843 1.4002 1.6528 1.9479 2.2920 2.6928 3.1588 3.7000 4.3276 5.0545 5.8951 6.8660 7.9861 9.2765 10.761 12.468 22.186 17
18 1.1961 1.4282 1.7024 2.0258 2.4066 2.8543 3.3799 3.9960 4.7171 5.5599 6.5436 7.6900 9.0243 10.575 12.375 14.463 26.623 18
19 1.2081 1.4568 1.7535 2.1068 2.5270 3.0256 3.6165 4.3157 5.1417 6.1159 7.2633 8.6128 10.197 12.056 14.232 16.777 31.948 19
20 1.2202 1.4859 1.8061 2.1911 2.6533 3.2071 3.8697 4.6610 5.6044 6.7275 8.0623 9.6463 11.523 13.743 16.367 19.461 38.338 20
FT-1
Financial Accounting & Reporting
Table 2: Present value of $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8333 1
2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 0.7695 0.7561 0.7432 0.6944 2
Financial tables
3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 0.6750 0.6575 0.6407 0.5787 3
4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 0.5921 0.5718 0.5523 0.4823 4
5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 0.5194 0.4972 0.4761 0.4019 5
Chartered Accountants Program
6 0.9420 0.8880 0.8375 0.7903 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 0.4556 0.4323 0.4104 0.3349 6
7 0.9327 0.8706 0.8131 0.7599 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 0.3996 0.3759 0.3538 0.2791 7
8 0.9235 0.8535 0.7894 0.7307 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 0.3506 0.3269 0.3050 0.2326 8
9 0.9143 0.8368 0.7664 0.7026 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 0.3075 0.2843 0.2630 0.1938 9
10 0.9053 0.8203 0.7441 0.6756 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 0.2697 0.2472 0.2267 0.1615 10
11 0.8963 0.8043 0.7224 0.6496 0.5847 0.5268 0.4751 0.4289 0.3875 0.3505 0.3173 0.2875 0.2607 0.2366 0.2149 0.1954 0.1346 11
12 0.8874 0.7885 0.7014 0.6246 0.5568 0.4970 0.4440 0.3971 0.3555 0.3186 0.2858 0.2567 0.2307 0.2076 0.1869 0.1685 0.1122 12
13 0.8787 0.7730 0.6810 0.6006 0.5303 0.4688 0.4150 0.3677 0.3262 0.2897 0.2575 0.2292 0.2042 0.1821 0.1625 0.1452 0.0935 13
14 0.8700 0.7579 0.6611 0.5775 0.5051 0.4423 0.3878 0.3405 0.2992 0.2633 0.2320 0.2046 0.1807 0.1597 0.1413 0.1252 0.0779 14
15 0.8613 0.7430 0.6419 0.5553 0.4810 0.4173 0.3624 0.3152 0.2745 0.2394 0.2090 0.1827 0.1599 0.1401 0.1229 0.1079 0.0649 15
16 0.8528 0.7284 0.6232 0.5339 0.4581 0.3936 0.3387 0.2919 0.2519 0.2176 0.1883 0.1631 0.1415 0.1229 0.1069 0.0930 0.0541 16
17 0.8444 0.7142 0.6050 0.5134 0.4363 0.3714 0.3166 0.2703 0.2311 0.1978 0.1696 0.1456 0.1252 0.1078 0.0929 0.0802 0.0451 17
18 0.8360 0.7002 0.5874 0.4936 0.4155 0.3503 0.2959 0.2502 0.2120 0.1799 0.1528 0.1300 0.1108 0.0946 0.0808 0.0691 0.0376 18
19 0.8277 0.6864 0.5703 0.4746 0.3957 0.3305 0.2765 0.2317 0.1945 0.1635 0.1377 0.1161 0.0981 0.0829 0.0703 0.0596 0.0313 19
20 0.8195 0.6730 0.5537 0.4564 0.3769 0.3118 0.2584 0.2145 0.1784 0.1486 0.1240 0.1037 0.0868 0.0728 0.0611 0.0514 0.0261 20
FT-2
Financial Accounting & Reporting
Table 3: Compound amount of annuity of $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 1.0000 1.0200 1.0300 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900 1.1000 1.1100 1.1200 1.1300 1.1400 1.1500 1.1600 1.2000 1
2 2.0100 2.0200 2.0300 2.0400 2.0500 2.0600 2.0700 2.0800 2.0900 2.1000 2.1100 2.1200 2.1300 2.1400 2.1500 2.1600 2.2000 2
Financial tables
3 3.0301 3.0604 3.0909 3.1216 3.1525 3.1836 3.2149 3.2464 3.2781 3.3100 3.3421 3.3744 3.4069 3.4396 3.4725 3.5056 3.6400 3
4 4.0604 4.1216 4.1836 4.2465 4.3101 4.3746 4.4399 4.5061 4.5731 4.6410 4.7097 4.7793 4.8498 4.9211 4.9934 5.0665 5.3680 4
5 5.1010 5.2040 5.3091 5.4163 5.5256 5.6371 5.7507 5.8666 5.9847 6.1051 6.2278 6.3528 6.4803 6.6101 6.7424 6.8771 7.4416 5
Chartered Accountants Program
6 6.1520 6.3081 6.4684 6.6330 6.8019 6.9753 7.1533 7.3359 7.5233 7.7156 7.9129 8.1152 8.3227 8.5355 8.7537 8.9775 9.9299 6
7 7.2135 7.4343 7.6625 7.8983 8.1420 8.3938 8.6540 8.9228 9.2004 9.4872 9.7833 10.089 10.405 10.730 11.067 11.414 12.916 7
8 8.2857 8.5830 8.8923 9.2142 9.5491 9.8975 10.260 10.637 11.028 11.436 11.859 12.300 12.757 13.233 13.727 14.240 16.499 8
9 9.3685 9.7546 10.159 10.583 11.027 11.491 11.978 12.488 13.021 13.579 14.164 14.776 15.416 16.085 16.786 17.519 20.799 9
10 10.462 10.950 11.464 12.006 12.578 13.181 13.816 14.487 15.193 15.937 16.722 17.549 18.420 19.337 20.304 21.321 25.959 10
11 11.567 12.169 12.808 13.486 14.207 14.972 15.784 16.645 17.560 18.531 19.561 20.655 21.814 23.045 24.349 25.733 32.150 11
12 12.683 13.412 14.192 15.026 15.917 16.870 17.888 18.977 20.141 21.384 22.713 24.133 25.650 27.271 29.002 30.850 39.581 12
13 13.809 14.680 15.618 16.627 17.713 18.882 20.141 21.495 22.953 24.523 26.212 28.029 29.985 32.089 34.352 36.786 48.497 13
14 14.947 15.974 17.086 18.292 19.599 21.015 22.550 24.215 26.019 27.975 30.095 32.393 34.883 37.581 40.505 43.672 59.196 14
15 16.097 17.293 18.599 20.024 21.579 23.276 25.129 27.152 29.361 31.772 34.405 37.280 40.417 43.842 47.580 51.660 72.035 15
16 17.258 18.639 20.157 21.825 23.657 25.673 27.888 30.324 33.003 35.950 39.190 42.753 46.672 50.980 55.717 60.925 87.442 16
17 18.430 20.012 21.762 23.698 25.840 28.213 30.840 33.750 36.974 40.545 44.501 48.884 53.739 59.118 65.075 71.673 105.931 17
18 19.615 21.412 23.414 25.645 28.132 30.906 33.999 37.450 41.301 45.599 50.396 55.750 61.725 68.394 75.836 84.141 128.117 18
19 20.811 22.841 25.117 27.671 30.539 33.760 37.379 41.446 46.018 51.159 56.939 63.440 70.749 78.969 88.212 98.603 154.740 19
20 22.019 24.297 26.870 29.778 33.066 36.786 40.995 45.762 51.160 57.275 64.203 72.052 80.947 91.025 102.444 115.380 186.688 20
FT-3
Financial Accounting & Reporting
Table 4: Present value of annuity $1
Periods 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 20% Periods
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696 0.8621 0.8333 1
2 1.9704 1.9416 1.9135 1.8861 1.8594 1.8334 1.8080 1.7833 1.7591 1.7355 1.7125 1.6901 1.6681 1.6467 1.6257 1.6052 1.5278 2
Financial tables
3 2.9410 2.8839 2.8286 2.7751 2.7232 2.6730 2.6243 2.5771 2.5313 2.4869 2.4437 2.4018 2.3612 2.3216 2.2832 2.2459 2.1065 3
4 3.9020 3.8077 3.7171 3.6299 3.5460 3.4651 3.3872 3.3121 3.2397 3.1699 3.1024 3.0373 2.9745 2.9137 2.8550 2.7982 2.5887 4
5 4.8534 4.7135 4.5797 4.4518 4.3295 4.2124 4.1002 3.9927 3.8897 3.7908 3.6959 3.6048 3.5172 3.4331 3.3522 3.2743 2.9906 5
Chartered Accountants Program
6 5.7955 5.6014 5.4172 5.2421 5.0757 4.9173 4.7665 4.6229 4.4859 4.3553 4.2305 4.1114 3.9975 3.8887 3.7845 3.6847 3.3255 6
7 6.7282 6.4720 6.2303 6.0021 5.7864 5.5824 5.3893 5.2064 5.0330 4.8684 4.7122 4.5638 4.4226 4.2883 4.1604 4.0386 3.6046 7
8 7.6517 7.3255 7.0197 6.7327 6.4632 6.2098 5.9713 5.7466 5.5348 5.3349 5.1461 4.9676 4.7988 4.6389 4.4873 4.3436 3.8372 8
9 8.5660 8.1622 7.7861 7.4353 7.1078 6.8017 6.5152 6.2469 5.9952 5.7590 5.5370 5.3282 5.1317 4.9464 4.7716 4.6065 4.0310 9
10 9.4713 8.9826 8.5302 8.1109 7.7217 7.3601 7.0236 6.7101 6.4177 6.1446 5.8892 5.6502 5.4262 5.2161 5.0188 4.8332 4.1925 10
11 10.368 9.7868 9.2526 8.7605 8.3064 7.8869 7.4987 7.1390 6.8052 6.4951 6.2065 5.9377 5.6869 5.4527 5.2337 5.0286 4.3271 11
12 11.255 10.575 9.9540 9.3851 8.8633 8.3838 7.9427 7.5361 7.1607 6.8137 6.4924 6.1944 5.9176 5.6603 5.4206 5.1971 4.4392 12
13 12.134 11.348 10.635 9.9856 9.3936 8.8527 8.3577 7.9038 7.4869 7.1034 6.7499 6.4235 6.1218 5.8424 5.5831 5.3423 4.5327 13
14 13.004 12.106 11.296 10.563 9.8986 9.2950 8.7455 8.2442 7.7862 7.3667 6.9819 6.6282 6.3025 6.0021 5.7245 5.4675 4.6106 14
15 13.865 12.849 11.938 11.118 10.380 9.7122 9.1079 8.5595 8.0607 7.6061 7.1909 6.8109 6.4624 6.1422 5.8474 5.5755 4.6755 15
16 14.718 13.578 12.561 11.652 10.838 10.106 9.4466 8.8514 8.3126 7.8237 7.3792 6.9740 6.6039 6.2651 5.9542 5.6685 4.7296 16
17 15.562 14.292 13.166 12.166 11.274 10.477 9.7632 9.1216 8.5436 8.0216 7.5488 7.1196 6.7291 6.3729 6.0472 5.7487 4.7746 17
18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.3719 8.7556 8.2014 7.7016 7.2497 6.8399 6.4674 6.1280 5.8178 4.8122 18
19 17.226 15.678 14.324 13.134 12.085 11.158 10.336 9.6036 8.9501 8.3649 7.8393 7.3658 6.9380 6.5504 6.1982 5.8775 4.8435 19
20 18.046 16.351 14.877 13.590 12.462 11.470 10.594 9.8181 9.1285 8.5136 7.9633 7.4694 7.0248 6.6231 6.2593 5.9288 4.8696 20
FT-4
Financial Accounting & Reporting