Unity University

Department of Accounting and Finance

Advanced Financial Accounting 1
Group members Id no
1. Etsegenet Gezahegn UUR00513R
2. Meron Endale UUR00258R
3. Keweser Mustefa UUR00262R
4. Kidist Genetu UUR00140R
5. Yididiya Million UUA00094R
6. Bisrat Semu UUA00055R

SUBMITED TO : Melese Z.

SUBMMITION DATE JAN, 2023

ADDIS ABABA, ETHIOPIA
1. List and discuss in detail the key differences between IFRS 4 and IFRS 17, and the
rational for the amendment and replacement of IFRS 4 by IFRS 17.

IFRS standards are established in order to have a common accounting language, so business and
accounts can be understood and compared from company to company and from country to
country. IFRS 4 explains how to disclose insurance contracts, but to put it simple, there are too
many issues with IFRS 4 to make a good comparisement among insurance companies and to
compare an insurance company to a non-insurance company, therefore IFRS 17 is needed. This
gives a basis for users of financial statements to assess the effect that insurance contracts have on
the entity’s financial position, financial performance and cash flows.

IFRS 17 explains how you should account for insurance contracts and the connected events.
Currently this is explained within IFRS 4, but there are several problems with IFRS 4. Within
IFRS 4 it is hard to compare profitability between insurance companies and between an
insurance company and companies within other industries. This is mainly because with IFRS 4
insurance companies can use old parameters for calculating their financial results and positions
while they can also take a profit when the product (the insurance coverage) is not yet delivered.
Another problem with IFRS 4 is that the real profit drivers are not visible.

Differences between IFRS 4 & IFRS 17

IFRS 17 deals with these problems; insurance companies need to consistently update their
estimates, take correct time and risk effects into account and insurers need to present the drivers
behind the profits and also risks more transparently. The standard also forces insurance
companies to connect profits to the period in which the coverage is given. 
 Profit and Loss presentation differences between the
IFRS 4 & IFRS 17

2. Discuss in detail about

A. insurance contract measurement models with practical illustrations that incorporates major
insurance contract features and shows initial and subsequent measurement of insurance contracts.
(Note-Don’t forget to discuss their key differences and applicable areas)

B. Insurance contract with direct participation and discretionary participation features.

IFRS 17 Definitions:
In order to explain the measurement models it is important to first highlight the main definitions

 Expected cash flows: the expected cash flows the insurance company expects to get and pay.
The expected cash flows are calculated among different unbiased scenarios, taking into
account different cash flows like expenses, claims, premiums etc.
 Discount rate; the expected cash flows are discounted with the discount rate which reflect the
time period and the financial risk of the contract.
 Risk Adjustment: the money the insurer wants to get on top of the cash flows in order to take
the uncertainty of the insurance contract. So this is for the insurance risk, the non-financial
risk.
 CSM: contribution service margin. The expected unearned profit of a contract. So more or less
the profit we expect to make if our assumptions hold. This is the money which is left if we
 take the expected cash flow in – expected cash flow out – risk adjustment. If this total is
negative then we have a loss component instead of the CSM, this holds for onerous contracts.

IFRS 17 Measurement models

1. The General measurement model (GMM) or Building Block approach
(BBA)

Measurement using the GMM is based on the present value of the fulfillment cash flows (the
discounted probability-weighted average of expected future cash inflows and outflows), the risk
adjustment and the contractual service margin. The contractual service margin is then amortized
over the remaining coverage period.

General Measurement Model

In subsequent measurement, for insurance contracts without direct participating features, the
contractual service margin at the end of the reporting period equals the contractual service
margin at the start of the period adjusted for:

 Interest accreted on the carrying amount of the contractual service margin during that
period
 Changes in fulfillment cash flows relating to future services
 Amount recognized as insurance revenue in P/L because of the transfer of services in the
period.
Subsequent Measurement in General Measurement Model (GMM) of the CSM
The carrying amount at the end of the reporting period for the liability for remaining coverage is
calculated as follows:

 Interest accreted on present value of fulfillment cash flows and the contractual service
margin during that period
 Change in estimates: New cash flows (if any) discounted and added to the present value
of fulfillment cash flows and the contractual service margin. An onerous contract test is
performed and the contractual service margin is adjusted if there is no loss component.
 Amount is recognized as insurance revenue in P/L because of the transfer of services in
the period
 Discount rate change effect: The present value of fulfillment cash flows is calculated
using new rates, compared with the present value based on the rates locked-in at initial
recognition and posted to finance income or expense or to other comprehensive income.
 The liability for incurred claims calculation is performed in the same way as any other
calculation of fulfillment cash flows (as described above) by discounting the estimated
cash flows for claim payments (for claims already incurred, not the claim payment cash
flows for future claims) using the interest rates valid on the contract start date.

2. The Premium allocation approach (PAA)

Simplified approach which you may only use when contracts are at inception onerous, or when
the coverage period is smaller than one year or when the insurer can show that the result of the
PAA is no different than the GMM. The way of calculating the insurance liability once a policy
holder has indicated a claim is not different, the only difference is for the coverage period. With
PAA there is a simplified method, comparable with how insurers currently do, while with GMM
are the cash flows, discounting, risk adjustment and CSM calculated.

IFRS 17 PAA (premium allocation approach) presentation explained

Our IFRS e-learning are specifically designed for those in financial and actuarial functions
within insurers. These modules are also of interest to those working within Reporting,
Controlling, IT, Internal Audit, Risk, ALM / Treasury, Account Management and Tax

3. The Variable fee approach (VFA)

Comparable to GMM, only difference is that this group of insurance contract has policy holders
who participate in share of clearly identified pool of underlying items. The insurer expects that
part of the profit of the underlying items needs to be paid to the policy holder, while the amount
paid to the policy holder depends on the underlying item. The result is that VFA looks like
GMM, not different at the start of the contract. Only the subsequent years there are differences in
the cash flows (as part goes to policy holder) and the CSM does not reflect the unearned profit
for the insurer, as part of it also belongs to the policy holder.

 
The basic assumptions for the example contract are as follows:

A, The contract:

Promises the policyholder a return equivalent to an investment in debt instruments;

The contract will end after six years.

The amount payable to policyholders on maturity is determined by the fair value of equivalent
investments at the end of the sixth year after deducting 5% of those fair values.

At contract inception, a single premium of CU1, 000 is paid and the fair value of equivalent
investments is CU1, 000.

Investment income of any assets held by the entity is recognized in the statement of profit and
loss in accordance with IFRS 9 Financial Instruments (IFRS 9). The underlying items are
measured at FVPL.

(C)There is no insurance risk. The risk adjustment is immaterial

(d) In the market discount rate at inception for the assets is 8%. The yield curves are flat.

At initial measurement
(a) The fair value of the underlying items:

(i) Is CU 1,000.0

(ii) At the end of Year 6, is expected to be CU1,586.9 (CU1,000.0 x 1.086 = CU1,586.9).

(b) At the end of Year 6, the entity expects to pay policyholders CU1,507.5 (95% of CU1, 586.9)
and retain CU79.3 (5% of CU1, 586.9).

(c) The entity invests the premium received in the investments on which the promise to the
policyholder is based (i.e., the entity invests the premium received in variable rate debt
instruments that determine the policyholder cash flows).

General model—Initial measurement

The present value of future cash outflows at inception is CU950 (CU1, 507.5/1.086). The CSM
at inception is an amount equal to the initial

Premium (CU1, 000) less the present value of future cash outflows (CU950), i.e.

CU50. The total liability is CU1, 000.

At inception, the journal entries are:

Dr Cash……………………………….. 1,000.0

Cr Insurance liability (fulfillment cash flows)……………….. 950.0

Insurance liability (CSM)…………………………………………… 50.0

 The receipt of the premium

Dr Variable rate investments……........ 1,000.0

Cr Cash………………………………………………… 1,000.0

 The purchase of the variable rate investments

At initial there is no difference between the variable fee approach and the general model.

 Subsequent measurement

General model—subsequent measurement

Subsequent to initial recognition, there are no changes in expectations. Applying the general
model, the statement of profit or loss records the following:

(a) For the investments held, the investment income determined in accordance with the
appropriate IFRSs

(b) For the insurance liability: Interest expense;

The accretion of the CSM; and An allocation of the CSM to profit or loss.

The journal entries in Year 1 are as follows:

Dr Variable rate investments………………………… 80.0

Cr Investment income……………………………………. 80.0

[Increase in the fair value of investments (CU1, 000 x 8% = CU80.0)]

Dr Interest expense…………… 76.0

Cr Insurance liability (fulfillment cash flows)……………… 76.0

[Unwind of discount rates for the insurance liability (opening fulfillment cash flows of CU950 x
8% = CU76.0)]

The CSM is accreted each year at the rate applicable (8% pa) at the inception of the
contract. The CSM at inception and each subsequent period end is as follows:

Dr Interest expense……………………. 4.0

Cr Insurance liability (CSM)……………………….. 4.0

[Accreting interest on the CSM (opening CSM of CU50 x 8% = CU4.0)

CSM Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Opening balance 50.0 54.0 58.3 63.0 68.0 73.5

Accretion (8% x opening balance) 4.0 4.3 4.7 5.0 5.4 5.9

Allocation to P&L (79.3)

Closing balance 54.0 58.3 63.0 68.0 73.5 0.0

The statement of profit or loss for scenario 1 under the general model is as
follows
CU2 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Revenue 79.3
Net underwriting result 79.3

Investment income 80.0 86.4 93.3 100.8 108.8 117.5

Interest expense (76.0) (82.1) (88.6) (95.7) (103.4) (111.7)

Accretion of CSM (4.0) (4.3) (4.7) (5.0) (5.4) (5.9)

Net investment income 0.0 0.0 0.0 0.0 0.0 0.0

Net profit 0.0 0.0 0.0 0.0 0.0 79.3

variable fee approach—subsequent measurement

Applying the variable fee approach, the accounting entries in Year 1 of the coverage period
are as follows:

Dr Variable rate investments…………….. 80.0

Cr Investment income………………………………. 80.0

[Increase in the fair value of investments (CU1,000 x 8% = CU80.0)]

Dr Interest expense……………….. 80.0

Cr Insurance liability (fulfillments cash flows ‘FCF’)……….. 80.0

To record the increase in fulfillment cash flows representing the

Dr Insurance liability (FCF)………………. 4.0

Cr Insurance liability (CSM)…………………… 4.0

[Change in the estimated additional fee the policyholder will pay

Under the variable fee approach the CSM in each period can be derived by a series of steps3, as
follows:

(a) Determine the return on the underlying items.

Policyholder fund Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Opening balance 1,000 1,080 1,166.4 1,259.7 1,360.5 1,469.3

Change in FV of underlying item 80.0 86.4 93.3 100.8 108.8 117.5

Closing balance 1,080.0 1,166.4 1,259.7 1,360.5 1,469.3 1,586.8

(b) Record the change in fulfillments cash flows representing the change in the obligation
to pay an amount equal to the value of the underlying items.

(c) Determine the change in the estimated fee the policyholder will pay as below.

Year 1 Year2 Year3 Year4 Year5 Year 6

A) Change in FV of the underlying item 80.0 86.4 93.3 100.8 108.8 117.5

B) Fulfillment cash flows b/f 950.0 1,026.0 1,108.1 1,196.7 1, 292.5 1,395.9

C) Fulfillment cash flows c/f (1,026.0)4 (1,108.1) (1,196.7) (1,292.5) (1,395.9) (1,507.5)

D) VF for service (A+B-C) 4.0 4.3 4.7 5.0 5.4 5.9

(d) Adjust the CSM for changes in the fee and allocate the CSM to profit or loss for each
period

CSM Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Opening balance 50.0 54.0 58.3 63.0 68.0 73.5

Variable fee for service 4.0 4.3 4.7 5.0 5.4 5.9

Allocation to P&L (79.3)

Closing balance 54.0 58.3 63.0 68.0 73.5 0.0

 The statement of profit or loss under the variable fee approach is as follows

CU Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Revenue 79.3

Net underwriting result 79.3

Investment income 80.0 86.4 93.3 100.8 108.8 117.5

Interest expense (80.0) (86.4) (93.3) (100.8) (108.8) (117.5)

Net investment income 0.0 0.0 0.0 0.0 0.0 0.0

Net profit 0.0 0.0 0.0 0.0 0.0 79.3

B. IFRS 17 distinguishes between insurance contracts with and without direct participation
features. The general model for insurance contracts without direct participation features is
modified for insurance contracts with direct participation features—those contracts are measured
applying modified requirements referred to as the ‘variable fee approach’.

The variable fee approach was developed as part of the Board’s thinking on how to account for
insurance contracts with participation features. Many insurance contracts include participation
features, whereby policyholders share in the returns of underlying items. The Board discussed
the treatment of participation features extensively during the development of IFRS 17, resulting
in the following requirements:

(a) the fulfillment cash flows of all insurance contracts with participation features include the
effect of policyholders’ participation—the estimates of future cash flows include the expected
effect of the returns on underlying items and the discount rate applied to the future cash flows
reflects the variability of those returns; and

(b) for insurance contracts with direct participation features, additional adjustments are made in
the subsequent measurement of the contractual service margin (the variable fee approach)
compared to those made for insurance contracts without direct participation features (the general
model).

Discretionary participation features are present in many insurance contracts, including contracts
that combine investment and life insurance. Some insurers also issue investment contracts that
contain discretionary participation features without the addition of significant life insurance.
These contracts sometimes have the legal form of an insurance contract and sometimes transfer a
small amount of insurance risk. However, they do not transfer significant insurance risk so do
not meet the definition of an insurance contract.

The contracts are issued predominantly by life insurers as general investment / savings vehicles
to enable contract holders to participate in the performance of designated assets held by the
insurer. In some cases, assets for both participating insurance and participating investment
contracts are held in the same fund and both types of contracts share in the profits of the fund. In
other cases, assets for participating investment contracts are held separately.
3,
A. It is true that selling current assets, such as receivables and notes to factors, will generate
cash flows for the company, but this practice does not cure the systemic cash problems for
the organization. In short, it may be a bad business practice to liquidate assets, incurring
expenses and losses, in order to Window dress" the cash flow statement. The ethical
implications are that Brockman creates a short-term cash flow at the longer-term expense
of the company's operations and financial position. Barbara's idea creates the deceiving
illusion that the company is successfully generating positive cash flows.
B. Barbara Brockman should be told that if she executes her plan, the company may not
survive. While the factoring of receivables and the liquidation of inventory will indeed
generate cash, the actual amount of cash the company receives will be less than the
carrying value of the receivables and the raw materials. In addition, the company would
still have the future expenditure of replenishing its raw materials inventories, at a cost
higher than the sales price. As chief accountant for Brockman Guitar, it is your
responsibility to work with the company's chief financial officer to devise a coherent
strategy for improving the company's cash flow problems. One strategy may be to
downsize the organization by selling excess property, plant, and equipment to repay long-
term debt.

4, Alpha Trading

Statement of Cash flow

For the year ended on dec 31,2018
Cash flow from operating activities:

Loss before tax……………………………………………………………………………………………………………..(1800)

Adjustments for:
Depreciation of non-current assets ……………………………………..3700
Loss on sale of leasehold property……………………………………….100
Interest expense…………………………………………………………………..1000
Increase in inventory………………………………………………………….. (7900)
Increase in trade receivables …………………………………………….(2500)

Increase in trade payable……………………………………………………500 (5100)

Cash deficit from operations ……………………………………………………………………………………….(6900)

Interest paid……………………………………………………………………………………………………………….(1000)

Income tax paid(w (i))………………………………………………………………………………………………….(1900)

Net cash deficit from operating activities ……………………………………………………………………(9800)

Cash flow from investing activities :
Disposal of leasehold property…………………………………………………………………………………………8500

Cash flow from financing activities:

Shares issued ………………………………………………………1200
Payment of finance lease obligations (w(ii))……………….….(2100)
Equity dividends paid(w(iii)……………………………………. (700)

Net cash from financing activities ………………………………………………………………………………….…(1600)

Net decrease in cash and cash equivalents ……………………………………………………………………...(2900)

Cash and cash equivalents at beginning of period………………………………………………………………1500

Cash and cash equivalents at the end of period ……………………………………………………………….(1400)

i. Income tax paid:

provision b/f -current (2500)

-differed (800)

Income statement tax relief 700

Provision c/f -current (500)

-differed 1200

Difference – cash paid (1900)

ii. Lease plant:

Balance b/f 2500

Depreciation (1800)

Leased during year (balance) 5800

Balance c/f 6500

Lease obligations:
Balance b/f -current (800)

-non-current (2000)
New leases (from above) (5800)

Balance c/f - current 1700

-non-current 4800

Difference – repayment during year (2100)

iii. Equity dividend paid:

Retained earnings b/f 6300

Loss for period (1100)

Dividends paid(balance) 700

Retained earnings c/f 4500

5. a. In generating a statement of cash flows in accordance with GAAP, both the direct and
indirect methods for reporting cash flows from operating activities are appropriate; nevertheless,
the FASB promotes the use of the direct approach. The statement of cash flows' main benefit
under the direct method may be that it provides more information while reporting the main
categories of Cash received and disbursements. The indirect approach converts accrual-basis net
income to cash-basis net income by adding or subtracting non-cash items included in net income,
creating a useful connection between the statement of cash flows and the income statement,
balance sheet, and other financial statements.

b, Statement of cash flow by using direct method:

General Motors Company
 Statement of cash flow
For the year ended May 31, 2022
Cash flows from operating activities:
Cash received from customers (1,255,250-17,000)……………………………… 1,238,250
Cash payments:
To suppliers (722,000-30,000-8,000)…………….. 684,000

To employees (252,100+24,750)…………………… 276,850

For other expenses (8,150+2,000)………………….10,150

For interest (75,000-2,000)…………………………….. 73,000

For income taxes……………………………………..……. 43,000…………………………. (1,087,000)

Net cash provided by operating activities………………………………………………..….. 151,250

Cash flows from investing activities:
Purchase of plant assets…………………………. (28,000)
Net cash flow used by investing activity:………………………………………………..(28000)

Cash flows from financing activities :

Payments of long-term notes payable ………...(30,000)
Cash dividends paid …………………………..(105,000)
Issuance of common stock ……………………20,000
Net cash used by financing activities …………………………………………………(115,000)
Net increase in cash……………………………………………………………………. 8,250
Cash, January 1, 2017…………………………………………………………………… 20,000
Cash, December 31, 2017 ………………………………………………………………..28,250
C. Net cash flows from operating activities using indirect method
Net income……………………………………………………………………….……………………… 130,000
Adjustment to reconcile net income to net cash provided by operating activities
Depreciation expense…………………………… 25,000
Decrease in salaries and wages payable…...…. (24,750)
Increase in prepaid expenses…………………. (2,000)
Increase in account receivables(net)…….…… (17,000)
Decrease in inventory…………………………. 30,000
Increase in accounts payable ………….……….8,000
Increase in interest payable …………..……2,000……………………………………….. 21,250
Net cash provided by operating activities `…………………………………………… 151,250

6.
a. Lenny’s statement is correct and Net changes in cash are $109,000. Lenny’s statement is
appropriate that the year was an operating failure because the business entity is generating
a net loss of $11,000 despite having positive cash flow. Also, the presentation of the
sources and use of cash is not done in a proper format. The business entity must represent
each item by classifying it as financing, investing, and operating.
Calculation of net income or loss:
Sales……………………………………………………………………………………………$382,000
Add: gain on sale of investment………………….25,000
Interest revenue………………………………………….8,000
Total revenue………………………………………………………………………………$415,000
Less: Expenses
Purchase of merchandise…………………………..(253,000)
Operating expenses…………………………………..(90,000)
Depreciation………………………………………………(80,000)
Interest expenses……………………………………….(3,000)
Total expenses………………………………………………………………………….....($426,000)
Net Loss…………………………………………………………………………………………($11,000)

b. Statement of cash flow using the indirect method

Panaka Clothing Store

Statement of Cash Flows
For the Year Ended January 31, 2022
Cash flow from operating activity

Net loss………………………………………………………………………………………………………………..(11,000)

Adjustment to reconcile NI to NC provided by operating activities:

Depreciation expense………………………….. 80,000

Gain from sales of investment……………. (25,000) 55,000

Net cash provided by operating activity……………………………………………………………….44,000

Cash flow from investment activity

Sales of debt investment…………………………120,000

Purchase of equipment and fixtures………(330,000)

Purchase of investment…………………………(95,000)

Net cash used by investment activity………………………………………………………………… (305,000)

Cash flow from financing activity

Sales of ordinary shares………………………380,000

Purchase of ordinary shares…………………(10,000)

Net cash provided from financing activity…………………………………………………………….370,000

Net increase in cash………………………………………………………………………………………….,…109,000