SBR Zubair Saleem Notes (F.F 2024 To 2025)

Strategic Business Reporting
(SBR)
By Zubair Saleem
CONTENT
Sr.No Topic Pg#
1 Interpretation of Financial Statements 1
2 IAS 19 – Employee Benefits 03
IFRS 2 – Share Based Payments 12

3
4 IFRS 13- Fair Value Measurements 17
IAS 16 – Property, Plant & Equipment 23

5
IAS 38 – Intangible Assets 24
6
IAS 40 – Investment Property 27
7
IAS 8 – Changes in Accounting Policy, Estimate and Error 29
8
9 IAS 10 – Event after reporting date 32
10 IAS 36 – Impairment of Assets 34
11 IAS 37 – Provisions, Contingent Liabilities and Contingent Assets 36
12 IAS 24 – Related Party Disclosures 38
13 IFRS 5 – Non-current Held for Sale and Discontinued Operations 40
14 IFRS 8 – Operating Segments 42
15 IAS 12 – Income Tax 44
16 IFRS 15 – Revenue from Contract with Customers 51
17 IAS 32 – Presentation of Financial Instruments 66
18 IFRS 9 – Financial Instruments 75
19 Derivates and hedging 88
20 IFRS 16 – Leases 95
21 Consolidation 119
22 IAS 28 – Investment in Associate 143
23 Step/Piecemeal Acquisition 147
24 Disposal Of Interest in Subsidiary 153

25 IFRS 11 – Joint Arrangements 157
26 IAS 21 – Effects of Foreign Currency Changes 167

27 IAS 7 – Statement of Cash flows 177
28 IFRS-10 – Definition of controls 182
29 Ethics 187
Content of questions
Topics Questions Page SR Topics Questions Page
no no no
1 IAS -19 COLUMBIA 9 IAS 32 and IFRS Colat and co
Employee (MAR/JUN 2021) 9-Financial CRYPTO and co
benefit SYMBAL (SEP/DEC 188 instrument Artwright’s & 246
2021) co Hill & co
Aron & co
ECOMA CO (MAR
2020)
Hudson
(Mar/June 2019)
DIGIWIRE
(SEP/DEC
2019)
2 IAS 37 – RUBUL (SEP/DEC 10 IAS 12 -Income Hill and co

Provisions, 2022) tax Stent Co BOHAI
Contingent Juan Co 194 (MAR/JUN 256
Liabilities and COLAT 2022)
Mehran and co
Contingent
Assets
3 IAS 24 – BAGSHOT (MAR 11 IAS 38 and 36- COLAT SITKA 260
2020)
Related Party SUNY and co 202 Impairment and (MAR/JUN
Disclosures Stent intangibles 2021) Corbel
and co Renshu
Co
4 IFRS 8 – KLANCET 12 SME 3 Small and HANDFOOD 266
Operating 207 medium (SEP/DEC 2020)
Segments enterprises
5 IFRS 2 and 13 - LUPLOID 13 Consolidation STERLING

Share based (SEP/DEC (SEP/DEC 2022)
payment and fair 2019) 210 LUPLOID 268
value MARGIE (SEP/DEC 2019)
measurement Example o f I F R S Banana and co
2 (by sir Zubair (2018)
Saleem) HUMMINGS
Mehran (MAR 2020)
SITKA (MAR/JUN Ribby and co
2021) Ashanti Co
Minny Co
6 LEASESS - (IFRS Bohai Co 14 Interpretation Colat and co
16) LERIA CO (MAR HANDFOOD &
2020} 219 CO HOLLS and
Fiskerton co (DEC 2018) 307
Calendar and co
(specimen
exam 2018)
Stem (Sep/Dec 21)
7 IAS 16 and 36 - FILL and co 15 Ethics RENSHU
Property plant Luploid Co (SEP/DEC 2021) 313
and equipment (consolidation) 229
and impairment Stent (2019)
AGENCY
GROUP (SEP
/DEC 2021)
8 IFRS 15 – Luna and co
Revenue from SITKA (MAR/JUN 236
Contract with 2021)
Customers DIGIWIRE (SEP/DEC
2019) (IFRS 15 &
13)
Calibra and co dec
2020
Calendar and co
JASSIE (SEP /DEC
2022)
01
Interpretation of financial statements

User Information needs Items of interest
Investors/ potential investors Risks and returns relating to Trend analysis revenue, costs
their investment and profits over the past few
Security of dividend years
payments Information to Dividend cover
make decisions about buying, Events and announcements
selling or holding shares after the reporting period
Future growth prospects Share price
Corporate governance
reports.
Employees Stability of the company Profitability and cash position

(job security and job Increases in salaries (%)
prospects) relative to increases in profit
and dividends
Information about the Directors’ remuneration
company’s ability to pay
bonuses or higher salaries
Lenders (banks, bondholders) Whether the entity has Total borrowing by the entity:
sufficient cash flow to repay financial gearing
loans Interest cover
The entity’s ability to pay New charges created over
interest the entity’s assets
The adequacy of collateral/ Cash flows
security for loans and bonds
Suppliers The entity’s ability to settle Net current assets
its liabilities The entity’s Growth record
ability to survive and continue
as a customer
Customers The entity’s ability to Growth record

survive and continue as a Cash flow
supplier
Government The entity’s contribution to Revenue and profit

the economy Market share
Regulation of activities
Taxation
Obtaining government
statistics
STRATEGIC BUSINESS REPORTING (SBR) | By Zubair Saleem

02
General public Environmental and social Environmental and social

awareness reports
Contributions to the local Directors’ report
economy Narrative business review
Criticisms of financial reporting

1.Historical information
Little insight into future

2.Unrecognize assets and liability
Goodwill, reputation, employee, skills
3.Clutter
Lot of general information in disclosure, financial statements
becomes increasingly clutter with extensive information so it’s
harder to find specific information
4.Financial and non-financial information
Current and past profits, cash flows are not the only determinate of
future success.
Other factors like governance, management style, risk to which

entity is exposed are also important for long term success, but
financial statements say little about these factors
5.Estimates /professional judgement

Use of estimates are subjective which makes comparison difficult
with other entities financial statements, use of estimates gives an
opportunity of window dressing
6.Use of historic cost
Some standards allow historic cost and

03
IAS 19 - EMPLOYEE BENEFITS

Employee benefits are all forms of consideration given by an entity in exchange for service
rendered by employees or for the termination of employment.
Employee benefits include benefits provided either to
▪ employees or
▪ their dependents or
▪ beneficiaries and may be settled by payments (or the provision of goods or services) or
to others, such as insurance companies.
Scope
▪ This Standard shall be applied by an employer in accounting for all employee benefits,
except those to which IFRS 2 Share-based Payment applies.
1-Post Employment Benefits

04
Accounting for Defined benefit Pension Plan
1. Contribution by Entity:
7.Remeasurment Gain or Loss
Dr Pension Asset xx
Cr Entity’s Cash xx
Dr Pension Asset/Liability xx
Cr Remeasurement gain xx (OCI)
2. Expected Return on Pension Asset:
(O/B * % on interest on high quality bond) Dr Remeasurement Loss xx (OCI)
Dr Pension Asset xx Cr Pension Asset/Liability xx
Cr Pension liability XX
✓ The actuary's calculation of the value of the plan
obligation and assets is based on assumptions,
3. Pension Benefits Paid: such as life expectancy and final salaries, and
these will have changed year-on-year.
Dr Pension Liability xx
Cr Pension Asset xx
✓ The actual return on plan assets is different from
the amount taken to profit or loss as part of the
4. Current Service Cost:
net interest component.
Present value of pension earned by employee during year
Dr Interest Expense xx (P/L)

Cr Pension Liability xx 8- Gain or Loss on Settlement
Dr Pension Liability
5. unwinding of interest: Dr P&l
Cr. Pension Asset
(O/B * % on interest on high quality bond) Cr. Cash
Dr Expense xx (P/L)
Cr Pension Liability xx
6. Past Service Cost: Past service cost is recognised as an adjustment to the

obligation and as an expense (or income) at the earlier of
Increase or decrease in present value of pension the following dates:
liability due to plan amendment or curtailment (a) When the plan amendment or curtailment
occurs; or
Increase
Dr Expense xx (P/L) (b) When the entity recognises related

Cr Pension Liability xx restructuring costs (in accordance with IAS 37)
Decrease or termination benefits
Dr Pension Liability
Cr Income xx (P/L)
05
Company Name Company Name

Statement of Comprehensive Income Statement of financial position
For the year ended For the year ended
Profit and loss Non-current asset

Operation cost (Note 1) Net defined benefit plan asset ( Note -3)
(surplus)
Long term liability

Other comprehensive income Net defined benefit pension liability (Note -3)
Net measurement Gain loss (Note 2) (deficit)
Note 1 charge to profit and loss

$
(a) Current service cost X
(b) Any past service cost and gain or loss on settlement X
(c) Net interest on the net defined benefit liability (asset) X
Note 2 charge to other comprehensive income

$.
(a) Actuarial gains /losses on Pension Asset/Liability X
(b) Asset Ceiling gain or loss X
Reconciliation of PV of defined Reconciliation of PV of defined Reconcile the movement in the

benefit obligation benefit Asset net obligation or asset
Net obligation as at 1 XXX

Opening PV of defined XX Opening. FV of plan XX Jan
benefit obligation assets
+Interest cost XX + Interest on plan XX Current service cost XXX
+Current service cost XX assets
past service cost XXX
+ Contributions made XX
+-Past service cost XX Net interest charge XXX
-Benefits paid - Benefits paid XX
Contribution into plan XXX
-Settlement XX - Settlement XX
+-Actuarial (gains) / XX +- Return on plan assets XX Net re measurement XXX
losses (balancing figure) (balancing figure) component
Clos. PV of defined XX
benefit obligation Net obligation as at XXX
Clos. FV of plan assets XX 31 December
06
Defined benefit plan- Practice Question
Brutus operates a defined benefit pension plan for its employees. The present value of the future
benefit obligations and the fair value of its plan assets on 1 January 20X1 were $110 million
and $150 million respectively.
The pension plan received contributions of $7 million and paid pensions to former employees of
$10 million during the year.
Extracts from the most recent actuarial report shows the following:
Present value of pension plan obligation at 31 December 16m

20X1
Fair value of plan assets at 31 December 20X1 40m
Present cost of pensions earned in the period 11m
Yield on high quality corporate bonds at 1 January 20X1 10%
On 1 January 20X1, the rules of the pension plan were changed to improve benefits for plan
members. The actuary has advised that this will cost $10 million.
Required:
Prepare extracts from the notes to Brutus' financial statements for the year ended 31 December
20X1 which show how the pension plan should be accounted for
Note. Assume contributions and benefits were paid on 31 December

07
Defined benefit plan- Practice Question (BBP Example)-Assignment
For the sake of simplicity and clarity, all transactions are assumed to occur at the year end.
The following data applies to the post employment defined benefit compensation scheme of
BCD Co.
Discount rate: 10% (each year)

Present value of obligation at start of 20X2: $1 m
Market value of plan assets at start of 20X2: $1 m
The following figures are relevant.

20X2 20X3 20X4
$'000 $'000 $'000
Current service cost 140 150 150
Benefits paid out 120 140 150
Contributions paid by entity 110 120 120
Present value of obligation at year end 1,200 1,650 1,700
Fair value of plan assets at year end 1,250 1,450 1,610
Additional information:
At the end of 20X3, a division of the company was sold. As a result of this, a large number of
the employees of that division opted to transfer their accumulated pension entitlement to
their new employer’s plan. Assets with a fair value of $48,000 were transferred to the other
company’s plan and the actuary has calculated that the reduction in BCD’s defined benefit
liability is $50,000. The year-end valuations in the table above were carried out before this
transfer was recorded.
At the end of 20X4, a decision was taken to make a one-off additional payment to former
employees currently receiving pensions from the plan. This was announced to the former
employees before the year end. This payment was not allowed for in the original terms of the
scheme. The actuarial valuation of the obligation in the table above includes the additional
liability of $40,000 relating to this additional payment.
Required
Show how the reporting entity should account for this defined benefit plan in each of years
20X2,20X3 and 20X4.
08
Past Service Cost

An entity operates a pension plan that provides a pension of 3% of final salary for each year
of service. On 1 January 2023, the entity improves the pension to 4.5% of final salary for
each year of service, including service before this date. Employees must have worked for the
entity for at least five years in order to obtain this increased benefit.
At the date of the improvement,
the present value of the additional benefits for service from 1 January 2011 to 1 January
2023, is as follows: $000
Employees with more than five years’ service at 1.1.23 1150
Employees with less than five years’ service at 1.1.23
(Average length of service: two years) 1120
Total 2270
Required:
Explain how the additional benefits are accounted for in the financial statements of the
entity
Solution
The entity recognises all $2270,000 immediately as an increase in the defined benefit
obligation following the amendment to the plan on 1 January 2023. This will form part of the
service cost component. Whether or not the benefits have vested by the reporting date is
not relevant to their recognition as an expense in the financial statements
09
Asset ceiling Test

Most defined benefit pension plans are in deficit (i e. the obligation exceeds the plan assets)
although some defined benefit pension plans show a surplus.
If a defined benefit plan is in surplus
IAS 19 states that the surplus must be measured at the lower of:
a. the amount calculated as normal (per earlier examples and illustrations)

b. the total of the present value of any economic benefits available in the form of refunds from the
plan or reductions in future contributions to the plan.
This is known as applying the ‘asset ceiling’. It means that a surplus can only be recognised to
the extent that it will be recoverable in the form of refunds or reduced contributions in the
future. This ensures that an asset is only recognised if it has the potential to bring economic
benefits to the reporting entity.
The following information relates to a defined benefit plan:

$000
Fair value of plan assets 950
Present value of pension liability 800
Present value of future refunds and reductions in future contributions 70
Required:
What is the value of the asset that should be recognised in the financial statements?
09
2-SHORT-TERM EMPLOYEE BENEFITS

Benefits to be paid within a year of service or within 12 months from the year of service
✓ Wages ▪ When an employee has rendered service to an entity during an

✓ salaries accounting period,
bonuses
✓ Compensated
absences ▪ The entity shall recognize the undiscounted amount of short-term
✓ Benefits in kind employee benefits expected to be paid in exchange for that service:
✓ Profit-sharing
and bonus Dr Expense XX
plans
Cr Expense Payable XX
Short term paid Holidays (If any compensation is available)

Unconsumed Holidays -Expected to be consumed in upcoming years
Accumulated Holidays Non-Cumulative Paid Holidays Cash Compensation

10
The salaried employees of an entity are entitled to 20days’paid leave each year. The
entitlement accrues evenly over the year and unused leave may be carried forward for one
year. The holiday year is the same as the financial year. At 31 December 2004, the entity had
2,200 salaried employees and the average unused holiday entitlement was 4 days per
employee. Approximately 6% of employees leave without taking their entitlement
Required
Discuss, with suitable computations, how the leave that may be carried forward is treated in
the financial statements for the year ended 31 December 2004
11
3-Other Long-Term Benefits

An entity shall recognize other long-term employee benefits in a similar manner to account for
post-employment benefits, typically using the projected unit credit method, as benefits are
payable more than twelve months after the period in which services are provided by an
employee.
Exception. Recognise remeasurements in profit and loss.
A cumulative bonus is payable at start of year 6(1 January 2016) and

equal to 2% of cumulative final salary of 5 years of service. The salary in
year ended 31 December 2011 is 20,000 and is assumed to increase at
Example 10% (compound) each year. The discount rate used is 8% per annum.
Required: - prepare extracts from statement of comprehensive income

(along with journal entries) to each of years ended 31 December 2011 to
2015?
4-Termination benefits
Termination benefits are to be recognised at the earlier of

(a). when the entity can no longer withdraw the offer of those benefits,
And
(b) when the entity recognises costs for a restructuring that is within the scope of IAS 37.
Since termination benefits do not confer any future economic benefits on the employing entity,
these must be expensed immediately.
12
IFRS -2 Share Based payment (SBPs)
Share based payments.

When Goods or Services received in exchange of shares, share options or cash based on share price.
Categories:
(i) Equity Settled SBP
(ii) Cash Settled SBP
(iii) Choice of Settlement (Counter Party has Choice/ Entity has Choice)
Equity Settled SBP Cash Settled SBP

1. When Goods/Services received in exchange 1. When Goods/Services received in exchange
of shares/share option. (Equity Instruments) of cash-based on share price.
2. Dr Asset/Expense xx 2. Dr Asset/Expense xx
Cr Equity xx Cr Liability xx
3. Equity will not be re-measured. 3. Liability will be re-measured to its fair value at
each reporting date.
4. Allocation of Expense
- If Vesting Period Exist=Allocate exp over vesting 4. Allocation of Expense Same as Equity Settled SBP
period
- If Immediately Vest=Charge exp to P/L immediately 5. Share Appreciation Rights
No. of SARs X F. Value of SARs X Time Ratio
5. Share Option Plan Calculation Expected to Vest at each Reporting Date
No. of Options X F. Value of Option X Time Ratio
Expected to Vest at Grant Date
Conditions
Non-Vesting Conditions
Not related to qualification of SBP.
Not related to service of employee

13
Vesting Conditions
Conditions that employee has to fulfill in order to qualify for SBP
Related to service of employee
Non-market based vesting conditions

These are conditions other than those relating to the market value of the entity’s shares.
Examples include vesting dependent on:

 The employee completing a minimum period of service (also referred to as a service condition)
 Achievement of minimum sales or earnings target
 Achievement of a specific increase in profit or earnings per share
 Successful completion of a flotation
 Completion of a particular project
Market based vesting conditions

Market-based performance or vesting conditions are conditions linked to the market price of the shares in some way.
Examples include vesting dependent on achieving:
A minimum increase in the share price of the entity
 A minimum increase in shareholder return
 A specified target share price relative to an index of market prices
Treatment
This distinction is very important. The probability of achieving each type of condition affects the
accounting treatment of equity-settled share-based payments but in different ways.
Market conditions Non-market conditions 1

Definition Any condition that relates to share price. Any other condition.
Examples Increase in share price to a specified value. Increase in profitability to a specified

Total shareholder return to a specified amount.
percentage (total shareholder return refers to Launch of a new product.
dividends and share value) Achieving quality improvement.
Market conditions Non-market conditions 1

How the Probability of meeting the condition is a Probability of meeting the condition is a
probability of measurement attribute. recognition attribute.
achieving the Probability of meeting the condition is taken into
condition account when measuring the fair value of the Probability of meeting the condition plays no
affects the instrument at the grant date. part in measuring the fair value of the
accounting instrument at the grant date.
treatment.

14
Subsequent changes in the probability of meeting Subsequent changes in the probability of

the condition meeting the condition have no impact and are
have no impact and are ignored. ignored.
Measurement of Equity Settled SBP
With Employee with 3rd Party

F.V of Equity Instruments issued F.V of Goods/Services Received at received
(shares/share option) at grant date date
If fair value of equity option is not If fair value of goods and services cannot be
measurable reliably the measured reliably
Then
Intrinsic Value of share opt. at each
Fair value of equity instruments issued at grant date
reporting date.
Variable Vesting Period

Due to Due to
Market Related Conditions Non-Market Related Conditions
- Assess at Grant Date. Consistent with fair value
measurement assumption - Allocate exp over expected vesting period at
- It can't be pro-long but can be shorter each reporting date.
at actual vesting.
Cash Settled SBP Question

15
Choice of Settlement
Counter Party Has Choice Entity Has Choice

Treat as issue of compound financial instruments, (a) Intention
with debt & equity element. (b) Rules & Regulation
(c) Past Practice
> Split Accounting

-Shares
-Cash
Equity Settle SBP Cash Settle
SBP
Split Accounting
Employee Third Party

$ $
F.Value of equiity alternative ‘’ F.V of goods/Services Received ‘’
Lability (P.V of future Cash Flow) ‘’ Lability (P.V of future Cash Flow) ‘’
Equity Option ‘’ Equity Option ‘’
SCOPE
Within x
The IFRS applies to share based payment Transfers of an entity’s equity instruments by its shareholders to
transactions in which an entity acquires or parties that have supplied goods or services to the entity when such a
receives goods or services unless the transfer is clearly for a purpose other than payment for goods or
transaction is specifically excluded from its services supplied (in which case it is within the scope of IFRS 2)
scope.
Transactions with an employee (or other party) in their capacity as a
shareholder.
Transactions where equity instruments are issued in exchange for

control of an acquiree in a business combination.
Share-based payment transactions in which the entity receives or

acquires goods or services under a “contract to buy or sell a non-
financial item” that is within the scope of IFRS on financial instruments.

16
(IAS 32 Financial Instrument: Presentation and IFRS 9 Financial

Instruments)
SBP among group entities

In case employees of subsidiary shall be awarded equity instruments of Parent
In case of equity-settled
Journal entry
In subsidiary FS:
Dr. Expense
Cr. Equity
In parent FS:
Dr. Investment in subsidiary
Cr. Equity
In consolidated FS
Dr. Expense
Cr. Equity
In case of cash-settled:
In subsidiary FS:
Dr. Expense
Cr. Equity
In parent FS:
Dr. Investment in subsidiary
Cr. Liability
In consolidated FS:
Dr. Expense
Cr. Liability

17

18

19

20

21

22

23
IAS 16 Property, Plant and Equipment

24
IAS-38 Intangible Asset

Assets that are identifiable, non-monetary & without any physical existence
(License, Software, Patents, Brands, Copy Rights, Franchise Right, Product Formula/Design, motion picture films, customer
lists, mortgage servicing rights, fishing licenses, import quotas, franchises, customer or supplier relationships, & marketing
rights etc.)
> Identifiable = Arise from Contractual OR

Separable
Can be sold, Exchanged, Transferred, Licensed, + Rented out separately without selling business
(Not Separable -Customer Loyalty, Market Share, Goodwill).
> Monetary Assets = Benefits of assets is to be received is Fixed/Determinable units of currency.

> Non-Monetary Assets = Assets other than monetary assets.
1) Recognition: - Definition of IAS-38 should be met

- Cost can be measured reliably
- Inflow of economic benefits are probable
Things Can’t be Recognized as Intangible

(Training Cost, Advertisement Cost, Internally Generated G.Will, Internally Generated Brands, Internally Generated Customer List) =
Lack of Control, Inflow not Probable, Cost can’t be Measured Reliably.
2) Measurement:
• Initial Measurement = (At cost) [cost depends on source of Intangible Assets] a) Separate
Acquisition (Purchase Price + Directly Attributable Expense) b)Arises from Business
Combination:
Purchased Goodwill (Consideration Paid – F.V of Net assets) Other Intangible
Assets (If Separable=At F.V)
In-process research or development projects acquired in Business combination
Initial Measurement = Recognized as a separate asset at cost
Subsequent cost = Expense if research phase + Capitalize as development if criteria met
c).Arises from Government Grant:
Fair Value:
Dr Intangible Assets xx (Fair Value) Nominal Value: Dr License xx Dr Cash xx

Cr Cash xx Cr Govt. Grant Liability xx (Amortize Income)
d).Exchange of Assets:

25
Lack of Commercial Substance Exchange has Commercial Substance Recognized: Carrying

Value of Asset Given 1.Recognized: Fair Value of Asset -If not
2.Available? : Carrying Value of Asset

Given
e). Internally Generated Intangible Asset:
I.G Good Will Separate Project

I.G Customer List, brands, Mastheads
And Publishing titles
To develop Product Design/ Formula Software Cost can’t be measured
reliably as cost of Research & Development Project developing these Intangible
Assets is not. Research Cost: Development Cost:
separable from overall cost of developing - Information Gathering (Prototypes, Pilot Plant the Business.
- Alternative Selection Jigs, Tools, Dyes etc)
Cannot be Recognized in Statement Charge to P/L Account Development Criteria:

- Met: Capitalize as I.A (Amortization will be start
with commercial production)
Not Met: Charge to P/L
Criteria: (i) Technical Feasible, (ii) Intention to Complete, (iii) Adequate Resources Available,
(iv) Inflow of Economic Benefit are Probable, (v) Cost Reliably Measure, (vi) Ability to Sell or Use
Rule of thumb.
For sale = Demonstrate existence of market
For internal use =There must be Usefulness or cost Savings
• Subsequent Measurement =
Cost Model: Revaluation Model:
Carrying Value = Cost xx Carrying Value = Fair Value Cost. xx
- Acc. Amortization (xx) - Sub. Acc. Amortization (xx)
- Acc. Impairment Loss (xx) - Sub. Acc. Impairment Loss (xx)
xx xx
F.V must be available from ‘Active Market’
Active Market: (i) Willing Buyers & Sellers are available

(ii) Prices are Available to General Public
(iii) Similar Assets are Traded
3) De-Recognition: Profit or Loss = Disposal Proceeds – Carrying Value
4) Types of Intangible Assets according to useful life.
- With Definite Useful Life - With Indefinite Useful Life

26
There is foreseeable limit on Benefits of Assets. There is no foreseeable limit on Benefits of Assets.
• Amortization will be charged. • No Amortization will be charged.
• Annual Impairment Test.
• Renewable Contract = On Nominal Cost = IUL
5) Residual Value of Intangible Asset will be zero unless there is any binding contract
6)Software
Operating Systems (Windows, IOS, Android) Add on Software’s (Applications, Anti-Virus)
IAS-16 PPE IAS-38 Intangible asset
Amortization and Useful life:

An intangible asset may have a finite useful life or an indefinite useful life; useful life is indefinite where there is
no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity.
 An intangible asset with an indefinite useful life is not amortized but is tested for impairment every year in
accordance with IAS 36 Impairment of Assets and whenever there is an indicator of impairment.
 An intangible asset with a finite useful life is amortized over that useful life:
o The useful life that arises from contractual or other legal rights should not exceed the period of the
contractual or other legal rights, but may be shorter depending on the period over which the entity
expects to use the asset.
o Amortization begins when the asset is available for use.
o The amortization method should reflect the pattern in which the future economic benefits
associated with the asset are expected to be consumed. A method that reflects expected revenue
generation is generally inappropriate.
o The amortization charge is recognized in profit or loss unless another IFRS Accounting Standard
permits inclusion in the carrying amount of another asset.
o The amortization period and method should be reviewed at least at each year end.
In addition to the legal forms of the acquired intangible assets’ useful lives, management should base their
assessment on the best estimates and judgements while taking into consideration the cumulative facts and
figures e.g period of cash inflows, company’s past history, market trend, renewal option and management
intention for renewal.

27

28

29

30

31
Apply IAS-8

32

33

34

35

36

37

38

39

40

41
Discontinued Operations:
A discontinued operation is a component of an entity that either has been disposed of or is classified as held for
sale, and:
 represents either a separate major line of business or a geographical area of operations
 is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of
operations, or
 is a subsidiary acquired exclusively with a view to resale and the disposal involves loss of control
IFRS-5 prohibits the retroactive classification as a discontinued operation, when the discontinued criteria are met
after the end of the reporting period.

42
IFRS-8 Segment Reporting

Applies to the financial statements of any entity whose debt or equity instruments are traded in a
public market or who is seeking to issue any class of instruments in a public market.
Identification of operating segments:

• That engages in revenue earning business activities.
• Whose operating results are regularly reviewed by the chief operating decision maker to make
decisions about resources to be allocated to segments & assess its performance.
• For which discrete financial information is available.
Aggregation Criteria:
Two or more operating segments may be aggregate if segments are similar in respects:
(i) The nature of products & services (ii) The nature of production processes
(iii) The nature of regulatory environment (iv) The type/class of customer for their
product & services.
(v) The methods used to distribute their product & services
Reportable segments:
• If Quantitative Criteria Met: (Any one if criteria met)
- Its reported revenue (external and internal) is 10% or more of the combined revenue, internal and
external, of all operating segments.
e.g# 1 2 3 4 5*(5,6) Total
200 100 5 2 3 310 × 10%
_/ _/ × × × = 31
- Its assets are 10% or more of the combined assets of all operating segments.
e.g# 1 2 3 4 5*(5,6) Total
10 300 50 3 1 364 × 10%
× _/ _/ × × =36.4
- Its reported profit or loss is 10% or more of the greater, in absolute amount, of
▪ The combined profit of all operating segments that did not report a loss and
▪ The combined loss of all operating segments that reported a loss or
e.g# 1 2 3 4 5*(5,6) Total
50 70 (30) 1 (2) profit 121
_/ _/ _/ × × loss (32) Higher-of 121 × 10%= 12.1
• If the total external revenue reported by the operating segments constitutes less than 75% of total
entity revenue then additional segments need to be reported on until the 75% level is reached.
Disclosures:
• Entities are required to provide information on such matters as how the reportable segments are
identified and the types of products or services from which each reportable segment derives its
revenue.
• Entities are required to report a measure of profit or loss and total assets for each reportable

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segment. Both should be based on the information provided to the chief operating decision maker.
• An entity reports the following geographical information:

- The total of the reportable segments' revenues to the entity's revenue.
- The total of the reportable segments' profit or loss to the entity's profit or loss.
- The total of the reportable segments' assets to the entity's assets.

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IAS 12 Income Tax

Tax Expense= Current tax +/- Movement in Deferred tax Liability or Asset
Deferred tax
Current tax Deferred tax is a tool to follow matching concept
the income xe Arises on temporary difference
payable e o e in e h taxable SOCI -Approach SOFP- Approach
e i
Income/Exp Difference b/w carrying
Difference b/w recognition value & tax base of asset
Entry Year and application year or liability
Taxable profit Taxable loss
Dr.Tax expense ** Dr. tax receivable
Cr. Tax payable Cr. Tax Exp
Follow the treatment of line item
Line Item Tax will be charged
P/L P/L
OCI OCI
SOCIE SOCIE
Types of Temporary Difference

Taxable temporary difference Deductible temporary difference
1). Difference which will increase future taxable 1). Difference which will decrease future taxable Profits. When
related asset/liability realized or Profits. When related asset/liability realized settled
or settled
2). TTD will generate DTL 2) .DTD will generate DTA (subject to
availability of future taxable profit
Recognized D.T. Liability for all TTD Except
a). Initial recognition of goodwill
b). Initial recognition of A/L which
-Affects neither accounting nor taxable profit
- Is not a business combination
3). Deferred tax liability =TTD * %age 3). Deferred tax Asset =DTD * % age
4). Dr. Tax expense xx 4). Dr. DTA xx

Cr. DTL xx Cr. Tax income xx

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Future changes in DTL Future changes in DTA

Increase in liability Decrease in liability Increase in asset Decrease in asset
Dr. Tax Expense xx Dr. Def. tax liability xx Dr. Def. tax asset xx Dr. Tax Expense xx
Cr. Def. tax liability xx Cr. Tax income xx Cr. Tax income xx Cr. Def. tax asset xx
(net settlement as (Reversal of entry)
reversal entry)
Balance Sheet approach

TTD DTD
Carrying value of asset carrying value of asset

Vs. Vs.
Tax base of asset Tax base of asset
Carrying value of liability Carrying value of liability

Vs. Vs.
Tax base of liability Tax base of liability
Income statement approach

Current year future year Generate
Income /gain recognized Tax will pay TTD
Expense/loss recognize Tax relief DTD
Tax will pay income/gain recognize DTD
Tax relief Expense/loss recognize TTD
Example (Taxable temporary difference)
Each of the following is a taxable temporary difference leading to the recognition of a deferred tax liability.
Carrying Temporary tax liability

amount Tax base difference (30%)
Non-current asset 1,000 800 200 60
Inventory 650 600 50 15
Receivable 800 500 300 90
Receivable (note 1) 500 nil 500 150
Payable (note 2) (1,000) (1,200) 200 60
Note 1:
This implies that an item accounted for using the accruals basis in the financial statements is being taxed on a cash bases.
If an item is taxed on cash basis the tax base would be zero as no receivable would be recognized under the tax rules
Note 2:
The credit balance in the financial statements is Rs. 1,000 and the tax base is a credit of Rs. 1,200. Therefore, the financial
statements show a debit balance of 200 compared to the tax base. This leads to a deferred tax liability.

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Deferred Tax Computation

Line Item Carrying value Tax base TTD/(DTD)
Rs. Rs. Rs.

PPE xx xx xx(xx)
Intangibles xx xx x(x)
Inventory xx xx x/(x)
Equity
Loan xx xx x(x)
Payable xx xx x(x)
Net Taxable/Deductible x(x)
Tax rate %
How to tax
Deferred calculate “tax
Asset or liability base”? xx
Value of asset or liability under tax rules
1. Depreciable asset
 IN accounting IN tax
Cost ** Cost **
Less: Acc. Dep. (**) Less: Capital allowance (**) dep under tax rules
Carrying value ** Tax base/ Tax WDV **
2. Asset /Liability Tax rules
Income/expense are taxable/allowable when receipt/paid (cash basis)
In cash basis; tax base of asset or liability will nil
3. Exempt or Permanent Disallowable or No Tax Consequence
If asset/liability or income/expense has no consequences then carrying value of

asset/liability would be equal to tax base of asset/liability
4. Non-Depreciable land Cost
5. Lease Contracts
Right-of-use assets Zero

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Lease receivable Zero

Lease Liability Zero
6. NRV adjustments
Inventory Cost [If NRV write down is not tax allowable]

Carrying amount [If NRV write down is tax allowable
7. Debtors
Taxation on cash basis - Zero

Taxation on accrual basis - Gross carrying amount (i.e. before deducting provision for bad debts)
8. Prepaid expenses:

Taxation on accrual basis - Carrying amount
9. Accrued income:
Taxation on cash basis Zero

Taxation on accrual basis C.value
10. Cash/Bank
- Carrying amount
11. Share Based Payment
Intrinsic value
12. Compound Instrument
Total Value of Compound Instrument
13. Revenue Received in Advance

Taxation on accrual basis Carrying value
14. Provision Allowable when expense incurred
Tax Base Zero

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15. Development cost

Development cost is allowable when incurred
Tax Base Zero
Examples of Taxable Temporary Difference
Accounting rule Tax rule
1. Fair value Adjustments
Fair value adjustment (Upward) Gains are taxable in future (at disposal)
Recognize when increase
IAS 16, Revaluation Gain (OCI)
IAS 40, Fair Value Gain (P&L)
IFRS 9: FVTPL & FVTOCI
2. Prepayment (expense of future)

Expenses are allowable on cash basis
C.value of asset excess than
tax base therefore TTD
Relief would be available in

current year but expense would charge in future
3. Loan note issued with issue cost

Issue cost is allowable expense as incurred Less issue cost from loan notes
4. Income accrued but not yet received
Dr. Interest Receivable $xxx

Cr. Interest Income $xxx
Income is taxable on cash basis

Record when incurred
Examples of Deductible Temporary Difference
Recognize Deferred Tax Asset up to the availability of “future taxable profits”
Accounting rules Tax rules
1. Carry Forward Losses

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2. Fair value adjustment (decrease) Losses are taxable in future (at disposal)
Recognize when decrease
IAS 16 ( Revaluation loss); Profit and loss account
IAS 40 ( Fair value increase); Profit and loss account
IFRS 9; FVTOCI; Other comprehensive income
IFRS 9; FVTPL; Profit and loss account
3. Impairment losses
Relief is available at disposal
i. IAS - 36
Charge at the time of impairment
Carrying value xxx
Recoverable value (xxx) Higher off:

Impairment Loss xxx a) Value in use
b) Net selling price
ii.
4. Accruals (expense pay in future)

Expenses are allowable on cash
C.value of liability excess than
tax base therefore DTD
5. lease (IFRS 16) Leases rentals are allowable expenses when paid
6. Revenue received in advance

Recognized as liability Related income is taxable on cash basis

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Consolidated Books
Parent Subsidiary Consolidated adjustments (P+S) P+S
Individual Individual Consolidated

Accounts Accounts accounts
Tax base carrying value

Tax base will calculate from individual accounts carrying value will calculated from consolidated
In group in group
a. Fair value adjustment;

 If fair value increase than TTD
 If fair value decrease than DTD
Whereas there is no implication of deferred tax on goodwill
b. Unrealized profits;
Dr. profit
Cr. Inventory DTD DTA ( use buyer tax rate)
 Tax will paid in current year but profit will charge in future
Retained earnings;(post)
c. Retained Earnings of Sub, Associate
Generate TTD DTL

No deferred tax will be recognized
If two criteria met;
Control over entity
No future dividends are expected
Measurement
 At tax rates enacted or substantively enacted by the end of the reporting period. Deferred tax is measured using a
tax rate that reflects the manner to recover carrying amount.
 When tax rate will be revised, then revised tax rate will be used with prospective effect
 Manners of recovery will also affect tax rate
For example; benefits arise due to use or sale of asset
 IAS 12 does not account for time value of money (ultimately ignore) because it will create more complexity and cost
benefit analysis don’t permit
Framework
 but it is consistent with other standards as it follows SOFP approach
 Deferred tax asset and liability does not meet the definition of asset and liability, it is written in SOFP to follow
matching concept.

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IFRS 15
Revenue from contracts with customers
Revenue. Income arising in the course of an entity’s ordinary activities.
(normal trading & operating activities)”
Core principle
IFRS 15 is based on a core principle that requires a supplier to recognize revenue:
 in a manner that depicts the transfer of goods or services to customers;
 at an amount that reflects the consideration the supplier expects to be entitled to in exchange for those
goods or services.
Revenue Recognition Model

To recognize revenue the following five steps should be applied:
Identify the contract(s) with the customer (recognition)
Identify the performance obligations(PO) in the

contract (recognition)
Determine the transaction price (Measurement)
Allocate transaction price to performance obligation

(measurement)
Recognise revenue when PO satisfied

(recogntion)
over period,(services)
at point of time(goods)

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Example.5 Step Model

Example: applying the IFRS five-step model
On 1 January 20X4, Angelo enters into a twelve-month ‘pay monthly’ contract for a mobile phone. The
contract is with Tele South, and terms of the plan are
(a) Angelo receives a free handset on 1 January 20X4

(b) Angelo pays a monthly fee of $200, which includes unlimited free minutes.
Angelo is billed on the last day of the month Customers may purchase the same handset from Tele South
for $500 without the payment plan. They may also enter into the payment plan without the handset, in
which case the plan costs them $175 per month. The company’s year-end is 31 July 20X4.
Required
Show how Tele South should recognize revenue from this plan in accordance with IFRS 15
Revenue from contracts with customers.
Solution
Application of the five-step process to TeleSouth
(i) Identify the contract with a customer. This is clear. TeleSouth has a twelve-month contract
with Angelo.
(ii) Identify the separate performance obligations in the contract. In this case there are two
distinct performance obligations:
(1) The obligation to deliver a handset
(2) The obligation to provide network services for twelve months
(The obligation to deliver a handset would not be a distinct performance obligation if the
handset could not be sold separately, but it is in this case because the handsets are sold
separately.)
(iii) Determine the transaction price. This is straightforward: it is $2,400, that is 12 months ×
the monthly fee of $200.
(iv) Allocate the transaction price to the separate performance obligations in the contract. The
transaction price is allocated to each separate performance obligation in proportion to the
standalone selling price at contract inception of each performance obligation, that is the
stand-alone price of the handset ($500 and the stand-alone price of the network services
($175 × 12 = $2,100.00):

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(v) Recognize revenue when (or as) the entity satisfies a performance obligation, that is when
the entity transfers a promised good or service to a customer. This applies to each of the
performance obligations:
(1) When TeleSouth gives a handset to Angelo, it needs to recognize the revenue of
$460.80.
(2) When TeleSouth provides network services to Angelo, it needs to recognize the total
revenue of $1,939.20. It’s practical to do it once per month as the billing happens. Journal
Detailed Discussion
Five Step Process/Model:(Revenue Recognition)
Step 1. Identify the Contract
(Oral, written)
How to identify the contract
✓ Contract is approved by both parties
✓ Payment terms agreed
✓ Each party’s rights & obligations are identifiable
✓ Contract has commercial substance Non-Refundable deposit

(criteria not met)
✓ Inflow of future economic benefits is probable ✓ Entity has no remaining
contractual obligations to
(patient, new market) implicit price concession transfer goods or services and
all, or substantially all, of the
consideration has been
received and is non-
refundable.
✓ The contract has been
terminated and the
consideration received is non-
refundable.

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Modification of contract
Separate contract Not a separate contract

additional goods or services are distinct Are the remaining goods and
services to be transferred
under the original contract
distinct?
The price of the contract increases by an
vendor’s stand-alone selling price of the Yes No

additional promised goods or Terminate existing Adjust the revenue to
contract date
services.
Creation of new calculate revised % of
contract completion
Illustration.
A vendor enters into a contract with a customer to sell 200 units of a product for CU 16,000 (CU 80 per unit).
These are to be supplied evenly to the customer over a four-month period (50 units per month) and control over
each unit passes to the customer on delivery.
After 150 units have been delivered, the contract is modified to require the delivery of an additional 50 units.
At the point at which the contract is modified, the stand-alone selling price of one unit of the product has
declined to CU 75.
In accordance with the requirements of IFRS 15, the additional units to be delivered are distinct. Consequently,
the subsequent accounting will depend on whether the sales price for the additional units reflects the stand-
alone selling price at the date of contract modification (CU 75).
Scenario A – the price of each of the additional units is CU 75

The vendor recognizes revenue of CU 80 per unit for the remaining 50 units specified in the original contract and
CU 75 per unit for the 50 units that are added as a result of the contract modification.

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Scenario B – the price of each of the additional units is CU 65, including a CU 10 discount for poor service
At the point of contract modification, the vendor recognizes the CU 10 per unit discount as an immediate reduction in
revenue of CU 500.
This is because the discount relates to units that have already been delivered to the customer
The selling price of the additional units is therefore the stand-alone selling price (CU 75) at the date of contract
modification. Consequently, the additional units are accounted for as being sold under a new and separate contract from
the units to be delivered under the terms of the original contract.
This means that, as in scenario A, the vendor recognizes revenue of CU 80 per unit for the remaining 50 units specified in
the original contract, and CU 75 per unit for the 50 units that are added as a result of the contract modification.
Scenario C – the price of each of the additional units is CU 60

The selling price of the additional units is not the stand-alone price at the date of contract modification.
Consequently, for accounting purposes, the original contract is considered to be terminated at the point of contract
modification. T
he remaining units to be sold that were covered by the original contract, together with the additional units from the
contract modification, are accounted for as being sold under a new contract.
The amount of revenue recognized for each of the units is a weighted average price of CU 70. This is calculated as ((50* CU
80) + (50* CU 60)) / 100.
Step 2. Identify the separate performance obligations within a contract

A contract includes promises to provide goods or services to a customer. Those promises are called
performance obligations.
A company would account for a performance obligation separately only if the promised goods or service is
distinct. A good or service is distinct if it is sold separately or if it could be sold separately because it has a
distinct function and a distinct profit margin.
✓ the good or service is capable of being distinct

Can the customer benefit from the good or service, either on its own, or with other
readily available resources? (‘readily available resources’ are those that the
customer possesses or is able to obtain from the entity or another third party)

55
✓ the promise to transfer the good or service is distinct within the context of the contract, means distinct from
other promises within a contract
 The entity does not provide a significant service of integrating the

goods or services
(build a new office block)
 A good or service does not significantly modify or customise the other
goods or services
(Software with installation that creates interface with existing
software)
 A good or service is not highly dependent or interrelated with the
other goods or services
(Software with installation that creates interface with existing software
and updates in system necessary for software to be operational)
Step 3. Determine the transaction price

The transaction price is the amount of consideration a company expects to be entitled to from the
customer in exchange for transferring goods or services. The transaction price would reflect
✓ variable consideration (contingent consideration)
Examples of where a variable consideration can arise include: discounts, rebates, refunds, price
concessions, credits and penalties, incentives, performance bonuses, sale or return basis
Estimation technique
Expected value method
The sum of probability weighted amounts in a range of possible outcomes.
Most likely amount

The most likely outcome from the contract. This may be an appropriate approach if a contract has
two possible outcomes, such as a performance bonus which will or will not be received.

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Constraining estimates of variable consideration
Reversal test. Variable contingent amounts are only included where it is highly probable
that there will not be a reversal of revenue when any uncertainty associated with the
variable consideration is resolved.
Example 1: Variable Consideration
Tayyab Co. enters into a contract to build an oil rig for Rs. 100,000
If the oil rig is not completed on time there will be a Rs. 20,000 penalty
Tayyab Co. has built similar oil rigs before and there is 90% chance that the oil rig will be
completed on time
What is the transaction price?
Answer 1:
Two possible outcomes:
Rs. 100,000 if completed on time
Rs. 80,000 if not completed on time
The “most likely amount” method better predicts the amount of consideration
Therefore, transaction price is Rs. 100,000 as there is 90% chance that the oil rig will be
completed on time.
✓ the time value of money (if material).

 Cash received in advance and goods will be sold in future.
liability and unwinding (seller incremental borrowing rate)
 Goods sold today and cash will be received in future

Debtor and unwinding (Buyer incremental borrowing rate)

57
Example 2: Time Value
Zee Ltd. (ZL) sold a machine on 1 January 2017. The terms of sale are that it will receive Rs.5
million on 31 December 2018. Discount rate is 6% p.a.
Required: Pass the journal entries at the end of financial year 2017 and 2018 for ZL?
Answer 2:
Sale proceeds => 5,000,000 = Rs.4,449,982 (1+

0.06) ^2
Year end (Period covered) Calculation Amount of

interest
expense
2017 (Interest for the year) (4,449,982 x 6%) 266,999
2018 (Interest for the year) (4,449,982 + 266,999) x 283,019
6%
✓ Non-cash consideration
Where a customer promises consideration in a form other than cash, an entity shall measure the non-cash
consideration at fair value (e.g. shares)
Non-cash consideration AX Ltd. (AXL) decides to take a contract to perform

consulting service that would normally be valued at Rs.50,000. AXL determines that
the service is a single performance obligation. AXL agrees to receive 1,000 shares of
customer (Company B). Both accept the contract on 1 January 2017, when shares
are valued at Rs. 50 a share. On 1 February 2017, AXL completes the services, when
shares are valued at Rs. 52 a share.

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Answer 3: AX Ltd. would recognize the revenue of Rs. 52,000
(Rs. 52 x 1,000 shares)
 Consideration payable to customer

Consideration payable to a customer includes cash amounts that an entity pays to customer. It
will be treated as reduction of the transaction price (i-e deducted from revenue e.g. vouchers) if
not a purchase price for goods or services received
Blochberger is a manufacturer of consumer goods. On 30 November 20X7, Blochberger

entered into a one-year contract to sell goods to a large global chain of retail stores. The
customer committed to buy at least $30 million of products over the one-year contract.
The contract required Blochberger to make a non-refundable payment of $3 million to the
customer at the inception of the contract. The $3 million payment is to compensate the
customer for the changes required to its shelving to accommodate Blochberger's
products. Blochberger duly paid this $3 million to the customer on 30 November 20X7.
In December 20X7, Blochberger transferred goods to the customer worth $4
million to the customer and invoiced them for this amount
JJ Ltd. enters into a contract with Dynasty super store (DSS). DSS commits to buy at least
Rs.20 million of items over the next 12 months. The terms of the contract require JJ Ltd. to
make a payment of Rs. 1 million to compensate the DSS for changes that it will need to
make to its retail stores to accommodate the products. Required: How much revenue should
be recognized by JJ Ltd.?
Answer 4: The Rs. 1 million paid to the DSS is a reduction of the transaction price and therefore, revenue of
Rs. 19 million will be recorded on satisfaction of performance obligation.
Step 4. Allocate transaction price to the performance obligations in contract

Where a contract contains more than one distinct performance obligation a company allocates the
transaction price to all separate performance obligations in proportion to the stand-alone selling price of
the good or service underlying each performance obligation at contract inception
A stand-alone selling price is the price at which an entity would sell a promised good or service separately
to a customer
methods of estimating stand-alone selling price
 market assessment approach

 cost plus margin approach
 residual approach.

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Step 5. Recognize revenue when or as performance obligation is satisfied

Performance obligations satisfied
At particular point of time
“when control of the goods transferred to the customer”
FOB shipping point = customer bears risk of damage during shipment

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Over the period of time

• “performance obligation satisfied over the period of time i.e. Providing technical support or warranty
services”
An obligation satisfied over time will meet one of the following criteria:
✓ The customer simultaneously receives and consumes the benefits as the performance takes place.
✓ The entity’s performance creates or enhances an asset that the customer controls as the asset is
created or enhanced.
(for example, a building that is being constructed on land owned by the customer, or customized
software that is being written into a customer’s existing IT infrastructure).
✓ The entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.
The amount of revenue recognized is the amount allocated to that performance obligation in Step 4.
 Cost incurred as a percentage of total cost to  Surveys of work performed;

be incurred.  Units produced as a percentage of total
 Labour hours used as a percentage of total units to be produced;
labour hours to be used;
 Machine hours used as a percentage of total
 Units delivered as a percentage of total
units to be delivered; or
machine hours to be used;
 Contract milestones achieved

61

62
Specific Situations
1.Sale of goods with rendering of services
• Revenue of goods sold should be recognized when control passes to customer usually at delivery date,
where as
• Rendering of services revenue should be allocated over service period.
2. Sale of goods with the right to return

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Recognize a Right to receive inventory
At Lower of cost or NRV
Example.
Entity sold goods (50 units) with right to return at selling price of $1000/unit cost of each unit is $400. it is
expected that 7 units will be returned.
3.Sales as an agent
Commission earned will be recognized as revenue.
4. Warranty
5. Customers’ unexercised rights

When a customer pays in advance for goods or services the prepayment gives rise to a contract liability,
which is derecognized when the performance obligation is satisfied. If, having made a non-refundable
prepayment, the customer does not exercise their right to receive the good or service, the unexercised
right is often referred to as breakage.
 A breakage amount can be recognized as revenue if the pattern of rights exercised by the
customer gives rise to the expectation that the entity will be entitled to a breakage amount.
If this does not apply
 it can be recognized as revenue when the likelihood of the customer exercising its rights becomes
remote.

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6. Licensing
7. Consignment inventory/Consignment arrangement

“Arrangement where a product is delivered to customer (dealer) under consignment arrangement, as dealer
doesn’t obtain control of the product at that point so ‘NO’ revenue will be recognized”
Indicators of arrangement:
1. Product is controlled by entity until sold to customers
2. Entity may require a return of product or transfer from one dealer to another
3. Dealer has not unconditional obligation to pay

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8. Non-refundable upfront fees

A non-refundable upfront fee is often charged at the beginning of a contract, such as joining fees in health
club membership contracts. In many cases upfront fees do not relate to the transfer of any promised good
or service but are simply advance payments for future goods or services. In this case revenue is recognized
when the future goods or services are provided.
9. Sales with a Right of Return

A customer can return a product for various reasons and receive any combination of:
 A full or partial refund;
 A credit note;
 Another product in exchange.

The selling entity should recognize:
 An asset for the amount received/receivable and corresponding entries:
o to revenue (for items not expected to be returned); and
o a refund liability (for items expected to be returned); and
 An asset for its right to recover products from customers (i.e. returns) and a corresponding adjustment to cost
of sales. This is initially measured at the former carrying amount of the product less any expected costs to
recover the goods
The measurement of the refund liability should be updated at each period end and similar adjustment made to
revenue; the measurement of the right to returns should also be updated with corresponding adjustment to cost
of sales.

66
IAS 32 Presentation of Financial Instruments
Financial instruments
Financial instrument is any contract that give rise to a financial asset of one entity and a financial liability or
equity instrument of another entity
E.g.
1- Definitions
A-Financial Assets
A financial asset is any asset that is:
1) Cash
2) an equity instrument of another entity
(we bought Ordinary shares of Pael, ICI, MCB from stock exchange)
3) a contractual right to receive cash or another financial asset from another entity
e.g.
• Debtors
• Investment in Debenture (liability instruments
4) a contractual right to exchange financial instruments with another entity under conditions
that are potentially favourable

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Any contract that may or will be settled in own equity instruments
5) a contract that will or may be settled in the entity’s own equity instruments, and is a
non-derivative for which the entity is or may be obliged to receive a variable number
of the entity’s own equity instruments
6) a contract that will or may be settled in the entity’s own equity instruments, and is a derivative that will or may
be settled other than by the exchange of a fixed amount of cash or another financial asset for a fixed number of
the entity’s own equity instruments
B-Financial liability
1) contractual obligation to deliver cash or another financial asset to another
entity payable
Debenture issued (loan liya hua hain)
2) contractual obligation to exchange financial instruments with another entity

under conditions that are potentially unfavorable
Any contract that may or will be settled in own equity instruments
3) a contract that will or may be settled in the entity’s own equity instruments,
and is a non-derivative for which the entity is or may be obliged to deliver a
variable number of the entity’s own equity instruments
4) a contract that will or may be settled in the entity’s own equity instruments, and is
a derivative that will or may be settled other than by exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity
instruments.
C-Equity
1) An equity instrument is any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities.
2) Any contract that may or will be settled in own equity instruments

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Contracts that may or will be settled in own equity instruments (own company ordinary shares)
No of shares
Amount of shares
Situation arises
Fixed no of shares against fixed amount variable no of shares or amount

Classified as equity option
(Fixed for Fixed) Shares will issue shares will receive

Financial Liability Financial asset
Fixed for variable or

Variable for variable
2-Classification of financial liabilities and equity
Classification of issue of financial instruments: (in issuer’s book)

Classify issue of
Dr. cash financial
Cr. Liability/equity instrument at
Criteria; the time of
a. Substance over form issue
b. Definition of financial liability or equity
Obligation to pay interest or principle No Obligation to pay interest or principle

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 Issue of financial instrument in which repayment is contingent on occurrence or non-occurrence of event not
within control of entity should be classified as liability like death of shareholder, unless contingency is remote
 Puttable financial instruments (repayable on demand)

Will be classified a financial liability
Holder of bond can put it back to you and ask you to give his/her money
Puttable instruments can be classified as Equity

Classification Examples
Redeemable preference shares.
 Redemption is mandatory:
Since the issuing entity will be required to redeem the shares, there is an obligation. The shares are a
financial liability.
 Redemption at the choice of the holder:
Since the issuing entity does not have an unconditional right to avoid delivering cash or another financial
asset there is an obligation. The shares are a financial liability.
 Redemption at the choice of the issuer:
The issuing entity has an unconditional right to avoid delivering cash or another financial asset there is no
obligation. The shares are equity.
 Irredeemable non-cumulative preference shares should be treated as equity, because the entity has no
obligation to the shareholders that the shareholders have any right to enforce.
Coasters issued the following preference shares.
• 1 million preference shares for Rs.3 each. No dividends are payable.

Coasters will redeem the preference shares in three years' time by issuing
ordinary shares worth Rs.3 million. The exact number of ordinary shares
issuable will be based on their fair value on 30
September 20X6.
• 2 million preference shares for Rs.2.80 each. No dividends are payable. The
preference shares will be redeemed in two years' time by issuing 3 million
ordinary shares.
• 4 million preference shares for Rs.2.50 each. They are not mandatorily
redeemable. A dividend is payable if, and only if, dividends are paid on ordinary
shares.

70
3-Treatment of interest, dividend and issue cost
On equity
On liability
Directly charge to equity in SOCIE
charge to p/l as finance cost using
effective interest rate method  issue cost of ordinary shares less from
premium or R/E
 ord. dividend less from R/E and
 issue of equity option less from equity op.

71
Financial Liability accounting

(Loan, payable, derivatives standing at loss)
Classification
At amortized cost At FVTPL

(Default category) D
e
Initial measurement: r
Initial measurement:
i
Fair Value (cash received) xxx
Fair Value (cash received) v xx
- Issue cost (xx)
a
t
Subsequent measurement: Subsequent measurement:
i
At Fair value
At amortized cost using effective Any Gain or loss will be charged to v
interest rate method P&L e
s
Rs s
FVO
Gain and loss t
Opening balance XX
a
Finance cost at effective rate XX
Interest paid at nominal rate (XX) Own credit risk Other riskn
=OCI d loss
= Profit and
Closing balance XX
i
n
g
Illustration 1
a
t
On 1 January 20X1 James issued a loan note with a Rs.50,000 nominal value. It was l
issued at a discount of 16% of nominal value. The costs of issue were Rs.2,000. o
Interest of 5% of the nominal value is payable annually in arrears. The bond must be s
redeemed on 1 January 20X6 (after 5 years) at a premium of Rs.4,611. s
The effective rate of interest is 12% p.a.
Illustration 2
Hoy raised finance on 1 January 20X1 by the issue of a two-year 2% bond with a
nominal value of Rs.10,000. It was issued at a discount of 5% and is redeemable at a
premium of Rs.1,075. Issue costs can be ignored. The bond has an effective rate of
interest of 10%.

72
Illustration 3
Wiggins raised finance by issuing Rs.20,000 6% four-year loan notes on 1

January 20X4. The loan notes were issued at a discount of 10%, and will be redeemed
after four years at a premium of Rs.1,015. The effective rate of interest is 12%. The
issue costs were Rs.1,000.
5-compound instruments
a financial instrument that has characteristics of both equity and liabilities.
Bond can be redeemed either in cash or in a fixed number of equity shares
at the choice of holder (loan provider)
Every convertible is not compound

Compound instrument
Convertible bond at split accounting
the option of issuer
Rs
(issuer has choice)
Proceeds received from compound XX
NO
Liability component
Present value of future cash flows at (XX)

Convertible bond at interest rate on similar without conversion
the option of holder loan
into variable Equity component (Residual value) XX
ordinary share
At the time of issue
NO Dr Bank XX
Cr liability at amortized cost XX
Cr Equity component XX
Convertible bond
which is convertible Liability will be re-measured at amortized cost using effective rate
(effective rate = interest rate on loan without conversion option)
(compulsory
conversion)
NO
Illustration 1 (compound instruments)

73
B Itd Issued 9% Convertible Debentures of Rs.700,000 on 1-4-2008 convertible on 31-3-2011 at the option of
loan provider into 23,000 (Rs 10 par value) ordinary shares of B ltd.
Otherwise debentures are to be redeemed at 10% Premium.
Interest Rate on similar Non- Convertible Debentures is 13%
Calculate Debt. and Equity and pass conversion or redemption entries at maturity?
(Answer: Fin. Liab.: Rs. 682402; Equity option: Rs. 17598)
6-Treasury shares
A company may reacquire its own shares. Such shares are called treasury shares.
The company might then hold on to the shares until it uses them
for a particular purpose, such as awarding shares to employees
in a share grant scheme.
The accounting treatment of treasury shares is that they should be deducted from equity.
Any gain or loss on transactions involving treasury shares is recognize directly in equity,
and should not be reported in the statement of profit or loss and other comprehensive income.
IAS 32 requires that the amount of treasury shares held should be disclosed separately, either:
 on the face of the statement of financial position as a deduction from share capital, or
 offset against share capital and disclosed in the notes to the accounts.
7-Offsetting
Offsetting an asset and a liability and presenting a net amount on the face of the statement of financial position
can result in a loss of information to the users. IAS 1 prohibits offset
- required or permitted by an IFRS. The idea is that offset should only be allowed if it reflects the substance of
the transactions or balances.
IAS 32 adds more detail to this guidance in respect of offsetting financial assets and liabilities.
IAS 32 requires the presentation of financial assets and financial liabilities in a way that reflects the company’s
future cash flows from collecting the cash from the asset and paying the cash on the liability.

74
It limits a company’s ability to offset a financial asset and a financial liability to those instances when the cash
flows will occur at the same time. The IAS 32 rule is that a financial asset and a financial liability must be offset
and shown net in the statement of financial position when and only when an entity:
 Currently has a legal right to set off the amounts; and

 Intends either to settle the amounts net, or to realize (sell) the asset and settle the liability
simultaneously.
In order for a legal right of set off to be current it must not be contingent on a future event. Furthermore, it must
be legally enforceable in all of the following circumstances:
 The normal course of business;

 The event of default;
 The event of insolvency or bankruptcy of the entity and all of the counterparties
Note: The existence of a legal right to set off a cash balance in one account with an overdraft in another is
insufficient for offsetting to be allowed. The company must additionally show intent to settle the balances net,
and this is likely to be rare in practice. Consequently, cash balances in the bank and bank overdrafts are usually
reported separately in the statement of financial position, and not ‘netted off’ against each other. Many
companies adopting IFRS for the first time find that they have net amounts in the statement of financial position
under their old GAAP that have to be shown as a separate financial asset and financial liability under IFRS. The net
position is described as being “grossed up”.

75
IFRS-9
Classification of Financial Assets
Test Amortized cost Fair value through Fair value through other
profit or loss comprehensive income
Only Debt investment Debt investment Equity investment
BMM objective is to hold (Residual category) objective is achieved by Not held for trading
assets in order to collect Or both collecting
contractual cash flows; Default category contractual cash flows
and and selling financial
assets and
CCPI the contractual terms the contractual terms of Entity has made an
of the financial asset the financial asset give Irrevocable election
give rise on specified rise on specified dates
dates to cash flows that to cash flows that are
are solely payments of solely payments of
principal and interest on principal and interest on
the principal amount the principal amount
outstanding outstanding
Option to designate a financial asset at fair value through profit or loss

Despite the above, a company may, at initial recognition, irrevocably designate a financial asset as measured at
fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition
inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring
assets or liabilities or recognizing the gains and losses on them on different base

76
At amortized cost FV through PL FV through OCI

Initial Fair value Fair value Fair value
measurement +Transaction cost +Transaction cost
Transaction cost Capitalize Profit and loss Capitalize
Subsequent At amortized cost using Fair Value Fair value

measurement effective rate
Fair value gain Profit and loss OCI

/loss
Interest/Dividend Effective rate in profit and Profit and loss Profit and loss
loss Effective rate for debt
investment
Right to receive dividend

established for equity
investment
Profit and loss
Impairment test Yes No Debt investment Yes

Equity investment NO
Impairment loss/
Reversal of Profit and loss Profit and loss
impairment loss
Profit and loss
Profit and loss Profit and loss Debt investment
Previously recognized gain and
loss will be
reclassified to profit and loss
Equity investment
Previously recognized gain and loss
will Not be reclassified to profit
and loss
but can be transferred to Retained
earnings within
Statement of changes in equity.

77
Impairment loss of Financial Assets
1.General impairment model -3 stag approach 2. Simplified impairment model
(expected loss model)
1.General impairment model -3 stag approach
Initial Measurement – 12-month expected credit losses

12-month ECLs are calculated by multiplying the probability of a default occurring in the next 12 months by the
total (lifetime
Subsequent Measurement – Reporting date Lifetime ECL or 12 months ECL

Depending on stage of Financial asset
Stage1 Stage2 Stage3
Credit Worthiness Not Deteriorated Deteriorated Objective evidence Received

(of Issuer)
Impairment Loss 12 Months Life time Life time

(Using Expected
Loss)
Interest Income Gross Amount Gross Amount Net Amount

Calculation

78
Lifetime expected credit losses

are the present value of expected credit losses that arise if a borrower defaults on its obligation at any point
throughout the term of a lender’s financial asset.
This requires an entity to consider all possible default events during the term of the financial asset in the analysis.
Lifetime expected credit losses are calculated based on a weighted average of the expected credit losses, with
the weightings being based on the respective probabilities of default.
Identifying the stage of Financial Asset
Stage 2 Stage 3
A significant increase in credit risk (moving from Credit-impaired financial asset
Stage 1 to Stage 2) can include:
 Actual breach of contract (e.g.
 Changes in general economic and/or default or delinquency in
market conditions (e.g. expected payments);
increase in unemployment rates, interest  Granting of a concession to the
rates); borrower due to the borrower’s
 Significant changes in the operating financial difficulty;
results or financial position of the  Probable that the borrower will
borrower; enter bankruptcy or other financial
 Changes in the amount of financial re-organization.
support available to an entity (e.g. from
its parent);
 Expected or potential breaches of
covenants;
 Expected delay in payment (Note: Actual
payment delay may not arise until after
there has been a significant increase in
credit risk).

79
2.Simplified impairment model

Receivable/contract asset/lease receivables
Trade receivables and contract assets without a significant financing component

should always recognize life time ECLs
Trade receivables and contract assets with a significant financing component

80
SUMMARY
Reclassification adjustment
Although financial assets may be reclassified, reclassification is only allowed when:
 the entity changes its business model for managing those specific assets; and
 this change in the business model’s objective has already been put into effect.
(IFRS 9 B4.4.2)
The following are not changes in business model:
a) change in intention related to particular financial assets (even in circumstances of significant changes in
market conditions).
b) the temporary disappearance of a particular market for financial assets.
c) a transfer of financial assets between parts of the entity with different business models.

81
The reclassification date is the first day of the first reporting period following the change in business
model that results in the entity reclassifying financial assets.
All reclassifications are accounted for prospectively and no gains, losses or interest previously recognized shall be
restated.
Financial Liability Reclassification not allowed

Investment in Equity Reclassification not allowed
Investment in Debt
Followings are the situations of transfer if there is a change in business model
Old class New class Transfer value Gain/loss Extra adj.

treatment
Amortized cost FVTPL fair value Recognized in
profit or loss.
FVTPL Amortized cost fair value
Amortized cost FVTOCI fair value Recognized in

OCI

82
FVTOCI Amortized cost fair value All previous cumulative

gain/loss adjusted against
carrying .value
FVTOCI FVTPL Fair value The cumulative gain or loss

reclassified from equity to
profit or loss
FVTPL FVTOCI Fair value
De-recognition of financial asset
Partial disposal /Strip Disposal Complete disposal
One stream of identifiable cashflows =interest cashflows

transferred
Pro rate stream of identifiable cashflows =90% of both cashflows
(interest, principle)
Pro rata stream of single cashflows =90% of interest
cashflows
De-recognition of financial asset

 the contractual rights to the cash flows from the financial asset expire,
e.g. cash received from receivable then derecognize receivable
derecognize option when option expired
derecognize option when option exercised

83
 Financial asset transfer to another party

Assess risk and reward of financial asset, immediately before and after transfer
Substantial risk and reward Substantial risk and reward Substantial risk and rewards neither transfer nor retained
transfer retained
Transfer qualifies for de- Transfer Not qualifies for
recognition. de-recognition. assess control
Derecognize assets
Dr. cash/asset Continue to retain asset and
Control lost Control retained
Dr./Cr. Profit/loss any cash received would be
Derecognize the Continue to recognize
Cr. Financial asset secured loan
asset The financial instruments up
E.g. Dr. Cash
to continues involvement
Unconditional sale Cr. loan
of financial asset E.g.
Factoring receivable Factoring with
without recourse recourse
Sale with repurchase Sale with repurchase
term in market price term and Repurchase
Sale with call or put price is already
option and option is decided and above
deep out of money original selling price
Sale with call or put
option and option is
deep in money

84
Financial Liability accounting

(Loan, payable, derivatives standing at loss)
Classification
At amortized cost At FVTPL

(Default category) D
e
Initial measurement: r
Initial measurement:
i
Fair Value (cash received) xxx
Fair Value (cash received) v xx
- Issue cost (xx)
a
t
Subsequent measurement: Subsequent measurement:
i
At Fair value
At amortized cost using effective v
Any Gain or loss will be charged to
interest rate method P&L e
s
Rs s
FVO
Gain and loss t
Opening balance XX
a
Finance cost at effective rate XX
n
Interest paid at nominal rate (XX)
Own credit risk Other
d risk
Closing balance XX =OCI = Profit
i and loss
n
g
a
t
De-recognition of financial liabilities l
o
A financial liability (or a part of a financial liability) is derecognized when, and only when, it is extinguished. Thiss is when the
obligation specified in the contract is discharged or cancelled or expires. s
•
Sometimes modification of financial liability would lead to De-recognition of financial liability
Modification (restructuring) of a liability

An entity facing liquidity problems might ask a lender to modify the terms of a loan. This might involve the lender changing
the timing of payments (restructuring) the liability, waiving part of the loan (thus reducing the amount payable) or a
combination of both.

85
The accounting treatment for a modification depends on whether the terms of the loan after the modification are
substantially different from those of the original loan.
Modification
Substantial modification
Non substantial modification
the original loan is extinguished and
a new financial liability is recognized A liability is not derecognized
Instead, a new effective rate is calculated

based on the carrying amount at the date of
Dr Old Fin.Liabilty c.value the modification (adjusted for any associated
modification fee) and the revised cash flows.
Cr new Financial Liability
Dr/Cr Loss/Gain on Modification
Modification with substantially different terms

If the new terms are identified as a substantial modification, the original loan is extinguished and a new financial liability is
recognized in its place with any gain or loss recognized in the statement of profit or loss. The new liability is recognized at its
fair value in accordance with the normal rules of recognition of financial instruments. This is found by discounting the
revised future payments at the market rate of interest that applies to such cash flows.
Example: Substantial modification of a liability

X Limited had a loan of Rs. 1,000 repayable in 4 years on which it paid interest at 10%. The carrying amount of the liability
was Rs. 1000.
The effective rate of the liability is 10%. (The IRR of any loan carried and redeemed at par is the same as the coupon rate).
X Limited faced liquidity problems and the lender agreed to restructure the loan.
Under this new arrangement X limited was to make a single payment of Rs. 1,200 at the end of Year 4 instead of the
originally scheduled payments.
The market rate at the time of restructuring was 12%.
This would be accounted for as follows:

86
Conclusion: The terms of the original loan have been substantially modified
Modification with terms that are not substantially different

A liability is not derecognized when the terms of a modification are not substantially different from those of the original
loan.
Instead, a new effective rate is calculated based on the carrying amount at the date of the modification (adjusted for any
associated modification fee) and the revised cash flows.

87

88
89
90
91
92
93
94
95
IFRS 16 Lease
“Lessee”
Single Accounting model with exceptions (short term lease, low value underlying asset)
Initial Recognition:
At commencement date
Recognize
Right to use asset Lease obligation
At cost PV of future lease payments (unpaid) at relevant discount rate*
Cost includes: 1. Fixed payment (fixed in substance)
1. Lease liability 2. Variable based on index or rate (market rate, interest rate, CPI)
3. payment for purchase of asset if virtually certain (under purchase

2. Prepayment – incentives
option)
3. initial direct cost 4. payment for penalty/ termination charges (if virtually certain)
4. Present value of Dismantling, removing & 5. Guaranteed residual value expected to be paid (by lessee or related
restoration party of lessee)
Journal -entries
Dr ROU xx
Cr Lease Liability xx

96
Subsequent Measurement: at each reporting date

Right to use asset: Lease obligation:
$
IAS-16 IAS-40 O/B xx
Finance cost xx
Cost model Cost model Installment paid (xx) (Principle + interest)
Revaluation model Fair value model C/B xx
Depreciation period: OR
(a) Lease term O/B Installment interest Principle C/B
(b) Lower of lease term or useful life xx xx xx xx xx

97
Journal entries
1) Finance cost xx
Lease liability xx
2) Lease liability xx
Bank xx

98
IFRS -16 Leases

Separating Non lease component from lease component

99

100

101
Reassessment of lease liability

Reassessment of estimates already used in lease accounting;
Future lease payments resulting Lease term

from a change in an index or a rate Assessment of an option to
Amounts expected to be payable purchase
under a residual value guarantee.
Original rate Revised rate
Increase in Lease liability Increase in Lease liability

Right of use asset XXX Lease liability XXX
Lease liability XXX Right of use asset* XXX
* If the carrying amount of the right-of-use
asset is reduced to zero, then any further

reductions are recognized in profit or loss.
Modification of lease
A lease modification is a change

in the scope of a lease,
or the consideration for a lease,
that was not part of its

original terms and conditions.

102
Examples
 increasing the scope of the lease by adding the right to use one or more underlying assets;
 decreasing the scope of the lease by removing the right to use one or more underlying assets or
shortening the contractual lease term;
 increasing the scope of the lease by extending the contractual lease term;
 and – changing the consideration in the lease by increasing or decreasing the lease payments.
 Changes that result from renegotiations and changes to the terms of the original contract are lease
modifications.
Accounting for modification
Separate contract Not a separate contract
(a) Scope lease term Lease term
(b) Stand alone price = rental scope scope
rentals
Partial termination
Modification
Modification

103

104
Modification
The accounting for lease modifications depends on whether the lease is classified as a finance lease or an operating lease
from the lessor’s perspective immediately prior to the modification.
Modifications – Separate Leases

A finance lessor needs to consider the same criteria as the lessee when the contract is modified. Therefore, a modification
to a lease classified as a finance lease is accounted for as a separate lease if both:
– The modification increases the scope of the lease by adding the right to use one or more underlying assets; and
– The consideration for the lease increases by an amount commensurate with the standalone price for the increase in
scope.
If both criteria are met, a lessor would follow the lessor guidance on recognition and measurement of that separate lease.
Modifications – Not Separate Leases
If a modification to a finance lease does not meet both of the above criteria, the lessor follows the following guidance:

105
Operating Lease
Continue to recognize the asset in Lessor book

Depreciation = Depreciation policy as per IAS 16
Impairment = As per IAS 36
Recognition = rental received should be Income on straight line basis / another systematic basis
Disclosures Requirement

106
Exceptions to (recognition) normal accounting (choice)
No need to recognize Right of use asset

and Lease liability in SOFP
1.Short term lease 2. Lease of low value asset
A short-term lease is defined as a based on the value of the asset

lease that, at the commencement when it is new
date, has a lease term of 12 months
or less and does not include an tablets, computers, fixtures and
option to purchase the underlying furniture
asset (whole class)
 Asset should not be for sub

lease.
 Election lease by lease
Accounting treatment.
The lessee recognizes the lease payments associated with those leases as
an expense on either a straight-line basis over the lease term or another
systematic basis

107
Example 1- Applying the short-term lease exemption
Lessee ABC enters into a 8-year lease of a machine to be used in manufacturing parts for a plane that it expects to
remain popular with consumers until it completes development and testing of an improved model. The cost to
install the machine in DEF manufacturing facility is not significant.
ABC and DEF each have the right to terminate the lease without a penalty on each anniversary of the lease
commencement date.
The lease term consists of a one-year non-cancellable period because both ABC and DEF have a substantive
termination right
– both can terminate the lease without penalty

– and the cost to install the machine in DEF manufacturing facility is not significant.
As a result, the lease qualifies for the short-term lease exemption.
Example 2 – Applying the leases of low value exemption Lessee,
A is in the pharmaceutical manufacturing and distribution industry and has the following leases:
– leases of real estate: both office building and warehouse;
– leases of office furniture;
– leases of company cars, both for sales personnel and for senior management and of varying quality,
specification and value;
– leases of trucks and vans used for delivery; and
– leases of IT equipment such as laptops.

A determines that the leases of office furniture and laptops qualify for the recognition exemption on the basis that
the underlying assets, when they are new, are individually of low value. B elects to apply the exemption to these
leases.
As a result, it applies the recognition and measurement requirements in IFRS 16 to its leases of real estate,
company cars, trucks and vans.

108
Presentation

109
Lessor accounting
Separation of Lease and non-Lease Components
Unlike lessees, lessors do not have an option to account for a contract that contains both a lease and non-lease
component as a single lease. Lessors must use the principles within IFRS 15 for allocating consideration to
components of a contract.
Lessor need to classify the lease into
Finance lease Operating lease
Classification Criteria
1. Ownership will transfer at end of lease term

2. Purchase option for lessee and exercise of option is virtually certain
3.Lease term is for major part of economic life
4. Fair value = PV of Lease payments
5. Asset is of specialized nature
Further Indicators
1. Lessee can cancel and will bear the costs
2. Gain/loss on Residual Value will be enjoyed by lessee
3. Secondary period on substantially lower than market rent

110
Finance Lease
Lessor is a financial institution
Initial measurement
(Net
investment =P. Value of lease payments + UGRV)
Dr. Lease Receivable XXX (Fair value of asset + initial direct cost)
Cr. Bank XXX
Subsequent measurement
Arrears
B/D XXX
Investment income XXX (B/D *% of interest rate implicit in a lease)
Installment received (XXX)

C/D XXX
Advance
B/D XXX
Installment received (XXX)
Investment income XXX (B/D *% of interest rate implicit in a lease)
C/D XXX

111
A lessor shall recognize finance income over the lease term, based on a pattern reflecting a constant periodic rate
of return on the lessor’s net investment in the lease.
A lessor shall apply “the de-recognition” and impairment requirements in IFRS 9 to the net investment in the
lease.
A lessor shall review regularly estimated unguaranteed residual values used in computing the gross investment
in the lease. If there has been a reduction in the estimated unguaranteed residual value, the lessor shall revise
the income allocation over the lease term and recognize immediately any reduction in respect of amounts
accrued.
Extract for financial statements

Statement of comprehensive income
Year 1 Year 2 Year 3
Finance income XX XX XX
Statement of financial position

112
Non-current asset
Net investment in finance lease XX XX XX
Current asset
Current maturity of Net investment in finance lease XX XX XX

113
Lessor is a Dealer or manufacturer
1)Revenue
Dr Lease receivable XXX

Cr Sales XXX
Lower of a) Fair value of goods
b) Present value of lease payments @ market interest rate
2) cost of sales
Dr Cost of sales XX
Cr Inventory XX (cost or carrying value of inventory - Present value of
UGRV)
3) Present value of UGRV
Dr lease receivable XX
Cr inventory XX
A manufacturer or dealer lessor shall recognize as an expense costs incurred in connection with obtaining a
finance lease at the commencement date because they are mainly related to earning the manufacturer or
dealer’s selling profit.
Costs incurred by manufacturer or dealer lessors in connection with obtaining a finance lease are excluded from
the definition of initial direct costs and, thus, are excluded from the net investment in the lease.

114
Extract for financial statements
Statement of comprehensive income

Revenue = Lower of fair value / PV of lease payments XX
Cost of sales = Cost – UGRV (XX)
Initial direct cost = Expense (XX)
Profit & Loss = Revenue – Cost of sales – initial direct cost
Finance income XX XX XX
Statement of financial position
Non-current asset
Net investment in finance lease XX XX XX
Current asset
Current maturity of Net investment in finance lease XX XX XX
EXAMPLE

115
Multan Motors is a car dealer.
It sells cars and offers a certain model for sale by lease. The following information is
relevant:
Price of the car in a cash sale Rs.2,000,000

Cost of the car Rs.1,500,000
Finance option:
Annual rental Rs.804,230
Lease term 3 years
Interest rate 10%
Estimated residual value nil
Lessor’s cost of setting up the lease Rs.20,000
Discount factor
t1 to t3 @ 10% 2.486852 (written as 2.487)

116
Sale and lease back
Assess is it a sale as per IFRS- 15
Sale proceeds equal to fair value:
Example: Sale and leaseback
A company sold a machine for Rs.1.5 million which is also fair value and leased it back under a five-year lease.
The asset has a carrying value of Rs.1 million. The lease payments made by the lessee is Rs.200,000 p.a paid
at the end of the year. The interest rate implicit in the lease is 5% p.a. Assume that the transfer of machine by
the seller-lessee satisfies the requirements of IFRS
15 to be accounted for as a sale
Debit Credit
Rs. Rs.
Cash 1,500,000

117
Right of-use 577,263

Asset
Liability - PV of lease payment 1,000,000
865,895
Gain 211,368
Sale proceeds above or below fair value:
(a) any below-market terms shall be accounted for as a prepayment of lease

payments; and
(b) any above-market terms shall be accounted for as additional financing provided by the buyer-
lessor to the seller-lessee.
Example: Sale and leaseback – Sale above fair value
A company sold an asset for Rs.1.5 million and leased it back under a five-year lease. The asset had a
carrying value of Rs.1 million. The fair value of the asset at the date of sale is Rs.1.2 million. The lease
payments made by the lessee is Rs.100,000 p.a paid at the end of the year. The interest rate implicit in the
lease is 5% p.a. Assume that the transfer of asset by the seller- lessee satisfies the requirements of IFRS 15
to be accounted for as a sale
Cash 1,500,000
Right-of-use 110,789
Asset 1,000,000
Lease Liability (PV of Lease
Payments) 432,947
Gain 177,842
Sale proceeds below fair value:

118
Atlas Ltd. sells its manufacturing equipment at a price of Rs.5,500,000 to Hybrid Leasing Co. (buyer-lessor). The fair
value of the equipment at time of sale is Rs.6,000,000 and the carrying value is Rs.3,000,000. The seller-lessee
leases back the equipment for 10 years in exchange for annual rent payments of Rs.400,000 payable at the end of
each year. The seller-lessee’s incremental borrowing rate is 6%. Assume that the transfer of equipment by the seller-
lessee satisfies the requirements of IFRS 15 to be accounted for as a sale.
Cash 5,500,000
Right-of-use asset 1,722,017
Equipment 3,000,000
Lease Liability (PV of Lease
payments)
2,944,034
Gain 1,277,983

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“CONSOLIDATION”
(P+S) – Single Economic entity concept
1. Line by line (100%) Addition

2. Intra group transaction / balances must be eliminated
3. Goodwill calculation
4. NCI value calculation
5. Consolidated earnings calculations
(W-1) Goodwill
Goodwill: An asset representing the future economic benefits arising from other assets acquired in a businesscombination that are not
individually identified and separately
Rs.'000 Rs.'000
Consideration paid by parent xx

add: Fair value of NCI xx (NCI no. of shares x MV of sub share price at Acq.)
less: FV of sub net assets at Acq.
share capital xx
share premium xx
OCE xx
RE xx
FV adjustment xx (xx)
Goodwill / Bargain purchase gain xx / (xx)
income (P&Loss) in the year of

1. Non-current asset (SOFP) acquisition
2. No amortization
3. Impairment test apply
(W-2) Consolidated Reserves

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2(a)
Cons.
Retained. Cons.
Earnings OCE

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Parent xx Xx
Parent Income/gain xx Xx
Parent Expense/ loss (xx) (xx)
Parent's share in sub's post Acq. Profit/loss(2(b)) xx Xx

xx Xx
Equity section of consolidated SOFP
2(b)
Subsidiary's Post
Retained
earnings OCE
Subsidiary xx Xx
Sub's Income/gain xx Xx
Sub's Expense/ loss (xx) (xx)

(Only post) xx Xx
Parent share xx Xx
NCI share xx Xx

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Subsidiary’s Equity
Post-
At Acquisition(W1)
Acquisition(W2)
Goodwill
Parent NCI
calculation
Consolidated NCI
R.E / OCE Working
(W-3) NCI
Non-controlling interest (NCI) is defined by IFRS 10 as: ‘the equity in a subsidiary not attributable, directly or
indirectly, to a parent.’
Rs.
FV of NCI at Acq. / Proportionate share of NCI xx
NCI share in sub post R/E xx
NCI share in sub post OCE xx
Adjustments:
NCI in imp loss on Goodwill (if 100% goodwill) (xx)
xx

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Example
P ltd S ltd
Non-current asset 250 300
Investment in subsidiary 350
Current asset 100 100
TOTAL 700 400
Share Capital 100 50
Retained earnings 350 200
Other components of equity 150 100
Liabilities 100 50
Total 700 400
1. P ltd acquired80% of S ltd and at acquisition retained earnings and other components of equity of S ltd
were Rs.120 and Rs.70.
2. Fair value of NCI at acquisition Date was Rs.120
Required: Prepare consolidated statement of financial position.

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Note the following features in following examples:

 The asset in the parent’s statement of financial position representing the cost of investment in
the subsidiary disappears in the consolidation.
 Each consolidated asset and liability is constructed by adding together the balances from the
statements of financial position of the parent and the subsidiary.
 The share capital (and share premium) in the consolidated statement of financial position is
always just the share capital (and share premium) of the parent. That of the subsidiary
disappears in the consolidation process.

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IFRS-3 Goodwill
Proportionate Full Goodwill
Only parent related goodwill
(W1) Consideration XX
(W1) Consideration xx
NCI at fair value XX
NCI at proportinated share
F.value of sub Net Assets at acq. (xx)
XX
Goodwill XX
F.value of sub Net Assets at acq.
(xx)
Goodwill xx
NCI should be measured at

proportionated share
NCI should be measured at
proportionated share

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Impairment loss on goodwill
Dr. Impairment loss xxx
Cr. Goodwill xxx
Full Goodwill Impairment loss will be charged to CRE and NCI in case of 100% goodwill;
Proportionated Goodwill Whereas it will be charged to CRE in case of proportionate goodwill.
FAIR VALUE ADJUSTMENT
Parent's Assets
Fair value Fair value

increase decrease
Dr. Asset For Dr. Loss (Cons. RE/OCE) For

Cr. Gain (Cons. RE/OCE) Depreciation: (w2(a)) Depreciation
(w2(a)) Reversal:
Dr. Dep Exp Cr. Asset
(CRE(w2(a)) Dr. Asset
Cr. Asset Cr. Dep

(CRE(w2(a))
Subsidiary's Assets

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After Acquisition
At Acquisition date date
Fair value Fair value increase Fair value

increase Fair value decrease
decrease
Dr. Asset Dr. Loss (pre acq.)(w1) Dr. Asset Dr. Loss (post acq.)(w2(b))
Cr. Asset Cr. Asset
Cr. Gain (pre acq.)(w1) Cr. Gain (post acq.)(w2(b))
For Depreciation: For Depreciation Reversal: For Depreciation: For Depreciation Reversal:
Dr. Dep Exp (Post RE(w2(b))) Dr. Asset Dr. Dep Exp (Post RE(w2(b))) Dr. Asset
Cr. Asset Cr. Asset
Cr. Dep (Post RE(w2(b))) Cr. Dep (Post RE(w2(b)))

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OTHER FAIR VALUE ADJUSTMENTS:
1. Intangible asset of subsidiary at acquisition date (whether recognized or not) should be recognized at its
FAIR VALUE at acquisition date.
Dr. Intangible asset xxx
Cr. Gain (Pre)(w1) xxx
Amortization:
Dr. Amortization (post) (w2(b)) xxx

Cr. Intangible asset xxx
2. Contingent liability of subsidiary at acquisition date should be recognized at its FAIR VALUE.
Many acquired businesses will contain contingent liabilities such as contingent liabilities for the settlement of legal
disputes or for warranty liabilities. IFRS 3 states that contingent liabilities should be recognized at acquisition ‘even if it is
not probable that an outflow of resources embodying economic benefits will be required to settle the obligation.’ The
contingent liabilities should be measured at fair value at the acquisition date. (Contingent assets are not recognized).
Dr. Expense (Pre) xxx

Cr. Contingent liability xxx
POST ACQUISITION MOVEMENTS:
Increase - Dr. Expense (Post) xxx
Cr. Cont. Liability xxx
Decrease - Dr. Cont. liability xxx
Cr. Income xxx
Note: Restructuring costs
An acquirer should not recognize a liability for the cost of restructuring a subsidiary or for any other costs expected to
be incurred as a result of the acquisition (including future losses).
This is because a plan to restructure a subsidiary after an acquisition cannot be a liability at the acquisition date. For
there to be a liability (and for a provision to be recognized) there must have been a past obligating event. This can only
be the case if the subsidiary was already committed to the restructuring before the acquisition.
This means that the acquirer cannot recognize a provision for restructuring or reorganization at acquisition and then
release it to profit and loss in order to ’smooth profits’ or reduce losses after the acquisition.

129

130
Example 2 Followings are the statement of financial position at 31 December 2011 for P ltd and S ltd
P ltd S ltd
TOTAL 700 450
Share Capital @1 Rs. 200 50
Liabilities 100 100
Total 700 400
1 P ltd acquired 40 ordinary shares of S ltd on 1 January 2010 and retained earnings and other
components of S ltd were Rs.100 and Rs.60 at that date
2 Fair value of subsidiary asset at acquisition date not adjusted in subsidiary individuals’ financial
statements
All values are Rs.
Carrying value Fair value remaining life at acquisition exist at year end
Land 70 100 N/A yes
Building 80 120 20 years yes
Inventory 10 7 N/A No
3 FVTOCI investment of parent & subsidiary increase by Rs.30 & Rs.20 respectively at the year-end
4 Goodwill is impaired by 20% and 10% of its original value in the year ended 31 December 2010 and 31
December 2011 respectively

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Unrealized profit Adjustment
* (URP on unsold goods only)
Sale of inventory
Parent seller Subsidiary seller
Dr.Profit(CRE)(w2(a)) Dr. Profit (Sub. post)(w2(b))

Cr. Inventory Cr. Inventory

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Sale of Non-Current
Assets
Parent seller Subsidiary seller
Dr.Profit(CRE)(w2(a)) Dr. Profit (Sub. post)(w2(b))

Cr. Asset Cr. Asset
Dr.Asset Dr. Asset

Cr. Reversal of dep(w(2(b)) Cr. Reversal of dep(w2(a))

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Example 3
Followings are the statement of financial position at 31 December 2011 for P ltd and S ltd
P ltd S ltd
TOTAL 700 400
Liabilities 100 50
Total 700 400
1 P ltd acquired 40 ordinary shares of S ltd on 1 January 2010 and retained earnings and other
components of S ltd were Rs.100 and Rs.60 at that date
2 Fair value of subsidiary asset at acquisition not adjusted in subsidiary individuals’ financial statements
All values are Rs.
Carrying value Fair value remaining life at acquisition exist at year end
Land 70 100 N/A yes
Building 80 60 20 years yes
Inventory 10 15 N/A No
3 Goodwill is impaired by 20% and 10% of its original value in the year ended 31 December 2010 and 31
December 2011 respectively
4 FVTPL investment of parent & subsidiary increase by Rs.30 & Rs.20 respectively at the year-end
5 Parent sold goods to subsidiary and unrealized profit on these goods were Rs.20. 40% are still held in
subsidiary books at year end.
Required: Prepare consolidated statement of financial position at 31 December 2011.

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Intra group
Receivables/Payables
(current A/C's)
Balances are Balances are
same different
Cash in transit
Dr. Payables Errors
Goods in transit
Cr. Receivables
Dr. Cash/Goods
Cr. Receivables
Recipient books or
Parent books

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Intra group loan/Investment
Dr. Loan/Preference share

liability
Cr. Investment
Example 4
P ltd S ltd
TOTAL 700 400
Retained earning 350 200
Liabilities 100 50
Total 700 400
1 P ltd acquired 70% of S ltd and at acquisition retained earnings and other components of equity of S ltd
were Rs.90 and Rs.70
2 Fair value of subsidiary asset increases by Rs.110 at acquisition date &depreciation is Rs.10
3 FVTOCI investment of parent & subsidiary decrease by Rs.30 & Rs.20 respectively at the year-end
4 Subsidiary sold goods and unrealized profit at year end is Rs.20
5 Fair value of Non-controlling interest at acquisition date was Rs.120
6 Impairment loss on goodwill is Rs.10

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138
Example-5
You are provided with the following statements of financial position (balance sheets) for Shark and Minnow.
STATEMENTS OF FINANCIAL POSITION AS AT 31 OCTOBER 20X0
Shark Minnow
Rs.'000 Rs.'000 Rs.'000 Rs.'000
Non-current assets, at net book value
Plant 325 70
Fixtures 200 50
525 120
Investment
Shares in Minnow at cost 200
Current assets
Inventory at cost 220 70
Receivables 145 105
Bank 100 0
465 175
1,190 295
Equity
Rs.1 Ordinary shares 700 170
Current liabilities
Payables 275 55
Bank overdraft 0 20
275 75
1,190 295
The following information is also available.
(a) Shark purchased 70% of the issued ordinary share capital of Minnow four years ago, when the
retained earnings of Minnow were Rs.20,000. There has been no impairment of goodwill.
(b) For the purposes of the acquisition, plant in Minnow with a book value of Rs.50,000 was revalued to
its fair value of Rs.60,000. The revaluation was not recorded in the accounts of Minnow. Depreciation
is charged at 20% using the straight-line method.
(c) Shark sells goods to Minnow at a markup of 25%. At 31 October 20X0, the inventories of Minnow
included Rs.45,000 of goods purchased from Shark.
(d) Minnow owes Shark Rs.35,000 for goods purchased and Shark owes Minnow Rs.15,000.
(e) It is the group's policy to value the non-controlling interest at fair value.
(f) The market price of the shares of the non-controlling shareholders just before the acquisition was
Rs.1.50.

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Required: Prepare the consolidated statement of financial position of shark as at 31 October 20X0.

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CONSOLIDATION - FORMS OF CONSIDERATION:
1) “Cash”
Dr. Investment in subsidiary xxx

Cr. Cash xxx
2) “Issue of shares”
Dr. Investment in subsidiary* xxx

Cr. Share capital xxx
Cr. Share premium xxx
*(no. of shares issued by parent x Market value of parent’s share)
3) “Issue of loan notes”
Dr. Investment in subsidiary xxx

Cr. Loan xxx
4) “Deferred Consideration”
Dr. Investment in Subsidiary xxx (present value)Cr.

Deferred liability xxx (present value)
Unwinding of interest (Liability x interest rate)
Dr. Interest Expense xxx (CRE)

Cr. Deferred Liability xxx
5) “Contingent Consideration”
“Consideration dependent on certain future events or future performance targets”
Criteria:
 Fair value can be measured reliably. And probability will not be seen for recognition
Dr. Investment in Subsidiary xxx (Fair value)Cr.

Contingent Consideration xxx
“Further movement in contingent consideration depends on”
a) “Settlement in cash/other consideration”

Further movement will be charged to P&L (CRE)(w2(a))

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b) “Settlement in shares”
No further movement will be recognized
6) ” Other assets “
PPE, Investment property, and any other asset Transferred in exchange of Subsidiary shares
Dr. Investment in Subsidiary xxx (Fair value)Cr.

Asset carrying value xxx
Dr/Cr loss /Profit on disposal xxx/xxx
Not forms of consideration
Share options given to the previous owners
When an entity acquires a subsidiary that was previously managed by its owners, the previous owners mightbe given share
options in the entity as an incentive to stay on and work for the subsidiary after it has been acquired. IFRS 3 states that the award
of share options in these circumstances is not a part of the purchase consideration. The options are post-acquisition employment
expenses and should be accounted for as share-based payments in accordance with IFRS 2.
Costs of acquisition: transaction costs Transaction costs incurred in making an acquisition, such as the cost ofthe fees of advisers and
lawyers, must not be included in the cost of the acquisition.
These costs must be treated as an expense as incurred and written off to profit or loss.
The amount of transaction costs associated with an acquisition and written off during the period to profit orloss must be disclosed in
a note to the financial statements

142
Example A:
P Ltd. acquired 80% of S Ltd.’s equity shareholding. Share capital of S Ltd is Rs.125,000 @ Rs.20 each share.
P Ltd:
1) Paid cash of Rs.30 per share acquired
2) issued Rs.100 @ 6% loan note for every 600 shares acquired
3) issued its 3 ordinary shares for every 5 shares of subsidiary:
-Share price of P ltd @ acquisition Rs.25 each
-Share price of S ltd @ acquisition Rs.35 each
4) Promised to pay Rs.300,000 after 2 years
-Interest rate is 10%
Required:
Calculate the total amount of consideration.
Example B:
Beta Co. acquired 70% of XYZ Co.’s shareholding. XYZ’s share capital is Rs.40,000 @ Rs.10 each share.Beta Co.:
1) Paid cash of Rs.5 for each share acquired (Rs.14000)
2) Issued Rs.500 @ 8% loan notes for every 400 shares acquired (Rs.3500)
3) Issued its 2 ordinary shares for every 3 shares of XYZ Co. (Rs.59733)
-share price of Beta Co. @ acquisition Rs.32 each
-share price of XYZ Co. @ acquisition Rs.45 each
4) Promised to pay Rs.90,000 after 1 year. Interest rate prevailing in the market is 10% (Rs.81818)
Required:
Calculate the total amount of consideration.

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IAS 28 : Investment in Associates

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IAS-28 Investment in associate
SIGNIFICANT INFLUENCE
EQUITY METHOD:
Rs.'000
Cost (Pre + goodwill) xxx
Add: Share of post acq. Share xxx
Less: Impairment loss (xxx)
Add: BPG xxx
Less: URP if parent seller (xxx)
Investment in associate xxx SOFP(NCA)
W1 - SHARE OF POST ACQUISITION RESERVE

Dr. Investment in associate xxx
Cr. CRE/Cons. OCE xxx
W2 – IMPAIRMENT LOSS ON INVESTMENT IN ASSOCIATE

Dr. Impairment loss (CRE) xxx
Cr. Investment in associate xxx
W3 – DIVIDEND RECEIVED FROM ASSOCIATE
Dr. Cash xxx

Cr. Investment in associate xxx
W4 – URP WITH ASSOCIATE
Only parent share of URP:

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PARENT SELLER ASSOCIATE SELLER
Dr. Profit (CRE) xxx Dr. Profit (CRE) xxx

Cr. Investment in associate xxx Cr. Inventory xxx
Downstream transaction (P A) upstream transaction (P A)
(Inventory held with associate, and associate’s inventory cannot be consolidated therefore Investment in associate is
credited instead of inventory)
URP:
Dr. Profit xxx

Cr. Inventory xxx
EXAMPLE:
P Co, a company with subsidiaries, acquires 25,000 of the 100,000 Rs.1 ordinary share in A Co for Rs.60,000 on 1 January
20X8. In the year to 31 December 20X8, A Co earns profits after tax of Rs.24,000, from which it declares a dividend of
Rs.6,000.
How will A Co's results be accounted for in the consolidated accounts of P Co for the year ended 31 December 20X8?

147
Step Acquisition/Piecemeal Acquisition

1) Simple Investment to Subsidiary
2) Associate to Subsidiary
3) Simple Investment to Associate
4) Subsidiary to Subsidiary
1. Simple Investment to Subsidiary
Further acquired 40%

Acquisition Date 15% ------------| --------------- > 55%
1 Jan 2010 Sept 2012
Sept 2012 Goodwill Previous investment profit/(loss)

$ $
Consideration (40%) X F.V (15%) investment X
F.V of 15% X C.value (F.V of recent reporting date) (X)
+ NCI F.V X
-F. V of subsidiary N.A at Acq. (X) ---------
------- X/(X)
X ---------
------- P&L

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IFRS-10 New
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IAS 19- Employee benefit
Question 1
COLUMBIA (MAR/JUN 2021)
Background
Columbia Co is the parent of a listed group which operates within the telecommunications industry. On
31 December 20XS, Columbia Co acquired a new subsidiary. The company also has a defined benefit pension
scheme which has not yet been updated in Columbia's individual financial statements. The group's current
year end is 31 December 20XS.
The following exhibits, available, provide information relevant to the question: 1 Acquisition of
Peru Co
Columbia Co: Pension scheme - defined benefit pension scheme
- Columbia Co: Pension scheme
Columbia Co has, for many years, operated a defined benefit pension scheme. At 1 January 20X5, the fair
value of the pension scheme assets was estimated to be $260 million and the present value of the pension
scheme liabilities were $200 million. The total of the present value of future refunds and reductions in future
contributions (asset ceiling) was $20 million at 1 January 20X5.
This table provides details of the scheme for the year ended 31 December 20X5.
Discount rate on good quality 5%

corporate bond
Current service cost 30 m$
21 m$
Cash contributions
Benefits paid during the year 25 m$
The finance assistant was unsure how to record the contributions paid, so incorrectly recorded them within
other receivables as part of current assets. At 31 December 20X5, the fair value of the pension scheme assets
was estimated to be $242 million and the present value of the pension scheme liabilities were $195 million.
The total of the present value of future refunds and reductions in future contributions (asset ceiling) was $25
million at 31 December 20X5
Requirement
How the defined benefit pension scheme should be accounted for in the year ended 31 December 20X5.
(7 marks)
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189
Answer
Defined benefit plan Where a defined benefit pension scheme is in surplus, IAS® 19 Employee Benefits
requires the surplus to be measured as the lower of:
• The surplus in the plan, and
• The present value of the economic benefits in the form of refunds from the plan or reductions in the
future contributions to the plan (known as the asset ceiling).
At 1 January 20X5, the surplus of the scheme is $60 million {$260 million - $200 million) but the asset ceiling
is only $20 million, so the defined benefit pension asset would have been restricted to $20 million. Interest
on the opening asset would therefore be adjusted and only $1 million {5% x $20 million) interest income will
be recorded in profit or loss for the year.
The cash contributions of $21 million should be added to the scheme assets, benefits paid of $25 million are
deducted from both the scheme's assets and the scheme's liabilities and the current service cost of $30 million
is charged to profit or loss.
The pension scheme surplus at 31 December 20X5 is summarized as follows:
Net plan Net plan

asset celling asset after
Asset Liability before adjustment celling
celling adjustment
adjustment
$m $m $m $m $m
Before 1
January 20X5 260 200 60 (40) 20
Net interest
at 5% 13 10 3 (2) 1
Cash
contributions 21 21 _- 21
Benefits paid (25) (25) - - -

Current
service costs 30 (30) - (30)
Total at 31
December 54 (42) 12
20X5 269 215
The actuary has valued the scheme as a surplus of $47 million {$242 million - $195 million) which would result
in a remeasurement loss of $7 million ($54 million - $47 million) on 31 December 20X5. However, the effect
of the asset ceiling is that the pension scheme would only be recognized at a value of $12 million (see table
above).
Since the scheme is valued at the lower of the surplus of the scheme and the present value of the economic
benefits in the form of refunds from the plan or reductions in the future contributions, the scheme will be
restated to $25 million. A net gain of $13 million ($25 million - $12 million) will l be recognized in other
comprehensive income. The pension scheme asset should be included in the financial statements of Columbia
Co at $25 million (the lower of $25 million and $47 million).
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Question 2
SYMBAL (SEP/DEC 2021)

Background information
Walk in the footsteps of a top tutor 80 Symbal Co develops cryptocurrency funds and is a leading authority
on crypto investing. Symbal Co specializes in Initial Coin Offerings ('ICO') that raises funds from investors in
the form of cash or a crypto asset such as Bitcoin.
The year-end of Symbal Co is 31 March 20X7.
Tokens granted to directors
Symbal Co sometimes does not issue all the tokens from an ICO to investors but retains some to use to reward
their employees. On 1 March 20X7, Symbal Co granted tokens to its five directors from the issue on 30 April
20X7. The award vests on 31 March 20X7 to directors who were in Symbal Co's employment at 31 March
20X7. The tokens give the directors the right to receive a car of their choice up to a value of
$50,000 at any time in the next 12 months to 31 March 20X8 if they remain as directors of Symbal Co. All five
directors were still with Symbal Co on 31 March 20X7.
Requirement
Discuss why the granting of the tokens to the five directors should be accounted for in accordance with
IAS 19 Employee Benefits rather than IFRS 2 Share-based Payment in the financial statements for the year
ended 31 March 20X7. (6 marks)
Answer
When assessing the accounting treatment of such arrangements, an entity should consider the
characteristics of the ICO tokens generated. Equity is the residual interest in the assets of an entity after
deducting all of its liabilities. Unless the ICO tokens meet the definition of equity, the arrangements would
not meet the definition of a share-based payment arrangement in accordance with IFRS 2 Share- based
Payment.
Instead, they would fall within the scope of IAS 19 Employee Benefits as a non-cash employee benefit. IAS
19 can then be used to determine the recognition, as well as the measurement, of the employee benefit.
The tokens do not meet the definition of the equity of Symbal Co as they do not grant the directors a
residual interest in the net assets of Symbal Co.
Therefore, the arrangements do not meet the definition of a share-based payment arrangement in
accordance with IFRS 2. Instead, it is a non-cash short term employee benefit. Short-term employee benefits
are those expected to be settled wholly before twelve months after the end of the annual reporting period
during which employee services are rendered. The substance of the arrangement is an exchange of employee
services for the tokens.
The arrangement includes a condition that the directors should be in employment at 31 March 20X7.
Symbal Co should recognize a liability and short-term employee benefit expense at 31 March 20X7. Symbal
Co would measure the amount that it expects to pay by using the fair value of the tokens to be delivered to
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191
the employees, or by using the estimated cost of the goods or services which it expects to deliver in the
future. This amount would be $250,000 ((5 X $50,000). Thus, at 31 March 20X7
Dr Employee costs $250,000

Cr Short-term employee benefit liability $250,000
Question 3
ECOMA CO (MAR 2020)
Background
The directors of Ecoma Co consider environmental, social and governance issues to be extremely important
in a wide range of areas, including new product development, reputation building and overall corporate
strategy. The company is taking a proactive approach to managing sustainability and is actively seeking
opportunities to invest in sustainable projects and embed them in their business practices. The company's
financial year end is 30 September 20XS.
Defined benefit pension scheme

Ecoma Co is worried that the poor remuneration package offered to employees is putting the company at
risk of reputational damage. Consequently, Ecoma Co changed its pension scheme on 30 September
20XS to include all of its staff. The benefits accrue from the date of their employment but only vest after two
years additional service from 30 September 20XS. The net pension obligation at 30 September 20XS of $78
million has been updated to include this change. During the year, benefits of $6 million were paid under the
scheme and Ecoma Co contributed $10 million to the scheme. These payments had been recorded in the
financial statements but no other entries for the year have been made.
The following information relates to the pension scheme
Net pension obligation at 30 September 20X5 $78m
Net pension obligation at 30 September 20X4 $59
Current service cost for year $18
Past service cost relating to scheme amendment at 30 $9

September 20XS
Discount rate at 30 September 20X4 5.5 %
Discount rate at 30 September 20XS 5.9 %
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Requirement
Advise Ecoma Co on the principles of accounting for the pension scheme
including calculations, for the year to 30 September 20X5. (7 marks)
Answer
At each financial year end, the plan assets and the defined benefit obligation are remeasured. The
obligation is measured at present value, and the assets are measured at fair value. The amount of
pension expense to be recognized in profit or loss is comprised of the net interest component and
service costs. Net interest is calculated by multiplying the opening net defined benefit liability by the
discount rate at the start of the annual reporting period. Service costs are the current service costs,
which is the increase in the present value of the defined benefit obligation resulting from employee
services in the current period, and 'past-service costs'.
Ecoma Co's past-service costs are the changes in the present value of the defined benefit obligation for
employee services in prior periods which have resulted from the plan amendment and should be recognized
as an expense. IAS 19 Employee Benefits requires all past service costs to be recognized as an expense at the
earlier of the following dates:
(a) when the plan amendment or curtailment occurs, and
(b) when the entity recognizes related restructuring costs or termination benefits.
These costs should be recognized regardless of vesting requirements. Thus, the past service cost of $9 million
will be recognized at 30 September 20XS. Remeasurement gains and losses are recognized in other
comprehensive income.
The table below reflects the change in the net pension obligation for the period. The statement of profit or
loss will be charged with the net interest component of $3.2 million and the total service cost of $27 million
($18 million+ $9 million). Benefits paid have no effect on the net obligation as both plan assets and obligations
are reduced by $6 million. OCI will be credited with the $1.2 million remeasurement gain.
This gain cannot be reclassified to profit or loss.
Net pension obligation at 30 September 59.0

20X4
Net interest component (59m * 5.5% ) 3.2
Current service cost 18.0
Past service cost 9
Contribution (10)
Remeasurement bal fig (1.2)
pension obligation at 30 September 20X5 78
Profit adjustment
Draft profit 25.0

Net interest component (3.2)
Current and past service costs (2.7)
Revised loss before tax (5.2)
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Question 4
Hudson and co (Mar/June 2019)

Background
Background Hudson has a year end of 31 December 20X2 and operates a defined benefit scheme for
all employees. In addition, the directors of Hudson are paid an annual bonus depending upon the
earnings before interest, tax, depreciation and amortization (EBITDA) of Hudson. Hudson has been
experiencing losses for a number of years and its draft financial statements reflect a small loss for the
current year of $10 million. On 1 May 20X2, Hudson announced that it was restructuring and that it
was going to close down division Wye.
A number of redundancies were confirmed as part of this closure with some staff being reallocated to
other divisions within Hudson. The directors have approved the restructuring in a formal directors'
meeting. Hudson is highly geared and much of its debt is secured on covenants which stipulate that a
minimum level of net assets should be maintained. The directors are concerned that compliance with
IFRS Standards could have significant implications for their bonus and debt covenants.
Redundancy and settlement costs
Hudson still requires a number of staff to operate division Wye until its final expected closure in early 20X3.
As a consequence, Hudson offered its staff two packages in relation to the curtailment of the defined benefit
scheme. A pension enhancement was offered for all staff who leave before the final closure of division Wye.
An additional pension enhancement was offered for staff who remained in employment until the final closure
of division Wye. The directors of Hudson have only included an adjustment in the financial statements for those
staff who left prior to 31 December 20X2.
The directors have included this adjustment within the remeasurement component of the defined benefit
scheme. They do not wish to provide for any other enhancements until employment is finally terminated,
arguing that an obligation would only arise once the staff were made redundant. On final termination, the
directors intend to include the remaining basic enhancement and the additional pension enhancement within the
remeasurement component.
The directors and accountant are aware that the proposed treatment does not conform to IFRS Standards. The directors
believe that the proposed treatment is justified as it will help Hudson maintain its debt covenant obligations and will
therefore be in the best interests of their shareholders who are the primary stakeholder. The directors have indicated that,
should the accountant not agree with their accounting treatment, then he will be replaced.
Required
Explain why the directors of Hudson are wrong to classify the basic and additional pension enhancements as part of the
remeasurement component, including an explanation of the correct treatment for each of these items. Also explain how
any other restructuring costs should be accounted for.
(8 marks)
Answer
According to IAS 19 Employee Benefits, the remeasurement component is presented in other comprehensive income. It
comprises:
• Actuarial gains and losses
• Returns on plan assets not included in the net interest component

• Changes in the asset ceiling not included within the net interest calculation.
Actuarial gains and losses result from differences between actuarial assumptions and what actually occurred during the
period. These will arise in instances such as unexpected movements on interest rates, unexpectedly high or low rates of
employee turnover or unexpected increases or decreases in wage growth.
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The effects of the redundancy exercise are not part of the remeasurement component. A redundancy exercise is an example
of a curtailment because it significantly reduces the number of employees covered by the plan. Per IAS 19, the present
value of the change in the defined benefit obligation as a result of a curtailment is a past service cost and should be
recognized in profit or loss.
The basic enhancement is an obligation that Hudson must pay as compensation for terminating the employee's services
regardless of when the employee leaves the entity. IAS 19 Employee Benefits requires such payments to be recognized at
the earlier of when the plan of termination is announced and when the entity recognizes the associated restructuring costs
associated with the closure of Wye. Hudson should therefore have provided in full for the cost of the basic settlement
regardless of whether the staff have left or not. This should be recognized as part of the past service cost in the profit or
loss of Hudson for the year ended 31 December 20X2.
The additional pension enhancement is only received by employees who complete service up to the closure of division
Wye. In effect, the enhancement is in exchange for the period of service until redundancy. Hudson should estimate the
number of employees who will remain with Hudson until the closure of Wye and spread the estimated total cost over the
period of service. This should be included within the current service cost, thus having an adverse effect on the profit or
loss in both 20X2 and 20X3.
Redundancy costs
As set out in IAS 37 Provisions, Contingent Liabilities and Contingent Assets, an 'obligating event' must have arisen before
a provision can be recognized. With regards to restructuring, a present obligation from a past event arises if:
• a detailed formal plan for the restructuring is in place, and
• a valid expectation has been created in those affected that the restructuring will be carried out, either by starting to
implement the plan or publicly announcing its main features.
In the case of Hudson, a valid expectation has been created because the restructuring has been announced, the redundancies
have been confirmed and the directors have approved the restructuring in a formal directors' meeting. A restructuring
provision should therefore be recognized.
IAS 37 specifies that only the direct expenditure which is necessary as a result of restructuring can be included in the
restructuring provision. This includes costs of making employees redundant and the costs of terminating certain contracts.
However, the provision cannot include the costs of retraining or relocating staff, marketing or investment in new systems
and distribution networks, because these costs relate to future operations.
Question 5
DIGIWIRE (SEP/DEC 2019)

Digiwire Co has developed a new business model whereby it sells music licenses to other companies which then deliver
digital music to consumers.
Pension plan
Digiwire Co provides a defined benefit pension plan for its employees. From 1 September 20X6, Digiwire Co decided to
curtail the plan and to limit the number of participants. The monthly service cost calculated using assumptions at the start
of the year is $9 million. The monthly service cost calculated using assumptions at 1 September 20X6 is $6 million. The
relevant financial information relating to the plan is as follows:
Date Net deficit Discount rate

m$ %
1 January 20X6 30 3
1 September 20X6 36 3.5
31 December 20X6 39 3.7
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Required
Discuss the accounting repercussions of the pension plan curtailment, including a calculation of the net interest component
and current service cost for the year ended 31 December 20X6. (5 marks)
Answer
IAS 19 Employee Benefits
According to IAS 19 Employee Benefits, any gain or loss arising on a curtailment is recognized in the statement of profit
or loss.
When a plan amendment, curtailment or settlement occurs during the annual reporting period, an entity must:
Determine current service cost for the remainder of the period after the plan amendment, curtailment or settlement using
the actuarial assumptions used to remeasure the net defined benefit liability/asset reflecting the benefits offered under the
plan and the plan assets after that event.
Determine net interest for the remainder of the period after the plan amendment, curtailment or settlement using: (i) the
net defined benefit liability/asset reflecting the benefits offered under the plan and the plan assets after that event; and (ii)
the discount rate used to remeasure that net defined benefit liability/asset.
The current service cost would be $96 million ((8 months x $9 million) + (4 months x $6 million)). The net interest
component would be calculated as $1,020,000 (($900,000 x 8/12) + (3.5% X $36m X 4/12)}.
IAS 37 - Provisions, contingent asset, and liability

Question 1
RUBUL (SEP/DEC 2022)
Rubul Co is a group which manufactures furniture and is currently preparing its financial statements for the
year ended 31 December 20X7.
The following exhibits, available below, provide information relevant to the question:
Provision for tax liability - describes the basis of the calculation of sales and income tax liabilities for the
current and previous years.
- Provision for tax liability
Sales tax
Rubul Co has shipped and sold goods in an overseas country for ten years. Rubul Co was under the
impression that the sales in the overseas country are subject to sales tax if the company had a physical and
economic presence in the country. Rubul Co had always understood that because it did not have a physical
presence in the country, it was exempt from sales tax. However, the tax law stated that companies were
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subject to sales tax if they had a physical or economic presence. Therefore, at 31 December 20X7, Rubul Co
has realized that a liability for sales tax has existed for the previous ten years.
Rubul Co has never collected sales tax or filed sales tax returns in the overseas country. Rubul Co has
never been contacted regarding sales tax by the tax authorities in the overseas country. Rubul Co
therefore considers that the risk of detection by the taxation authorities is very low. However, if the
taxation authorities knew about Rubul Co's activities, it is probable that Rubul Co would be liable for
uncollected sales taxes, interest and penalties. Rubul Co considers that the tax authorities would settle
for an amount less than the full liability if full disclosure was made as it is 'widely understood' that the
taxation authority would look back no more than seven years to determine the amount of sales tax due.
The tax authorities can reclaim any sales tax liability from prior years.
Income tax
On 31 December 20X7, legal proceedings were started against Rubul Co by the tax authorities in the same
overseas country for unpaid income tax. Rubul Co disputes the fact that it owes income tax as it has always
paid this tax on time. Rubul Co considers that it is just coincidence that these proceedings have commenced
and does not relate to the sales tax issue. Rubul Co considers that there is little chance of the income tax
case succeeding. In any event, Rubul Co considers that it cannot measure any potential income tax liability
as in its opinion none exists.
Requirement Assess whether Rubul Co should create a provision in accordance with IAS 37 Provisions,
Contingent Liabilities and Contingent Assets for its sales tax and income tax liabilities in the financial statements
for the year ended 31 December 20X7. (10 mark)
Answer
IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that an entity must recognize a
provision if, and only if:
• a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event)
• payment is probable ('more likely than not'), and
• the amount can be estimated reliably.
An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an
entity having no realistic alternative but to settle the obligation.
Rubul Co should therefore record a sales tax liability on this basis, for the full amount that it is legally
obligated to remit t taxation authorities. The sale of goods creates the obligation to make the sales tax
payments. In measuring its liability, Rubul Co should not consider the fact that the risk of detection by the
taxation authorities is very low. Rubul Co should assume that the authorities have all the relevant facts.
Interest and penalties should also be included in the estimate of the liability.
Although it is 'widely understood' that the taxation authority would look back no more than seven years to
determine the taxation liability, Rubul Co must use judgement to determine what constitutes 'widely
understood'. The taxation authorities can reclaim any sales tax liability from prior years. Therefore, Rubul Co
should evaluate whether the taxation authorities will assess the liability back to the first year of taxable sales,
which is ten years.
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Rubul Co should take into account its previous dealings with the taxation authority. An assessment of what
Rubul Co believes it could negotiate as a settlement would not represent what is 'widely understood'. As the
obligating event is the sale of goods, Rubul Co should not record a sales tax liability for future sales until those
sales actually occur. The obligation for the previous years would be treated as a prior period error in
accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
As regards the income tax proceedings, the taxable profits were earned in the past and therefore it is a past
event, so if the income tax had not been paid, Rubul Co would have a present obligation. However, it is
uncertain whether the entity has any obligation and therefore whether a liability exists. This conclusion is
consistent with IAS 37, which identifies a disputed court case as an example of existence uncertainty.
It may be unclear whether a past event causing an obligation has occurred. The taxation authorities have
claimed that Rubul Co has committed an offence and, for that, the taxation authorities should be
compensated. It is uncertain whether Rubul Co has committed the offence. In this case, the uncertainty about
the existence of an obligation, combined with a low probability of outflows of economic benefits and a high
level of measurement uncertainty, may mean that there would be no recognition of a provision, but
consideration should be made of disclosing a contingent liability.
Question 2
Juan Co
Juan Co is a group of companies which operates in the energy industry. The financial year end of the
company is 31 December 20X7.
The following exhibit, available below, provides information relevant to the question: 1 Climate change
issues
- outlines the issues which Juan Co currently faces due to the impact of climate change. This information
should be used to answer the question requirements within your chosen response option(s).
1 - Climate change issue

Juan Co has several coal-fired power plants and is currently facing challenges dealing with the impact of
climate change. Juan Co has not considered the effect of climate change when preparing the current financial
statements.
There has been a decline in the demand for the energy from Juan Co's coal-fired plants because of the
volume of greenhouse gases emitted by the plants. The company is committed to meeting the expanding
climate change regulations of its jurisdiction relating to emissions. If a company does not meet the
jurisdiction's climate-related targets, then fines are imposed by the government for this failure. Juan Co
is also considering a restructure to achieve eco-design of its products and services and to improve the
energy efficiency of its existing buildings.
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As a result, Juan Co has had to change and adapt its business activities and operations, including increased
expenditure on research and development. The company has revised its assumptions about future
profitability and cash flows based upon it cutting its emissions. If it does not cut emissions, it will risk losing
many customers.
Juan Co's supply chains are becoming more complex and globally spread with many points of possible failure.
Juan Co has subsidiaries in regions of the world which are subject to weather extremes and anticipates some
physical harm to its property, plant and equipment because of this. There is the likelihood that some of the
power plants will require decommissioning sooner than expected which will mean restoring the land
damage.
Some restoration work may not be possible at the level required by regulatory changes. Corporate risk is
increasing due to environmental damage caused by climate change. Investors are worried about their share
value in Juan Co because of an anticipated increase in carbon taxes and the significant costs which the
company will have to incur if it is to meet its commitments. In the financial statements for the year ended
31 December 20X7, Juan Co has carried out impairment tests and has not recognized an impairment loss.
Required:
Many preparers of financial statements feel that there is sufficient disclosure of climate related matters in the
management commentary and therefore there is no need to disclose any further information in the actual
financial statements, especially if there is no impact on those financial statements. Even though there is an
acceptance that investors feel such information is important, some preparers think that the materiality
decision does not extend to climate change as there is no IFRS standard dealing with the subject.
Discuss the potential effects of climate-related matters on the financial statements of Juan Co for the year
ended 31 December 20X7 in applying the following IFRS standards. IAS 37 Provisions, Contingent Liabilities
and Contingent asset ( 6 marks )
Answer
IAS 37 Provisions, Contingent Liabilities and Contingent Asset
Climate-related matters may affect the recognition, measurement and disclosure of liabilities in the
financial statements when applying IAS 37. Climate-related risks and uncertainties may also affect the
best estimate of a provision. Juan Co may have to make a provision for potential fines imposed by
governments for failure to meet climate-related targets.
There will also be regulatory requirements to remediate environmental damage. Juan Co anticipates some
physical harm to its property, plant and equipment with risks rising as the world warms, which could lead
to environmental damage.
There will also be costs involved in the restructurings required to redesign products or services to achieve
climate-related targets. These costs will be provided for only when a detailed formal plan is in place and
Juan Co has started to implement the plan or has announced its main features to those affected.
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As there is a likelihood that some of the power plants will require decommissioning sooner than expected,
an increase in the provisions recognized for decommissioning is necessary. Also, the restoration of the land
damaged by these plants may not be possible at the level required by regulation.
Therefore, again, consideration should be given to creating a provision or a contingent liability for the costs
of restoration and the potential litigation and fines which may be imposed by government. Juan Co will be
required to disclose a brief description of the nature of any contingent liability and, where practicable, an
estimate of its financial effect including an indication of any uncertainties.
IAS 37 requires these disclosures unless, in extremely rare cases, disclosure of the information can be
expected to prejudice seriously the company's position in a dispute with other parties.
Question 3
COLAT (MAR/JUNE 2021}
Colat Co manufactures aluminum products and operates in a region that has suffered a natural disaster on 1
November 20X7. There has been an increase in operating costs as the company had to replace a regional
supplier with a more costly international supplier. The year-end of Colat Co is 31 December 20X7.
Potential insurance policy proceeds
Colat Co's insurance policy provides compensation for losses based on the fair value of non-current assets,
any temporary relocation costs estimated at $2million and any revenue lost during the two-month period
from 1 November 20X7. At 31 December 20X7, it is unclear which events and costs are covered by insurance
policies and significant uncertainty exists as to whether any compensation will be paid. Before the financial
statements were approved, it was probable that the insurance claim for the loss of the non-current assets
would be paid but no further information was available about other insured losses. The insurance policy does
not cover environmental damage which is the responsibility of the government.
Required Investors need to understand a variety of factors when making an investment decision. The nature
of the companies in which they are looking to invest is an important consideration, as is the need to
incorporate sustainability factors into investment decisions.
Discuss how the potential insurance policy proceeds should be accounted for in the financial statements for
the year ended 31 December 20X7: (4 marks )
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Answer
Potential insurance policy proceeds
IAS 37 does not permit the recognition of contingent assets. Accordingly, an insurance recovery asset can
only be recognized if it is determined that the entity has a valid insurance policy which includes cover for the
incident and a claim will be settled by the insurer.
The recognition of the insurance recovery will only be appropriate when its realization is virtually certain, in
which case the insurance recovery is no longer a contingent asset. Decisions about the recognition and
measurement of losses are made independently of those relating to the recognition of any
compensation which might be receivable. It is not appropriate to take potential proceeds into account
when accounting for the losses. The potential receipt of compensation should be assessed continually to
ensure that it is appropriately reflected in the financial statements. The asset and the related income are
recognised in the period in which it is determined that a compensation will be received which means
reviewing the situation after the end of the reporting period and before the date of approval of the
financial statements. In this case, as it appears probable that the insurance claim for the loss of the non-
current assets would be paid and as this information was received before the financial statements were
approved, the potential proceeds ($280 million) should be disclosed in the financial statements for the
year ended 31 December 20X7.
There would be no disclosure of the insurance recovery related to the relocation costs or the lost
revenue as the recovery is not virtually certain. The insurance policy does not cover environmental
damage which is the responsibility of the government
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Question 4
Mehran and co
Mehran has recognized provisions in its financial statements for the year ended 31 March 20X6. It has
produced the following provisions disclosure note:
Customer
refunds Reorganizations Total
$m $m
$m
1 April 10.2 8.0 18.2
20X5
Charged 31.1 10.2 23.3
to profit
or loss
Utilized (9.1) (9.6) (18.7)
31 14.2 8.6 22.8
March
20X6
Of
which:
Current 14.2 8.00 22.2
Non- - 0.6 0.6
current
Provisions for customer refunds reflect the company's expected liability for returns of goods sold in retail
stores based on experience of rates of return. Provisions for reorganizations reflect restructuring and
redundancy costs, principally in relation to our retail operations as well as restructurings in Finance and IT. The
directors of Mehran have been asked by an investor to explain the accounting for provisions in the financial
statements and to explain why the information provided in the provision’s disclosure note is useful.
Required: Explain to the investor the nature of accounting for provisions in financial statements. Your answer
should explain the benefits and limitations of the information provided in Mehran's disclosure note. (8 marks)
Solution
Accounting for provisions
Provisions are defined in IAS 37 Provisions, Contingent liabilities, and Contingent Assets as liabilities where
the timing or the amount of the future outflow is uncertain. A provision is recognized if all of the following
criteria are met:
• there is an obligation from a past event
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• an outflow of economic resources to settle the obligation is probable
• the outflow of economic resources can be measured reliably.
Provisions should be measured at the best estimate of the economic resources required to settle the
obligation. They should be remeasured at each reporting date using the best available information. If the
time value of money is material, then the provision should be discounted to present value. The discount rate
used should reflect risks specific to the liability.
Benefits and limitations
Provisions involve uncertainty. Disclosures should provide important information to help users understand
the nature of the obligation, the timing of any outflow of economic benefits, uncertainties about the
amounts or timing involved, and major assumptions made.
The disclosure note splits the provision between current and non-current liabilities. This helps users of the
financial statements assess the timing of the cash outflows and the potential impact on Mehran's overall
net cash inflows. It would be useful to provide further information about the expected timing of the
outflows classified as a non-current liability.
Financial reporting focusses on past events, but provisions disclosures also provide important information
about the future. This disclosure note informs investors about restructuring activities within stores, but also
in Finance and IT. Whilst this restructuring will incur costs, investors may value Mehran's efforts to streamline
its operations and improve efficiency.
The disclosure shows that provisions, as a total balance, increased year on year. Liabilities always entail risk
because there is an obligation to make payments to settle the obligation even if the company has
insufficient liquid resources to do so. Provisions might be viewed as particularly risky, because they are
estimated and therefore the actual cash outflows required might be significantly higher than estimated.
Some investors may be deterred from investing in companies with substantial provisions.
With regards to the refund provision, the amount utilized in the reporting period is less than the provision
at the start of the year. This suggests that, in the prior year, management had over-estimated the refund
provision. This information may cast doubt on management's ability to accurately estimate its provisions and
increase uncertainty regarding Mehran's future cash flows
Further information could be provided to help users assess the adequacy of the provisions made. Part of the
restructuring provision is classified as non-current but no information is provided about discount rates. Very
little information is provided about any uncertainties that would impact the measurement of the provision,
or the assumptions made. This hinders the ability of the users to assess the adequacy of management's
estimates.
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IAS 24-Related party transaction

QUESTION 1
BAGSHOT (MAR 2020)
Bagshot Co has a controlling interest in a number of entities. Group results have been disappointing in
recent years and the directors of Bagshot Co have been discussing various strategies to improve group
performance. The current financial year end is 31 December 20XS.
The following personnel are relevant to the scenario:
Mr Shaw: Head accountant of Bagshot Co
Mrs Dawes: Chief executive of Bagshot Co
Mike Starr: Nephew of Mr Shaw
Mrs Shaw: Wife of Mr Shaw Group
Group restructure
Mr Shaw, an ACCA member, is the head accountant of Bagshot Co. He is not a member of the board of
directors. Mrs Dawes, the chief executive of Bagshot Co, is also an ACCA member. During December
20XS, Mrs Dawes revealed plans to Mr Shaw of a potential restructure of the Bagshot group which had been
discussed at board meetings. The restructuring plans included a general analysis of expected costs which
would be incurred should the restructure take place. These include legal fees, relocation costs for staff and
also redundancy costs for a number of employees. One such employee to be made redundant, Mike Starr,
is the nephew of Mr Shaw.
Mrs Dawes is insistent that Mr Shaw should include a restructuring provision for all of the expenditure in
the financial statements of Bagshot Co for the year ended 31 December 20XS. Mrs Dawes argues that, even
if the restructure did not take place exactly as detailed, similar levels of expenditure are likely to be incurred
on alternative strategies. It would therefore be prudent to include a restructuring provision for all
expenditure. None of the staff other than Mr Shaw have been notified of the plans although Mrs Dawes has
informed Mr Shaw that she expects a final decision and public announcement to be made prior to the
authorization of the financial statements.
Mrs Shaw
Mrs Shaw is the wife of Mr Shaw, the head accountant of Bagshot Co. She is not an employee of Bagshot Co
and does not know about the proposed restructure. However, Mrs Shaw recently acquired 5% of the equity
shares in Bagshot Co. Mr Shaw is considering informing his wife of the proposed restructure so that she can
make an informed decision as to whether to divest her shareholding or not.
Mr Shaw is concerned that, in the short term at least, the inclusion of any restructuring costs would be
harmful to the profitability of Bagshot Co. It is also uncertain as to how the market may react should the
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restructure take place. It is, however, anticipated that in the long term, shareholder value would be
enhanced.
Requirement
(i) Discuss the appropriate accounting treatment of the restructuring costs in the financial statements of
Bagshot Co for the year ended 31 December 20XS. (6 marks)
(ii) Discuss what is meant by good stewardship of a company and whether the restructure and the
recognition of a restructuring provision in the financial statements are examples of good stewardship.
(4 mark)
(ii) Discuss briefly whether Mrs Shaw's acquisition of the equity shares in Bagshot Co should be disclosed
as a related party transaction. (3 marks)
Answer
A provision for restructuring costs should only be recognised in the financial statements of Bagshot Co where
all of the following criteria are met:
• A reliable estimate can be made of the amount of the obligation
• It is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation
• There is a present obligation as a result of a past event.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that it would be extremely rare that no
reliable estimate can be made.
A best estimate of the expenditure required to settle the present obligation should be provided as at 31
December 20XS should all criteria be met. In the case of a restructuring provision, this should only include
direct expenditure arising from the restructuring and not associated with ongoing activities. Hence the
relocation costs would not be included as, although they relate directly to the restructuring, the costs would
be classified as an ongoing activity.
It is not clear yet that restructuring payments are probable. Mrs Dawes has indicated that alternative
strategies are possible and further clarification is required. Only then may it be determined that such
restructuring payments are probable.
A constructive obligation for restructuring only arises where a detailed formal plan exists and a valid
expectation to those affected by the restructuring that it will take place has occurred. A plan is in place but
management does not yet appear committed as alternative strategies are possible. It is unlikely therefore that
the plan is detailed and specific enough for these criteria to be satisfied.
For example, the specific expenditure to be incurred, the date of its implementation and timeframe which
should not be unreasonably long must be identified. With alternative strategies available, this does not appear
to be the case. Furthermore, Mr Shaw is the only member of staff who has been notified and no public
announcement has been made as at the reporting date.
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Consequently, there is no obligation in existence as at 31 December 20XS and no provision can be recognised.
Mrs Dawes has identified that a final decision on the restructuring and communication is likely to take place
before the financial statements are authorised. This would almost certainly be a material event arising after
the reporting date but should be treated as non-adjusting. Accordingly, Bagshot Co should disclose the nature
of the restructuring and an estimate of its financial effect but recognition of a restructuring provision is still
prohibited.
ii) Stewardship
Stewardship is an ethical principle which embodies the responsible planning and management of resources.
The directors of Bagshot Co perform a stewardship role in that they are appointed by the shareholders to
manage Bagshot Co on their behalf. The directors therefore assume responsibilities to protect the entity's
resources from unfavorable effects of economic factors such as price and technological changes and to ensure
that Bagshot Co complies with all laws, regulations and contractual obligations. Group results have been
disappointing in recent years although no specific causes have been identified. It could be argued, therefore,
that the restructure is acting in good faith and reflecting good principles of stewardship. It is anticipated that
long-term shareholder value will be enhanced from the proposals.
A second factor of good stewardship is that it is important that investors, both existing and potential, and
lenders have reliable and accurate information about the entity's resources so that they can assess how
efficiently and effectively the entity's management and governing board have discharged their responsibilities.
It is important therefore that the financial statements are transparent, objective and comply fully with IFRS
Standards. Mrs Dawes wants Bagshot Co to include a restructuring provision as at 31 December 20XS even
though no obligation arises. Whilst prudence is a guiding principle when dealing with issues of uncertainty,
excessive prudence cannot be justified. As a qualified member of ACCA, it should be apparent to Mrs Dawes
that no provision should be recognized and to include one would be misleading to the stakeholders of Bagshot
Co.
Related parties
Mrs Shaw's acquisition of the equity shares in Bagshot Co would be deemed a related party transaction if the
acquisition enabled her to control or have significant influence over Bagshot Co.
A person is a related party of an entity that they control or have significant influence over. Mrs Shaw has a 5%
interest, which is way below the threshold to exercise control. Mrs Shaw has a holding of less than 20% of the
voting power so it is very unlikely that she has significant influence over the entity. Bagshot Co's directors
would be related parties of Bagshot Co. However, Mrs Shaw is unaware of the proposed restructure which
suggests that she does not have a board position. Mrs Shaw would be deemed to be a close family member
of Mr Shaw and so would be a related party of Bagshot Co if it was concluded that Mr Shaw is a member of
key management personnel of Bagshot Co.
Mr Shaw is the head accountant of Bagshot Co but it seems highly unlikely that he would be deemed to be
key management personnel. There is no evidence that he has authority or responsibility for planning, directing
and controlling the activities of Bagshot Co. Nor does he appear to be a director of the entity.
Based on the above, it can be concluded that Mrs Shaw's acquisition of the 5% of the equity in Bagshot Co is
not a related party transaction.
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Question 2
SUNY and co
Suny, a private limited company, has two overseas subsidiaries, Maior and Minor. Suny is based in a country
which has a currency of the dollar.
Related parties
At 30 November 20X8, three people own the shares of Suny. The finance director owns 60%, and the
operations director owns 30%. The third owner is a passive investor who does not help manage the entity.
All equity shares carry equal voting rights. The wife of the finance director is the sales director of Suny. Their
son is currently undertaking an internship with Suny and receives a salary of $30,000 per annum, which is
normal compensation.
The finance director and sales director have set up an investment company, Baleel. They jointly own Baleel
and their shares in Baleel will eventually be transferred to their son when he has finished the internship with
Suny.
In addition, on 1 June 20X8 Suny obtained a bank loan of $500,000 at a fixed interest rate of 6% per annum.
The loan is to be repaid on 30 November 20X9. Repayment of the principal and interest is secured by a
guarantee registered in favor of the bank against the private home of the finance director
Requirement
Advise the directors of Suny on the identification and disclosure of the company’s related parties
in preparing its separate financial statements for the year ending 30 November 20X8. (8 marks)
Answer
Related parties
IAS 24 Related Party Disclosures requires financial statements to contain the disclosures necessary
to draw attention to the possibility that the financial position and profit or loss may have been
affected by the existence of related parties and by transactions and outstanding balances with such
parties.
A person or a close member of that person’s family is related to a reporting entity if that person:
i. Has control or joint control over the reporting entity;
ii. Has significant influence over the reporting entity; or
iii. Is a member of the key management personnel of the reporting entity or of a parent.
With regards to Suntory, the finance director is a related party, as he owns more than half of the voting
power (60%). In the absence of evidence to the contrary, he controls Suntory and is a member of the
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key management personnel. The sales director is also a related party of Suntory as she is a member of
the key management personnel and is a close member (spouse) of the family of the finance director.
Their son is a related party of Suntory as he is a close member (son) of their family. The operations
director is also a related party as he owns more than 20% of the voting power in Suntory. In the
absence of evidence to the contrary, the operations director has significant influence over Suntory and
is a member of the key management personnel.
An entity is related to a reporting entity if the entity is controlled or jointly controlled by a person
identified as a related party. Hence, Baleel is a related party of Suntory. Baleel is controlled by related
parties, the finance and sales directors, for the benefit of a close member of their family, their son.
In the absence of evidence to the contrary, the third owner of the shares is not a related party. The
person is a passive investor who does not appear to exert significant influence over Suntory. IAS 24
requires details of transactions with related parties to be disclosed in the financial statements. The
only transaction appears to be the guarantee provided by the finance director in respect of the bank
loan and details of this arrangement should be provided.
Disclosure is also required of key management personnel compensation, by category. Therefore,
remuneration provided to the finance, sales, operations and any other directors is disclosed in total for
categories including short-term employee benefits, pension benefits, other long-term employee
benefits, termination benefits and share-based.
Question 3
Stent Co
Stent Co is a consumer electronics company which has faced a challenging year due to increased competition.
Stent Co has a year end of 30 September 20X9 and the unaudited draft financial statements report an
operating loss. In addition to this, debt covenant limits based on gearing are close to being breached and the
company is approaching its overdraft limit.
Cash advance from Budster Co
On 27 September 20X9, Stent Co's finance director asked the accountant to record a cash advance
of $3 million received from a customer, Budster Co, as a reduction in trade receivables. Budster Co
is solely owned by Stent Co's finance director. The accountant has seen an agreement signed by
both companies stating that the $3 million will be repaid to Budster Co in four months' time. The
finance director argues that the proposed accounting treatment is acceptable because the payment
has been made in advance in case Budster Co wishes to order goods in the next four months.
However, the accountant has seen no evidence of any intent from Budster Co to place orders with
Stent Co.
Required: (a) Discuss appropriate accounting treatments which Stent Co should adopt for all issues identified above
and their impact upon gearing. (4 marks)
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Answer
Cash advance
IAS 24 Related Party Disclosures requires an entity's financial statements to contain disclosures necessary to draw
attention to the possibility that its financial statements may have been affected by the existence of related parties and by
transactions and outstanding balances with such parties. The finance director of Stent Co is a related party of Stent Co.
The finance director controls Budster Co and therefore Stent Co and Budster Co are related parties of one another. As
such, Stent Co must disclose the nature of the related party relationship with Budster Co as well as information about all
transactions and outstanding balances between Stent Co and Budster Co. According to the Conceptual Framework, the
advance from Budster Co is a liability: Stent Co has a present obligation (legally enforceable as a consequence of a
binding contract), the settlement of which involves Stent Co giving up resources embodying economic benefits in order
to satisfy the claim.
Except when it reflects the substance of the transaction or other event, offsetting detracts from the ability of users to
understand the entity's transactions and to assess the entity's future cash flows. IAS 1 Presentation of Financial Statements
states that an entity shall not offset assets and liabilities, unless required or permitted by an IFRS Standard. Offsetting a
financial asset and a financial liability is permitted according to IAS 32 Financial Instruments: Presentation when, and
only when, an entity has a legally enforceable right to set off the recognized amounts and intends either to settle on a net
basis, or to realize the asset and settle the liability simultaneously. No such agreement is evident in this case, so Stent Co
should report the receivables and the advance separately. If the error was not corrected, Stent Co would be showing a
lower current asset figure and concealing the liability. If disclosed as a current liability it might be included in the debt
element of the gearing calculation, thus increasing gearing.
IFRS -8 - Operating segment
Question 1
KLANCET
Background info
Klancet, a public limited company, is a pharmaceutical company and is seeking advice on several financial
reporting issues.
Klancet produces and sells its range of drugs through three separate divisions. In addition, there are two
laboratories which carry out research and development activities.
In the first of these laboratories, the research and development activity is funded internally and centrally for
each of the three sales divisions. It does not carry out research and development activities for other entities.
Each of the three divisions is given a budget allocation which it uses to purchase research and development
activities from the laboratory. The laboratory is directly accountable to the division heads for this expenditure.
The second laboratory performs contract investigation activities for other laboratories and
pharmaceutical companies. This laboratory earns 75% of its revenues from external customers and these
external revenues represent 18% of the organization’s total revenues.
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The performance of the second laboratory's activities and of the three separate divisions is regularly
reviewed by the chief operating decision maker (CODM). In addition to the heads of divisions, there is a
head of the second laboratory.
The head of the second laboratory is directly accountable to the CODM and they discuss the operating
activities, allocation of resources and financial results of the laboratory.
Required
Klancet is uncertain as to whether the research and development laboratories should be reported
as two separate segments under IFRS 8 Operating Segments, and would like advice on this issue.
Advise Klancet on how the above transactions should be dealt with in its financial statements with
reference to relevant International Financial Reporting Standards. (8 marks)
Answer
IFRS 8 Operating Segments

States that an operating segment is a component of an entity which engages in business activities from which
it may earn revenues and incur costs. In addition, discrete financial information should be available for the
segment and these results should be regularly reviewed by the entity's chief operating decision maker
(CODM) when making decisions about resource allocation to the segment and assessing its performance. If
a function is an integral part of the business, it may be disclosed as a segment even though it may not earn
revenue.
According to IFRS 8, an operating segment should be reported if it meets one of the following
quantitative thresholds:
1) Its reported revenue, including both sales to external customers and intersegment sales or transfers, is
10% or more of the combined revenue, internal and external, of all operating segments.
2) The absolute amount of its reported profit or loss is 10% or more of the greater, in absolute amount, of
(i) the combined reported profit of all operating segments which did not report a loss and
(ii) the combined reported loss of all operating segments which reported a loss.
3) Its assets are 10% or more of the combined assets of all operating segments.
The research and development laboratories
The first laboratory is not an operating segment. This is because:
• The laboratory does not have a separate segment manager and the existence of a segment manager is
normally an important factor in determining operating segments
• The laboratory is responsible to the divisions themselves, which would seem to indicate that it is
simply supporting the existing divisions and not a separate segment.
• There does not seem to be any discrete performance information, which is reviewed by the CODM.
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The second laboratory is an operating segment. This is because:
• It has a separate segment manager
• It engages in activities which earn revenues and incurs costs
• Its operating results are reviewed by the CODM and discrete information is available for the laboratory's
activities. The second laboratory should be separately disclosed because its revenues make up more than
10% of the revenues of all operating segment.
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IFRS 2 and 13 - Share based payment and fair value measurement

Question1
LUPLOID (SEP/DEC 2019)
Background
Luploid Co is the parent company of a group undergoing rapid expansion through acquisition. Luploid Co
has acquired two subsidiaries in recent years, Colyson Co and Hammond Co. The current financial year end
is 30 June 20X8.
Acquisition of Hammond Co and share-based payments
Luploid Co acquired 60% of the 10 million equity shares of Hammond Co on 1 July 20X7. Two Luploid Co
shares are to be issued for every five shares acquired in Hammond Co. These shares will be issued on 1 July
20X8. The fair value of a Luploid Co share was $30 at 1 July 20X7.
Hammond Co had previously granted a share-based payment to its employees with a three-year vesting
period. At 1 July 20X7, the employees had completed their service period but had not yet exercised their
options. The fair value of the options granted at 1 July 20X7 was $15 million. As part of the acquisition,
Luploid Co is obliged to replace the share-based payment scheme of Hammond Co with a scheme that has
a fair value of $18 million at 1 July 20X7.
There are no vesting conditions attached to this replacement scheme. Unrelated to the acquisition of
Hammond, Luploid Co issued 100 options to 10,000 employees on 1 July 20X7. The shares are conditional
on the employees completing a further two years of service. Additionally, the scheme required that the
market price of Luploid Co's shares had to increase by 10% from its value of $30 per share at the acquisition
date over the vesting period. It was anticipated at 1 July 20X7 that 10% of staff would leave over the vesting
period but this was revised to 4% by 30 June 20X8.The fair value of each option at the grant date was $20.
The share price of Luploid Co at 30 June 20X8 was $32 and is anticipated to grow at a similar rate in the year
ended 30 June 20X9.
Requirement
(i) How the consideration for the acquisition of Hammond Co should be measured on 1 July 20X7. Your
answer should include a discussion of why only some of the cost of the replacement share-based
payment scheme should be included within the consideration. (4 marks)
(ii) How much of an expense for share-based payment schemes should be recognized in the consolidated
statement of profit or loss of Luploid Co for the year ended 30 June 20X8.
Your answer should include a brief discussion of the relevant principles and how the vesting conditions
impact upon the calculations. (5 marks)
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Answer
Consideration
IFRS 3 Business Combinations requires all consideration to be measured at fair value on acquisition of a
subsidiary. Deferred shares should be measured at the fair value at the acquisition date with subsequent
changes in fair value ignored. Luploid Co will issue 2.4 million (60% x 10m x 2/5) shares as consideration. The
market price at the date of acquisition was $30, so the total fair value is $72 million (2.4m x $30).Since Luploid
Co is obliged to replace the share-based scheme of Hammond Co on acquisition, the replacement scheme
should also be included as consideration (but only up to the fair value of the original scheme as at 1 July
20X7). The fair value of the replacement scheme at the grant date was $18 million. However the fair value
of the original Hammond Co scheme at the acquisition date was only $15 million. As such, only $15 million
should be added to the consideration.
The total consideration should be valued as $87 million ($72m + $15m).
(ii) Expense related to replacement scheme
The $3 million ($18m - $15m) not included within the consideration {see above) should be
treated as part of the post-acquisition remuneration package for the employees and measured
in accordance with IFRS 2 Share-based Payment. As there are no further vesting conditions it
should be recognized as a post-acquisition expense immediately.
When dealing share-based payment questions, students tend to provide answers that are wholly
numerical. Make sure that you discuss and apply the principles from IFRS 2 Share- based Payments or you
will miss out on some very easy marks.
Expense related to additional scheme
The condition relating to the share price of Luploid Co is a market based vesting condition. These are
adjusted for in the calculation of the fair value at the grant date of the option. An expense is therefore
recorded in the consolidated profit or loss of Luploid Co {and a corresponding credit to equity) irrespective
of whether the market based vesting condition is met or not.
The additional two years' service is a non-market based vesting condition. The expense and credit to equity
should be adjusted over the vesting period as expectations change regarding the non-market based vesting
condition. The correct charge to the profit or loss and credit to equity in the year ended 30
June 20X8 is $9.6 million {{10,000 x 96%) x 100 x $20 x ½).
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Question 2
MARGIE
(a) Margie, a public limited company, has entered into several share related transactions during the
period and wishes to obtain advice on how to account for them.
(i) On 1 May 20X2, Margie granted 500 share appreciation rights (SARs) to its 300 managers. All of the
rights vested on 30 April 20X4 but they can be exercised from 1 May 20X4 up to 30 April 20X6. At the
grant date, the value of each SAR was $10 and it was estimated that 5% of the managers would leave
during the vesting period. The fair value of each SAR is as follows:
Date Fair value ($)

30 April 20X3 9
30 April 20X4 11
30 April 20X5 12
All of the managers who were expected to leave employment did leave the company as expected before
30 April 20X4. On 30 April 20XS, 60 managers exercised their options when the intrinsic value of the right
was $10.50 and were paid in cash.
Margie is confused as to whether to account for the SARs under IFRS 2 Sharebased Payment or IFRS 13
Fair Value Measurement, and would like advice as to how the SARs should have been accounted for
between the grant date and 30 April 20X5. (6 marks)
(ii) Margie issued shares during the financial year. Some of those shares were subscribed for by employees
who were existing shareholders, and some were issued to an entity, Grief, which owned 5% of Margie's share
capital. Before the shares were issued, Margie offered to buy a building from Grief and agreed that the
purchase price would be settled by the issue of shares. Margie requires advice about how to account for these
two transactions. (5 marks)
(iii) Margie has entered into a contract with a producer to purchase 350 tonnes of wheat. The purchase price
will be settled in cash at an amount equal to the value of 2,500 of Margie's shares. Margie may settle the
contract at any time by paying the producer an amount equal to the current market value of 2,500 of Margie
shares, less the market value of 350 tonnes of wheat. Margie has no intention of taking physical delivery of
the wheat. The directors of Margie are unsure as to whether this transaction is a sharebased payment and
require advice as to how it should be accounted for in the financial statements. ( 7 marks )
Required:
Advise the directors of Margie on their various requests above.
Note: The mark allocation is shown against each of the three issus.
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Answer
(a) (i) Share-appreciation rights
The scope of IFRS 13

IFRS 13 Fair Value Measurement applies when another IFRS or IAS Standard requires or permits fair value
measurements or disclosures about fair value measurements. IFRS 13 specifically excludes transactions
covered by certain other standards including share-based payment transactions within the scope of IFRS 2
Share-based Payment. Thus share-based payment transactions are scoped out of IFRS 13.
Important note
There are key differences between the accounting treatment of cash-settled share-based payments and
equity-settled share-based payments. Make sure that you learn the rules thoroughly.
The scope of IFRS 13
IFRS 13 Fair Value Measurement applies when another IFRS or IAS Standard requires or permits fair value
measurements or disclosures about fair value measurements. IFRS 13 specifically excludes transactions
covered by certain other standards including share-based payment transactions within the scope of IFRS 2
Share-based Payment. Thus share-based payment transactions are scoped out of IFRS 13.
Accounting for SARs
For cash settled share-based payment transactions, the entity should recognize an expense and liability as
service is rendered. The fair value of the liability is measured at each reporting date. Any changes in fair value
are recognized in profit or loss in the period. The SARs would have been accounted for during the vesting
period as follows:
Year Expense Liability Calculations
30 April 20X3 641,250 641,250 (300 X 95%) X 500 X

$9 X ½
30 April 20X4 926,250 1,567,500 (300 X 95%) X 500 X
$11
Until the liability is settled, the entity must re-measure the fair value of the liability at the end of each reporting
period and at the date of settlement, with any changes in fair value recognized in profit or loss for the period.
$
Liability 1 May 20X4 1567500
Cash paid (60 x 500 x $10.50) (315000)
Expense (bal. fig.) 97500
Liability 30 April 20X5 ((285 - 60) x 500 x 1350000
$12)
The fair value of the liability would be $1,350,000 at 30 April 20X5 and the expense for the year would be
$97,500.
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Share transactions
A share-based payment is when an entity receives goods or services in exchange for equity instruments or
cash based on the value of equity instruments The shares issued to the employees were issued in their
capacity as shareholders and not in exchange for their services. The employees were not required to complete
a period of service in exchange for the shares.
Thus, the transaction is outside the scope of IFRS 2 Share-based Payment. As regards to Grief, Margie
approached the company with the proposal to buy the building in exchange for shares. As such the
transaction comes under IFRS 2. Grief is not an employee so the transaction will be recorded at the value of
the goods received. This means that the building is recognised at its fair value and equity will be credited with
the same amount.
iii) Wheat contract
important note
Determine whether or not the transaction falls within the scope of IFRS 2. If not, explain why not and
then continue by discussing the required accounting treatment.
The arrangement is not within the scope of IFRS 2 Share-based Payment because Margie is not expecting to
take delivery of the wheat.
This contract is within the scope of IFRS 9 Financial Instruments because it can be settled net and was not
entered into for the purpose of the receipt or delivery of the item in accordance with the entity's expected
purchase, sale, or usage requirements.
The contract is a derivative because it meets the following criteria:
• Its value changes compared to an underlying item
• It required no, or a low, initial investment
• It is settled in the future
IFRS 9 Financial Instruments requires derivatives to be measured at fair value through profit or loss, unless
the entity applies hedge accounting. The contract will be initially recognized at fair value. This will probably
be nil as, under the terms of a commercial contract, the value of 2,500 shares should equate to the value of
350 tons of wheat. Derivatives are remeasured to fair value at each reporting date, with the gain or loss
reported in the statement of profit or loss. The fair value will be based on the values of wheat and Margie
shares. The fair value gain or loss should be recorded in the statement of profit or loss.
(b) Share based payment

The Conceptual Framework defines an expense as a decrease in economic benefits that result in decreases in
equity (other than those related to distributions to equity participants).
In the case of a cash-settled share-based payment, the entity has an obligation to pay cash in the future. This
therefore meets the definition of an expense. However, in the case of an equity-settled share-based payment,
the entity is providing equity as payment for the good or service received.
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There is no apparent reduction in an asset or increase in a liability in accordance with the definition of an
expense. In fact, an equity-settled share-based payment has no net impact on equity (expenses reduce
retained earnings, but the other side of the transaction increases other components of equity).
Although IFRS 2 Share-based Payment requires the recognition of an expense for equity-settled schemes, it
can be argued that this is not in accordance with the definitions in the Conceptual Framework. The Board
refute the above. They argue that employee service is an asset that is received by the reporting entity but
then simultaneously consumed. In other words, in accordance with the definition of an expense, there is a
decrease in the assets of the reporting entity.
Non-refundable deposits
The Conceptual Framework defines a liability as a present obligation from a past event to transfer an
economic resource. In this example, there is no obligation to repay the cash because the deposit is non-
refundable. Some commentators believe that the deposit amount should therefore be recognized
immediately as income.
Nonetheless, the seller has an obligation to transfer the related goods or services to the customer. These
goods or services are economic resources because they have the potential to produce economic benefits.
As such, a non-refundable deposit received would seem to meet the definition of a liability. That said, it
can be argued that the liability to transfer goods or services should be recognized at the cost to the entity
of providing these, rather than the price that was charged to the customer.
internally generated brands
The Conceptual Framework defines an asset as a resource controlled by an entity as a result of a past
event. Brands, whether internally generated or purchased, meet the definition of an asset. This is
because they are controlled by the entity, normally through trademarks, and they have the potential
to bring economic resources. The Conceptual Framework says that items are recognized in the
financial statements if recognition provides relevant information and a faithful representation of the
underlying transaction.
Recognition of a brand in the financial statements would most likely provide relevant information.
Non- recognition arguably understates the financial value of the reporting entity to the primary users
of the financial statements. However, the cost of an internally generated brand cannot be measured
reliably because brand expenditure cannot be differentiated from the day-to-day operating costs of
the business. This measurement uncertainty means that it is not possible to represent the brand
faithfully in the financial statements. The prohibition in IAS 38 on recognizing internally generated
brands would appear to be consistent with the Conceptual Framework.
Example of IFRS 2 (by sir Zubair Saleem)
One CEO joins the company condition is market value of share must be $ 30 at end of year 3 in order to
qualify for 10,000 shares fair value of option @ grant date 3 $.
At the end of year 1 target expected to vest.
At the end of year 2 target not expected to meet.
At the end of year 3 target actually not met.

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Answer
Equity Expense
Year 1 (1 * 10000 ) * 3 *1/3 = 10000 10000
Year 2 (1 *10000) * 3 *2/3 = 20000 10000
Year 3 (1*10000) * 3 *3/2 = 30000 1000
Question 3
SITKA (MAR/JUN 2021)
Sitka Co is a software development company which operates in an industry where technologies change rapidly. Its
customers use the cloud to access the software and Sitka Co generates revenue by charging customers for the software
license and software updates. It has recent ly disposed of an interest in a subsidiary, Marlett Co, and purchased a controlling
interest in Billing Co. The year end of the company is 31 December 20X7.
Acquisition of Billing Co
Sitka Co has acquired two assets in a business combination with Billing Co. The first asset is 'Qbooks' which is an
accounting system developed by Billing Co for use with the second asset which is 'Best Cloud' software. The directors of
Sitka Co believe that the fair value of the assets is higher if valued together rather than individually. If the assets were to
be sold, there are two types of buyers that would be interested in purchasing the assets. One buyer group would be those
who operate in the same industry and have similar assets.
This group of buyers would eventually replace Qbooks with their own accounting system which would enhance the value
of their assets. The fair values of the individual assets in the industry buyer group would be $30 million for Qbooks and
$200 million for 'Best Cloud', therefore being $230 million in total. Another type of buyer is the financial investor who
would not have a substitute asset for Qbooks. They would license Qbooks for its remaining life and commercialize the
product. The indicated fair values for Qbooks and Best Cloud within the financial investor group are $50million and $150
million, being $200 million in total.
Requirement
Discuss how the two assets acquired on the acquisition of Billing Co should be valued in accordance IFRS 13 Fair Value
Measurement. (4 marks)
Answer
IFRS 13 Fair Value Measurement states that the fair value is the price which would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the measurement date. However, IFRS 13 also
uses the concept of the highest and best use which is the use of a non-financial asset by market participants which would
maximize the value of the asset or the group of asset s and liabilities within which the asset would be used. The fair values
of the two assets would be determined based on the use of the assets within the buyer group which operates in the industry.
The fair value of the asset group of $230 million is higher than the asset group for the financial investor of $200 million.
The use of the assets in the industry buyer group does not maximize the fair value of the assets individually but it maximizes
the fair value of the asset group. Thus, even though Qbooks would be worth $50 million to the financial investors, its fair
value for financial reporting purposes is $30 million as this is the value placed upon Qbooks by the industry buyer group.
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Question 4
Mehran and co
Mehran is a public limited company. It operates in a number of business sectors, including farming, mining and retail.
The directors require advice about how to apply IFRS 13 Fair Value Measurement.
(i)Mehran has just acquired a company, which comprises a farming and mining business. Mehran wishes advice on
how to fair value some of the assets acquired. One such asset is a piece of land, which is currently used for farming.
The fair value of the land if used for farming is $5 million. If the land is used for farming purposes, a tax credit of
$0.1 million arises. Mehran has determined that market participants would consider that the land could have an
alternative use for residential purposes. The fair value of the land for residential purposes before associated costs is
thought to be $7.4 million.
In order to transform the land from farming to residential use, there would be legal costs of $200,000, a viability
analysis cost of $300,000 and costs of demolition of the farm buildings of $100,000. Additionally, permission for
residential use has not been formally given by the legal authority and because of this, market participants have
indicated that the fair value of the land, after the above costs, would be discounted by 20% because of the risk of not
obtaining planning permission.
In addition, Mehran has acquired the brand name associated with the produce from the farm. Mehran has decided to
discontinue the brand on the assumption that it is similar to its existing brands. Mehran has determined that if it ceases
to use the brand, then the indirect benefits will be $20 million. If it continues to use the brand, then the direct benefit
will be $17 million. Other companies in this market do not have brands that are as strong as Mehran's and so would
not see any significant benefit from the discontinuation. (9 marks)
(ii)Mehran owns a non-controlling equity interest in Erham, a private company, and wishes to fair value it as at its
financial year end of 31 March 20X6. Mehran acquired the ordinary share interest in Erham on 1 April 20X4. During
the current financial year, Erham has issued further equity capital through the issue of preferred shares to a venture
capital fund. As a result of the preferred share issue, the venture capital fund now holds a controlling interest in Erham.
The terms of the preferred shares, including the voting rights, are similar to those of the ordinary shares, except that
the preferred shares have a cumulative fixed dividend entitlement for a period of four years and the preferred shares
rank ahead of the ordinary shares upon the liquidation of Erham. The transaction price for the preferred shares was
$15 per share. Mehran wishes to know the factors which should be taken into account in measuring the fair value of
their holding in the ordinary shares of Erham at 31 March 20X6 using a market-based approach.
Required:
Discuss the way in which Mehran should fair value the above assets with reference to the principles of IFRS 13 Fair
Value Measurement.
(6 marks)
Note: The mark allocation is shown against each of the two issues above.
Answer
(a) (i) IFRS 13 and non-financial assets
IFRS 13 Fair Value Measurement requires the fair value of a non-financial asset to be measured based on its highest
and best use. This is determined from the perspective of market participants. It does not matter whether the entity
intends to use the asset differently.
The highest and best use takes into account the use of the asset which is physically possible, legally permissible and
financially feasible. IFRS 13 allows management to presume that the current use of an asset is the highest and best
use unless factors suggest otherwise. Land If the land zoned for agricultural use is currently used for farming, the fair
value should reflect the cost structure to continue operating the land for farming, including any tax credits which could
be realised by market participants.
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Thus the fair value of the land if used for farming would be $5.1 million ($Sm + $0.lm). The agricultural land appears
to have an alternative use as market participants have considered its use for residential purposes instead. A use of an
asset need not be legal at the measurement date, but it must not be legally prohibited in the jurisdiction. If used for
residential purposes, the value should include all costs associated with changing the land to the market participant's
intended use.
In addition, demolition and other costs associated with preparing the land for a different use should be included in the
valuation. These costs would include the uncertainty related to whether the approval needed for changing the usage
would be obtained, because market participants would take that into account when pricing value of the land if it had
a different use. Thus the fair value of the land if used for residential purposes would be $5.44 million (($7.4m -$0.2m
-$0.3m - $0.lm) x 80%).
In this situation, the presumption that the current use is the highest and best use of the land has been overridden by
the market factors which indicate that residential development is the highest and best use. Therefore the fair value of
the land would be $5.44 million.
Brand
In the absence of any evidence to the contrary, Mehran should value the brand on the basis of the highest and best use
by market participants, even if Mehran intends a different use. Market participants would not discontinue the brand,
because their existing brands are less strong. Instead market participants would continue to use the brand in order to
obtain the direct benefits. Mehran's decision to discontinue the brand is therefore not relevant in determining fair
value. As such, the fair value of the brand is $17 million
(iii) IFRS 13 and financial assets
IFRS 13 Fair Value Measurement states that fair value is a market-based measurement, although it acknowledges that
observable market transactions might not be available. Whether or not observable information is available, the aim of
IFRS 13 is to estimate the price at which an asset would be sold at in an orderly transaction between market participants
at the measurement date.
The market approach takes a transaction price paid for an identical or a similar instrument and adjusts it. Using a
market approach, Mehran could take the transaction price for the preferred shares and adjust it to reflect certain
differences between the preferred shares and the ordinary shares. For example:
• There would be an adjustment to reflect the priority of the preferred shares upon liquidation. • Mehran should
acknowledge the benefit associated with control. This adjustment relates to the fact that Mehran's individual ordinary
shares represent a non-controlling interest whereas the preferred shares issued reflect a controlling interest.
• There will be an adjustment for the lack of liquidity of the investment which reflects the lesser ability of the ordinary
shareholder to initiate a sale of Erham relative to the preferred shareholder.
• There will be an adjustment for the cumulative dividend entitlement of the preferred shares. This would be calculated
as the present value of the expected future dividend receipts on the preferred shares, less the present value of any
expected dividend receipts on the ordinary shares.
Mehran should review the circumstances of the issue of the preferred shares to ensure that its price was a valid
benchmark. In addition, Mehran should consider whether there have been changes in market conditions between the
issue of the preferred shares and the measurement date.
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LEASESS - (IFRS 16)

Question 1
Bohai Co
Background
Bohai Co trades as a leisure travel group and provides travelers with unique vacations. The financial year
end of the company is 31 December 20X8. The following exhibits, available below, provide information
relevant to the question:
Operating leases - describes the lease and non-lease components of agreements with third parties.
This information should be used to answer the question requirements within your chosen response
option(s).
- Operating leases
The business model of Bohai Co also includes the management and refurbishment of cruise ships.
Income is generated by:
(i) leasing cruise ships on operating leases to third parties, normally for a period of five years, and
(ii) managing the cruise ships operations (non-lease element).
Gross revenue therefore comprises rental income and recharges of operating fees. Bohai Co bears all
costs which occur when the lessee operates the cruise ships and recharges them to the lessee. For
some operational items such as fuel and food supplies, the lessee can enter into direct purchase
agreements with third parties at each port. The third parties bill Bohai Co directly as Bohai Co arranges
the port facility.
In this specific case, Bohai Co then recharges the costs to the lessee based on the lessee's consumption
of goods plus a management fee. For other operating costs of the cruise ship such as engine
maintenance and cleaning of the cruise ship, these are billed at a price agreed on the date when the
lease is signed. Bohai Co concluded that it acts as a principal in all of its dealings with the lessee and
recorded all revenue gross.
Requirement
Explain how Bohai Co should account for the lease and non-lease components of the cruise ship
agreements in accordance with IFRS 15 Revenue from Contracts with Customers and IFRS 16 Leases.
(9 marks)
ANSWER
Lease and non-lease component
IFRS 16 Leases states that for a contract which contains a lease, an entity should account for each lease
component within the contract as a lease separately from non-lease components. In this case, IFRS 16 is
applicable because the lessee has the right to use the cruise ship for a specified period (five years) in
exchange for a rental fee. Bohai Co should reflect the underlying asset (the cruise ships) subject to the
lease arrangement on the statement of financial position.
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Bohai Co has to assess whether the operating services for the cruise ship are non-lease components.
This in turn leads to an assessment as to whether IFRS 15 Revenue from Contracts with Customers is
applicable to these services or whether amounts payable do not give rise to a separate component
from the lease.
If the services are not separate from the lease, they are part of the consideration which is allocated to
the separately identified components of the lease contract. In this case, both IFRS 15 and 16 can be
applicable, depending on the identified components. Bohai Co should allocate consideration between
individual lease and non-lease components of the contract in line with IFRS 15's guidance on allocating
the transaction price to performance obligations, i.e. based on stand-alone selling prices or estimation
thereof.
Therefore, the operating costs are deemed to be separate non-lease components. When more than
one party is involved in providing goods or services to a customer, IFRS 15 requires an entity to
determine whether it is a principal or an agent in these transactions by evaluating the nature of its
promise to the customer.
An entity is a principal and, therefore, records revenue on a gross basis, if it controls a promised good
or service before transferring that good or service to the customer. An entity is an agent if its role is to
arrange for another entity to provide the goods or services and, therefore, records as revenue the net
amount which it retains for its agency services. The operating costs of the cruise ship such as engine
maintenance and cleaning of the cruise ship are carried out by Bohai Co and are billed at a price agreed
on the signing of the lease.
Therefore, Bohai Co is acting as a principal and therefore the recording of the operating costs at the
gross amount is correct. The direct purchase agreements with third parties at each port are billed to
Bohai Co and the entity adds a management fee and bills the total to the lessee. In this case, Bohai Co
is acting as an agent for arranging the supply of fuel and food supplies.
The fact that Bohai Co acts as an agent is only relevant for the presentation of the consideration and
not for identification of separate components in a lease contract. Bohai Co should recognize revenue
only in the amount of the management fee to which it expects to be entitled in exchange for arranging
for the specified goods or services to be provided by the third party
The relevant criterion is whether Bohai Co obtains control of the services before they get passed to the
lessee. In this case, Bohai Co cannot control the fuel and food supplies before they are transferred to the
lessee. Bohai Co has no consumption or inventory risk, is not able to set its own prices and does not earn
any margin on the supply of goods. The fact that Bohai Co arranges the port facility does not give the
entity control over the fuel and food suppliers.
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Question 2
LERIA CO ( MAR 2020}
Background
Leria Co is an internationally successful football club. Leria Co is preparing the financial statements for the
year ending 31 October 20XS but is currently facing liquidity problems.
Stadium sale/leaseback and improvements
Leria Co has entered into a contract regarding its stadium whereby it will sell the stadium on 30 November
20X6 and immediately lease it back.
The directors of Leria Co wish to classify the stadium as a non-current asset 'held for sale' in its financial
statements for the year ended 31 October 20XS as they believe the sale to be highly probable at that date.
The sale contract requires the disposal of the stadium for its fair value (market value) of $30 million and
for Leria Co to lease it back over 10 years.
The present value of the lease payments at market rates on 30 November 20X6 will be $26 million. The
market value for a stadium of this type has not changed in several years and is unlikely to change in the
near future. The stadium is being depreciated by 5% per annum using the reducing balance method. In
the year to 31 October 20X6, it is anticipated that $2 million will be spent to improve the crowd barriers
in the stadium.
There is no legal requirement to improve the crowd barriers. Leria Co has incorrectly treated this amount
as a reduction of the asset's carrying amount at 31 October 20XS and the corresponding debit has been
made to profit or loss. At 31 October 20XS, the carrying amount of the stadium, after depreciation and
deduction of the crowd barrier improvements, is $18 million.
Requirement
Discuss with reference to IFRS Standards the principles of the accounting treatment for the sale and
leaseback of the stadium at 30 November 20X6. (7 marks)
Answer
Sale and leaseback
A sale and leaseback transaction occurs where an entity transfers an asset to another entity and leases that
asset back from the buyer/lessor. The accounting treatment depends on whether a sale has occurred. Under
IFRS 16 Leases, an entity must apply the IFRS 15 Revenue from Contracts with Customers requirements to
determine when a performance obligation is satisfied.
In this case it seems that a sale will occur on 30 November 20X6 because of the binding sale
commitment.
Leria Co should account for the sale and leaseback as follows:
• Derecognize the $18.92 million (W1) underlying asset
• Recognize the $30 million proceeds from the sale
• Recognize a right-of-use asset at $16.4 million (W2)
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• Recognize a lease liability at $26 million
• Recognize a profit on disposal of the underlying asset of $1.48 million (W3).
{W l)
Carrying amount of the underlying asset
Carrying amount of stadium is $20 million ($18m + $2m).
Depreciation for year to 31 October 20X6 is $1 million ($20m x 5%).
Depreciation for November 20X6 is $0.08 million (($20m - $1m) x 5% x 1/12).
The carrying amount at the sale date= $20m - $1m - $0.08m = $18.92m
(W2)
Right-of-use asset
The right-of-use asset is recorded at the proportion of the asset's previous carrying amount that relates to
the rights retained. This is $16.4 million (($26m/$30m) x $18.92m).
{W3)
Profit on disposal
The profit on disposal relates solely to the rights transferred. This amounts to $1.48 million ($30m +
$16.4m - $18.92m - $26m)
Question 3
Fiskerton
Background
The following is an extract from the statement of financial position of Fiskerton, a public limited entity as at
30 September 20X8.
$’000
160,901
Non-current assets
110,318
Current assets
Equity share capital ($ each) 10,000
Other components of equity 20,151
Retained earnings 70,253
Non-current liabilities (bank loan) 50,000
Current liabilities 120,815
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The bank loan has a covenant attached whereby it will become immediately repayable should the gearing
ratio (long-term debt to equity) of Fiskerton exceed 50%. Fiskerton has a negative cash balance as at 30
September 20X8.
Halam property
Included within the non-current assets of Fiskerton is a property in Halam which has been leased to
Edingley under a 40-year lease. The property was acquired for $20 million on 1 October 20X7 and was
immediately leased to Edingley. The asset was expected to have a useful life of 40 years at the date of
acquisition and have a minimal residual value.
Fiskerton has classified the building as an investment property and has adopted the fair value model. The
property was initially revalued to $22 million on 31 March 20X8. Interim financial statements had
indicated that gearing was 51% prior to this revaluation. The managing director was made aware of this
breach of covenant and so instructed that the property should be revalued. The property is now carried
at a value of $28 million which was determined by the sale of a similar sized property on 30 September
20X8.
This property was located in a much more prosperous area and built with a higher grade of material. An
independent professional valuer has estimated the value to be no more than $22 million. The managing
director has argued that fair values should be referenced to an active market and is refusing to adjust the
financial statements, even though he knows it is contrary to international accounting standards.
Requirement
Discuss how the Halam property should have been accounted for and explain the implications for the financial
statements and the debt covenant of Fiskerton. (7 marks)
Answer
The Halam property should not have been classified as an investment property because it is a finance lease
as the lease term is equal to the useful life and its residual value is deemed to be minimal. Edingley should
record a right to use asset and Fiskerton should derecognize the property. Fiskerton should instead record a
lease receivable equal to the net investment in the lease.
The property needs to be removed from investment properties and the fair value gains of $8 million
reversed. In any case, the fair value gains were incorrectly calculated since adjustments should have been
made for the differences between the Halam building and the one sold due to the different location and
quality of the materials between the two buildings. It would appear that $22 million would have been a
more accurate reflection of fair value.
The incorrect treatment has enabled Fiskerton to remain within its debt covenant limits. Gearing per the
financial extracts is currently around 49·8% (50/(10 + 20·151 + 70·253)). Fair value gains on investment
properties are reported within profit or loss. Retained earnings would consequently be restated to
$62·253 million ($70·253m – $8m). Gearing would subsequently become 54·1% (50/10 + 20·151 +
62·253). Furthermore, retained earnings would be further reduced by correcting for rental receipts.
These presumably have been included in profit or loss rather than deducted from the net investment in the
lease. This would in part be offset by interest income which should be recorded in profit or loss at the
effective rate of interest. After correcting for these errors, Fiskerton would be in breach of their debt
covenants. They have a negative cash balance and would appear unlikely to be able to repay the loan.
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Serious consideration should therefore be given as to whether Fiskerton is a going concern. It is likely that non-
current assets and non-current liabilities should be reclassified to current and recorded at their realizable
values. As an absolute minimum, should Fiskerton be able to renegotiate with the bank, the uncertainties
surrounding their ability to continue to trade would need to be disclosed
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Question 4
Calendar and co (specimen exam 2018)
Calendar has a reporting date of 31 December 20X7. It prepares its financial statements in accordance with
International Financial Reporting Standards. Calendar develops biotech products for pharmaceutical
companies. These pharmaceutical companies then manufacture and sell the products. Calendar receives stage
payments during product development and a share of royalties when the final product is sold to consumers. A
new accountant has recently joined Calendar’s finance department and has raised a number of queries
Aircraft contract
While searching for some invoices, the accountant found a contract which Calendar had entered into on
1 January 20X7 with Diary, another entity. The contract allows Calendar to use a specific aircraft owned by
Diary for a period of three years. Calendar is required to make annual payments. On 1 January 20X7, costs
were incurred negotiating the contract. The first annual payment was made on 31 December 20X7. Both of
these amounts have been expensed to the statement of profit or loss. There are contractual restrictions
concerning where the aircraft can fly. Subject to those restrictions, Calendar determines where and when
the aircraft will fly, and the cargo and passengers which will be transported.
Diary is permitted to substitute the aircraft at any time during the three-year period for an alternative model
and must replace the aircraft if it is not working. Any substitute aircraft must meet strict interior and exterior
specifications outlined in the contract. There are significant costs involved in outfitting an aircraft to meet
Calendar’s specifications. The accountant requires advice as to the correct accounting treatment of this
contract.
Required:
Advise the accountant on the matters set out above with reference to International Financial Reporting
Standards. (9 marks)
Answer
Contract IFRS 16 Leases says that a contract contains a lease if it conveys the right to control the use of an
identified asset for a period of time in exchange for consideration. When deciding if a contract involves the
right to control an asset, the customer must assess whether they have:
– The right to substantially all of the identified asset’s economic benefits;
– The right to direct the asset’s use.
Calendar has the right to use a specified aircraft for three years in exchange for annual payments. Although
Diary can substitute the aircraft for an alternative, the costs of doing so would be prohibitive because of
the strict specifications outlined in the contract.
Calendar appears to have control over the aircraft during the three-year period because no other parties can
use the aircraft during this time, and Calendar makes key decisions about the aircraft’s destinations and the
cargo and passengers which it transports. There are some legal and contractual restrictions which limit the
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aircraft’s use. These protective rights define the scope of Calendar’s right of use but do not prevent it from
having the right to direct the use of the aircraft.
Based on the above, the contract contains a lease. IFRS 16 permits exemptions for leases of less than 12
months or leases of low value. However, this lease contract is for three years, so is not short term, and is for
a high value asset so a lease liability should have been recognized at contract inception.
The lease liability should equal the present value of the payments yet to be made, using the discount rate
implicit in the lease. A finance cost accrues over the year, which is charged to profit or loss and added to the
carrying amount of the lease liability. The year-end cash payment should be removed from profit or loss and
deducted from the carrying amount of the liability.
A right-of-use asset should have been recognized at the contract inception at an amount equal to the
initial value of the lease liability plus the initial costs to Calendar of negotiating the lease. The right-of-
use asset should be depreciated over the lease term of three years and so one year’s depreciation should
be charged to profit or loss.
Question 5
STEM (SEP/DEC 2021)
Stem Co is a manufacturing company and is considering providing cars for its senior management. It has also entered
into an agreement with two other companies to develop a new technology through a separate legal entity, Emphasis
Co. The financial year end of Stem Co is 31 December 20X7.
Option 1 The cars can be leased for a period of four years starting on 1 January 20X7. The cars have a total market
value of $75,274 on this date. The lease requires payments of $1,403 on a monthly basis for the duration of the lease
term of which $235 is a servicing charge. Stem Co wishes to show the servicing charge as a separate line item in
profit or loss. At the end of the four-year period, there is no option to renew the lease or purchase the cars, and there
is no residual value guarantee. The interest to be charged for the year ended 31 December 20X7 is correctly calculated
at $2,274 based upon the implicit interest rate in the lease. The net present value of the lease payments over four
years is $50,803 excluding the service charge.
Option 2 The cars can be purchased for $75,274 with a 100% bank loan. The cars would be purchased on 1 January
20X7 and held for four years. The estimated residual value is $29,753. Monthly service costs would still be $235 per
month. The loan would be repayable in four annual instalments commencing 1 January 20X8. Assume that an average
annual percentage rate on a loan is 5%.
Option 3 A final alternative is to lease the cars with a 12-month agreement on 1 January 20X7 with no purchase
option. The cost would be $1,900 per month in advance including servicing charge. Stem Co would take advantage
of the short-term lease exemption under IFRS 16 Leases.
Other relevant information The profit before tax and before accounting for any of the three options for cars is
likely to be $100,000 for the year ended 31 December 20X7. Stem Co depreciates cars over a fouryear period using
straight line depreciation.
Emphasis Co On 1 January 20X7, Stem Co has contributed cash to a new legal entity, Emphasis Co, and holds an
interest of 40%. The other two companies contributing have retained equity interests of 40% and 20%, respectively.
The purpose of the entity is to share risks and rewards in developing a new technology. The holders of a 40% interest
can appoint three members each to a sevenmember board of directors. All significant decisions require the unanimous
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consent of the board. The holder of the 20% interest can appoint only one board member and can only participate in
the significant decisions of the entity through the board. There are no related parties
Stem Co contributed cash of $150,000 to Emphasis Co. The entity will use the cash invested by Stem Co to gain access
to new markets and to develop new products. At 1 January 20X7, the carrying amount of the net assets contributed by the
three companies was $310,000 but the fair value of the net assets contributed was $470,000
Required: (a) Explain, with suitable calculations, the impact of the three alternative company car options on
• earnings before interest, tax, depreciation and amortization (EBITDA)
• profit before tax,
• and the statement of financial position for the year ended 31 December 20X7.
Note: Candidates should refer to IFRS 16 Leases where appropriate . (13 marks)
(b) (i) Discuss briefly principles of the equity method of accounting and whether it is a more relevant measurement
basis than cost or fair value of an investment in an associate company. Note: There is no need to refer to any exhibit
when answering part (b)(i). (4 marks)
Answer
(a) Company cars
Option 1: Leased for a four-year period
At 1 January 20X7, a right-of-use asset and lease liability of $50,803 would be recognized according to IFRS 16
Leases. The annual lease component of the lease payments is $14,016 (12 x ($1,403- $235)) and the service component
is $2,820 (12 x $235). At 31 December 20X7, operating expenses will comprise the service component of $2,820 and
depreciation of $12,701 ($50,803/4). An interest expense of $2,274 will be recognized as a finance cost. The lease
liability recognized will be $50,803 less the annual payments of $14,016 plus the interest element of $2,274 i.e.
$39,061. The closing lease liability will be split between its non-current and current liability in the statement of
financial position. IFRS 16 requires a company to recognize interest on lease liabilities separately from depreciation
on leased assets.
Option 2: Purchased on 1 January 20X7
If the cars were purchased on 1 January 20X7, then depreciation of $11,380 ($75,274 - $29,753 = $45,521/4 = $11,380)
would be charged and interest of $3,764 ($75,274 x 5%) would also be charged. The cars would have to be serviced
at a cost of $2,820.
Option 3: Leased on a 12-month agreement
Instead of applying the recognition requirements of IFRS 16 Leases, a lessee may elect to account for lease payments
as an expense on a straight-line basis over the lease term for the following two types of leases:
(i)leases with a lease term of 12 months or less and containing no purchase options, and
(ii)leases where the underlying asset has a low value.
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The effect of applying the IFRS 16 exemption would be that neither an asset nor a liability will be recognized and
therefore it will not affect the statement of financial position. Neither a right of use asset nor lease liability will be
recognized if this exemption is applied. Instead, an expense will be recognized in the statement of profit or loss. The
cost of the short-term lease would be included in operating expenses at $22,800 (12 X $1,900).
It can be seen that the impact on EBITDA is greatest if 12-month leases are chosen. This is because the cost is shown
in operating expenses. Additionally, profit before tax is lower under this option. EBITDA does not include lease
interest when IFRS 16 is used and thus is naturally higher. There will be no effect on EBITDA if Stem Co leases or
buys the cars and, further, the impact on profit before tax is minimal with profit being lower if Stem Co purchases the
cars. If 12-month leases are chosen, then there will be no recognition of an asset for the cars which will result in a
higher asset base for the four-year lease/purchase of cars, which will affect ratios such as asset turnover. Similarly, a
liability will not be recognized in the case of the 12-month lease which will mean higher financial liabilities for the
four-year lease/purchase, which will affect financial leverage (gearing). The carrying amount of the leased cars will
typically reduce more quickly than the carrying amount of lease liabilities. This is because, in each period of the lease,
the leased car is depreciated on a straight-line basis, and the lease liability is reduced by the amount of lease payments
made and increased by the interest which reduces over the life of the lease. Consequently, although the amounts of the
lease asset and lease liability are the same at the start and end of the lease, the amount of the asset would typically be
lower than that of the liability throughout the lease term. This will result in a further reduction in reported equity as
compared to 12-month leases. This will be similar to the effect on reported equity which arises from financing the
purchase of the cars through a loan
Option 1: Option 2: Option 3:

Lease over 4 Purchase with 12-month
years $ loan $ leases ($)
Profit before 100,000 $ 100,000 $ 100,000 $
accounting for cars
Service cost (2,820) (2,820)
Operating expense (22,800)
EBITDA 97,180 97,180 77,200
Depreciation (12,701) (11,380}
Interest (2,274) (3,764)
Profit before tax 82,205 82,036 77,200
Statement of
financial position
PPE 38,102 63,894 0
(50,803 -12, 701) (75,274-
11,380)
Lease/Loan Liability 39,061 (see 79,038 0
explanation) (75,274 +
3,764)
(b) (i) Equity method
The equity method is a measurement method and not a consolidation method, as the equity-accounted entity remains
as a single line in the investor's statement of financial position and, in IFRS standards, consolidation is based on the
existence of control. Equity accounting is a measurement method for investments where there is 'significant influence'
and recognises an associate's profits which have not been received and could not be successfully demanded. The equity
method consists of the cost of t he investment in the associate, plus the parent's share of the associate's post-acquisition
movement in net assets. The equity method provides better information than that provided by cost, but it can be argued
that, where investments are listed, there is no reason not to use fair value. The equity method is likely to be better than
cost because cost is, in isolation, an uninformative basis for decision-making. However, if an investment is listed, then
its fair value would be easier to establish and more intuitively appealing than the numbers derived from the equity
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method. If the associate is unlisted, then there might be questions about the verifiability of fair value. However, even
then, there appears to be no reason why the equity method should be preferred to IFRS 13 Fair Value Measurement.
IAS 16 and 36 - Property plant and equipment and impairment
Question 1
GASNATURE ( IAS 16 with joint arrangement )
(a) Gasnature is a public limited company involved in the production and trading of natural gas and oil. It prepares its
financial statements using International Financial Reporting Standards. The directors require advice about the
accounting treatment of some of the transactions that Gasnature has entered into during the year.
(i) Gasnature jointly owns an underground storage facility with another entity, Gogas. Both parties extract gas
from offshore gas fields, which they own and operate independently from each other. Gasnature owns 55%
of the underground facility and Gogas owns 45%. They have agreed to share services and costs accordingly,
with decisions regarding the storage facility requiring unanimous agreement of the parties. Local legislation
requires the decommissioning of the storage facility at the end of its useful life. Gasnature wishes to know
how to treat the agreement with Gogas including any obligation or possible obligation arising on the
underground storage facility.
Required:
Discuss, with reference to IFRS Standards, how Gasnature should account for the above agreement and
contract (7 marks)
Answer
Joint arrangements
A joint arrangement occurs where two or more parties have joint control. Joint control exists when decisions
about the relevant activities require the unanimous consent of the parties sharing control. The classification
of a joint arrangement as a joint operation or a joint venture depends upon the rights and obligations of the
parties to the arrangement. A joint arrangement which is not structured through a separate vehicle is normally
a joint operation. A joint operator accounts for the assets, liabilities, revenues and expenses relating to its
involvement in a joint operation. The arrangement with Gogas is a joint arrangement, because decisions
regarding the platform require unanimous agreement of both parties. The joint arrangement with Gogas
should be classified as a joint operation because there is no separate vehicle involved. Gasnature should
recognise 55% of the asset's cost as property, plant and equipment.
Dismantling
Under IAS 16 Property, Plant and Equipment (PPE), the cost of an item of property, plant and equipment
must include the initial estimate of the costs of dismantling and removing the item and restoring the site on
which it is located. IAS 37 Provisions, Contingent Liabilities and Contingent Assets stipulates how to
measure decommissioning and restoration costs and similar liabilities. Where the effect of the time value of
money is material, the amount of a provision should be the present value of the expected expenditure required
to settle the obligation.
Thus Gasnature should account for 55% of the present value of the estimated decommissioning costs.
Gasnature will include this in PPE and will also recognise a provision for the same amount.
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Because Gasnature is a joint operator, there is also a contingent liability for 45% of the decommissioning
costs as there is a potential obligation if some uncertain future event occurs (such as if Gogas goes into
liquidation and cannot fund the decommissioning costs). Therefore Gasnature should disclose a contingent
liability to the extent that it is potentially liable for Gogas's share of the decommissioning costs.
Question 2
Luploid Co (consolidation)
Luploid Co is the parent company of a group undergoing rapid expansion through acquisition. Luploid Co has
acquired two subsidiaries in recent years, Colyson Co and Hammond Co. The current financial year end is 30
June 20X8.
Impairment of Colyson Co
Colyson Co incurred losses during the year ended 30 June 20X8 and an impairment review was performed.
The recoverable amount of Colyson Co’s assets was estimated to be $100 million. Included in this assessment
was the only building owned by Colyson Co which had been damaged in a storm and impaired to the extent
of $4 million. The carrying amount of the net assets of Colyson Co at 30 June 20X8 (including fair value
adjustments on acquisition but excluding goodwill) are as follows:
$m
Land and buildings 60
Other plant and machinery 15
Intangibles other than goodwill 9
Current assets (recoverable amount) 22
Total 106
The recoverable amount of Colyson Co's assets was estimated to be $100 million. Included in this assessment
was a building owned by Colyson Co which had been damaged in a storm and needs to be impaired by $4
million. Other land and buildings are held at recoverable amount. None of the assets of Colyson Co including
goodwill have been impaired previously. Colyson Co does not have a policy of revaluing its assets.
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Answer
An impairment arises where the carrying amount of the net assets exceeds the recoverable amount. Where
there is a clear indication of impairment, this asset should be reduced to the recoverable amount.
Where the cash flows cannot be independently determined for individual assets, they should be assessed
as a cash generating unit. That is the smallest group of assets which independently generate cash flows.
Impairments of cash generating units are allocated first to goodwill and then pro rata on the other assets.
It should be noted that no asset should be reduced below its recoverable amount.
Fair value method
The overall impairment of Colyson Co is $30 million ($106m + goodwill $24m – $100m). The damaged building
should be impaired by $4 million with a corresponding charge to profit or loss. Since $4 million has already
been allocated to the land and buildings, $26 million remains. The goodwill should therefore be written off
and expensed in the consolidated statement of profit or loss.
Of the remaining $2 million, $1·25 million will be allocated to the plant and machinery (15/(15 + 9) x
2m) and $0·75 million will be allocated to the remaining intangibles (9/(9 + 15) x 2m). As no assets have been
previously revalued, all the impairments are charged to profit or loss. $24 million (80% x $30m) will be
attributable to the owners of Luploid Co and $6 million to the NCI in the consolidated statement of
The allocation of the impairment is summarized in this table:
Original CV Impairment Revised CV

$m $m $m
Land and 60 4 56
buildings
Plant and 15 1.25 13.75
machinery
Intangibles 9 0.75 8.25
other than
goodwill
Goodwill 24 24 0
Current assets 22 0 22
(at
recoverable
amount)
Total 130 30 100
Proportionate method
The basic principles and rule for impairment is the same as the fair value method and so $4 million will
again first be written off against the land and buildings. The problems arise when performing the
impairment review as a cash generating unit. When NCI is measured using the proportional share of net
assets, no goodwill is attributable to the NCI since goodwill is not included within the individual net assets
of the subsidiary. This means that the goodwill needs to be grossed up when an impairment review is
performed so that it is comparable with the recoverable amount. Under the fair value method, the NCI fully
represents any premium the other shareholders would be prepared to pay for the net assets and so
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goodwill does not need to be grossed up. The goodwill of $19·6 million is grossed up by 100/80 to a value of
$24·5 million.
This extra $4·9 million is known as notional goodwill. The overall impairment is now $30·5 million ($106m +
$24·5m – $100m) of which $4 million has already been allocated. Since the remaining impairment of $26·5
million exceeds the value of goodwill, the goodwill is written down to zero.
However, as only $19·6 million goodwill is recognized within the consolidated accounts, the impairment
attributable to the notional goodwill is not recognized. Only $19·6 million is deducted in full from the owners
of Luploid Co’s share of profits since there is no goodwill attributable to the non-controlling interest.
The remaining $2 million impairment is allocated between plant and machinery and intangibles (other than
goodwill). NCI will be allocated 20% of $6m ($4m + $2m), i.e. $1·2 million. Consolidated retained earnings will
be charged with 80% of $6m (i.e. $4·8m) plus $19·6 million goodwill impairment (i.e.$24·4m in total). The
allocation of the impairment is summarized in this table:
The impairment expense attributable to the owners of Luploid Co is $24.4 million ($19.6m goodwill
impairment+ (80% x ($4m building+ $2m plant and machinery and other intangibles))). The impairment
expense attributable to the NCI is $1.2 million (20% x $6m). This is summarized below:
Original CA Impairment Revised

$m $m CA $m
Land and 60 (4.00) 56
buildings
Plant and 15 (1.25) 13.75
machinery
intangibles other 9 (0.75) 8.25
than goodwill
Goodwill 19.6 (19.60) 0
(Notional 4.9 (4.90) 0
goodwill)
Current assets (at 22 - 22
recoverable
amount)
Total 130.5 (30.5) 100
Tutorial note: Notional goodwill and impairment of notional goodwill does not impact on the
consolidated financial statements.
Question 3
FILL and co
Fill is a coal mining company and sells its coal on the spot and futures markets
Following exhibit provides the following information
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Coal inventory
At 30 November 20X6, the directors of Fill estimate that a piece of mining equipment needs to be
reconditioned every two years. They estimate that these costs will amount to $2 million for parts and $1
million for the labor cost of their own employees. The directors are proposing to create a provision for the
next reconditioning which is due in two years’ time in 20X8, along with essential maintenance costs. There is
no legal obligation to maintain the mining equipment. As explained above, it is expected that there will be
future reductions in the selling prices of coal which will affect the forward contracts being signed over the
next two years by Fill. The directors of Fill require advice on how to treat the reconditioning costs and whether
the decline in the price of coal is an impairment indicator.
Required:
Advise the directors of Fill on how the above transactions should be dealt with in its financial statements with
reference to relevant IFRS Standards (8 marks)
Answer
IAS 16 Property, Plant and Equipment (PPE) requires an entity to recognize in the carrying amount of PPE,
the cost of replacing part of such an item. When each major inspection is performed, its cost is recognized
in the carrying amount of the item of PPE as a replacement if the recognition criteria are satisfied. Any
remaining carrying amount of the cost of a previous inspection is derecognized. The costs of performing a
major reconditioning are capitalized if it gives access to future economic benefits.
Such costs will include the labor and materials costs ($3 million) of performing the reconditioning. However,
costs which do not relate to the replacement of components or the installation of new assets, such as routine
maintenance costs, should be expensed as incurred. It is not acceptable to accrue the costs of reconditioning
equipment as there is no legal or apparent constructive obligation to undertake the reconditioning. As set
out above, the cost of the reconditioning should be identified as a separate component of the mine asset at
initial recognition and depreciated over a period of two years. This will result in the same amount of expense
being recognized as the proposal to create a provision.
IAS 36 Impairment of Assets says that at the end of each reporting period, an entity is required to assess
whether there is any indication that an asset may be impaired. IAS 36 has a list of external and internal
indicators of impairment. If there is an indication that an asset may be impaired, then the asset’s recoverable
amount must be calculated. Past and future reductions in selling prices may indicate that the future
economic benefits which relate to the asset have been reduced.
Mining assets should be tested for impairment whenever indicators of impairment exist. Impairments are
recognized if a mine’s carrying amount exceeds its recoverable amount. However, the nature of mining assets
is that they often have a 14 long useful life. Commodity prices can be volatile but downward price
movements are more significant if they are likely to persist for longer periods. In this case, there is evidence
of a decline in forward prices.
If the decline in prices is for a significant proportion of the remaining expected life of the mine, this is more
likely to be an impairment indicator. It appears that forward contract prices for two years out of the three
years of the mine’s remaining life indicate a reduction in selling prices. Based on market information, Fill has
also calculated that the three-year forecast price of coal will be 20% lower than the current spot price (part
(a) of question).
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Short-term market fluctuations may not be impairment indicators if prices are expected to return to higher
levels. However, despite the difficulty in making such assessments, it would appear that the mining assets
should be tested for impairment.
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IFRS 15 - Revenue from contract with customer
Question 1
Luna Co
Background
Luna Co is the parent company of a group that operates in the pharmaceutical industry. All entities in the
group have a financial year end of 31 March. The current year end is 31 March 20X6.
The following exhibits, available below, provide information relevant to the question: Sale of goods to Starlight
Co - provides information regarding a sale of goods between Luna Co and Starlight Co shortly before the
reporting date.
- Sale of goods to Starlight Co
On 20 March 20X6, Luna Co sold 5,000 units to Starlight Co at an initial transaction price of $200 per unit and
control of the goods passed from Luna Co to Starlight Co on that date. Payment is only due when Starlight
Co sells the goods on to the end consumer which typically takes around six months. Starlight Co had not yet
sold any goods on to the final consumer as at 31 March 20X6.
The goods have a high risk of obsolescence and therefore price concessions are regularly granted in order
that the goods can be easily transferred on within the distribution channel. On the basis of past practice,
Luna Co anticipates that it will grant Starlight Co a price concession of between 8% and 38%. Current
market data suggests that a maximum price concession of 35% may be necessary to enable Starlight Co
to distribute the goods to the final consumer.
The initial cost of the goods to Luna Co was $80 per unit. Luna Co has recorded the sale at the initial
transaction price of $200 per unit. Starlight Co has included the goods within their closing inventory at a
value of $1,000,000. Revenue and cost of sales for the respective entities for the year ended 31 March
20X6 are as follows:
Luna Co $ Starlight Co $
Revenue 29,812,540 14,185,160
Cost of sales (18,154,020) {11,042,120)
Required
Discuss the principles that should be considered by Luna Co in recording the sale of the goods to Starlight
Co in Luna Co's individuals’ financial statements for the year ended 31 March 20X6. Conclude on whether
the accounting treatment currently adopted is correct. (6 mark)
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Answer
Revenue should be recognized when a performance obligation is satisfied. This can be over time or at a point
in time. Since the risks and rewards of ownership of the goods pass to Starlight Co on 20 March
20X6, it is right that Luna Co should recognize revenue at this date and not when Starlight sells the
goods to the final consumer.
The price concession which is likely to be offered by Luna Co means that the value of the consideration
is variable and uncertain. IFRS 15 Revenue from Contracts with Customers requires the entity to estimate the
amount of consideration to which it is entitled in exchange for the goods sold. Luna Co should either choose
an expected value method or choose the most likely outcome to estimate the amount of the variable
consideration. Luna Co should choose whichever method will better predict the amount of the consideration
to which it is entitled.
Since Luna Co has a history of offering price concessions but over a range from 8% to 38%, it would appear
that an expected value method is probably more appropriate. In the absence of further information, it
would seem reasonable to make an initial estimate of the variable consideration by using the mid-point of
the previous price concessions. This mid-point would be a price concession equal to
23%. This would result in a revenue figure equal to $770,000 {$200 x 5,000 X 77%).
IFRS 15 states that when estimating the amount of variable consideration, revenue must only be
recognized to the extent that it is highly probable that a significant reversal of the cumulative revenue will
not be required in the future. The risk of obsolescence means that the value of the consideration
Luna Co is entitled to is highly contingent on factors outside the control of Luna Co. Luna Co has a history of
offering price concessions of up to 38%, so it is unlikely that Luna Co can conclude that it is highly probable
that a significant reversal in revenue will not be required.
Current market data suggests that the maximum price concession is likely to be 35%. Therefore, it seems
reasonable for Luna Co to revise its estimate to $650,000 ($200 x 5,000 x 65%). This is the maximum
amount that is highly probable that a significant reversal of revenue will not be required. Since the whole
$1,000,000 {$200 x 5,000) has been included within revenue, the accounting treatment adopted is not
correct. Revenue should be reduced by $350,000 ($1,000,000 - $650,000).
Question 2
Sitka Co is a software development company which operates in an industry where technologies change
rapidly. Its customers use the cloud to access the software and Sitka Co generates revenue by charging
customers for the software license and software updates. It has recently disposed of an interest in a
subsidiary, Marlett Co, and purchased a controlling interest in Billing Co. The year end of the company is 31
December 20X7.
Software contract and updates
On 1 January 20X7, Sitka Co agreed a four-year contract with Cent Co to provide access to license Sitka Co's
software including customer support in the form of monthly updates to the software. The total contract
price is $3 million for both licensing the software and the monthly updates. Sitka Co licenses the software on
a stand-alone basis for between $1 million and $2 million over a four-year period and regularly sells the
monthly updates separately for $2,5 million over the same period. The software can function on its own
without the updates.
Although, the monthly updates improve its effectiveness, they are not essential to its functionality. However,
because of the rapidly changing technology in the industry, if Cent Co does not update the software
regularly, the benefits of using the software would be significantly reduced. In the year to 31 December
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20X7, Cent Co has only updated the software on two occasions. Cent Co must access the software via the
cloud and does not own the rights to the software.
Required
(a) (i) Discuss whether the four-year software contract with Cent Co is a single performance obligation in accordance
with IFRS 15 Revenue from Contracts with Customers including how the revenue from the contract would be
accounted for in Sitka Co's financial statements for the year ended 31 December 20X7. Your answer should include
whether the revenue should be recognised at a point in time or over time . (8 marks)
Answer
IFRS 15 Revenue from Contracts with Customers states that goods or services which are promised to a
customer are distinct if both of the following criteria are met:
the customer can benefit from the good or service either on its own or together with other resources,
and the entity's promise to transfer the good or service to the customer is separately identifiable from other
promises in the contract.
The updates are integral to Cent Co's ability to derive benefit from the license during the four-year contract,
because the entity works in an industry in which technologies change rapidly. The determination of whether
license and updates are separate performance obligations requires judgement. In this case, the updates
improve the effectiveness of software without being essential. However, for the updates to be combined
with the license, they should fundamentally change the functionality of the software or be essential to its
functionality.
Although the software can function on its own without updates, the benefits of using the software would be
significantly reduced. The frequency of the monthly updates indicates that they are essential to the effective
operation of the software. However, Sitka Co should consider not only the frequency but also whether Cent
Co accepts the updates. Updates are made available every month but Cent Co has only updated its software
on two occasions which seems to indicate that the software is functional without updates.
To conclude, the benefit which Cent Co could obtain from the license over the four-year term without the
updates would be significantly reduced, the contract to grant the license and to provide the expected
updates is, in effect, a single promise to deliver a combined item to Cent Co. As Cent Co simultaneously
receives and consumes the benefits of the entity's performance as it occurs, the performance obligation is
satisfied over time. As the contract is a single promise, the revenue of $3 million will be allocated over the
four-year time period. Sitka Co should disclose the method used to recognize revenue together with the
judgements used to determine the timing of the satisfaction of performance obligations, in the financial
statements for the year ended 31 December 20X7. It should not and cannot allocate $2.5 million to the
monthly updates and the residual amount of $0.5 million to the license of software as this does not faithfully
reflect the stand-alone selling price of the software
Tutorial note This is another example where conclusions that are different to those made in the model
answer can still score well. You will be awarded marks for any well-argued points you make. Note: If the
conclusion was that the software could function without updates (since they are not essential to
functionality, and Cent Co has only updated twice, which could indicate the software is functional without
updates), then two performance obligations would be identified and the contract price allocated to each
performance obligation. This approach to an answer, if well argued, would have been given credit.
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Question 3
DIGIWIRE (SEP/DEC 2019) (IFRS 15 & 13)
Digiwire Co has developed a new business model whereby it sells music licenses to other companies
which then deliver digital music to consumers.
Revenue: sale of three-year license
Digiwire Co has agreed to sell Clamusic Co, an unlisted technology start-up company, a three-year
license to sell Digiwire Co's catalogue of classical music to the public. This catalogue contains a large
selection of classical music which Digiwire Co will regularly update over the three-year period.
As payment for the three-year license, Clamusic Co has issued shares to Digiwire Co equivalent to a 7%
shareholding. Voting rights are attached to these shares. Digiwire Co received the shares in Clamusic Co on
1 January 20X6, which is the first day of the license term.
Digiwire Co will also receive a royalty of 5% of future sales of Clamusic Co as additional revenue for the
license.
Clamusic Co valuation and revenue
On 1 January 20X6, Clamusic Co was valued at between $4- $5 million by a professional valuer who used a
market-based approach. The valuation was based on the share price of a controlling interest in a comparable
listed company. For the financial year end of 31 December 20X6, sales of the classical music were $1 million.
At 31 December 20X6, a further share valuation report had been produced by the same professional
valuer which indicated that Clamusic Co was valued in the region of $6-$7 million.
Required:
(a) Advise the directors of Digiwire Co on the recognition and measurement of the:
(i) Clamusic Co shares received as revenue for the sale of the three-year license and how they should be
accounted for in the financial statements for the year ended 31 December 20X6, and
(ii) royalties which Clamusic Co has agreed to pay in respect of the three-year license in the financial
statements for the year ended 31 December 20X6. Your answer to (a) (ii) should demonstrate how
recognition and measurement of the royalties is supported by the Conceptual Framework for Financial
Reporting. (10 marks)
Answer
(a) (i) Revenue recognition: Clamusic Co shares
IFRS 15 Revenue from Contracts with Customers requires that non-cash consideration received should
be measured at the fair value of the consideration received.
The fair valuation of shares in an unlisted start-up company is problematic. However, IFRS 13 Fair Value
Measurement gives advice on how to measure unlisted shares. It sets out three approaches: (i) the market
approach, such as the transaction price paid for identical or similar instruments of an investee; (ii) the
income approach, for example, using discounted cash flows; and (iii) the adjusted net asset approach.
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In this case, the market approach has been used and the range of fair values is significant based upon the
professional valuation report. The range of fair values for a 7% holding of shares would be $280,000 to
$350,000 (7% of $4-$5 million) at the date of the contract and $420,000 to $490,000 (7% of $6 - $7 million)
at the year end. As the fair valuation is based upon a similar listed company and is based upon a controlling
interest, a discount on the valuation of the shares should be applied to reflect the lack of liquidity and inability
to participate in Digiwire Co's policy decisions. Thus, an estimated value of the shares can be made which
takes into account the above facts. This could be the mid-point of $315,000 (($280,000 + $350,000)/2) at the
date of the contract and $455,000 (($420,000 + $490,000)/2) at the year end.
At contract inception the shares will be recognized at $315,000. However, a corresponding entry should not
be made to revenue. Digiwire Co retains an active role in the updating and maintenance of sold license to
ensure its continuing value to the client. As such, the customer is benefitting from Digiwire's continuing
performance as Digiwire performs. In accordance with IFRS 15 Revenue from Contracts from Customers,
revenue should be recognized over time - most likely over the three-year contract term. Any difference
between the initial carrying amount of the shares and the revenue recognized is recorded as a contract
liability.
Clamusic Co share valuation at 31 December 20X6 (valuation of share in context of IFRS 9)
Equity investments in scope of IFRS 9 Financial Instruments should be measured at fair value in the
statement of financial position, with gains and losses on remeasurement recognized in profit or loss. If an
equity investment is not held for trading, an entity can make an irrevocable election at initial recognition to
measure it at fair value through other comprehensive income (FVTOCI) with only dividend income
recognized in profit or loss. The shares will be remeasured to $455,000 (($420,000 + $490,000)/2) at 31
December 20X6. A gain of $140,000 ($455,000 - $315,000) will be recorded in profit or loss or other
comprehensive income dependent upon any election being made. If Digiwire Co elects to present the re
measurements through other comprehensive income, the gain will never be reclassified to the statement of
profit or loss.
(ii) Revenue: royalties
IFRS 15 states that revenue from a sales-based royalty should be recognized when the subsequent sale occurs.
At the end of the first year of the contract, revenue from royalties can be calculated based upon the
sales for the period. This would be $50,000 (5% x $1 million).
The Conceptual Framework supports

The Conceptual Framework states that an item which meets the definition of an element should be
recognized if recognition provides useful financial information.
In other words:
(a) relevant information, and
(b) a faithful representation of the underlying transaction
Recognition of royalties earned during the year in the statement of profit or loss will help users of the financial
statements to assess Digiwire Co's economic performance and thus
make investment decisions. The sales made in the year can be accurately measured and so the royalty can be
accurately calculated - thus a faithful representation of the income earned in
the period is possible.
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Future royalty incomes, relating to years two or three of the contract, should not be recognized because
Digiwire has not yet performed in those economic periods. Moreover, future royalties cannot be measured
with any certainty and so estimation and recognition of these would not provide a faithful representation of
revenue earned in the period. The principles in the Conceptual Framework relating to recognition are therefore
consistentwith the approach taken by Digiwire Co.
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Question 3
Calibra and co dec 2020
Calibra Cooperates in the property sector and has invested in new technology, distributed
ledgers/blockchain, to trade and to support property transactions.
The financial year end of Calibra Co is 31 December20X8.
Apartment blocks
Calibra Co builds apartment blocks which normally take two years to complete from the date of signing the
contract. The title and possession, and therefore control, of the apartment blocks pass to the customer upon
completion of construction. The price which is payable on completion of each apartment block is $9·55
million. Alternatively, customers can pay $8·5 million cash on the day that the contract is signed. The chief
accountant has calculated that this represents an appropriate borrowing rate of 6% for Calibra Co. Calibra Co
immediately recognizes $8·5 million as revenue if customers pay when they sign the contract.
Required:
(a) Discuss how Calibra Co should have accounted for the sale of the apartment blocks in accordance with
IFRS 15 Revenue from Contracts with Customers and IAS 23 Borrowing Costs. (5 marks)
(b) Provide the accounting entries that would be required to record the contractual sale of an apartment block
on 1 January 20X8 at the discounted amount over the two-year construction period. (3 marks)
Answer
(a)
The performance obligation will be satisfied upon the completion of construction which is also when the
title, possession and control of the apartment block pass to the customer. The advanced payment
represents a significant financing component and IFRS 15 Revenue from Contracts with Customers states
that where this is the case then revenue is recognized at an amount that reflects the price that a customer
would have paid if the customer had paid cash when they transfer the goods to the customer.
IFRS 15 also states that the interest rate used should reflect the credit characteristics of the party receiving
financing but may be the rate that discounts the nominal amount of the promised consideration to the
price that the customer would pay in cash. In this case, the interest rate would be 6%. Using this rate, the
cash sales price of $9·55 million can be discounted to $8·5 million.
Calibra Co should recognize a liability of $8·5 million and should subsequently accrue interest on this
liability balance for two years until it reaches $9·55 million when the performance obligation is satisfied.
The interest should be accounted for in accordance with IAS 23 Borrowing Costs as part of the cost of
constructing the apartment block. As Calibra Co’s business model is based on construction, IAS 23 states
that borrowing costs that are directly attributable to the acquisition, construction or production of a
qualifying asset form part of the cost of that asset and, therefore, in this case should be included in the
cost of inventory production. Other borrowing costs are recognized as an expense.
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(b) Journal entry
Dr ($m) Cr ($m)
cash 8.5
Liability 8.5
Records liability on receipt of cash (1/1/X8)
Inventory 0.51
Liability 0.51
Interest accruing on liability to 31/12/X8 (6% x 8.5m)

included in the costs of inventory
Inventory 0.54
Liability 0.54
Interest accruing on liability to 31/12/X9 (6% x

($8.5m + $0.51m)) included in the costs of inventory
Liability 9.55
Revenue 9.55
Revenue arising on sale of apartment block.
Revenue arising on sale of apartment block (per question) The balance on the contract liability at
31/12/X8 would be $9·55 million (8·5 + 0·51 + 0·54). When control passes to the customer, Calibra Co
recognizes revenue of $9·55 million.
Question 4
Calendar and co
Calendar has a reporting date of 31 December 20X7. It prepares its financial statements in accordance with
International Financial Reporting Standards. Calendar develops biotech products for pharmaceutical
companies. These pharmaceutical companies then manufacture and sell the products. Calendar receives stage
payments during product development and a share of royalties when the final product is sold to consumers.
A new accountant has recently joined Calendar’s finance department and has raised a number of queries.
(a) Development project
(i) During 20X6 Calendar acquired a development project through a business combination and recognized it as
an intangible asset. The commercial director decided that the return made from the completion of
this specific development project would be sub-optimal. As such, in October 20X7, the project was sold to a
competitor. The gain arising on derecognition of the intangible asset was presented as revenue in the financial
statements for the year ended 31 December 20X7 on the grounds that development of new products is one of
Calendar’s ordinary activities. Calendar has made two similar sales of development projects in the past, but
none since 20X0.
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Required
The accountant requires advice about whether the accounting treatment of this sale is correct. (6 marks)
Answer
Sale of intangible IFRS 15 Revenue from Contracts with Customers defines revenue as income arising from
an entity’s ordinary activities. Calendar’s ordinary activities do not involve selling development projects. In
fact, Calendar has made no such sales since 20X0. It would seem that Calendar’s business model instead
involves developing products for its customers, who then take over its production, marketing and sale. Stage
payments and royalties are the incomes which arise from Calendar’s ordinary activities and should be treated
as revenue. Based on the above, Calendar is incorrect to recognize the gain as revenue.
In fact, IAS 38 Intangible Assets explicitly prohibits the classification of a gain on derecognition of an
intangible asset as revenue. IAS 38 defines an intangible asset as an identifiable non-monetary asset without
physical substance. Intangible assets held for sale in the ordinary course of business are outside the scope of
IAS 38 and are instead accounted for in accordance with IAS 2 Inventories.
The fact that the development project was classified as an intangible asset upon initial recognition further
suggests that it was not held for sale in the ordinary course of business. If the development was incorrectly
categorized in the prior year financial statements as an intangible asset, then, as per IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors, this should be corrected retrospectively. However,
based on the infrequency of such sales, it seems unlikely that the development was misclassified.
Question 5
JASSIE (SEP /DEC 2022)
Background Jassie Cooperates in the oil and gas industry. The current financial year end of Jassie Co is 31 December
20X7.
Granting of licenses - describes the process of granting licenses to customers.
Granting of licenses
Jassie Co provides services to customers to help them evaluate whether there are potential oil reserves in a particular
geographical location. Customers generally enter into the contract before the survey process commences and eventually
purchase a license to search for oil deposits.
Service phase
During the service phase, Jassie Co collects site data over the first year of the contract, then processes and analyses the
data over the next six months. The area surveyed is determined by Jassie Co, who is the only decision-maker and the owner
of both the data and the land being surveyed. All of the data is made available to customers in the final survey report.
Customers cannot process the data or obtain a license other than by Jassie Co's approval. The value to the customer is in
the granting of the license and not in the data. As data is being collected and processed, presentations and reports are given
to customers to indicate the potential of an area. Customers have ongoing access to the data during collection and
processing. When the final report is made available, the customer decides whether to invest in the area.
Granting of license
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The customers can exit the contract on receipt of the report, but the total price of the contract, including the price of the
final license, is still payable to Jassie Co. In practice, no customer leaves the contract at this stage. The license is granted
at this stage and once the license has been granted, there is no further analysis or service provided to the customer. The
directors of Jassie Co concluded that the company has only one performance obligation, being the granting of a license at
the end of a survey. This is because the collection and processing of the data (service phase) is a component of the granting
of the license and cannot be distinguished from the license. In addition, the service phase alone is of no benefit on its own.
The final license provided to the customer is based upon the data collected and processed during the service phase.
Required:
Discuss:
• whether revenue from the service phase and the grant of a license to a customer are separate performance obligations or
a single performance obligation, and
• whether the revenue should be recognized at a point in time in accordance with IFRS 15 Revenue from Contracts with
Customers. (8 marks)
Answer
(a) Revenue
Under IFRS 15 Revenue from Contracts with Customers, a performance obligation is a promise to transfer to the customer
a good or service or a bundle of goods or services which is distinct. A good or service is distinct if both of the following
criteria are met:
• the customer can benefit from the good or service either on its own or together with other resources which are
readily available to the customer, and
• the entity's promise to transfer the good or service to the customer is separately identifiable from other promises
in the contract (in other words: the promise to transfer the good or service is distinct within the context of the
contract).
Entities should assess whether the good or service is capable of being distinct and whether this good or service is distinct
within the context of the contract. If a promised good or service is not distinct, it should be combined with other promised
goods or services until they become distinct together ('a bundle'). A bundle is then treated as a single performance
obligation. A good or service promised to the customer is not separately identifiable from other promises in the contract
when, in substance, the customer contracted for a combined good or service. In such cases, goods or services which seem
to be distinct are in fact only inputs to the combined item.
The final license provided to the customer relies on the data collected and processed during the course of the service phase,
and the data and the processing have no use or relevance without the license. The license and data services are highly
interdependent and highly interrelated. Furthermore, there is no added value for the customer before the survey is
completed as it cannot process the data by itself and obtain a license. The license does not form part of a separate
performance obligation.
Before the survey is complete, customers have access to data through presentations and reports but at this stage, there is
no granting of a license. Once the license has been granted, there is no further analysis or service provided to the customer.
Consequently, revenue should be recognized at a point in time when the license is granted (or when the contract is exited)
and as a single performance obligation. Any service phase component does not have any significant value. The customers
of Jassie Co contract for a combined good or service which includes the survey data, processing and granting of the license.
These are not separate performance obligations, but they are inputs to a combined item.
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IAS 32 and IFRS 9-Financial instrument
Question 1
Colat and co
Other natural disaster consequences
Hedge of commodity price risk in aluminum Colat Co hedges commodity price risk in aluminum and such
transactions were classified as 'highly probable' in accordance with IFRS 9 Financial Instruments. However, the
purchases which were considered highly probable prior to the natural disaster, are no longer expected to
occur.
Requirement Discus how the hedge of the commodity price risk in aluminum, should be accounted for in the
financial statements for the year ended 31 December 20X7 (4 marks )
Answer
Prior to the disaster, Colat Co hedges commodity price risk in aluminum and such transactions constituted
'highly probable' hedged transactions in cash flow hedges under IFRS 9 Financial Instruments. However, the
purchases which were considered highly probable prior to the natural disaster are now not expected to occur.
Colat Co should follow hedge accounting principles up until the date of the natural disaster and then should
cease hedge accounting. As the forecast transaction is no longer expected to occur, Colat Co should reclassify
the accumulated gains or losses on the hedging instrument from other comprehensive income into profit or
loss as a reclassification adjustment.
Tutorial note
IFRS 9 states that, to apply hedge accounting to forecasted hedge items, the transactions must be highly
probable to occur. If the transactions are no longer highly probable, hedge accounting cannot be applied.
Question 2
CRYPTO (MAR/JUN 2019)
Crypto operates in the power industry, and owns 45% of the voting shares in Kurran. Kurran has four other
investors which own the remaining 55% of its voting shares and are all technology companies. The largest of
these holdings is 18%. Kurran is a property developer and purchases property for its renovation potential and
subsequent disposal. Crypto has no expertise in this area and is not involved in the renovation or disposal of
the property.
On 1 April 20X7, Crypto purchased bonds in Eptruck for $20 million from an unconnected, third-party investor.
The five-year bonds were originally issued on 1 April 20X6 for $30 million and had an effective interest rate of
15%. However, in September 20X6, Eptruck indicated that it would be unable to fulfil any annual contractual
interest repayments and would offer a substantially reduced premium to bond holders on redemption. On 1
April 20X7, Crypto calculated a credit-adjusted effective interest rate based on expected future cash flows
associated with the bonds to be 4%.
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At 31 March 20X8 the increase in lifetime expected credit losses since 1 April 20X7 was calculated to be $0.3
million. The directors of Crypto would like advice on the accounting treatment of the financial asset in Crypto's
financial statements for the year ended 31 March 20X8 under IFRS 9 Financial Instruments.
Required
Advise the directors of Crypto as to how the above issues should be accounted for, with reference to relevant
IFRS Standards. (4 marks)
Answer
Financial asset
The investment in bonds is a financial asset. As per IFRS 9 Financial Instruments, Crypto should
initially recognize the financial asset at its fair value of $20 million (the price paid). When Crypto
purchased the bonds, the bond issuer had already defaulted on interest payments and announced
that the bond will pay out lower cash flows than initially promised. This means that Crypto purchased
a credit-impaired financial asset.
For a purchased or originated credit-impaired financial asset, interest income is calculated by

applying the credit-adjusted effective interest rate. This is the interest rate that considers all
contractual cash flows associated with the asset as well as expected credit losses. Based on the 4%
rate, interest income of $0.8 million ($20m x 4%) should be recognized in the statement of profit or
loss.
At the reporting date, the gross carrying amount of the financial asset is $20.8 million ($20m +
$0.8m). For purchased or originated credit-impaired financial assets, the loss allowance is measured
as the movement in lifetime expected credit losses since inception. This amounts to $0.3 million.
This amount will be charged to the statement of profit or loss and will reduce the net carrying
amount of the financial asset to $20.5 million.
Part b
The directors of Crypto have prepared forecasts for the next five years and have been assessing how to finance
their expansion plans. The directors propose to raise the required funds on 1 April 20X8 in one of the following
ways:
(i) The issue of 5 million ordinary shares
(ii) The issue of 10 million convertible bonds in exchange for cash proceeds. Interest is payable
annually in arrears. The bondholders will be able to redeem the bonds on 31 March 20X6 in
the form of cash or a fixed number of Crypto's ordinary shares.
The directors are unsure of the impact of the proposals on the financial statements.
Required:
Discuss the impact of the above proposals on the financial statements of Crypto. Your answer should consider
the potential impact on basic and diluted earnings per share and on the primary users' perception of Crypto's
financial performance and position. (9 marks)
Professional marks will be awarded in part (b) for clarity and quality of presentation. (2 marks)
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Answer
b) Proposed financing
Ordinary shares
Ordinary shares do not create a contractual obligation to deliver cash or another financial asset. As such, per
IAS 32 Financial Instruments: Presentation, ordinary shares are classified as equity on the statement of
financial position. If equity increases then the gearing ratio will improve, which may make Crypto's financing
structure look less risky to its investors.
Dividends paid on equity shares have no impact on profits because they are charged directly to retained
earnings. Dividends are, in substance, the distribution of the entity's profits to its shareholders.
Issuing equity shares will increase the number of ordinary shares in the basic earnings per share calculation.
If the entity is not able to grow its profits, then basic earnings per share may fall year-on-year. Investors might
perceive this negatively because it is an indication that their future dividend returns will fall.
Convertible bonds
A bond that is redeemed in the form of cash or a fixed number of the entity's own equity shares has
characteristics of debt and equity. According to IAS 32 Financial Instruments: Presentation, the issuer should
'split' the bond into a liability component and an equity component. The liability component is calculated by
taking the cash repayments and discounting them to present value using the rate on a similar nonconvertible
bond. The difference between the cash proceeds and the liability component on the issue date is classified as
equity.
The liability component is normally much larger than the equity component. As such, the issue of the bond is
likely to make the gearing ratio deteriorate, increasing investors' perception of risk. This perception is because
liabilities necessitate mandatory repayments, whereas equity does not.
If the convertible bond is issued then an annual interest expense will be charged to profit or loss. This interest
is calculated by applying the effective rate of interest to the liability component. Interest expenses are charged
to the statement of profit or loss and so will reduce profits and basic earnings per share. However, whilst in
issue, the convertible bonds have no impact on the number of shares used in the basic earnings per share
calculation.
Most convertible bonds are dilutive instruments. This is because the entity has a commitment to issue ordinary
shares in the future. The maximum number of shares that Crypto may issue to redeem the convertible bonds
should be included in the diluted earnings per share calculation. Moreover, the earnings figure used in the
calculation should be increased by the current year interest on the bond because this will not be charged after
redemption.
The disclosure of diluted earnings per share warns current and potential investors that earnings per share will
fall when the convertible bond is redeemed. If investors are concerned about the potential drop, and the
impact this may have on their investment returns, then they may decide to invest in other companies.
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Question 3
Art wright’s and co
Background
Art wrights has entered into three derivative contracts during the year ended 30 April 20X4, details of which
are as follows:
Initial Fair value 30 April Details

recognition at 20X4
fair value
A Nil $20m (liability) Artwright believes that oil prices are
due to rise in the future so during the
year has entered into futures contracts
to buy oil at a fixed price. Artwright has
no exposure to oil prices in the course
of its business. In fact, oil prices have
fallen resulting in the loss at the year-
end.
B $1m $9m (liability) Artwright has an investment in equity
designated to be measured at fair value
through other comprehensive income.
Artwright is concerned the investment
will fall in value and it wishes to cover
this risk. Thus, during the year, it
entered into derivative B to cover any
fall in value and designated this as a
hedging instrument as part of a fair
value hedge. In fact, by the reporting
date, the asset increased in value by
$8.5 million.
C Nil $25m (asset) Artwright is concerned about the
potential for raw material prices to rise.
It managed this risk by entering into
derivative C - a futures contract. This
arrangement has been designated as a
cash flow hedge. At the year-end the
raw material prices have risen,
potentially giving the company an
increased future cost of $24 million.
Required
Assume that all designated hedges meet the effectiveness criteria outlined in IFRS 9 Financial Instruments.
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The directors of Artwright would like an outline of the hedge effectiveness criteria and also require advice on
how the three derivatives should be accounted for in the financial statements for the year ended 30 April
20X4. (9 marks)
Answer
Hedge effectiveness
If an entity chooses to hedge account, then it must assess at inception and at each reporting date whether the
hedge effectiveness criteria have been met.
These criteria are as follows:
• '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 arise from that relationship
• The hedged ratio should be the same as that resulting from the quantity of the hedged item that the entity
actually hedges and the quantity of the hedging instrument that the entity actually uses.' (IFRS 9, para 6.4.1)
IFRS 9 Financial Instruments says that the assessment of effectiveness must be forwards-looking.
Derivatives
All derivatives have to be initially recognized at fair value, i.e. at the consideration given or received at
inception of the contract. Derivatives A and C appear to have no purchase price, so are initially recognized at
nil. Derivative B will be initially recognized at its fair value of $lm.
Derivative A: Artwright has entered into this derivative for speculative purposes. IFRS 9 requires that all
derivatives not designated as part of a hedge accounting arrangement are accounted for at fair value through
profit or loss. The loss of $20 million that has been incurred has to be immediately recognized profit or loss.
Dr Profit or loss $20m

Cr Derivative $20m
Derivative B: If a fair value hedge is effective, then the movement in the fair value of the item and the
instrument since the inception of the hedge are normally recognized in profit or loss. However, if the hedged
item is an investment in shares that has been designated to be measured at fair value through other
comprehensive income (FVOCI), then the fair value movement on the hedged item and the hedging
instrument are recognized in other comprehensive income. The hedged item is an investment of shares
designated to be measured at FVOCI. Therefore, the following entries are required at the reporting date:
Dr Financial asset $ 8.5m

Cr Other comprehensive income $ 8.5m
Dr Other comprehensive income 10m

Cr Derivative 10m
Derivative C: If a cash flow hedge is effective, then the movement in the fair value of the instrument is
accounted for through other comprehensive income. However, if the movement on the instrument exceeds
the movement on the item, then the excess is recognized in profit or loss. The following entry is required:
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Dr Derivative $25m
Cr Other comprehensive income 24 m
Cr Profit or loss 1m
When the raw materials are purchased, the gains recognized in other comprehensive income can be
reclassified against the carrying amount of the inventory.
Question 4
Hill and co (specimen exam)
Hill is a public limited company which has investments in a number of other entities. All of these entities
prepare their financial statements in accordance with International Financial Reporting Standards. Extracts
from the draft individual statements of profit or loss for Hill, Chandler and Doyle for the year ended 30
September 20X6 are presented below.
HILL Chandler Doyle

$m $m $m
Profit/(loss) (45) 67 154
before
taxation
Taxation 9 (15) (31)
Profit/(loss) (36) 52 123
for the period
Issue of convertible bond
On 1 October 20X5, Hill issued a convertible bond at par value of $20 million and has recorded it as a non-
current liability. The bond is redeemable for cash on 30 September 20X7 at par. Bondholders can instead opt
for conversion in the form of a fixed number of shares. Interest on the bond is payable at a rate of 4% a year
in arrears. The interest paid in the year has been presented in finance costs. The interest rate on similar debt
without a conversion option is 10%.
Year Discount rate 5% Discount rate 10%
1 0.952 0.909
2 0.907 0.826
Required
(iii) Discuss, with suitable calculations, how the convertible bond should be dealt with in the consolidated
financial statements for the year ended 30 September 20X6, showing any adjustments required. (6 marks)
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Answer
Convertible bond
Hill has issued a compound instrument because the bond has characteristics of both a financial liability (an
obligation to repay cash) and equity (an obligation to issue a fixed number of Hill’s own shares). IAS 32
Financial Instruments: Presentation specifies that compound instruments must be split into:
– a liability component (the obligation to repay cash);
– an equity component (the obligation to issue a fixed number of shares).
The split of the liability component and the equity component at the issue date is calculated as follows:
– the liability component is the present value of the cash repayments, discounted using the market rate on
non-convertible bonds;
– the equity component is the difference between the cash received and the liability component at the issue
date. The initial carrying amount of the liability should have been measured at $17·9 million, calculated as
follows:
Date Cash flow Discount rate Present value

$m $m $m
30 September 0.8 0.909 0.73

20X6
30 September 20.8 0.826 17.18

20X7
Total PV 17.91
The equity component should have been initially measured at $2·1 million ($20m – $17·9m).
The adjustment required is:
Dr non-current liabilities $2·1m

Cr Equity $2·1m
The equity component remains unchanged. After initial recognition, the liability is measured at amortized
cost, as follows:
Finance charge (10%) Cash paid 30 September 20X6

1 October 20X5 $m $m $m
17·9 1·8 (0.8) 18.9
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The finance cost recorded for the year was $0·8 million and so must be increased by $1·0 million ($1·8m –
$0·8m).
Dr Finance costs $1·0m

Cr non-current liabilities $1·0m
The liability has a carrying amount of $18·9 million as at the reporting date
Question 5
Aron and co
The directors of Aron would like advice about the financial reporting treatment of some financial instrument transactions
that took place during the year ended 31 May 20X7.
Convertible bonds
Aron issued one million convertible bonds on 1 June 20X6. The bonds had a term of three years and were issued for their
fair value of $100 million, which is also the par value. Interest is paid annually in arrears at a rate of 6% per annum. Bonds
without the conversion option attracted an interest rate of 9% per annum on 1 June 20X6. The company incurred issue
costs of $1 million. The impact of the issue costs is to increase the effective interest rate to 9.38%. At 31 May 20X9 the
bondholders can opt to be repaid the par value in cash, or they can opt to receive a fixed number of ordinary shares in
Aron.
Share exchange
Aron held 3% holding of the shares in Smart, a public limited company. The investment was designated upon recognition
as fair value through other comprehensive income and as at 31 May 20X7 was measured at its fair value of $5 million. The
cumulative gain reported in other comprehensive income and held in equity relating to this investment was $400,000. On
31 May 20X7, the whole of the share capital of Smart was acquired by Given, a public limited company. Aron received
shares in Given with a fair value of $5.5 million in exchange for its holding in Smart.
Winston bonds
On 1 June 20X6, Aron purchased $10 million of listed bonds at par and paid in cash. These bonds had been issued by
Winston, an entity operating in the video games industry. The bonds are due to be redeemed at a premium on 31 May
20X9, with Aron also receiving 5% interest annually in arrears. The effective rate of interest on the bonds is 15%. Aron
often holds bonds until the redemption date, but will sell prior to maturity if investments with higher returns become
available. Winston's bonds were deemed to have a low credit risk at inception.
On 31 May 20X7, Aron received the interest due on the bonds. However, there were wider concerns about the economic
performance and financial stability of the video games industry. As a result, the quoted price of Aron's investment at 31
May 20X7 was $9 million, although a pricing model developed by the financial controller that relies on management
estimates valued the holding at $9.5 million. Based on Winston's strong working capital management and market optimism
about the entity's forthcoming products, the bonds were still deemed to have a low credit risk.
The financial controller of Aron calculated the following expected credit losses for the Winston bonds as at 31 May 20X7:
12 month expected credit losses $0.2m
Lifetime expected credit losses $0.4m
Required:
(a) Discuss the accounting treatment of the convertible bonds in the financial statements for the year ended 31 May
20X7.
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(9 marks)
(b) Discuss the accounting treatment of the share exchange in the financial statements for the year ended 31 May
20X7.
(6 marks)
(c) Discuss the accounting treatment of the Winston bonds in the financial statements for the year ended 31 May
20X7. Your answer should explain the impact of the bonds in Aron's statement of cash flows. (10 marks)
(Total: 25 marks)
Answer
(a) Convertible bond
Some financial instruments have both a liability and an equity component. In this case, IAS 32 Financial Instruments:
Presentation requires that the component parts be accounted for and presented separately according to their substance. The
split is made on the issue date. A convertible bond contains two components:
• a financial liability- the issuer's contractual obligation to pay cash in the form of interest or capital
• an equity instrument - the contract to issue a fixed number of equity shares.
The liability component will be determined by discounting the future cash flows. The discount rate used will be 9%, which
is the market rate for similar bonds without the conversion right. The difference between cash received and the liability
component is the value of the equity.
$m
Present value of cash flows
Year 1 (31 May 20X7) ($100m x 6%) + 1.09 5.50

Year 2 (31 May 20X8) ($100m x 6%) + 1.092 5.05
Year 3 (31 May 20X9} ($100m + ($100m x 6%)) + 1.093 81.85
Total liability component 92.40
Total equity element 7.60
Proceeds of issue 100.00
The entries required to account for this are:

Dr Cash $100m
Cr Liability $92.40m
Cr Equity $7.60m
The issue cost will have to be allocated between the liability and equity. The entries required are:
Dr Liability $0.92 m
Dr Equity $0.08m
Cr Cash $1.00m
After posting the above entries, the liability and equity would have carrying amounts as follows:
$m Liability $m Equity
Proceeds 92.40 7.60
Issue cost (0.92) (0.08)
91.48 7.52
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The equity of $7.52 million will not be re-measured. The liability component of $91.48 million would be measured at
amortized cost. This means that interest is charged at the effective rate of 9.38%. The cash payments reduce the liability.
1 June X6 Interest {9.38%) Cash paid {6%x 31 MayX7
$100m)
91.48 8.58 (6.0) 94.06
The finance cost in profit or loss will be $8.58 million. The liability will have a carrying amount on 31 May 20X7 of $94.06
million.
(b) Shares in Smart
Aron has to determine if the transfer of shares in Smart qualifies for derecognition. If substantially all the risks and rewards
have been transferred, the asset is derecognized. If substantially all the risks and rewards have been retained, the asset is
not derecognized. In this case the transfer of shares in Smart qualifies for derecognition as Aron no longer retains any risks
and rewards of ownership.
Aron has obtained a new financial asset which is the shares in Given. Financial assets are initially recognized at fair value.
The shares in Given should therefore be initially recognized at $5.5 million. If not held for trading, a designation could be
made upon initial recognition to account for this new financial asset at fair value through other comprehensive income.
A profit on disposal of $0.5 million will be recorded in the statement of profit or loss. This is the difference between the
initial carrying amount of the Shares in Given and the carrying amount of the shares in Smart that have been derecognized.
The entries required are:

Dr Financial asset (shares in Given) $5.5m
Cr Financial asset (shares in Smart) $5.0m
Cr Profit on disposal $0.5m
In addition, Aron may choose to make a transfer within equity of the cumulative gain recognized up to the disposal date
of $400,000.
(c) Investment in bonds
Financial assets are initially measured at fair value, so the investment in the bond will be initially recognized at $10 million.
The entity's business model involves both holding debt instruments to collect their contractual cash flows and also selling
the assets. As a debt instrument, it would appear that the contractual terms of the asset comprise the repayment of the
principal and interest on the principal amount outstanding.
Therefore, the asset should be measured at fair value through other comprehensive income. Interest income should be
recognized in profit or loss using the effective rate of interest. At the reporting date, the asset should be remeasured to fair
value with the gain or loss recognized in other comprehensive income. These gains or losses will be recycled to profit or
loss if the asset is disposed of.
Interest income of $1.5 million (Wl) should be recognized in profit or loss.
Fair value is defined by IFRS 13 Fair Value Measurement as the price paid when an asset is sold, or a liability transferred,
in an orderly transaction between market participants at the measurement date. IFRS 13 requires entities to priorities the
use of level 1 inputs when measuring fair value, which are defined as quoted prices for identical assets or liabilities in an
active market. The quoted price of $9 million appears to be a level 1 input so this is the fair value measurement that should
be reported in the financial statements.
Remeasuring the asset to its fair value of $9.0 million will lead to a loss of $2.0 million (Wl), which is recorded in other
Loss allowance
IFRS 9 Financial Instruments requires a loss allowance to be recognized on investments in debt that are measured at
amortized cost or fair value through other comprehensive income. If credit risk has not increased significantly since initial
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recognition, the loss allowance should be equal to 12-month expected credit losses. If credit risk has increased significantly,
the loss allowance must be equal to lifetime expected credit losses. The credit risk of Winston's bonds remains low at the
reporting date, suggesting that there has not been a significant increase in credit risk. The loss allowance should therefore
be equal to the 12-month expected credit losses of $0.2 million. When the financial asset is measured at fair value though
other comprehensive income, the loss allowance is not adjusted against the asset's carrying amount (otherwise the asset
will be held below fair value). Therefore, the loss allowance is charged to profit or loss, with the credit entry being recorded
in other comprehensive income (essentially, this adjustment reclassifies $0.2 million of the earlier downwards revaluation
from other comprehensive income to profit or loss).
Statement of cash flows
The $10 million cash spent on the financial asset will be presented as a cash outflow from investing activities. The interest
received of $0.5 million will be presented as a cash inflow from investing activities
Working
(W l) Financial asset
1 June X6 Interest (15%) Cash received Total Loss. 31 MayX7

$m $m $m $m $m $m
10.0 1.5 (0.5) 11.0 (2.0) 9.0
IAS 12 -Income tax

Question 1
Hill and co
Hill has made a loss in the year ended 30 September 20X6, as well as in the previous two financial years. In
the consolidated statement of financial position, it has recognized a material deferred tax asset in respect of
the carry-forward of unused tax losses. These losses cannot be surrendered to other group companies. On 30
September 20X6, Hill breached a covenant attached to a bank loan which is due for repayment in 20X9. The
loan is presented in non-current liabilities on the statement of financial position.
The loan agreement terms state that a breach in loan covenants entitles the bank to demand immediate
repayment of the loan. Hill and its subsidiaries do not have sufficient liquid assets to repay the loan in full.
However, on 1 November 20X6 the bank confirmed that repayment of the loan would not be required until
the original due date. Hill has produced a business plan which forecasts significant improvement in its financial
situation over the next three years as a result of the launch of new products which are currently being
developed.
Required: Discuss the proposed treatment of Hill’s deferred tax asset and the financial reporting issues raised
by its loan covenant breach. (9 marks)
Answer
Deferred tax
According to IAS 12 Income Taxes, an entity should recognize a deferred tax asset in respect of the carry-
forward of unused tax losses to the extent that it is probable that future taxable profit will be available against
which the losses can be utilized. IAS 12 stresses that the existence of unused losses is strong evidence that
future taxable profit may not be available. For this reason, convincing evidence is required about the existence
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of future taxable profits. IAS 12 says that entities should consider whether the tax losses result from
identifiable causes which are unlikely to recur.
Hill has now made losses in three consecutive financial years, and therefore significant doubt exists about the
likelihood of future profits being generated. Although Hill is forecasting an improvement in its trading
performance, this is a result of new products which are currently under development. It will be difficult to
reliably forecast the performance of these products. More emphasis should be placed on the performance of
existing products and existing customers when assessing the likelihood of future trading profits. Finally, Hill
breached a bank loan covenant and some uncertainty exists about its ability to continue as a going concern.
This, again, places doubts on the likelihood of future profits and suggests that recognition of a deferred tax
asset for unused tax losses would be inappropriate. Based on the above, it would seem that Hill is incorrect to
recognize a deferred tax asset in respect of its unused tax losses.
Covenant breach
Hill is currently presenting the loan as a non-current liability. IAS 1 Presentation of Financial Statements states
that a liability should be presented as current if the entity:
– settles it as part of its operating cycle, or
– is due to settle the liability within 12 months of the reporting date, or
– does not have an unconditional right to defer settlement for at least 12 months after the reporting date.
Hill breached the loan covenants before the reporting date but only received confirmation after the reporting
date that the loan was not immediately repayable. As per IAS 10 Events after the Reporting Period, the bank
confirmation is a non-adjusting event because, as at the reporting date, Hill did not have an unconditional
right to defer settlement of the loan for at least 12 months. In the statement of financial position as at 30
September 20X6 the loan should be reclassified as a current liability.
Going concern
Although positive forecasts of future performance exist, management must consider whether the breach of
the loan covenant and the recent trading losses place doubt on Hill’s ability to continue as a going concern. If
material uncertainties exist, then disclosures should be made in accordance with IAS 1.
Question 2
Stent Co
Stent Co has a year end of 30 September 20X9 and the unaudited draft financial statements report an
operating loss. In addition to this, debt covenant limits based on gearing are close to being breached and the
company is approaching its overdraft limit.
Deferred tax asset

Stent Co includes a deferred tax asset in its statement of financial position, based on losses incurred in the
current and the previous two years. The finance director has asked the accountant to include the deferred tax
asset in full. He has suggested this on the basis that Stent Co will return to profitability once its funding issues
are resolved.
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Required: Discuss appropriate accounting treatments which Stent Co should adopt for all issues identified
above and their impact upon gearing.
(3 marks)
Answer
Deferred tax asset
Note Recognition of a deferred tax asset in respect of unused tax losses is a common exam topic.
Make sure that you memories the key principle below.
In accordance with IAS 12 Income Taxes, a deferred tax asset shall be recognized for the carry-forward of
unused tax losses to the extent that it is probable that future taxable profit will be available against which the
unused tax losses can be utilized. However, the existence of unused tax losses is strong evidence that future
taxable profit may not be available. Therefore, when an entity has a history of recent losses, the entity
recognizes a deferred tax asset arising from unused tax losses only to the extent that it has convincing
evidence that sufficient taxable profit will be available against which the unused tax losses can be utilized. In
such circumstances, the amount of the deferred tax asset and the nature of the evidence supporting its
recognition must be disclosed.
The directors of Stent Co should consider whether it is probable that Stent Co will have taxable profits before
the unused tax losses or unused tax credits expire, whether the unused tax losses result from identifiable
causes which are unlikely to recur, and whether tax planning opportunities are available to the entity which
will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilized. To
the extent that it is not probable that taxable profit will be available against which the unused tax losses or
unused tax credits can be utilized, the deferred tax asset should not be recognized. The removal of a deferred
tax asset would reduce net assets and, therefore, equity. Gearing would increase.
Note
Don't forget gearing. The carrying amount of equity equals the carrying amount of net assets - so a reduction
in assets causes a corresponding reduction in equity, meaning that the gearing ratio will deteriorate.
Question 3
BOHAI (MAR/JUN 2022)
Bohai Co trades as a leisure travel group and provides travelers with unique vacations. The financial year end
of the company is 31 December 20X8.
Deferred tax asset - describes the accounting treatment of deferred tax assets at 1 January 20X8 and 31
December 20X8. This information should be used to answer the question requirements with in your chosen
response option(s).
Deferred tax asset
Bohai Co applied the expected credit loss (ECL) model in accordance with IFRS 9 Financial Instruments for the
first time at 1 January 20X8. As a result, the ECL model had a negative impact on the opening retained earnings
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as Bohai Co correctly applied the impairment model retrospectively. Therefore, a deferred tax asset (DTA) was
recognized of $25 million because of increased tax losses.
The recoverability of the DTA was based upon future budgets. As at 31 December 20X8, there was a change
in the ECL allowance. As a result, Bohai Co increased the amount of DTAs assessed as recoverable from $25
million to $30 million and recognized the increase in DTAs of $5 million in profit or loss. Bohai Co has a
subsidiary, Yuyan Co, which has a deferred tax liability of $10 million.
Bohai Co has a legally enforceable right to offset its own tax assets and liabilities but not that of its subsidiary.
The directors of Bohai Co have decided that, as Yuyan Co is located within the same taxation jurisdiction as
Bohai Co, they can offset the deferred tax asset of $30 million against Yuyan Co's deferred tax liability of $10
million.
Requirement
In accordance with IAS 12 Income Taxes, discuss: whether it is acceptable for Bohai Co to recognize the
additional deferred tax asset of $5 million in profit or loss rather than equity at 31 December 20X8, and
whether the deferred tax liability of Yuyan Co of $10 million can be offset against the deferred tax asset of
$30 million of Bohai Co at the same date.
(7 marks)
Answer
Deferred tax
Important Note Make sure you answer both parts of the requirement - using sub-headings can help with
this. Also, try to avoid writing down everything you can remember about deferred tax unless it is relevant!
Focus on the specifics of the question and try to identify the relevant rules, then apply them to the scenario.
IAS 12 Income Taxes sets out the principle that accounting for the deferred tax effects of an event should be
consistent with the accounting for the event itself. IAS 12 also states that at the end of each reporting period,
an entity should reassess unrecognized deferred tax assets.
IAS 12 requires deferred tax which relates to items which are recognized in profit or loss, to be recognized in
profit or loss in other comprehensive income, to be recognized in other comprehensive income and
directly in equity, to be recognized directly in equity.
IAS 12 explains that IFRS standards require (or permit) particular items to be credited (or charged) directly to
equity, such as an adjustment to the opening balance of retained earnings resulting from a change in
accounting policy which is applied retrospectively.
However, such accounting treatment does not necessarily extend to the subsequent adjustments to the
deferred taxes of $5 million in December 20X8, originally recognized on 1 January 20X8. Also, where the IFRS
9 Financial Instruments expected credit loss model is applied, all impairment charges are recognized in profit
or loss. Therefore, it is acceptable to recognize the additional deferred tax assets in profit or loss.
Important note You may jump fairly quickly to a conclusion for this part - that the deferred tax asset and
liability should not be offset. However, to maximalize the marks you score, you need to show how you have
arrived at that conclusion, i.e. what are the relevant rules around offsetting.
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Deferred tax assets and liabilities are required to be offset only in certain restricted scenarios. Deferred tax
assets and liabilities must be recognized gross unless the entity has a legally enforceable right to set off current
tax assets against current tax liabilities and the deferred tax assets and the deferred tax liabilities relate to the
same taxation authority. This is only the case where the right to set off relates to the same taxable entity or
different taxable entities which intend either to settle taxation on a net basis, or to realize the assets and settle
the liabilities simultaneously.
As the deferred tax asset and liability of Bohai Co and Yuyan Co do not relate to the same taxable entity, the
directors of Bohai Co must consider whether these entities either intend to settle current tax liabilities and
assets on a net basis or to realize the assets and settle the liabilities simultaneously. Net settlement will
generally not be the case, unless Bohai Co and Yuyan Co are part of a tax group and where the local tax
jurisdiction allows a group of companies to file tax returns on a consolidated basis. Therefore, Bohai Co should
not set off the Yuyan Co deferred tax liability in the consolidated financial statements.
IAS 38 and 36-Impairment and intangibles

Question 1
COLAT
Non-current assets
As a result of the natural disaster, the share price of Colat Co has declined as a significant amount of non-
current assets were destroyed, including the manufacturing facility. In addition, Colat Co has suffered
reputational damage resulting in a decline in customer demand. The non-current assets of Colat Co that were
destroyed had a carrying amount of $250 million on 31 October 20X7 and the fair value of these non-current
assets was $280 million based on an independent appraisal shortly before that date.
In addition, Colat Co determined that a power plant will have to be closed and decommissioned earlier than
previously expected. The remaining useful life of the power plant has reduced from 25 years to 8 years. Non-
current assets are valued using the cost model.
Required
(a) Discuss any events affecting Colat Co which might indicate that an impairment test ought to be conducted
in accordance with IAS 36 Impairment of Non-Current Assets. (3 marks)
Answer
Impairment
If Colat Co determines that the events resulting from a natural disaster have triggered impairment indicators,
an impairment test must be performed in accordance with IAS 36 Impairment of Assets for the respective
assets and/or cash-generating units. In this instance, a decline in customer demand has taken place because
of the damage in reputation resulting from the disaster. Also, the share price of Colat Co has declined which
again may indicate that the carrying amount of the entity's net assets is higher than its market capitalization.
Finally, damage to the manufacturing facility is a direct indicator and the increase in operating costs resulting
from the replacement of a supplier in the region with an international supplier is an indirect indicator. The
increase in costs as an indicator of impairment depends on the significance and duration of the expected
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change. Short-term, temporary disruptions are not necessarily indicative of an impairment for assets with a
long-term remaining useful life. As a result of the above impairment indicators, an impairment test must be
performed in accordance with IAS 36.
Question 2
Sitka Co is a software development company which operates in an industry where technologies change
rapidly. Its customers use the cloud to access the software and Sitka Co generates revenue by charging
customers for the software license and software updates. It has recently disposed of an interest in a
subsidiary, Marlett Co, and purchased a controlling interest in Billing Co. The year end of the company is 31
December 20X7.
Software contract and updates

On 1 January 20X7, Sitka Co agreed a four-year contract with Cent Co to provide access to license Sitka Co's software
including customer support in the form of monthly updates to the software. The total contract price is $3 million for
both licensing the software and the monthly updates. Sitka Co licenses the software on a stand-alone basis for between
$1 million and $2 million over a four-year period and regularly sells the monthly updates separately for $2,5 million
over the same period. The software can function on its own without the updates.
Although, the monthly updates improve its effectiveness, they are not essential to its functionality. However, because
of the rapidly changing technology in the industry, if Cent Co does not update the software regularly, the benefits of
using the software would be significantly reduced. In the year to 31 December 20X7, Cent Co has only updated the
software on two occasions. Cent Co must access the software via the cloud and does not own the rights to the
software.
Required
Discuss briefly why the right to receive access to Sitka Co's software is unlikely to be accounted for as an
intangible asset or a lease in Cent Co's financial statements.
(4 marks)
Answer
Cent Co pays fees to Sitka Co to access and use its software. The recognition criteria for an intangible asset, in
accordance with IAS 38 Intangible Assets, are identifiability, control over a resource and existence of future economic
benefits. These need to be considered when determining whether an intangible asset is created. The current
arrangement with Sitka Co is likely to satisfy the identifiability and existence of future economic benefits criteria, but it
is questionable whether the control criterion is satisfied. IAS 38 states that 'an entity controls an asset if the entity has
the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of
others to those benefits.
Cent Co does not own the rights to the software at any time. Thus, Cent Co should not recognize an intangible asset
because Cent Co does not control the resource. The contract is not a lease contract, in accordance with IFRS 16 Leases,
as Cent Co does not have the right to direct the use of an asset by having decisionmaking rights to change how and for
what purpose the asset is used throughout the four-year contract. At 1 January 20X7, the contract gave Cent Co only
the right to receive access to Sitka Co's software in the future and is therefore a service contract which is expensed
over the four-year period.
Question 3
Corbel and co
Corbel Co trades in the perfume sector. It has recently acquired a company for its brand 'Jengi', purchased
two additional brand names, and has announced plans to close its Italian stores. Corbel Co also opened a new
store on a prime site in Paris. The current financial year end is 31 December 20X7.
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Acquisition of Jengi Co
On 1 January 20X7, Corbel Co acquired 100% of Jengi Co. Both companies operate in the perfume sector.
Corbel Co intends to merge the manufacture of Jengi Co's products into its own facilities and close Jengi Co's
manufacturing unit. Jengi Co's brand name is well known in the sector, retailing at premium prices, and
therefore, Corbel Co will continue to sell products under the Jengi brand name after its registration has been
transferred and its manufacturing units have been integrated. The directors of Corbel Co believe that most of
the value of Jengi Co was derived from the brand and there is no indication of the impairment of the brand at
31 December 20X7.
Acquisition of perfume brands
In addition to now owning the Jengi Co brand, Corbel Co has acquired two other perfume brand names to
prevent rival companies acquiring them. The first perfume (Locust) has been sold successfully for many years
and has an established market. The second is a new perfume which has been named after a famous actor
{Clara) who intends to promote the product. The directors of Corbel Co believe that the two perfume brand
names have an indefinite life.
Required:
(a)Describe the main challenges in recognizing and measuring intangible assets, such as brands, in the
statement of financial position. (5 marks)
(b)Discuss the following accounting issues relating to Corbel Co's financial statements for the year ended 31
December 20X7 in accordance with IFRS standards:
i) whether the Jengi Co brand name will be accounted for separately from goodwill on acquisition and
whether it should be accounted for as a separate cash generating unit after the integration of the
manufacturing units (4 marks)
ii) how to account for intangible assets with an indefinite life and whether the Locust and Clara
perfume brand names can be regarded as having an indefinite life (6 marks)
Answer
The importance of intangible assets is reflected in the increasing proportion of a company's market value
being attributable to them. However, there are many challenges involved in recognizing and measuring
intangible assets, such as brands, in the statement of financial position.
According to IAS 38 Intangible Assets are recognized at cost. For purchased intangibles, this is easy to
determine. However, some intangible assets, including many brands, are internally generated. IAS 38 prohibits
the recognition of internally generated intangible assets (except those arising from development activity)
because the cost of the asset cannot be determined.
Once an intangible asset has been recognized, it can be measured using a cost model (cost less amortization
and impairment) or using a revaluation model (fair value less amortization and impairment). Whichever model
is used, determining the useful life of intangible assets is often subjective. Many intangible assets are not
traded on a stand-alone basis and so there is rarely an active market for them. This makes it difficult to
determine a fair value. For these intangible assets, IAS 38 prohibits the revaluation model.
IFRS 3 Business Combinations It was noted above that internally generated brands are not recognized in the
statement of financial position. One exception to this rule is a business combination. If a company acquires
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control over another company, IFRS 3 Business Combinations requires that the subsidiary's identifiable net
assets at the acquisition date are measured in the consolidated financial statements at fair value -even those
that have not been recognized in the subsidiary's separate financial statements.
Many intangible assets are unique and therefore it is not easy to identify and assess their value. Valuation
methods are often complex and subjective and the measurement is more subjective when the intangible
assets are not based on legally enforceable rights. In some cases, the acquirer does not intend to use the
intangible assets (for example, Corbel has acquired brands for defensive reasons) and this raises further issues
with regards to arriving at a value.
b (i) Jengi brand
IFRS 3 Business Combinations says that the acquirer must recognized identifiable intangible assets acquired in
a business combination separately from goodwill. To be identifiable, the asset must be separable or arise from
contractual or legal rights. The Jengi brand is intangible because it has no physical substance. It meets the
definition of an asset because it has the potential to generate future economic benefits by increasing sales
volumes and the ability to charge premium prices. Brands are separable because they can be disposed of.
As such, the brand is a separable intangible asset and must be recognized separately from goodwill.
IAS 38 Intangible Assets states that intangible assets have an indefinite useful life when there is no foreseeable
limit to the period the asset is expected to generate net cash inflows for the entity. An intangible asset with
an indefinite useful life is not be amortized.
Cash generating units
IAS 36 Impairment of Assets defines a cash generating unit (CGU) as the smallest identifiable group of assets
that generates cash inflows that are largely independent of the cash inflows from other assets or other groups
of assets. As such, brands rarely qualify as a separate CGU. The brand is most likely to qualify as a corporate
asset. This is because it does not generate cash flows independently of other assets, but is also not attributable
to just one single cash generating unit. Instead, it provides benefits across the business. This means that the
brand should be allocated to each of Corbel Co's cash generating units that are expected to benefit from the
synergies of the combination.
ii) Intangible assets with an indefinite useful life
IAS 38 Intangible Assets states that intangible assets have an indefinite useful life when there is no foreseeable
limit to the period the asset is expected to generate net cash inflows for the entity. An intangible asset with
an indefinite useful life is not be amortized.
IAS 36 Impairment of Assets, requires an entity to test an intangible asset with an indefinite useful life for
impairment on an annual basis. The useful life of an intangible asset that is not being amortized should be
reviewed each period to determine whether events and circumstances continue to support an indefinite
useful life assessment for that asset. If they do not, the change in the useful life assessment from indefinite to
finite should be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors.
Locust and Clara Corbel Co should consider various factors to determine whether the brand names can be
considered to have a useful life. These will include the extent to which Corbel Co is prepared to support the
brand and the extent to which the brand has long-term potential and has had proven success. Perfume is
subject to market and fashion trends and therefore, an assessment of how resistant the brands are to change
should be made. Also, Corbel Co has purchased the brands as a defensive measure to prevent rival companies
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acquiring them. Therefore, there may be a doubt as to the support that Corbel Co may be prepared to give to
the brands. The Locust perfume has been sold successfully in the market for many years and could be deemed
to have an indefinite life. The Clara perfume is linked to the popularity of the actor and therefore, it is difficult
to assess whether the brand has an indefinite life as it is likely to be dependent upon the longevity of the
popularity of the actor. In the case of the Clara perfume, it is difficult to state that the brand will have an
indefinite life. Thus, Clara is likely to have a finite life.
Question 4
Renshu Co
Renshu Co develops gaming apps for which customers are encouraged to buy enhancements and add-ons to
play more effectively. The company's current financial year end is 31 December 20X8. The following exhibits,
available below, provide information relevant to the question:
a) Payments for the app - describes the accounting for and derecognition of intangible assets. This information
should be used to answer the question requirements within your chosen response option(s).
Acquisition of assets
Renshu Co has purchased a company which comprised a customer database and a number of domain names
which do not constitute a business. Therefore, Renshu Co has to allocate the purchase price to the individual
identifiable assets in accordance with IFRS 3 Business Combinations.
The customer database relates to a contractual arrangement whereby Renshu Co receives a commission for
referring customers to online gaming websites. Renshu Co either receives an up-front payment for every
customer referred to the gaming websites or it receives a share of revenue streams based on the referred
customer's further usage.
The acquired assets also included a number of domain names for websites which have gaming content. Renshu
Co had arbitrarily allocated the purchase price for the company to the two intangible assets, domain names
and customer databases, on a 50:50 basis.
Payments for the app
Renshu Co develops new gaming apps in conjunction with other companies. When acquiring a stake in these
projects, Renshu Co makes an up-front payment and agrees a series of further payments based upon the
fulfilment of certain defined objectives in the process, both before and after the app is given final government
approval. Prior to the current year, the payments made have been accounted for as an acquisition of separate
intangible assets as the price paid reflected its belief that expected future economic benefits would flow to
Renshu Co.
The probability recognition criterion in IAS 38 Intangible Assets was considered to be met. However, in the
year to 31 December 20X8, Renshu Co revised its strategic plan and decided that all previously capitalized
payments to date were to be derecognized and expensed as research and development costs. This reversal of
the current accounting treatment has arisen due to concerns that the payments did not meet the criteria for
recognition as intangible assets and also that the costs will not be recovered in full. Renshu Co considered this
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action to be a change in an accounting estimate and, therefore, recognized the amounts prospectively by
recharging the payments to profit or loss.
Required
(a)Discuss whether the customer databases and domain names should be recognized under IAS 38 Intangible
Assets and how the purchase price should have been allocated in accordance with IFRS 3 Business
Combinations. (4 marks)
(b) Advise Renshu Co on the accounting treatment of the payments for the app in the year ended 31 December
20X8 on the assumptions that the amounts:
• did meet the recognition criteria for an intangible asset, or
• did not meet the recognition criteria for an intangible asset. (6 marks)
Answer
Customer databases and domain names
The arbitrary allocation of the purchase price to the two intangible assets is inaccurate. Renshu Co has a
present right to receive future cash flows under the contractual arrangement in relation to the customer
database and therefore, in accordance with IAS 38 Intangible Assets, an intangible asset should be recognized
for the customer database as it is probable that the expected future economic benefits will flow to Renshu
Co. In addition, Renshu Co also acquired domain names for websites which have gaming content. This
acquisition will satisfy the separability criterion for recognition in IAS 38 and should therefore be recognized
as an intangible asset. The arbitrary allocation of the purchase price on a 50:50 basis to the domain names
and customer database is not in accordance with IFRS 3 Business Combinations.
New purchase price allocations for the separate intangible assets should be carried out in accordance with
IFRS 3 whereby the purchase price should be allocated to the individual identifiable assets and liabilities on
the basis of their relative fair values. The fair value of the separate intangible assets should be identified using
appropriate valuation techniques in accordance with IFRS 13 Fair Value Measurement.
Part b
Payments for the app
IAS 38 requires an entity to recognize an intangible asset if it is probable that the future economic benefits
which are attributable to the asset will flow to the entity, and the cost of the asset can be measured reliably.
(i) If the payments met the criteria for recognition of intangible assets, then according to IAS 38, the intangible
asset should have been recognized prior to the current period. The intangible asset should be derecognized
only on disposal or when no future economic benefits are expected from its use or disposal. It seems that
neither of these tests for derecognition have been met by Renshu Co. Therefore, it is not appropriate to
derecognize the intangible assets.
If there are doubts over the recoverable amount of the intangible asset, then Renshu Co should assess
whether the intangible assets are impaired at 31 December 20X8, in accordance with IAS 36 Impairment of
Assets. If Renshu Co considers that the intangible assets' carrying amounts exceed their recoverable amounts,
then the company should recognize an impairment loss in profit or loss. For any apps that are now generating
an economic benefit for Renshu, amortization should be charged to the profit or loss over the expected useful
life of the asset.
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(i) Renshu Co should have considered whether the recognition criteria in IAS 38 or the recognition criteria
for internally generated intangible assets were fulfilled at the time Renshu Co capitalized the intangible assets
prior to the current period. If in the current period it is discovered that the criteria were not met and the
payments should have been expensed, Renshu Co will have to recognize a prior period error correcting the
effects retrospectively, as if the error had never occurred. This would mean adjusting the opening balance of
each affected component of equity (likely to be retained earnings) for the earliest prior period presented and
the other comparative amounts disclosed for each prior period. The reclassification of intangible assets to be
expensed as research and development costs does not constitute a change in an accounting estimate.
Estimates must be revised when new information becomes available which indicates a change in
circumstances upon which the estimates were formed. However, the payments for the app are not estimates
of the cost of developing the assets. Thus, if the payments were intangible assets, then they should be
recognized and tested for impairment. If the payments did not qualify as intangible assets, then the amount s
should be t related as prior period errors.
SME 3 Small and medium enterprises
HANDFOOD (SEP/DEC 2020)
Hand food Co is a small and medium-sized enterprise (SME) which has introduced a benefit to encourage
employees to remain with the entity. The company's financial year end is 31 December and it prepares its
financial statements using IFRS Standards but is interested in the differences with the SMEs Standard.
SMEs
It can be argued that small and medium-sized enterprises (SM Es) face financing difficulties because there is
serious information asymmetry between SM Es and investors. Information asymmetry, in the context of SMEs,
means that the SME has access to relevant information, while the investor suffers from a lack of relevant
information. It can be argued that the SMEs Standard decreases information asymmetry between the entity
and investors. Where SMEs lead in product and service innovation, they can also lead in innovation for
integrated reporting. There is a clear, concise and persuasive case for why SMEs and their stakeholders stand
to benefit greatly by using integrated reporting.
Required:
(1) Discuss the nature of the SMEs Standard and the principal differences between the SMEs Standard and full
IFRS Standards. (4 marks)
(2) Discuss the effect that information asymmetry can have on the decision to invest in SMEs. (4 marks)
(3) Discuss how integrated reporting could help SMEs better understand and better communicate how they
create value to investors. (5 marks)
Answer
i ) Nature of the SME's Standard
The principal aim when developing the SMEs Standard was to provide a framework that generated relevant,
reliable and useful information and the provision of a high quality and understandable accounting standard
suitable for SMEs. The Standard itself is self-contained, and incorporates accounting principles based on full
IFRS standards. It comprises a single standard divided into simplified sections for each relevant IFRS standard
but which have also omitted certain IFRS standards such as earnings per share and segmental reporting. In
addition, there are certain accounting treatments that are not allowable under the SM Es Standard. For
example, there is no separate guidance for non-current assets held for sale. To this end, the SMEs Standard
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makes numerous simplifications to the recognition, measurement and disclosure requirements in full IFRS
standards. Examples of these simplifications are:
• Intangible assets must be amortized over their useful lives. If the useful life is not determinable then it is
presumed to be 10 years.
• The cost model (investment is measured at cost less any accumulated impairment losses) can be used for
investments in associates. This model may not be used for investments for which there is a published price
quotation, in which case the fair value model must be applied. The disclosure requirements in the SMEs
Standard are also substantially reduced when compared with those in full IFRS standards partly because they
are not considered appropriate for users' needs and for cost-benefit considerations.
ii) Information asymmetry
IFRS for SMEs decreases information asymmetry between the firm and the users, because of its recognition,
measurement and disclosure requirements. However, there are certain facts and information in companies
which is not disclosed by them to investors under any accounting standards.
SMEs have access to all relevant information, while investors lack much of the relevant information.
Unfortunately, lack of relevant information will have an adverse effect on the decision-making of the investor.
Information related to the SM E's credit, project risk and benefits are known more by the SME than by the
investor giving the SME an information advantage. Therefore, investors are in a relatively disadvantaged
position, and if they, for example, are financial institutions, they will raise lending rates to reduce potential
risk of credit losses or may not invest at all.
The more incomplete and the less transparent the information from the SME, the higher will be the risk related
to the investment and the higher will be the return that the investor requires. The access to investment by
SM Es could be determined by the quality of financial statements, information asymmetry and perceived risk.
Quality financial statements reduce the level of information asymmetry which reduces perceived risk.
ii) Integrated reporting
Integrated reporting could help SMEs better understand and better communicate how they create value. It
can provide a roadmap for SMEs to consider the multiple capitals that make up its value creation. An
integrated report represents a more complete corporate report which will help SMEs understand their
business so they can implement a business model that will help them grow.
SMEs use a range of resources and relationships to create value. An integrated reporting approach helps SMEs
build a better understanding of the factors that determine its ability to create value over time. Integrated
thinking helps SM Es gain a deeper understanding of the mechanics of their business. This will help them
assess the strengths of their business model and spot any deficiencies.
These will create a forward-looking approach and sound strategic decision making. Some SMEs have few
tangible assets and operate in a virtual world. As such, conventional accounting will fail to provide a complete
picture as to its ability to create value. Capitals, such as employee expertise, customer loyalty, and intellectual
property, will not be accounted for in the financial statements which are only one aspect of an SM E's value
creation. As a result, SME stakeholders can be left with insufficient information to make an informed decision.
Integrated reporting will include key financial information but that information is alongside significant non-
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financial measures and narrative information. Integrated reporting can help fulfil the communication needs
of financial capital and other stakeholders and can optimize reporting.
Consolidation
Question 1
STERLING (SEP/DEC 2022)
Background
Sterling Co is currently preparing its individual and consolidated financial statements for the year ended 31
March 20X9 in accordance with International Financial Reporting Standards.
1)Acquisition of Berthold Co - describes the purchase of 40% of Berthold Co on 1 January 20X7 and the further
acquisition of 35% on 1 December 20X8
2) Investment in Malting Co - describes the purchase of 30% of Malting Co on 1 July 20X8.
3) Batch Co: discontinued operation - describes the acquisition of Batch Co that Sterling Co decides to sell on
1 January 20X9. This information should be used to answer the question requirements within your chosen
response option(s).
1 - Acquisition of Berthold Co
Sterling Co paid $25 million for 40% of Berthold Co's 10 million $1 ordinary shares on 1 January 20X7 when
Berthold Co's retained earnings were $18 million. Berthold Co has no other reserves. Sterling Co exercised
significant influence over Berthold Co's financial and operating policy decisions.
A further 35% stake in Berthold Co was acquired on 1 December 20X8 for $41 million, when the fair value of
Berthold Co's identifiable assets and liabilities was $55.3 million, and Berthold Co's retained earnings were
$42.3 million. The difference between the fair value of the identifiable assets and liabilities of Berthold Co and
their carrying amounts related to non-depreciable land. The market price of Berthold Co's shares immediately
prior to 1 December 20X8 was $9.20 per share. Sterling Co measures non-controlling interest at fair value at
the date of acquisition. Goodwill at 31 March 20X9 is not impaired. Berthold Co reported a profit for the year
ended 31 March 20X9 of $11.1 million.
2 - Investment in Malting Co
On 1 July 20X8, Sterling Co paid cash of $2.5 million and issued loan notes with a nominal value of $1.1 million
and a fair value of $1.3 million, to acquire 30% of the equity interest of Malting Co. The remaining 70% of the
equity in Malting Co is owned equally between two unrelated companies. All key operating decisions require
unanimous consent of all three investing parties. Each of the three investing parties has the right to its share
of the net assets of Malting Co via a contractual agreement. Malting Co reported a loss of $0.Bm for the year
ending 31 March 20X9 and a dividend was neither paid nor proposed. All three investing parties provided
separate guarantees to Malting Co's bank because of Malting Co's poor performance in the year.
3 - Batch Co: discontinued operation
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On 1 January 20X9, Sterling Co announced a plan to dispose of Batch Co, which operates in a significantly
different business sector to the rest of the group. Sterling Co first acquired 70% of the equity shares in Batch
Co on 1 January 20X7, for consideration of $3.1 million, when the fair value of the identifiable net assets
acquired was $3.6 million. The ordinary share capital and retained earnings of Batch Co were $0.5 million and
$2.1 million respectively.
The excess of the fair value of the identifiable net assets was due to a building with an estimated useful life of
10 years at the acquisition date. The fair value of the non-controlling interest (NCI) in Batch Co was $0.9 million
on 1 January 20X7. Sterling Co uses fair values to measure NCI. On 1 January 20X9, Batch Co reported retained
earnings of $2.9 million, with no change in ordinary share capital, or impairment of goodwill, since acquisition.
Sterling Co decided to treat Batch Co as a disposal group held for sale in accordance with IFRS 5 Non-current
Assets Held for Sale and Discontinued Operations.
Assets and liabilities of Batch Co require no remeasurement to meet applicable IFRS standards prior to
restating as a disposal group, and the total fair value less costs to sell of the disposal group at 1 January 20X9
was estimated to be $4.4 million.
Required:
(a) Using the exhibit
(1) explain how Berthold Co will be accounted for, including calculations, in Sterling Co's consolidated
statement of profit or loss for the year ended 31 March 20X9, and (8 marks)
(2) Explain and show how the goodwill in Berthold Co would be calculated at 1 December 20X8. (6 marks)
(a) Using exhibit 2, advise the directors of Sterling Co, with illustrative calculations, how the 30%
investment in Malting Co should be accounted for in Sterling Co's individual and consolidated financial
statements. (7 marks)
(b) Using exhibit 3, explain to the directors of Sterling Co how to account for Batch Co as a
discontinued operation at 1 January 20X9 in Sterling Co's consolidated financial statements. Your
answer should include:
• a calculation of the goodwill at 1 January 20X7, and
• a calculation of how the investment in Batch Co should be measured prior to disposal. (9 marks)
(30 marks)
Answer
STERLING (SEP/DEC 2022)
a) (i) Treatment of Berthold Co in Sterling Co's consolidated statement of profit or loss for the year ended
31 March 20X9
Prior to the investment in Berthold Co on 1 December 20X8, Sterling Co's 40% investment in Berthold Co
would be accounted for in its consolidated financial statements as an associate, using equity accounting in
accordance with IAS 28 Investments in Associates and Joint Ventures. Sterling Co exercises significant
influence, and so should recognize Sterling Co's share of Berthold Co's post-acquisition profits. Up to 1
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December 20X8, the first eight months of the year ended 31 March 20X9, Sterling Co should report its share
of Berthold Co's profits as a single line entry in the consolidated statement of profit or loss using the equity
method. This amount would be S2.96 million (8/12 x S 11.1m x 40%).
In addition to Sterling Co's share of profit prior to gaining control, the step acquisition from associate to
subsidiary on 1 December 20X8 requires the acquirer to remeasure its previously held equity interest in the
acquiree to its fair value at the step acquisition date, recognizing any resulting gain or loss in profit or loss. The
fair value of the 40% investment in Berthold Co at 1 December 20X8 (when control was obtained) was S36.80
million (40% x 10m x S9.20). The carrying amount of the 40% investment under equity accounting would be
S34.72 million. The investment in associate is made up of the historic cost of the investment (S25 million) plus
Sterling Co's share of post-acquisition profits up to the step acquisition date of S9.72 million ((S42.3m - S18m)
x 40%).
A gain on remeasurement of S2.08 million (S36.80m less S34. 72m) is therefore recognized in the consolidated
statement of profit or loss alongside the share of profit of associate for the first eight months.
Gain on remeasurement of associate
m$ m$
FV at control date (40% x 36.80
10m x S9.20)
Carrying amount:
Cost 25.00
Post-acquisition ((S42.3m - 9.72
Sl8.0m) x 40
(34.72)
2.08
On 1 December 20X8, Sterling Co acquires a further 35%, thereby gaining control (holding a total of 75% of
equity). IFRS 3 Business Combinations describes this manner of acquisition as a business combination achieved
in stages, or a step acquisition. Once control is obtained, Berthold Co will be accounted for in the consolidated
statement of profit or loss as a subsidiary, using the acquisition method in accordance with IFRS 3.
The accounting treatment conforms with the substance of the transaction as, once a majority of the voting
rights are obtained by Sterling Co, it can control the actions of Berthold Co. Sterling Co should therefore
recognize 4/12 of Berthold Co's sales, expenses and tax in its consolidated statement of profit or loss,
representing the transactions of Berthold Co under the control of Sterling. Since Sterling Co owns 75% of the
equity of Berthold Co, 25% of the 4/12 of Berthold's sales, expenses and profit included in the consolidated
statement of profit or loss is attributable to the non-controlling interest (NCI). The profit for the year reported
in Sterling Co's consolidated statement of profit or loss should therefore be shared between Sterling Co (as
the parent) and the NCI, who are attributed (4/12 x 11.1m x 25%) = S925,000.
Goodwill in Berthold
On 1 December 20X8, Sterling Co recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any noncontrolling interest in Berthold Co, and recognizes and measures
the goodwill acquired in the business combination. In order to calculate goodwill in this step acquisition, the
purchase consideration of $41 million paid on 1 December 20X8 is combined with the fair value of the 40%
share at the date of control (1 December 20X8). This 40% holding now has a fair value of $36.8 million (40% x
10m x $9.20). A 25% non-controlling interest will also be incorporated into the goodwill calculation, and into
the equity section of the consolidated statement of financial position, based on a fair value of $23 million (25%
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x 10m x $9.20). The fair value of Sterling Co's consideration at the date of obtaining control ($41 million plus
$36.8 million) and the fair value of non-controlling interest ($23 million) is compared with the fair value of the
net assets of Berthold Co ($55.3 million), resulting in goodwill of $45.5 million:
Goodwill at 1 December 20X8:
$m
Previous 40% holding now at FV (40% x 10m x $9.20) 36.8
Cost of 35% acquired in year 41.0
FV of NCI (25% x 10m x $9.20) 23.0
less: Fair value of net assets (55.3)
Total 45.5
(b) Malting Co: joint venture
Under IFRS 11 Joint Arrangements, the acquisition of a 30% interest in Malting Co is a joint arrangement since
the three parties are bound by a contractual arrangement which gives each party joint control (where
decisions about the relevant activities require the unanimous consent of the parties sharing control). The
contractual agreement distinguishes this transaction as a joint arrangement rather than an investment in an
associate. Under IFRS 11, there are two types of joint arrangement:
• A joint operation is a joint arrangement in which the joint controlling parties have rights to the assets
and obligations for the liabilities relating to the arrangement.
• A joint venture is a joint arrangement in which the joint controlling parties have rights to the net assets
of the arrangement.
The accounting treatment is determined based on whether or not the investor has direct rights to the assets,
and obligations for the liabilities, which should be recognized separately in its financial statements, rather
than merely following the legal form of the joint arrangement. In the case of the investment in Malting Co,
the contractual agreement describes the conditions of a joint venture, since Malting Co is a separate vehicle
with rights to the assets and obligations for the liabilities.
The three investing parties have no interests (no rights, title or ownership) in the assets of Malting Co and are
not liable to Malting Co for any obligations beyond unpaid or additional capital (presumably fully paid by each
party). The fact that the parties provided a guarantee to a third-party providing finance to Malting Co does
not, by itself, determine that the joint arrangement is a joint operation. IFRS 11 outlines how the provision of
guarantees to third parties is often required. The parties did not have obligations for the liabilities relating to
Malting Co but had instead provided a guarantee for some of them.
The contractual arrangement establishes each party's share in the profit or loss relating to the activities of the
arrangement based on shares held rather than through relative performance of each party to the joint
arrangement. All of the above lead to the conclusion that Malting Co should be accounted for as a joint venture
under IFRS 11.
Accounting for Malting Co in the separate financial statements of Sterling Co
According to IAS 27 Separate Financial Statements, investments in subsidiaries, associates and joint ventures
are carried in the investor's separate financial statements at cost, at fair value (as a financial asset under IFRS
9 Financial Instruments), or using the equity method as described in IAS 28. Where the joint venturer has no
subsidiaries, the equity method must be used. As a holding company, Sterling Co can therefore choose to keep
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the investment at cost of $3.8 million ($2.5m cash plus the fair value of the loan notes of $1.3m), fair value or
under the equity method (as required in the consolidated financial statements). If they elect to account for it
as an investment at cost or fair value, any dividends received would be recorded as investment income. If they
elect for the equity method, the statement of profit or loss would be the same as the consolidated financial
statements (see below).
Accounting for Malting Co in the consolidated financial statements of Sterling Co
According to IFRS 11, joint ventures are accounted for using the equity method in the consolidated financial
statements in exactly the same way as for associates. The share of Sterling Co's post-acquisition loss (0.8 x
9/12 x 30% = $0.18m) of Malting Co would be deducted from the fair value of the consideration of $3.8 million,
leaving $3.62 million shown under 'Investment in joint venture' in the consolidated statement of financial
position. The 'share of loss of joint venture' of $0.18 million will be shown as a single line in the consolidated
statement of profit or loss for the year.
Investment in joint venture:
m$
Cost 2.50
FV of loan notes 1.30
Consideration 3.80
Share of loss: (0.8 x 9/12 x 30% ) 0.18
Total 3.62
(a) Batch Co: discontinued operation

The adjustments required on 1 January 20X9 to account for Batch Co as a discontinued operation
The disposal group will include goodwill acquired upon acquisition. On 1 January 20X7, goodwill at acquisition
was S0.4 million.
$m $m
Cost 3.10
F.V of non-controlling 0.90

interest
4.00
Equity 0.50
Retained earnings 2.10
Fair value adjustment: 1.00 (3.6)
building
Goodwill 0.40
Immediately before initial classification of the disposal group as held for sale, the carrying amounts of the
assets and liabilities in the group should be remeasured in accordance with applicable IFRS standards. In this
case, no adjustments were needed. On classification as held for sale, Batch Co must be measured at the lower
of carrying amount and fair value less costs to sell. An impairment arises of S0.2 million, which will be allocated
to goodwill. The impairment loss will be recorded in the consolidated statement of profit or loss. The carrying
amount of Batch Co prior to reclassification includes goodwill of S0.4 million, the net assets reported by Batch
Co, and the fair value adjustment on consolidation adjusted for two years depreciation (at 10%).
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m$ m$
Fair value less costs to sell 4.4
Goodwill 0.4
Share capital 0.5
Retained earnings 2.9
Fair value adjustment 1.0
Fair value depreciation ($1m / 10) x 2 (0.2)
years
Carrying amount (4.6)
Impairment (against goodwill, i.e. S0.4 (0.2)
- S0.2m
shared between parent and NCI
Tutorial note: Journal to correct for

reclassification:
DR RE of group (70% share of 0.14

impairment)
DR NCI (30% share of impairment) 0.06
CR Goodwill 0.20
DR FV less costs to sell (of disposal 4.40
group)
CR Net assets at FV (after goodwill 4.40

write-off)
4.60 4.60
Question 2
LUPLOID (SEP/DEC 2019)
Background
Luploid Co is the parent company of a group undergoing rapid expansion through acquisition. Luploid Co has
acquired two subsidiaries in recent years, Colyson Co and Hammond Co. The current financial year end is 30
June 20X8.
Acquisition of Colyson Co
Luploid Co acquired 80% of the five million equity shares ($1 each) of Colyson Co on 1 July 20X4 for cash of
$90 million. The fair value of the non-controlling interest (NCI) at acquisition was $22 million. The fair value of
the identifiable net assets at acquisition was $65 million, excluding the following asset. Colyson Co purchased
a factory site several years prior to the date of acquisition. Land and property prices in the area had increased
significantly in the years immediately prior to 1 July 20X4. Nearby sites had been acquired and converted into
residential use. It is felt that, should the Colyson Co site also be converted into residential use, the factory site
would have a market value of $24 million. $1 million of costs are estimated to be required to demolish the
factory and to obtain planning permission for the conversion. Colyson Co was not intending to convert the site
at the acquisition date and had not sought planning permission at that date. The depreciated replacement
cost of the factory at 1 July 20X4 has been correctly calculated as $17.4 million.
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Impairment of Colyson Co
Colyson Co incurred losses during the year ended 30 June 20X8 and an impairment review was performed.
The carrying amount of the net assets of Colyson Co at 30 June 20X8 (including fair value adjustments on
acquisition but excluding goodwill) are as follows:
$m
Land and buildings 60
Plant and machinery 15
Intangibles other than goodwill 9
Current assets (at recoverable amount) 22
Total 106
The recoverable amount of Colyson Co's assets was estimated to be $100 million. Included in this assessment
was a building owned by Colyson Co which had been damaged in a storm and needs to be impaired by $4
million. Other land and buildings are held at recoverable amount. None of the assets of Colyson Co including
goodwill have been impaired previously. Colyson Co does not have a policy of revaluing its assets.
Acquisition of Hammond Co and share-based payments
Luploid Co acquired 60% of the 10 million equity shares of Hammond Co on 1 July 20X7. Two Luploid Co shares
are to be issued for every five shares acquired in Hammond Co. These shares will be issued on 1 July 20X8.
The fair value of a Luploid Co share was $30 at 1 July 20X7.
Hammond Co had previously granted a share-based payment to its employees with a three-year vesting
period. At 1 July 20X7, the employees had completed their service period but had not yet exercised their
options. The fair value of the options granted at 1 July 20X7 was $15 million. As part of the acquisition, Luploid
Co is obliged to replace the share-based payment scheme of Hammond Co with a scheme that has a fair value
of $18 million at 1 July 20X7. There are no vesting conditions attached to this replacement scheme.
Unrelated to the acquisition of Hammond, Luploid Co issued 100 options to 10,000 employees on 1 July 20X7.
The shares are conditional on the employees completing a further two years of service. Additionally, the
scheme required that the market price of Luploid Co's shares had to increase by 10% from its value of $30 per
share at the acquisition date over the vesting period. It was anticipated at 1 July 20X7 that 10% of staff would
leave over the vesting period but this was revised to 4% by 30 June 20X8. The fair value of each option at the
grant date was $20. The share price of Luploid Co at 30 June 20X8 was $32 and is anticipated to grow at a
similar rate in the year ended 30 June 20X9.
Required: Draft an explanatory note to the directors of Luploid Co, addressing the following:
(a) (i) How the fair value of the factory site should be determined at 1 July 20X4 and why the depreciated
replacement cost of $17.4 million is unlikely to be a reasonable estimate of fair value. (7 marks)
(ii)A calculation of goodwill arising on the acquisition of Colyson Co measuring the non-controlling
interest at:
• fair value
• proportionate share of the net assets. (3 marks)
(b) The calculation and allocation of Colyson Co's impairment loss at 30 June 20X8 and a discussion of
why the impairment loss of Colyson Co would differ depending on how non-controlling interests are
measured. Your answer should include a calculation and an explanation of how the impairments
would impact upon the consolidated financial statements of Luploid Co. (11 marks)
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(c) (i)How the consideration for the acquisition of Hammond Co should be measured on 1 July 20X7. Your
answer should include a discussion of why only some of the cost of the replacement share-based
payment scheme should be included within the consideration. (4 marks)
ii) How much of an expense for share-based payment schemes should be recognized in the consolidated
statement of profit or loss of Luploid Co for the year ended 30 June 20X8. Your answer should include a brief
discussion of the relevant principles and how the vesting conditions impact upon the calculations. (5 marks)
Note: Any workings can either be shown in the main body of the explanatory note or in an appendix to the
explanatory note. (Total: 30 marks)
Answer
(a) (i) Fair value measurement
IFRS 13 Fair Value Measurement defines fair value as the price which would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Fair value is therefore not supposed to be entity specific but rather market focused. Essentially the estimate
is the amount that the market would be prepared to pay for the asset. The market would consider all
alternative uses for the assessment of the price which they would be willing to pay. For non-financial assets,
fair value should therefore be measured by consideration of the highest and best use of the asset. There is a
presumption that the current use would be the highest and best use unless evidence exists to the contrary.
The highest and best use of the asset appears to be as residential property and not the current industrial use.
The intentions of Colyson Co are not relevant as fair value is not entity specific. The alternative use would
need to be based upon fair and reasonable assumptions. In particular, it would be necessary to ensure that
planning permission to demolish the factory and convert into residential properties would be likely.
Since several nearby sites have been given such permission, this would appear to be the case. The fair value
of the factory site should be valued as if converted into residential use. Since this cannot be determined on a
stand-alone basis, the combined value of the land and buildings is calculated. The Sl million demolition and
planning costs should be deducted from the market value of S24 million. The fair value of the land and
buildings should be S23 million. The fair value of the identifiable net assets at acquisition are S88 million (S6Sm
+ S23m).
Depreciated replacement cost
Depreciated replacement cost should only be considered as a possible method for estimating the fair value of
the asset when other more suitable methods are not available. This may be the case when the asset is highly
specialized. This is not the case with the factory site. Depreciation is unlikely to be an accurate reflection of all
forms of obsolescence including physical deterioration. Moreover, the rise in value of land and properties
particularly for residential use would mean that to use depreciated replacement cost would most likely
undervalue the asset.
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(ii) Goodwill calculations
Goodwill should be calculated as follows:

Fair value method Proportioned method
$m $m
Consideration 90 90
Non-controlling interest NCI 22 17.6
Net assets at acquisition (88) (88)
Goodwill 24 19.6
NCI at acquisition under proportional method is Sl7.6m (20% x S88m). The fair value of the net assets at
acquisition is S88m as per part (a) (i) (S6Sm + S23m).
(b) Impairment
An impairment arises where the carrying amount of the net assets exceeds the recoverable amount.
Where the cash flows cannot be independently determined for individual assets, they should be
assessed as a cash generating unit. That is the smallest group of assets which independently generate
cash flows. Impairments of cash generating units are allocated first to goodwill and then to the other
assets in proportion to their carrying amounts. No asset should be reduced below its recoverable
amount.
Fair value method
The overall impairment of Colyson Co is $30 million ($106m + goodwill $24m - $100m). The damaged
building should be impaired by $4 million with a corresponding charge to profit or loss. Since $4 million
has already been allocated to the land and buildings, $26 million of impairment loss remains to be
allocated. The full $24 million of goodwill should be written off and expensed in the consolidated
statement of profit or loss. Of the remaining $2 million impairment ($30m - $4m - $24m), $1.25 million
will be allocated to the plant and machinery ((15/ (15 + 9)) x 2m) and $0.75 million will be allocated
to the remaining intangibles ((9/ (9 + 15)) x 2m). As no assets have been previously revalued, all the
impairments are charged to profit or loss.
Of the impairment loss, $24 million (80% x $30m) will be attributable to the owners of Luploid Co and
$6 million {20% x $30m) to the NCI in the consolidated statement of profit or loss. The allocation of
the impairment is summarized in this table:
Original CA Impairment Revised CA

$m $m $m
Land and buildings 60 (4.00) 56
Plant and machinery 15 (1.25) 13.75
Intangibles other than 9 (0.75) 8.25
goodwill
Goodwill 24 (24.00) 0
Current assets (at 22 22
recoverable amount)
Total 130 (30) 100
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Proportionate method
The basic principles and rule for impairment is the same as the fair value method and so $4 million will again
first be written off against the land and buildings. When NCI is measured using the proportional share of net
assets, no goodwill attributable to the NCI is recognized. This means that the goodwill needs to be grossed up
when an impairment review is performed so that it is comparable with the recoverable amount.
The goodwill of $19.6 million is grossed up by 100/80 to a value of $24.5 million. This extra $4.9 million is
known as notional goodwill. The overall impairment is now $30.5 million ($106m + $24.5m - $100m) of which
$4 million has already been allocated to land and buildings.
Since the remaining impairment of $26.S million ($30.Sm - $4m) exceeds the total notional goodwill, this is
written down to zero. However, as only $19.6 million goodwill is recognized within the consolidated accounts,
the impairment attributable to the notional goodwill is not recognized. The impairment charged in the
consolidated statement of profit or loss is therefore $19.6 million and this is fully attributable to the owners
of Luploid Co. Of the remaining $2 million ($30.Sm - $4m - $24.5m), $1.25 million will be allocated to the plant
and machinery (15/(15 + 9) x 2m) and $0.75 million will be allocated to the remaining intangibles (9/(9 + 15) x
2m). As no assets have been previously revalued, all the impairments are charged to profit or loss.
The impairment expense attributable to the owners of Luploid Co is $24.4 million ($19.6m goodwill
impairment+ (80% x ($4m building+ $2m plant and machinery and other intangibles))). The impairment
expense attributable to the NCI is $1.2 million (20% x $6m). This is summarized below:
Original CA Impairment Revised CA

$m $m $m
Land and buildings 60 (4.00) 56
Plant and 15 (1.25) 13.75
machinery
Intangibles other 9 (0.75) 8.25
than goodwill
Goodwill 19.6 (19.60) 0
Notional goodwill 4.9 (4.90) 0
Total 130.5 (30.5) 100
(c)
(i) Consideration
IFRS 3 Business Combinations requires all consideration to be measured at fair value on

acquisition of a subsidiary. Deferred shares should be measured at the fair value at the acquisition
date with subsequent changes in fair value ignored. Luploid Co will issue 2.4 million (60% x 10m x
2/5) shares as consideration. The market price at the date of acquisition was $30, so the total fair
value is $72 million (2.4m x $30)
Since Luploid Co is obliged to replace the share-based scheme of Hammond Co on acquisition, the
replacement scheme should also be included as consideration (but only up to the fair value of the
original scheme as at 1 July 20X7). The fair value of the replacement scheme at the grant date was
$18 million. However, the fair value of the original Hammond Co scheme at the acquisition date
was only $15 million. As such, only $15 million should be added to the consideration. The total
consideration should be valued as $87 million ($72m + $15m).
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(ii) Expense related to replacement scheme
The $3 million ($18m - $15m) not included within the consideration {see above) should be treated
as part of the post-acquisition remuneration package for the employees and measured in
accordance with IFRS 2 Share-based Payment. As there are no further vesting conditions it should
be recognized as a post-acquisition expense immediately.
Expense related to additional scheme
The condition relating to the share price of Luploid Co is a market based vesting condition. These
are adjusted for in the calculation of the fair value at the grant date of the option. An expense is
therefore recorded in the consolidated profit or loss of Luploid Co {and a corresponding credit to
equity) irrespective of whether the market based vesting condition is met or not. The additional
two years' service is a non-market based vesting condition. The expense and credit to equity
should be adjusted over the vesting period as expectations change regarding the non-market
based vesting condition. The correct charge to the profit or loss and credit to equity in the year
ended 30 June 20X8 is $9.6 million {{10,000 x 96%) x 100 x $20 x ½)
Question 3
Banana and co (2018)
Background
Banana is the parent of a listed group of companies which have a year end of 30 June 20X7. Banana
has made a number of acquisitions and disposals of investments during the current financial year
and the directors require advice as to the correct accounting treatment of these acquisitions and
disposals.
The acquisition of Grape
On 1 January 20X7, Banana acquired an 80% equity interest in Grape. The following is a summary
of Grape’s equity at the acquisition date.
$m
Equity share capital ($1 each) 20
Retained earnings 42
Other components of equity 8
Total 70
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The purchase consideration comprised 10 million of Banana’s shares which had a nominal value of $1 each
and a market price of $6·80 each. Additionally, cash of $18 million was due to be paid on 1 January 20X9 if the
net profit after tax of Grape grew by 5% in each of the two years following acquisition. The present value of
the total contingent consideration at 1 January 20X7 was $16 million. It was felt that there was a 25% chance
of the profit target being met. At acquisition, the only adjustment required to the identifiable net assets of
Grape was for land which had a fair value $5 million higher than its carrying amount. This is not included within
the $70 million equity of Grape at 1 January 20X7.
Goodwill for the consolidated financial statements has been incorrectly calculated as follows:
$m shares
Consideration 68
Add NCI at acquisition (20% x $70 million) 14
Less net assets at acquisition (70)
Goodwill at acquisition 12
The financial director did not take into account the contingent cash since it was not probable that it would be
paid. Additionally, he measured the non-controlling interest using the proportional method of net assets
despite the group having a published policy to measure non-controlling interest at fair value. The share price
of Grape at acquisition was $4·25 and should be used to value the non-controlling interest.
The acquisition and subsequent disposal of Strawberry
Banana had purchased a 40% equity interest in Strawberry for $18 million a number of years ago when the
fair value of the identifiable net assets was $44 million. Since acquisition, Banana had the right to appoint one
of the five directors on the board of Strawberry. The investment has always been equity accounted for in the
consolidated financial statements of Banana. Banana disposed of 75% of its 40% investment on 1 October
20X6 for $19 million when the fair values of the identifiable net assets of Strawberry were $50 million. At that
date, Banana lost its right to appoint one director to the board. The fair value of the remaining 10% equity
interest was $4·5 million at disposal but only $4 million at 30 June 20X7. Banana has recorded a loss in reserves
of $14 million calculated as the difference between the price paid of $18 million and the fair value of $4 million
at the reporting date. Banana has stated that they have no intention to sell their remaining shares in
Strawberry and wish to classify the remaining 10% interest as fair value through other comprehensive income
in accordance with IFRS® 9 Financial Instruments.
The acquisition of Melon
On 30 June 20X7, Banana acquired all of the shares of Melon, an entity which operates in the biotechnology
industry. Melon was only recently formed and its only asset consists of a licence to carry out research
activities. Melon has no employees as research activities were outsourced to other companies. The activities
are still at a very early stage and it is not clear that any definitive product would result from the activities. A
management company provides personnel for Melon to supply supervisory activities and administrative
functions. Banana believes that Melon does not constitute a business in accordance with IFRS 3 Business
Combinations since it does not have employees nor carries out any of its own processes. Banana intends to
employ its own staff to operate Melon rather than to continue to use the services of the management
company. The directors of Banana therefore believe that Melon should be treated as an asset acquisition but
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are uncertain as to whether the International Accounting Standards Board’s exposure draft Definition of a
Business and Accounting for Previously Held Interests ED 2016/1 would revise this conclusion.
The acquisition of bonds
On 1 July 20X5, Banana acquired $10 million 5% bonds at par with interest being due at 30 June each year.
The bonds are repayable at a substantial premium so that the effective rate of interest was 7%. Banana
intended to hold the bonds to collect the contractual cash flows arising from the bonds and measured them
at amortized cost. On 1 July 20X6, Banana sold the bonds to a third party for $8 million. The fair value of the
bonds was $10·5 million at that date. Banana has the right to repurchase the bonds on 1 July 20X8 for $8·8
million and it is likely that this option will be exercised. The third party is obliged to return the coupon interest
to Banana and to pay additional cash to Banana should bond values rise. Banana will also compensate the
third party for any devaluation of the bonds.
Required:
(a) Draft an explanatory note to the directors of Banana, discussing the following:
(i) how goodwill should have been calculated on the acquisition of Grape and show the accounting entry
which is required to amend the financial director’s error. (8 marks)
(ii) why equity accounting was the appropriate treatment for Strawberry in the consolidated financial
statements up to the date of its disposal showing the carrying amount of the investment in Strawberry
just prior to disposal. (4 marks)
(iii) how the gain or loss on disposal of Strawberry should have been recorded in the consolidated
financial statements and how the investment in Strawberry should be accounted for after the part
disposal. (4 marks)
Note: Any workings can either be shown in the main body of the explanatory y note or in an appendix
to the explanatory note.
(b) Discuss whether the directors are correct to treat Melon as a financial asset acquisition and
whether the International Accounting Standards Board’s proposed amendments to the definition of
a business would revise your conclusions. (7 marks)
(c) Discuss how the derecognition requirements of IFRS 9 Financial Instruments should be applied to
the sale of the bond including calculations to show the impact on the consolidated financial
statements for the year ended 30 June 20X7. (7 marks)
(30 marks)
Answer
1 (a i) Explanatory note to: Directors of Banana Subject:
Consolidation of Grape and Strawberry
Goodwill should be calculated by comparing the fair value of the consideration with the fair value of the
identifiable net assets at acquisition. The shares have been correctly valued using the market price of Banana
at acquisition. Contingent consideration should be included at its fair value which should be assessed taking
into account the probability of the targets being achieved as well as being discounted to present value. It
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would appear reasonable to measure the consideration at a value of $4 million ($16 million x 25%). A
corresponding liability should be included within the consolidated financial statements with subsequent
remeasurement.
This would be adjusted prospectively to profit or loss rather than adjusting the consideration and goodwill.
The finance director has erroneously measured non-controlling interest using the proportional method rather
than at fair value. Although either method is permitted on an acquisition-by-acquisition basis, the accounting
policy of the Banana group is to measure non-controlling interest at fair value. The fair value of the non-
controlling interest at acquisition is (20% x $20 million x $4·25) = $17 million. Net assets at acquisition were
incorrectly included at their carrying amount of $70 million. This should be adjusted to fair value of $75 million
with a corresponding $5 million increase to land in the consolidated statement of financial position. Goodwill
should have been calculated as follows:
$m
Fair value of share exchange 68
Contingent consideration 4
Non-controlling interest at acquisition 17
Fair value of identifiable net assets acquired (75)
Goodwill 14
The correcting entry required to the consolidated financial statements is:
Dr Goodwill $2 million
Dr Land $5 million
Cr non-controlling interest $3 million
Cr Liabilities $4 million
(ii)If an entity holds 20% or more of the voting power of the investee, it is presumed that the entity has
significant influence unless it can be clearly demonstrated that this is not the case. The existence of significant
influence by an entity is usually evidenced by representation on the board of directors or participation in key
policy making processes. Banana has 40% of the equity of Strawberry and can appoint one director to the
board. It would appear that Banana has significant influence but not control. Strawberry should be classified
as an associate and be equity accounted for within the consolidated financial statements.
The equity method is a method of accounting whereby the investment is initially recognized at cost and
adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The
investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other
comprehensive income includes its share of the investee’s other comprehensive income. At 1 October 20X7,
Strawberry should have been included in the consolidated financial statements at a value of $20·4 million ($18
million + 40% x $50 million – $44 million).
(iii)
On disposal of 75% of the shares, Banana no longer exercises significant influence over Strawberry and a profit
on disposal of $3·1 million should have been calculated.
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$ million
Proceeds 19
Fair value of retained interest 4·5
Carrying amount of investment (20·4)

in associate (see part (ii)
Gain on disposal 3.1
Banana is incorrect to have recorded a loss in reserves of $14 million and this should be reversed. Instead, a
gain of $3·1 million should have been included within the consolidated statement of profit or loss. The
investment is initially restated to fair value of $4·5 million. Banana does not intend to sell their remaining
interest and providing that they make an irrecoverable election, they can treat the remaining interest at fair
value through other comprehensive income. The investment will be restated to $4 million at the reporting
date with a corresponding loss of $0·5 million reported in other comprehensive income.
(b)
Melon should only be treated as an asset acquisition where the acquisition fails the definition of a business
combination. In accordance with IFRS® 3 Business Combinations, an entity should determine whether a
transaction is a business combination by applying the definition of a business in IFRS 3. A business is an
integrated set of activities and assets which are capable of being conducted and managed for the purpose of
providing a return in the form of dividends, lower costs or other economic 12 benefits directly to investors or
other owners, members or participants. A business will typically have inputs and processes applied to the
ability to create outputs. Outputs are the result of inputs and processes and are usually present within a
business but are not a necessary requirement for a set of integrated activities and assets to be defined as a
business at acquisition.
It is clear that Melon has both inputs and processes. The license is an input as it is an economic resource within
the control of Melon which is capable of providing outputs once one or more processes are applied to it.
Additionally, the seller does not have to be operating the activities as a business for the acquisition to be
classified as a business. It is not relevant therefore that Melon does not have staff and outsources its activities.
The definition of a business requires just that the activities could have been operated as a business. Processes
are in place through the research activities, integration with the management company and supervisory and
administrative functions performed. The research activities are still at an early stage, so no output is yet
obtainable but, as identified, this is not a necessary prerequisite for the acquisition to be treated as a business.
It can be concluded that Melon is a business and it is incorrect to treat Melon as an asset acquisition.
The International Accounting Standards Board has sought to give greater clarity to the definition of a business
since the definition has proven difficult to apply in practice. Consequently, an exposure draft has been issued
so that no business acquisition occurs where substantially all of the fair value of the gross assets acquired is
concentrated in a single asset or group of similar assets. This is sometimes referred to as a screening test. The
fair value of the gross assets acquired includes the fair value of any acquired input, contract, process,
workforce and any other intangible asset which is not identifiable. In the case of Banana, they are not
intending to use the services of the management company and are not looking to take on any of the
employees. It is unclear therefore as to the extent of ‘know how’ from research activities which would be
obtainable. Research activities appear to be at a very early stage and, whilst in substance are very different in
nature to the license itself and would be treated as separate assets, are likely to be of relatively low value. It
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is perfectly plausible that substantially all of the fair value is concentrated in the license itself and the
acquisition would not be treated as a business combination. Should it be determined that the research
activities obtainable are of sufficient value so that not all the fair value is concentrated in a single asset, the
acquisition would be treated as a business combination since the activities and processes are substantive.
(c)
IFRS 9 Financial Instruments requires that a financial asset only qualifies for derecognition once the entity has
transferred the contractual rights to receive the cash flows from the asset or where the entity has retained
the contractual rights but has an unavoidable obligation to pass on the cash flows to a third party. The
substance of the disposal of the bonds needs to be assessed by a consideration of the risks and rewards of
ownership. Banana has not transferred the contractual rights to receive the cash flows from the bonds. The
third party is obliged to return the coupon interest to Banana and to pay additional amounts should the fair
values of the bonds increase.
Consequently, Banana still has the rights associated with the interest and will also benefit from any
appreciation in the value of the bonds. Banana still retains the risks of ownership as it has to compensate the
third party should the fair value of the bonds depreciate in value. It would be expected that, if the sale were
a genuine transfer of risks and rewards of ownership, then the sales price would be approximate to the fair
value of the bonds. It would only be in unusual circumstances such as a forced sale of Banana’s assets arising
from severe financial difficulties that this would not be the case. The sales price of $8 million is well below the
current fair value of the bonds of $10·5 million.
Additionally, Banana is likely to exercise their option to repurchase the bonds. It can be concluded that no
transfer of rights has taken place and therefore the asset should not be derecognized. To measure the asset
at amortized cost, the entity must have a business model where they intend to collect the contractual cash
flows over the life of the asset. Banana maintains these rights and therefore the sale does not contradict their
business model.
The bonds should continue to be measured at amortized cost in the consolidated financial statements of
Banana. The value of the bonds at 30 June 20X6 would have been $10·2 million ($10 million + 7% x $10 million
– 5% x $10 million). Amortized cost prohibits a restatement to fair value. The value of the bonds at 30 June
20X7 should be $10·414 million ($10·2 million + 7% x $10·2 million – 5% x $10 million). The proceeds of $8
million should be treated as a financial liability and would also be measured at amortized cost. An interest
charge of $0·8 million would accrue between 1 July 20X6 and 1 July 20X8, being the difference between the
sale and repurchase price of the bonds.
HUMMINGS (MAR 2020)
Background
Hummings Co is the parent company of a multinational listed group of companies. Hummings Co uses the
dollar ($) as its functional currency. Hummings Co acquired 80% of the equity shares of Crotchet Co on 1
January 20X4 and 100% of Quaver Co on the same date. The group's current financial year end is 31 December
20X4.
Crotchet Co: functional currency

The head office of Crotchet Co is located in a country which uses the dinar as its main currency. However, its
staff are located in a variety of other locations. Consequently, half of their employees are paid in dinars and
the other half are paid in the currency of grommits. Crotchet Co has a high degree of autonomy and is not
reliant on finance from Hummings Co, nor do sales to Hummings Co make up a significant proportion of their
income. All of its sales and purchases are invoiced in grommits and therefore Crotchet Co raises most of its
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finance in grommits. Cash receipts are retained in both grommits and dinars. Crotchet Co does not own a
dollar ($) bank account. Crotchet Co is required by law to pay tax on its profits in dinars.
The acquisition of Crotchet Co

Hummings Co paid cash of $24 million for the 80% holding in Crotchet Co on 1 January 20X4. Hummings Co
has a policy of measuring non-controlling interests at fair value. The fair value of the non-controlling interests
in Crotchet Co on 1 January 20X4 was $6 million. Since Crotchet Co has a range of net assets held domestically
and overseas, the fair values of the net assets at acquisition were determined in their local currency. Hence,
the fair value of some assets has been determined in dinars and others in grommits. The total fair value of the
net assets denominated in grommit s at 1 January 20X4 was 43 million grommits. The total fair value of the
net assets denominated in dinars at 1 January 20X4 was SO million dinars. Excluded from these fair values are
several contracts with the customers of Crotchet Co. These contractual relationships prohibit the customers
of Crotchet Co from obtaining services from any of the main competitors of Crotchet Co. They have an
estimated fair value at 1 January 20X4 of 15 million grommits. At 31 December 20X4, it was decided to impair
goodwill by 30%.
The following is a summary of the exchange rates between the dollar, grommits and dinars at 1 January 20X4
and 31 December 20X4:
1 January 20X4 31 December 20X4

$1:8 grommits $1:7 grommits
$1: 4 dinar $1: 3.5 dinar
1 dinar:2 grommits 1 dinar:2 grommits
The acquisition of Quaver Co
On 1 January 20X4, Hummings Co purchased a 100% equity interest in Quaver Co. Hummings Co made the
acquisition with the intention to sell and therefore did not wish to have an active involvement in the business
of Quaver Co. Hummings Co immediately began to seek a buyer for Quaver Co and felt that the sale would be
completed by 31 October 20X4 at the latest. A buyer for Quaver Co was located in August 20X4 but, due to an
unforeseen legal dispute over a contingent liability disclosed in Quaver Co's financial statements, the sale had
not yet been finalised as at 31 December 20X4. The sale is expected to be completed in early 20XS.
Impairment of bonds
On 31 December 20X3, Hummings Co purchased $10 million 5% bonds in Stave Co at par value. The bonds are
repayable on 31 December 20X6 and the effective rate of interest is 8%. Hummings Co's business model is to
collect the contractual cash flows over the life of the asset. At 31 December 20X3, the bonds were considered
to be low risk and as a result the 12-month expected credit losses are expected to be $10,000.
On 31 December 20X4, Stave Co paid the coupon interest. However, at that date, the risks associated with the
bonds were deemed to have increased significantly. The present value of the cash shortfalls arising on default
in the year ended 31 December 20XS is $462,963 and the probability of default is 3%. The present value of
cash shortfalls arising on default in the year ended 31 December 20X6 is $6,858,710 and the probability of
default is 5%
Required: Draft an explanatory note to the directors of Hummings Co, addressing the following:
(a) How the functional currency of Crotchet Co should be determined. (5 marks)

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(b (i) How Crotchet Co's customer contracts should be accounted for in the consolidated financial statements
of Hummings Co, which are presented in dollars ($), for the year ended 31 December 20X4. (4 marks)
(ii) a calculation of the goodwill on acquisition of Crotchet Co (in grommits) and how it would be accounted
for in the consolidated statement of financial position of Hummings Co at 31 December 20X4 after translation.
Include a brief explanation and calculation of how the impairment and exchange difference on goodwill will
impact on the consolidated financial statements. (6 marks)
(c) how Quaver Co should be accounted for in the consolidated financial statements at 31 December 20X4.
(4 marks)
(d) A calculation and discussion of how the bonds should be accounted for in the financial statements of
Hummings Co as at 31 December 20X3 and for the year ended 31 December 20X4, including any
impairment losses. (11 marks)
(Total: 30 marks)
ANSWER
(a) Functional currency
The functional currency is the currency of the primary economic environment in which the entity operates.
With a foreign acquisition, consideration should be given as to whether Crotchet Co should adopt the same
functional currency as its parent, Hummings Co. However, Crotchet Co appears to be largely independent and
is not reliant on Hummings Co for either sales or finance. It is not required therefore for Crotchet Co to adopt
the same functional currency as Hummings Co. Crotchet Co does not appear to have transactions in dollars or
have a dollar bank account and it can be concluded that the dollar should not be their functional currency.
In determining its functional currency, Crotchet Co should consider the currency which mainly influences its
sales price of goods and the currency which mainly influences its labour and other costs. This is likely to be
the currency which goods are invoiced in and the currency in which costs are settled. The location of the
entity's head office is irrelevant except to the extent that it is likely that the costs of running the head office
are likely to be settled in the domestic currency. For Crotchet Co, whilst there are a number of transactions in
dinars and tax has to be paid in dinars, it appears that the vast majority of their transactions are in grommits.
All sales and purchases are invoiced in grommits as well as approximately half of their staff being paid in
grommits. Funds for finance are raised in grommits which further suggests that grommits should be chosen
as the functional currency of Crotchet Co.
(b) (i) Customer contracts
IFRS 3 Business Combinations requires the investor to recognize the investee's identifiable net assets at
acquisition at fair value. To be identifiable, a customer contract must either be capable of being used or sold
separately, or it must arise from legal or contractual rights. A reliable estimate of its fair value is also necessary
to be recognized as a separate asset rather than subsumed within the goodwill figure. This is the case
regardless of whether the contracts had been recognized within the individual financial statements of Crotchet
Co or not. The contracts provide Crotchet Co with a legal right to prevent their customers from obtaining
goods and services from their competitors and a reliable estimate of fair value appears to be obtainable. The
contracts should therefore be recognized as a separate intangible asset. Identifiable net assets should be
recognized at fair value as at the acquisition date. For the contracts, this amounts to 15 million grommits. This
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would be translated at the spot rate of exchange of $1 to 8 grommits and would be recognized initially in the
consolidated financial statements at $1.875 million.
The contracts need to be examined to determine their average unexpired useful life and amortized over this
period. This amortization expense should be translated at the average rate of exchange and recorded in
consolidated profit or loss. The carrying amount of the contracts would need to be retranslated at the closing
rate of exchange of $1 to 7 grommits, with a corresponding exchange gain recognized in other comprehensive
income.
(iii) Calculation of goodwill
Goodwill at 31 December 20X4 would be $8.2 million calculated as follows:
Grommits Rate $ millions

millions
Consideration 192
($24m x 8)
NCI at 48
acquisition ($6m
x 8)
Net assets at (158)
acquisition (Wl)
Goodwill at 1 82 8
January 20X4
Impairment (24.6) 7
(30%)
Exchange gain 1.46
(bal. fig.)
Goodwill at 31 57.4 7 8.2
December 20X4
{Wl) Net assets at acquisition Grommits millions 82 (24.6) 57.4 Rate 8 7 7 $ millions 10.25 (3.51) 1.46 8.2 Net
assets at acquisition are 43 million grommits plus 15 million grommits for the contractual relationships plus
100 million grommits for the dinar assets translated at 1 dinar to 2 grommits (S0m x 2).
Example answer
A B C D E F
1 (ii} Goodwill
2 Grommits
3 millions rate millions Example

$ formulae
used
4 Consideration $24mx8 192
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5 NCI at $6mx8 48
acquisition
6 Net assets at W1 -158
acquisition
7 Goodwill at 1 82 8 10.25 = C7/07
January 20X4
8 Impairment -24.6 8 -3.51 = CS/08
(30%
9 Exchange gain 1.46
(bal. fig.)
10 Goodwill at 57.4 7 8.2 = (10/010
31 December
20X4
11
12 (W1) Net Grommits

assets at millions
acquisition
13
14 Fair value in 43
grommits
15 Fair value in 100
dinars
16 Contractual 15
relationships
17 158 =SUM
(C14:C16)
Explanation of accounting treatment

Goodwill is initially recognized at the spot rat e of exchange of $1:8 grommits and so would initially be $10.25
million. The impairment loss of $3.51 million will be expensed to the consolidated stat ement of profit or loss.
Goodwill will be retranslated using the closing rate of exchange of $1:7 grommits with the exchange gain of
$1.46 million included in to her comprehensive income. Since non-controlling interests at acquisition are
measured at fair value, both the impairment and the exchange gain will be apportioned 80/20 between the
shareholders of Hummings Co and the non-controlling interest respectively.
(c) Quaver Co
An asset or disposal group should be classified as held for sale if the carrying amount will be primarily
recovered through a sales transaction. For this to be the case, IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations states that:
• The asset must be available for immediate sale in its present condition and the sale must be highly probable
• The sale must be expected to be complete within 12 months
• The asset must be actively marketed at a reasonable price
• Management must be committed to a plan of sale and it is unlikely that any significant changes to the plan
will be made.
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The sale has not taken place within 12 months of acquisition; however, an exception is permitted where the
sale is still deemed to be highly probable and the delay was caused by events which were unforeseen and
beyond the control of management. The sale is still expected early in 20XS and the legal dispute was
unforeseen, so this exception seems applicable. As such, Quaver should be classified as a disposal group held
for sale.
Quaver Co should initially be measured at fair value less costs to sell with any subsequent decreases in fair
value less costs to sell taken to consolidated profit or loss. It appears clear that management was immediately
committed to the sale as Hummings Co did not wish to have active involvement in the activities of Quaver Co.
Quaver Co is therefore a subsidiary acquired exclusively with a view to resale. In accordance with IFRS 5,
Quaver should be presented as a discontinued operation and so its earnings for the year must be disclosed
separately in the consolidated statement of profit or loss.
(d) Year ended 31 December 20X3
The business model of Hummings Co is to collect the contractual cash flows of the bonds over the life of the
asset, so the bonds should be measured at amortized cost. The financial asset should be recognized at fair
value (plus fees if applicable), which is equal to the $10,000,000 paid to purchase the bonds.
IFRS 9 Financial Instruments requires entities to calculate expected credit losses for investments in debt
instruments that are measured at amortized cost or fair value through other comprehensive income. On
acquisition, the bonds are low risk and are not credit impaired.
This means that Hummings Co should calculate 12-month expected credit losses. The 12-month expected
credit loss is defined as a portion of the lifetime expected credit losses which represent the expected credit
losses resulting from a default within the next 12 months. Hummings Co should therefore recognize an
allowance of $10,000 as at 31 December 20X3. This will be expensed to profit or loss and a separate allowance
created. The allowance is netted off the $10,000,000 bond in the statement of financial position of Hummings
Co as at 31 December 20X3. The carrying amount of the bonds in the statement of financial position at 31
December 20X3 will be $9.99 million ($10 million - $10,000).
Year ended 31 December 20X4

Interest income at the effective rate of 8% should be recognized in profit or loss and added to the carrying
amount of the financial asset. This is calculated on the gross carrying amount of the financial asset ($10m) and
amounts to $800,000 ($10m x 8%). The coupon interest of $500,000 ($10m x 5%) is deducted from the carrying
amount of the bonds. This means that the bonds would have a carrying amount of $10,300,000 ($10m + $0.8m
- $0. 5m) at 31 December 20X4 before considering any impairment issues.
At 31 December 20X4, there has been a significant increase in credit risk. This means that s Co should make
an allowance to recognize the lifetime expected credit losses. This is defined as the expected credit losses
(cash shortfalls) which result from all possible default events over the expected life of the bonds. An allowance
is required equal to the present value of the expected loss in contractual cash flows as weighted by the
probability of default. The expected default losses are discounted using the original effective rate of interest
of 8%.
Date Cashflow working PV of default

31/12/X5 3 % X $462,963 13889
31/12/X6 5% X $6,858,710 342936
356825
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The expected loss allowance should be increased to $356,825 with an expense recorded in profit or loss of
$346,825 ($356,825 - $10,000). The net carrying amount of the bonds reported in the statement of financial
position as at 31 December 20X4 would be $9,943,175 ($10,300,000-$356,825).
ACCA Study hub
RIBBY CO
Background
Ribby Co is the parent of a multinational group of companies, including Zian Co. The group’s current financial
year end is 31 May 20X9.
The following exhibits provide information relevant to the question:
1. Foreign currency – describes the currencies used by Zian Co.
2. Zian Co – provides information about the acquisition of Zian Co.
3. Further information –provides further information about the draft consolidated statement of
financial position (included in pre-formatted response option and exhibit 5).
4. Head office – describes the leasing agreements of Ribby Co’s head office.
5. Draft consolidated SOFP – draft consolidated statement of financial position (SOFP) at 31 May
20X9.
This information should be used to answer the question requirements.
1. Foreign currency
Zian Co is located in a foreign country and imports raw materials at a price which is normally denominated in
dollars. The product is sold locally at selling prices denominated in dinars and determined by local competition.
All selling and operating expenses are incurred locally and paid in dinars. Distribution of profits is determined
by the parent, Ribby Co. Zian Co has financed part of its operations through a $4 million loan from an overseas
bank which was raised on 1 June 20X8. This is included in the non-current liabilities of Zian Co. Zian Co’s
management has a considerable degree of authority and autonomy in carrying out the operations of Zian Co
and the company is not dependent on group companies for finance.
2. Zian Co
Ribby Co acquired 60% of the equity shares of Zian Co on 1 June 20X8. At the date of acquisition, Zian Co’s
equity share capital was 209 million dinars and its retained earnings were 286 million dinars. The fair value of
the net assets of Zian Co on 1 June 20X8 was equal to their carrying amount. There have been no issues of
equity shares since acquisition and goodwill on acquisition is not impaired for Zian Co. The non-controlling
interest is measured at the proportionate share of the net assets. At 31 May 20X9, Zian Co’s retained earnings
were 365 million dinars.
3. Notes on the preparation of the draft consolidated statement of financial position
Before preparing the draft consolidated statement of financial position, Zian Co’s separate financial
statements were translated from dinar into $ in accordance with IFRS® Accounting Standards; however, the
requirement to report exchange differences as a separate component of equity was ignored. The exchange
difference, together with all of Zian Co’s profits since acquisition, is instead included within draft consolidated
retained earnings.
Goodwill and the non-controlling interest are included in the draft consolidated statement of financial position
as measured on the acquisition date of 1 June 20X8.
Rates of exchange between the $ and dinar are given as follows:
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1 June 20X8 $1:10 dinar

31 May 20X9 $1:12 dinar
Average for year to 31 May 20X9 $1:10.5 dinar
4. Head office
On 1 June 20X5, Ribby Co acquired the use of its head office by entering into a 10-year lease, agreeing to pay
quarterly fixed rentals in advance plus a non-refundable deposit. On 1 May 20X9, due to the expansion of its
business and a change in strategic direction, Ribby Co vacated the property, and rented it to tenants for the
remaining term of the lease. During the term of the sublease, Ribby Co agreed to insure the property and
provide maintenance and security services. Ribby Co measures all property assets at fair value when allowed
by IFRS Accounting Standards; property values have risen steadily since 1 June 20X5.
5. Draft consolidated SOFP
In the exam the draft extract will be replicated in the spreadsheet response option.
Statement of financial position at 31 May 20X9

$000
Assets
Non-Current Assets
Property, plant and equipment 384,600
Financial Assets 22,300
Goodwill 3,300
Current Assets 29,000
Total Assets 439,200
Equity
Equity attributable to equity holders of the company
Share capital 60,000
Other component of equity 30,000
Retained earnings 119,400
209,400
Non-controlling interest 19,800
Total equity 209,200
Liabilities
Non-Current liabilities 94,000
Current liabilities 116,000
Total liabilities 210,000
Total equities and liabilities 439,200
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Requirements (30 marks)

(a)Using exhibit 1 only, discuss how the principles set out in IAS® 21 The Effects of Changes in
Foreign Exchange Rates are applied in order to determine the functional currency of Zian Co (6marks)
(b) Explain how goodwill in respect of a foreign subsidiary should be calculated and treated in the consolidated
financial statements
Noted: There is no requirement to refer to any exhibit when answering part (b). (4 marks)
(c)Using the pre-populated spreadsheet response option with exhibits 2 and 3, adjust the draft consolidated
statement of financial position in order to prepare a corrected consolidated statement of financial position at 31
May 20X9. The spreadsheet should take into account the following:
• the requirement of IAS 21 The Effects of Changes in Foreign Exchange Rates to report exchange
differences on translation as a separate component of equity
• the non-controlling interest (12 marks )
(d) Using exhibit 4, explain how Ribby Co should account for the head office property in the year ended 31 May
20X9 in its separate financial statements. (8 marks )
Answer
1. (a) Functional currency

The functional currency is the currency of the primary economic environment in which the entity operates.
The primary economic environment in which an entity operates is normally the one in which it primarily
generates and expends cash. An entity’s management considers the following factors in determining its
functional currency:
• the currency that dominates the determination of the sales prices; and
• the currency that most influences operating costs.
The currency that dominates the determination of sales prices will normally be the currency in which the sales
prices for goods and services are denominated and settled. It will also normally be the currency of the country
whose competitive forces and regulations have the greatest impact on sales prices. In this case it would appear
that currency is the dinar as Zian sells its products locally and the prices are determined by local competition.
However, the currency that most influences operating costs is in fact the dollar, as Zian imports raw materials
which are paid for in dollars although all selling and operating expenses are paid in dinars.
Factors other than the dominant currency for sales prices and operating costs are also considered when
identifying the functional currency. The currency in which an entity’s finances are denominated is also
considered. Zian has partly financed its operations by raising a $4 million loan but it does not depend entirely
on this loan for financing as the majority of finance is in the form of equity. The focus is on the currency in
which funds from financing activities are generated and the currency in which receipts from operating
activities are retained.
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Additional factors include the autonomy of a foreign operation from the reporting entity and the level of
transactions between the two. Zian operates with a considerable degree of autonomy both financially and in
terms of its management. Consideration is given to whether the foreign operation generates sufficient
functional cash flows to meet its cash needs which in this case Zian does as it does not depend on the group
for finance.
It would be said that the above indicators give a mixed view but the functional currency that most faithfully
represents the economic effects of the underlying transactions, events, and conditions is the dinar, as it most
affects sales prices and is most relevant to the financing of an entity. The degree of autonomy and
independence provides additional supporting evidence in determining the entity’s functional currency.
2. (b) Goodwill of a foreign subsidiary
Goodwill in respect of a foreign subsidiary is calculated initially in the subsidiary's functional currency. It is the
residual after deducting the fair value of identifiable net assets of the acquiree from the fair value of
consideration transferred plus the non-controlling interest. The non-controlling interest (NCI) can either be
measured at fair value or as a proportion of the fair value of the subsidiary’ identifiable net asset.
Once calculated, goodwill is treated as a foreign currency denominated asset: at each year end the carrying
amount of goodwill will be translated using the closing exchange rate. If exchange rates have moved, which is
highly likely, there will be an exchange difference on the retranslation of goodwill and this will be recognized
as other comprehensive income (OCI) that may be reclassified to profit or loss. The exchange difference is
allocated to the owners of the parent in its entirety if the NCI was initially measured as a proportion of net
assets; it is split between the owners of the parent and the NCI if the NCI was initially measured at fair value.
The exchange difference allocated to the owners of the parent is accumulated in a separate reserve in equity.
This exchange difference will be reclassified through profit or loss on disposal of the subsidiary.
Goodwill should be tested annually for impairment with any impairment loss being expensed to profit or loss.
The loss is allocated to the owners of the parent if goodwill is partial goodwill (i.e. the NCI was measured as a
proportion of net assets at acquisition) and it is allocated between the owners of the parent and the NCI in
proportion to ownership interests if recognized goodwill is full goodwill. There is some debate about whether
the test should be performed in the subsidiary’s functional currency or the presentation currency of the group,
the method chosen will give slightly different results.
3. (c) Consolidated statement of financial position

Corrected
consolidate
Retranslate Retranslate Allocate statement of
Zian's FS goodwill FS profits to financial
$000 (W1) (W2) NCI(W3) position Marks
Assets
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Non-current assets
Property, plant and
equipment 384,600 384,600
Financial Assets 22,300 22,300
Goodwill 3,300 2,750 1
Current Assets 29,000 29,000
Total Assets 439,200 438,650
Equity
Equity attributable to
equity holders of the
company
Share capital 60,000 60,000
Other component of
equity 30,000 30,000
Foreign exchange
reserve -5,515 -550 -6,065 1+1
Retained earnings 119,400 9,192 -3,010 125,582 1+1
209,400 209,517
Non-controlling interest 19,800 -3,677 3,010 19,133 1+1
Total equity 229,000 228,650
Liabilities
Non-Current liabilities 94,000 94,000
Current liabilities 116,000 116,000
Total liabilities 210,000 210,000
Total equities and
liabilities 439,200 438,650
WORKINGS
(1) Exchange difference on translation of Zian's separate financial statements
opening net assets at
opening/closing rate $000 $000
49,500
41,250
Loss 8,250 1
Profit at average/closing
rate
(Closing - opening
retained
earnings) ÷ exchange
rate
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7,524
6,583
Loss 941 1
Exchange loss on
transaction 9,191 to reverse out of retained earnings (CR)
Allocated to owners of
parent (FX reserve) 5,515 to foreign exchange reserve (DR)
Allocated to NCI 3,677 to NCI(DR)

(2) Exchange difference
on goodwill $000
At acquisition date
(CSOFP) 3,300
At closing rate
2,750
550 to reduce carrying amount of goodwill (CR) 2
550 to foreign exchange reserve (DR)
(3) Allocation of profit to
NCI $000
7524 (W1)×7524 (W1)×
40% 3,010 transfer from retained earnings (DR) to NCI(CR) 1
(d) Lease agreements

Ribby is lessee in the head lease and lessor in the sublease. IFRS 16 Leases applies to both the head lease and
sublease.
On acquiring the use of the property in 20X5, Ribby should have recognized a lease liability measured at the
present value of future quarterly lease payments over the 10-year lease term. Payments should have been
discounted at the interest rate implicit in the lease or, if this was not known, Ribby’s incremental borrowing
rate. The lease liability is subsequently amortized and at 31 May 20X9 it will remain in the statement of
financial position, split between a current and non-current amount.
At the commencement of the lease in 20X5, Ribby should also have recognized a right-of-use asset measured
at the amount of the lease liability plus the non-refundable deposit. This should subsequently have been
depreciated over the 10-year lease term. As Ribby measures property assets at fair value when permitted by
IFRS Standards, the IAS 16 Property, Plant and Equipment revaluation model should have been applied to the
right-of-use asset with revaluation gains recognized in OCI. At 1 May 20X9 the property should therefore be
measured at the fair value of the right to use the asset (rather than the fair value of the underlying property)
less depreciation subsequent to the most recent revaluation.
On 1 May 20X9 Ribby leased the property to tenants. As lessor in the arrangement Ribby should determine
whether the lease is classified as an operating or finance lease. The short-term nature of the lease and the
fact that Ribby will insure the property indicates that it retains the risks and rewards associated with the
property and this is an operating lease.
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In respect of the sublease, Ribby should therefore recognize rental income on a straight-line basis over the
lease term.
A change of use of the property occurs on 1 May 20X9. From this date it is rented to tenants under an operating
lease and so meets the definition of an investment property (IAS 40 Investment Property). This is not affected
by the provision of ancillary services (security and maintenance services) since these are insignificant to the
arrangement as a whole.
Ribby measures properties using the fair value model. On 1 May 20X9, prior to the transfer to investment
property the right to use the head office should be remeasured to fair value and the increase in fair value
should be recognized in OCI as an IAS 16 revaluation surplus. The property is then reclassified to investment
property.
Subsequently the right to use the property is measured at fair value and any gains or losses are recognized in
profit or loss.
Amounts included in the financial statements in the year ended 31 May 20X9 will be:
• In the statement of financial position:
o Investment property measured at the fair value of the right to use the
property
o The lease liability on the head lease, split between current and non-current
amounts
• In the statement of profit or loss:
o Finance costs arising on the lease liability
o Depreciation on the right-of-use asset from 1 June 20X8 to 1 May 20X9
o Operating lease income from 1 May 20X9 – 31 May 20X9
o Any increase in fair value from 1 May 20X9 to 31 May 20X9
• In OCI:
o The revaluation gain recognized at 1 May 20X9.
Ashanti Co
Background
Ashanti Co has several wholly owned subsidiaries and one part-owned subsidiary, Bochem Co. It is preparing
financial statements for the year ended 30 April 20X8.
1. Defined benefit plan – details of the defined benefit plan available to the employees of Ashanti
Co.
2. Financial asset investment – provides information about an investment in a financial asset.
3. Bochem Co – provides information about the acquisition of Bochem Co.
4. Further information – provides further information about the draft consolidated statement of
profit or loss and other comprehensive income (included in pre-formatted response option and
exhibit 6).
5. Equity investment.
6. Draft consolidated SOPL and OCI – draft consolidated statement of profit or loss (SOPL) and other
comprehensive income (OCI) for the year ended 30 April 20X8.
1. Defined benefit plan
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Ashanti Cooperates a defined benefit plan for its employees and the cost of remeasurements for the current
year in accordance with IAS 19 Employee Benefits is $14 million. This remeasurement cost has been included
in administrative expenses. In order to reduce the risks to which it is exposed, Ashanti Co’s directors are
considering reducing the number of participants in the defined benefit plan. The company would pay
compensation from plan assets to those participants who are affected.
2. Financial asset investment

On 1 May 20X5, Ashanti Co purchased a $20 million five-year bond with semi-annual interest of 5% payable
on 31 October and 30 April. The purchase price of the bond was $21.62 million. The effective annual interest
rate is 8% or 4% on a semi-annual basis. The bond is classified as an amortized cost financial asset in
accordance with IFRS 9 Financial Instruments.
During the preparation of the consolidated financial statements at the start of June 20X8, the financial
controller identified that the interest due on the bond at 30 April 20X8 had not been received. She observed
that the October 20X7 interest had been paid almost four weeks after the due date and is concerned that the
asset may be impaired. She is considering changing the classification of the asset to fair value through other
comprehensive income (FVTOCI) in order to avoid having to test for impairment.
2. Bochem Co
On 1 May 20X6, Ashanti Co acquired 70% of the equity interests of Bochem Co. The purchase consideration
comprised cash of $140 million and Ashanti Co elected to measure the investment at cost in its separate
financial statements. The fair value of the identifiable net assets of Bochem Co was $160 million at the
acquisition date and the fair value of the non-controlling interest (NCI) in Bochem was $54 million.
The share capital and retained earnings of Bochem Co were $55 million and $85 million respectively and other
components of equity were $10 million at the date of acquisition. The excess of the fair value of the
identifiable net assets at acquisition over carrying amount is due to plant, which is depreciated using the
straight-line method and has a five-year remaining life at the date of acquisition. Depreciation on plant is
recognized in cost of sales.
Goodwill has been impairment tested annually and as at 30 April 20X7 had not reduced in value but at 30 April
20X8 had lost 5% of its original value. Ashanti Co disposed of a 10% equity interest to the NCI of Bochem Co
on 30 April 20X8 for a cash consideration of $34 million.
3. Further information
The draft consolidated statement of profit or loss and other comprehensive income has been prepared by
aggregating the income and expenses of Ashanti Co and its subsidiaries on a line-byline basis. Ashanti Co’s
gain on disposal of shares in Bochem Co has been included within other income
The amount of profit and total comprehensive income due to the non-controlling interests has been calculated
as 30% of the profit and total comprehensive income reported in Bochem Co’s separate financial statements.
During the year ended 30 April 20X8 Bochem Co sold goods to Ashanti Co for $12 million. At 30 April 20X8,
goods costing Ashanti Co $5 million remained unsold. Bochem had made a profit of $1 million on these goods.
4. Equity investment
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297
The directors of Ashanti Co are considering the purchase of an equity stake in another company; however,
they are concerned that the investment is of a risky nature. They are looking to acquire a 25% holding initially
and if the investment proves to be successful then they will look to acquire a further 50% of the equity shares,
to give a holding of 75%.
5. Draft consolidated SOFP and OCI
Statement of profit and loss and OCI for the year ended 30 April 20X8
$m
Revenue 1,045
Cost of sales -823
Gross profit 222
Other income 48
Distribution costs -51
Administrative expenses -98
Operating profit 121
Net finance costs -14
Profit before tax 107
Income taxes -44
Profit for the year 63
Other comprehensive income
Fair value through OCI gains 29
Revaluation surplus/td> 18
Total comprehensive income 110
Profit allocated to NCI 10.8
TCI allocated to NCI 15.3
Requirements (30 marks)

(a)Using exhibit 1, explain how the defined benefit plan should be accounted for and how the change in the
defined benefit plan should be treated in the financial statements of Ashanti Co. (6 marks)
(b)Using exhibit 2, explain how the bond should be classified and the accounting treatment of the
potential impairment. (6 marks)
(c)Using the pre-populated spreadsheet response option with exhibits 3 and 4 and your previous answers, adjust
the draft consolidated statement of profit or loss and other comprehensive income for the year ended
30 April 20X8 in order to prepare a corrected statement. (12 marks)
(d)Using exhibit 5, explain how the initial 25% stake in the other company would be accounted for in both the
financial statements of Ashanti Co and also the consolidated financial statements, and discuss how the
additional 50% stake would be accounted for in the consolidated financial statements. ( 6 marks )
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298
Answer
1. (a) Accounting for defined benefit plan

A defined benefit plan fixes the amount of benefit to be paid to former employees; usually, as a percentage
of their final salaries. This means that the contributions throughout employees' working lives are variable and
therefore, the accounting is not straightforward.
• The entity’s statement of financial position will include a net defined benefit deficit (or unusually
a surplus). This is the difference between the fair value of the assets in the plan and the present
value of the obligation to pay future pensions. This is advised by an actuary and changes from year
to year; the change is recognized in profit or loss and other comprehensive income (OCI).
• The net interest (on the opening deficit or surplus) is recognized in profit or loss. This represents
the return on investments and the unwinding of the discount on the obligation.
• Current service cost is also recognized in profit or loss. This is the increase to the obligation
resulting from the provision of an additional year's service by employees.
• Remeasurements, which are recognized in OCI, include:
o any actuarial gain or loss for the period resulting from changes in actuarial
assumptions when determining the value of the obligation; and
o the difference between the actual return on assets held and the return that
has been included in profit or loss.
Ashanti is therefore incorrect to recognize the cost of remeasurements ($14 million) as an administrative
expense in profit or loss.
Ashanti is considering reducing the number of employees participating in the defined benefit plan. This would
be a curtailment and any compensation paid would be a settlement:
• As a result of the curtailment, the present value of the obligation will reduce and give rise to a
positive past service cost, which must be recognized in profit or loss in the period of the
curtailment.
• If the compensation paid (the settlement) is not the same amount as the reduction in the
obligation, a gain or loss will arise. This is also recognized in profit or loss.
The remaining net defined benefit surplus or deficit continues to be accounted for in line with IAS 19.
The remeasurement of the obligation at the time of the curtailment must be made using updated
assumptions, and these assumptions are also used after the curtailment to measure the interest cost and
current service cost for the remainder of the accounting period.
2. (b) Financial asset investment
Classification
The bond has been classified as a financial asset at amortized cost. As the bond carries contractual interest
payments on specified dates, this classification is correct assuming that Ashanti intends to hold the asset to
collect contractual cash flows (i.e. to hold it to maturity in April 20Y0).
The bond can only be reclassified to the FVTOCI category if Ashanti changes the business model within which
the asset is held such that it is held for the purpose of collecting contractual cash flows and selling. Otherwise,
it cannot be reclassified.
In any case, the financial controller is incorrect to assume that the expected credit loss (ECL) approach to
impairment in IFRS 9 does not apply to a financial asset at FVTOCI. It applies in the same way as to assets
classified as amortized cost, except that the ECLs are recognized as a balance in OCI and financial assets
continue to be presented gross in the statement of financial position. Financial assets at amortized cost are
presented net of the loss allowance.
Impairment
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299
The interest due on the bond at the end of the reporting period was not received and this fact was identified
during the preparation of the financial statements. Interest due was paid late in the previous six-month period
and it therefore seems indicative of a financial problem of the issuer. Therefore, this is an adjusting event after
the end of the reporting and Ashanti’s financial statements for the year ended 30 April 20X8 should recognize
the impairment of the financial asset.
At initial recognition of the bond investment, Ashanti should have recognized a 12-month ECL in line with IFRS
9. When contractual payments are more than 30 days past due there is a rebuttable presumption that the
credit risk attached to the asset has significantly increased.
Therefore, Ashanti should recognize a loss allowance equal to the lifetime ECL. This is the ECL that would arise
if default occurred at any time in the remaining term of the bond. ECLs are calculated as cash shortfalls (i.e.
the difference between amounts contractually due and what Ashanti expects to receive). These are probability
weighted to determine the loss allowance.
Ashanti should recognize a loss allowance in profit or loss and present the bond investment net of this amount.
As there was no objective evidence that impairment existed at the reporting date (30 April 20X8), interest
continues to be calculated on the gross carrying amount of the financial asset.
(c) Statement of profit or loss and OCI for the year ended 30 April 20X8
Pension Depreciate Impairment Eliminate Intra-

Adjust
remeasurement FV of gain on group Corrected Marks
NCI(W5)
(a) adjustment goodwill(W2) disposal trading
$m $m $m $m $m $m $m $m $m
Revenue 1,045 -12 1,033.00
Cost of sales -823 -2 11 -814 1+1
Gross profit 222 219
Other income 48 -14 34 1
Distribution
-51 -51
costs
Administrative -98 14 -1.7 -85.7 1+1
expenses
Operating profit 121 116.3
Net finance
-14 -14 1
costs
Profit before tax 107 102.3
Income taxes -44 -44
Profit for the
63 58.3
year
Other
comprehensive
income
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300
Fair value
through OCI 29 29
gains
Revaluation 18 18
surplus/td>
Remeasurement
of pension -14 -14 1
scheme
Total
comprehensive 94.7 91.3
income
Profit allocated 10.8 -1.4 9.4

to NCI
Profit allocated
to owners of the 48.9 1
parent
TCI allocated to
15.3 -1.4 13.9
NCI
TCI allocated to
owners of the 77.4 1
parent
Workings
(1) Depreciation for fair value adjustment
Fair value adjustment 10
Depreciation 2
(2) Goodwill impairment
Consideration 140
FV of NCI 54
FV of identifiable net assets -160
Goodwill at acquisition 34
Impairment at y/e 30.4.X8 1.7
(3) Gain on disposal
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Consideration 34
Carrying amount -20
Gain 14
(4) Intra group trading
Adj. to revenue (sales in year) 12
Adj. to cost of sales (sales in year-URP) 11
(5) Adjustment to NCI in profit and TCI
Share of depreciation of FV adj. -0.6
Share of goodwill impairment -0.5
Share of unrealized profit 0.3
-1.4
3. (d) Business combination in stages

The initial acquisition of a 25% equity stake in this entity is likely to lead to Ashanti having significant influence
over this entity. IAS 28 Investments in Associates and Joint Ventures states that significant influence exists if
an entity has between 20% and 50% of an equity stake, unless it can be proven otherwise.
IAS 27 Separate Financial Statements deals with accounting for the equity investment in Ashanti’s separate
financial statements, stating that the investment can either be accounted for:
• At cost;
• In accordance with IFRS 9, which means the investment will be accounted for at fair value with
any changes being taken either to profit or loss (or OCI if the relevant election is made at initial
recognition); or
• By using the equity method prescribed by IAS 28.
In the consolidated financial statements, assuming significant influence exists, Ashanti will account for the
25% equity investment using the equity method. In the statement of financial position, the investment will be
measured at cost plus a share of any post-acquisition profits less any impairment losses and distributions
received. The statement of profit or loss and OCI will include a share of the associate’s profit for the year and
a share of its OCI.
If Ashanti decides to acquire an additional 50% equity stake, then from that date the entity will be a subsidiary
of Ashanti as Ashanti will have the power to control the activities of the subsidiary.
The original 25% holding will be remeasured to fair value at the date the additional shares are acquired and
any gain or loss on remeasurement will be included in profit or loss.
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The assets, liabilities, income and expenses of the entity will be consolidated from the date on which control
is achieved and goodwill will be calculated at this date. The remaining 25% not held by Ashanti will be
recognized in the equity section of the consolidated statement of financial position as an NCI. Subsequently it
increases by the NCI's share of the subsidiary's total comprehensive income.
Minny Co
Background
Minny Cooperates in the service sector. Minny Co has two subsidiaries, Bower Co and Heeny Co. It is preparing
its financial statements for the year ended 30 November 20X8 and the financial accountant has been asked to
maximize retained earnings as afar as possible within the constraints of the requirements of IFRS Accounting
Standards.
1. Planned disposal – explains the planned disposal of a major line of business operations.
2. Putty Co – provides information regarding purchases of shares in Putty Co.
3. Purchase of patents –describes the purchase of patents and the project they relate to.
4. Further information –provides further information about the draft consolidated financial
statements (included in the pre-formatted response option and exhibit 5) and acquisition of
subsidiaries.
5. Draft consolidated SOFP – provides extracts of the draft consolidated statement of financial
position (SOFP) for the year ended 30 November 20X8.
1. Planned disposal
Minny Co intends to dispose of a major line of its business operations. At the date the held for sale criteria
were met, the carrying amount of the assets and liabilities comprising the line of business were:
$m
Property, plant and equipment 49
Inventory 18
Current liabilities 3
It is anticipated that Minny Co will realize $30 million for the business. No adjustments have been made in the
financial statements in relation to the above decision.
2. Putty Co
Minny Co acquired a 14% interest in Putty Co, a listed company, on 1 December 20X6 for cash consideration
of $18 million. The investment was classified as at fair value through other comprehensive income. At 30
November 20X7 the fair value of the shareholding was $20 million and the increase was recognized correctly
by Minny Co. On 1 June 20X8, Minny Co acquired an additional 16% interest in Putty Co for a cash
consideration of $27 million and achieved significant influence. The fair value of the original 14% investment
on this date was $21 million. The only accounting entry made by Minny Co in the year ended 30 November
20X8 was to recognize the additional shareholding at cost.
Putty Co made profits after tax of $20 million and $30 million for the years to 30 November 20X7 and 30
November 20X8 respectively and this accrued evenly in both years. On 30 November 20X8, Minny Co received
a dividend from Putty Co of $2 million, which has been credited to other components of equity. The
recoverable amount of Putty Co exceeds it carrying amount in the consolidated financial statements.
3. Purchase of patents
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Minny Co purchased patents of $10 million to use in a project to develop new products on 1 December 20X7.
Minny Co has completed the investigative phase of the project, incurring an additional cost of $7 million and
has determined that the product can be developed profitably. The additional cost included $4 million spent
on the creation of an effective and working prototype and a further $3 million in order to put the product into
a condition for sale. In addition, marketing costs of $2 million were incurred. All of the above costs are included
in the intangible assets of Minny Co.
4. Further information
The figures in the draft consolidated financial statements have been calculated by aggregating the individual
balances of Minny Co, Bower Co and Heeny Co. No further adjustments have been made.
Minny Co owns 100% of Bower Co and has done since Bower Co was incorporated. It acquired 56% of the
equity shares in Heeny Co on 1 December 20X7 for cash consideration of $224 million. The fair value of the
non-controlling interest at that date was $161 million. At the date of acquisition, Heeny Co’s share capital was
$200 million and retained earnings were $89 million. At 30 November 20X8 Heeny Co had retained earnings
of $139 million.
On 30 November 20X8 Minny Co acquired an additional 24% of the equity interest in Heeney, paying a further
$100 million. Heeny Co was impairment tested at 30 November 20X8 as a cash-generating unit. Recoverable
amount was greater than carrying amount.
5. Draft consolidated SOFP (extract)

Extract from draft consolidated statement of financial position at 30 November 20X8
$m
Equity and liability 1520
Share capital 135
Other component of equity 2476
1131
4. Requirements (30 marks)

Prepare an explanatory note for the directors of Minny Co, addressing the following:
(a)Using exhibit 1, discuss the criteria that Minny Co’s “major line of its business operations” must have
met to be classified as held-for-sale in accordance IFRS® 5 Non-current Assets Held for Sale and Discontinued
Operations and why regulators may question entities on the application of the standard. (7 marks)
(b)Using exhibits 1, 2 and 3, discuss how each of the following should be accounted for in the consolidated
financial statements for the year ended 30 November 20X8: (10 marks)
(i) the disposal of the major line of business;
(ii) the investment in Putty Co; and
(iii) the purchased patents.
Using the pre-populated spreadsheet response option with exhibit 4 and your previous answers, adjust the
spreadsheet in order to prepare a corrected consolidated statement of financial position at 30 November
20X8. (13 marks )
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Answer
(a) Non-current asset held for sale

An asset or disposal group is available for immediate sale in its present condition, if the entity has the intention
and ability to transfer the asset or disposal group to a buyer. There is no guidance in the standard on what
constitutes available for immediate sale but the guidance notes set out various examples. Customary terms
of sale such as surveys and searches of property do not preclude the classification as held for sale. However,
present conditions do not include any conditions that have been imposed by the seller of the asset or disposal
group, such as if planning permission is required before sale. In this case, the asset is not held for sale. The
problem is determining whether the entity truly intends to dispose of the group of assets.
A sale is “highly probable” where it is significantly more likely than probable that the sale will occur and
probable is defined as “more likely than not”. IFRS 5 attempts to clarify what this means by setting out the
criteria for a sale to be highly probable:
• There is evidence of management commitment;
• There is an active programme to locate a buyer and complete the plan;
• The asset is actively marketed for sale at a reasonable price compared to fair value;
• The sale is expected to be completed within 12 months of the classification; and
• Actions required to complete the plan indicate that it is unlikely that there will be significant
changes to the plan or that it will be withdrawn.
Because the standard defines “highly probable” as “significantly more likely than probable”, this creates a high
threshold of certainty before recognition as held-for-sale. IFRS 5 expands on this requirement with some
specific conditions but the uncertainty still remains. A number of issues have therefore arisen over the
implementation of the standard, mainly due to the fact that judgement is required in the application of its
requirements. As a result reporting entities may seek to manipulate their results by transferring the assets
and liabilities of divisions with a less healthy financial position to be reported as held for sale.
(b) Consolidated financial statements

(i)Disposal of major line of business
In accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations an asset or grouping
of assets must be measured in accordance with IFRS 5 and presented separately from other assets and
liabilities.
Prior to transferring the disposal group to the held for sale category, the assets and liabilities must be
measured in accordance with any applicable standards, in other words they must be tested for impairment
and property measured using the revaluation model must be revalued. Once the disposal group is classified
as held for sale, the disposal group will be measured at the lower of its carrying amount and fair value less
costs to sell.
The carrying amount of the disposal group is currently $64 million (49 + 18 − 3) and proceeds on disposal are
expected to be $30 million, leading to an impairment loss of $34 million. This is recognized in consolidated
profit or loss.
After transfer, the assets of the disposal group are presented separately as current assets and measured at
$33 million and the liabilities are presented separately as current liabilities and measured at $3 million. The
two amounts are not offset.
ii.Investment in Putty Co
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305
When the investment is increased, the original investment (14%) is deemed to be disposed of and the new
investment (30%) purchased at fair value. Prior to the disposal of a financial asset, it should be remeasured in
accordance with IFRS 9 Financial Instruments. Therefore the $1m increase in fair value between 1 December
20X7 and 1 June 20X8 should be recognized as other comprehensive income and the carrying amount of the
investment adjusted to be $21 million. The deemed disposal and repurchase does not therefore give rise to
any profit or loss. The total gain of $3 million ($21m – $18m) accumulated in OCE up to 1 June 20X8 cannot
be reclassified to profit or loss on the deemed disposal but can be transferred within equity and hence to
retained earnings.
After Putty becomes an associate Minny should recognize its share of profits made by Putty, being $4.5 million
($30m × 30% × 6/12m). This is added to the carrying amount of the investment. From a group perspective the
dividend received is recognized as a reduction in the carrying amount. The carrying amount of the investment
in Putty in the consolidated statement of financial position at 30 November 20X8 should therefore be:
$m
Cost ($21m + $27m) 48
6
Share of post-acquisition profits (30% × $30m × /12 months) 4.5
Less dividend received (2.0)
50.5
The dividend received should have been credited against the carrying amount of the investment and not to
OCE. There is no impairment as the recoverable amount of Putty exceeds its carrying amount in the
consolidated financial statements.
iii.Purchased patents
Minny should recognize the $10 million cost of patents as an intangible asset plus the cost of the prototype of
$4 million and the $3 million to get it into condition for sale. The remainder of the costs should be expensed,
including the marketing costs. This $9 million has been recognized as an intangible asset in the year. The error
is therefore corrected in the year by:
Dr profit and loss $9 million

Cr intangible asset $9 million
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(c) Consolidated statement of financial position
Extract from draft consolidated statement of financial position at 30 November 20X8
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307
Interpretation
Question 1
Colat and co
Investors need to understand a variety of factors when making an investment decision. The nature of the
companies in which they are looking to invest is an important consideration, as is the need to incorporate
sustainability factors into investment decisions.
Required
Discuss why sustainability has become an important aspect of the investors' analysis of companies. Note:
there is no requirement to refer to any exhibit when answering part (a). (4 marks)
Professional marks will be awarded in part (a) for clarity and quality of discussion. (2 marks)
Sustainability
Answer
Sustainability has become an increasingly crucial aspect of investing. There is a growing recognition that
sustainability can have a significant effect on company financial performance. Investors are increasingly
integrating consideration of sustainability issues and metrics into their decision-making. Investors require a
better understanding of the wider social and environmental context in which the business operates. This
creates a greater trust and credibility with investors and a reduced risk of investors using inaccurate
information to make decisions about the company. Investors have shown an appetite for products which
recognize and reflect the relationship between their investments and social and environmental conduct.
Investors need to completely understand the nature of the companies in which they are looking to invest and
need to incorporate material sustainability factors into investment decisions.
They need to understand whether there are material risks or opportunities connected with sustainability
factors which do not appear in traditional financial reports. Their materiality will differ from sector to sector,
industry to industry. Sustainability is often unique to the sector. This analysis can be the deciding factor
between otherwise identical companies. If the company is viewed poorly based on its sustainability
performance, it could lead to a non-investment decision. The increasing availability of data from companies
offers the opportunity for rating and ranking analysis, as well as observing trends. These advances have led to
the quantitative application of sustainability data in investment analysis and decision making. Companies need
a greater knowledge of investor needs and perspectives to help make reporting more relevant to investors
and to clearly communicate the financial value of the company's sustainability efforts.
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Question 2
HANDFOOD & CO
Hand food Co is a small and medium-sized enterprise (SME) which has introduced a benefit to encourage
employees to remain with the entity. The company's financial year end is 31 December and it prepares its
financial statements using IFRS Standards but is interested in the differences with the SMEs Standard.
SMEs
It can be argued that small and medium-sized enterprises (SM Es) face financing difficulties because there is
serious information asymmetry between SM Es and investors. Information asymmetry, in the context of SMEs,
means that the SME has access to relevant information, while the investor suffers from a lack of relevant
information. It can be argued that the SMEs Standard decreases information asymmetry between the entity
and investors.
Where SMEs lead in product and service innovation, they can also lead in innovation for integrated reporting.
There is a clear, concise and persuasive case for why SMEs and their stakeholders stand to benefit greatly by
using integrated reporting.
Required: (a) (i) Discuss the nature of the SMEs Standard and the principal differences between the SMEs
Standard and full lFRS Standards. (4 marks)
(iii) Discuss the effect that information asymmetry can have on the decision to invest in SMEs.
(4 marks)
(iv) Discuss how integrated reporting could help SMEs better understand and better
communicate how they create value to investors. (5 marks)
Professional marks will be awarded in part (a) for clarity and quality of discussion. (2 marks)
Answer
(a i)
Nature of the SME's Standard The principal aim when developing the SMEs Standard was to provide a
framework that generated relevant, reliable and useful information and the provision of a high quality and
understandable accounting standard suitable for SMEs. The Standard itself is self-contained, and incorporates
accounting principles based on full IFRS standards. It comprises a single standard divided into simplified
sections for each relevant IFRS standard but which have also omitted certain IFRS standards such as earnings
per share and segmental reporting. In addition, there are certain accounting treatments that are not allowable
under the SM Es Standard. For example, there is no separate guidance for non-current assets held for sale.
To this end, the SMEs Standard makes numerous simplifications to the recognition, measurement and
disclosure requirements in full IFRS standards. Examples of these simplifications are:
• Intangible assets must be amortized over their useful lives. If the useful life is not determinable then it is
presumed to be 10 years.
• The cost model (investment is measured at cost less any accumulated impairment losses) can be used for
investments in associates. This model may not be used for investments for which there is a published price
quotation, in which case the fair value model must be applied.
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The disclosure requirements in the SMEs Standard are also substantially reduced when compared with those
in full IFRS standards partly because they are not considered appropriate for users' needs and for cost-benefit
considerations.
(i) Information asymmetry IFRS for SMEs decreases information asymmetry between the firm and the
users, because of its recognition, measurement and disclosure requirements. However, there are
certain facts and information in companies which is not disclosed by them to investors under any
accounting standards.
SMEs have access to all relevant information, while investors lack much of the relevant information.
Unfortunately, lack of relevant information will have an adverse effect on the decision-making of the
investor. Information related to the SM E's credit, project risk and benefits are known more by the
SME than by the investor giving the SME an information advantage.
Therefore, investors are in a relatively disadvantaged position, and if they, for example, are financial
institutions, they will raise lending rates to reduce potential risk of credit losses or may not invest at
all. The more incomplete and the less transparent the information from the SME, the higher will be
the risk related to the investment and the higher will be the return that the investor requires. The
access to investment by SM Es could be determined by the quality of financial statements,
information asymmetry and perceived risk. Quality financial statements reduce the level of
information asymmetry which reduces perceived risk.
(ii) Integrated reporting
Integrated reporting could help SMEs better understand and better communicate how they create
value. It can provide a roadmap for SMEs to consider the multiple capitals that make up its value
creation. An integrated report represents a more complete corporate report which will help SMEs
understand their business so they can implement a business model that will help them grow. SM Es
use a range of resources and relationships to create value.
An integrated reporting approach helps SMEs build a better understanding of the factors that
determine its ability to create value over time. Integrated thinking helps SM Es gain a deeper
understanding of the mechanics of their business. This will help them assess the strengths of their
business model and spot any deficiencies. These will create a forward-looking approach and sound
strategic decision making.
Some SMEs have few tangible assets and operate in a virtual world. As such, conventional accounting
will fail to provide a complete picture as to its ability to create value. Capitals, such as employee
expertise, customer loyalty, and intellectual property, will not be accounted for in the financial
statements which are only one aspect of an SM E's value creation.
As a result, SME stakeholders can be left with insufficient information to make an informed decision.
Integrated reporting will include key financial information but that information is alongside significant
non-financial measures and narrative information. Integrated reporting can help fulfil the
communication needs of financial capital and other stakeholders and can optimize reporting.
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Question 3
HOLLS and Co (DEC 2018)
Holls Group is preparing its financial statements for the year ended 30 November 20X7. The
directors of Holls have been asked by an investor to explain the accounting for taxation in the
financial statements. The Group operates in several tax jurisdictions and is subject to annual tax
audits which can result in amendments to the amount of tax to be paid.
The profit from continuing operations was $300 million in the year to 30 November 20X7 and the
reported tax charge was $87 million. The investor was confused as to why the tax charge was not
the tax rate multiplied by the profit from continuing operations. The directors have prepared a
reconciliation of the notional tax charge on profits as compared with the actual tax charge for the
period.
$m
Profit from continuing operations 300
before taxation
Notional charge at local corporation 66
tax rate of 22%
Differences in overseas tax rates 10
Tax relating to non-taxable gains on (12)
disposals of businesses
Tax relating to the impairment of 9
brands
Other tax adjustments 14
Tax charge for the year $ million 87
The amount of income taxes paid as shown in the statement of cash flows is $95 million but
there is no current explanation of the tax effects of the above items in the financial statements.
The tax rate applicable to Holls for the year ended 30 November 20X7 is 22%. There is a
proposal in the local tax legislation that a new tax rate of 25% will apply from 1 January 20X8. In
the country where Holls is domiciled, tax laws and rate changes are enacted when the
government approves the legislation.
The government approved the legislation on 12 November 20X7. The current weighted average
tax rate for the Group is 27%. Holls does not currently disclose its opinion of how the tax rate may
alter in the future but the government is likely to change with the result that a new government
will almost certainly increase the corporate tax rate. At 30 November 20X7, Holls has deductible
temporary differences of $4.S million which are expected to reverse in the next year. In addition,
Holls also has taxable temporary differences of $5 million which relate to the same taxable
company and the tax authority.
Holls expects $3 million of those taxable temporary differences to reverse in 20X8 and the
remaining $2 million to reverse in 20X9. Prior to the current year, Holls had made significant
losses.
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Required:
With reference to the above information, explain to the investor, the nature of accounting for
taxation in financial statements.
Note: Your answer should explain the tax reconciliation, discuss the implications of current and
future tax rates, and provide an explanation of accounting for deferred taxation in accordance
with relevant IFRS Standards. (14 marks)
Professional marks will be awarded in part (b) for clarity and quality of discussion. (2 marks)
Answer
Current tax Current tax is based on taxable profit for the year. Taxable profit is different from
accounting profit due to temporary differences between accounting and tax treatments, and
due to items which are never taxable or tax deductible. Tax benefits such as tax credits are
not recognised unless it is probable that the tax positions are sustainable.
The Group is required to estimate the corporate tax in each of the many jurisdictions in which
it operates. The Group is subject to tax audits in many jurisdictions; as a result, the Group may
be required to make an adjustment in a subsequent period which could have a material
impact on the Group's profit for the year.
Tax reconciliation
The tax rate reconciliation is important for understanding the tax charge reported in the
financial statements and why the effective tax rate differs from the statutory rate. Most
companies will reconcile the group's annual tax expense to the statutory rate in the country
in which the parent is based. Hence the rate of 22% is used in the tax reconciliation. It is
important that the reconciliation explains the reasons for the differences between the
effective rate and the statutory rate.
There should be minimal use of the 'other' category. In this case, the other category is
significant ($14 million) and there is no explanation of what 'other' constitutes. This makes it
harder for investors to predict the Group's tax expense in future periods. One-off and unusual
items can have a significant effect on the effective tax rate, but financial statements and
disclosure notes rarely include a detailed discussion of them.
For example, the brand impairment and disposals of businesses should be explained to
investors, as they are probably material items. The explanation should include any potential
reversal of the treatment. Some profits recognized in the financial statements are non-
taxable.
In some jurisdictions, gains on disposals of businesses are not taxable and impairment losses
do not obtain tax relief. These issues should be explained to investors so that they understand
the impact on the Group's effective tax rate.
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Tax rates
As the Group is operating in multiple countries, the actual tax rates applicable to profits in
those countries are different from the local tax rate. The overseas tax rates are higher than
local rates, hence the increase in the taxation charge of $10 million. The local rate is different
from the weighted average tax rate (27%) of the Group based on the different jurisdictions in
which it operates.
Investors may feel that using the weighted tax rate in the reconciliation gives a more
meaningful number because it is a better estimate of the tax rate the Group expects to pay
over the long term. Investors will wish to understand the company's expected long-term
sustainable tax rate so they can prepare their cash flow or profit forecasts.
Information about the sustainability of the tax rate over the long term is more important than whether the
rate is high or low compared to other jurisdictions. An adjustment can be made to an investor's financial model
for a long-term sustainable rate, but not for a volatile rate where there is no certainty over future
performance. For modelling purposes, an understanding of the actual cash taxes paid is critical and the cash
paid of $95 million can be found in the statement of cash flows.
Deferred taxation
Provision for deferred tax is made for temporary differences between the carrying amount of assets and
liabilities for financial reporting purposes and their value for tax purposes. The amount of deferred tax reflects
the expected recoverable amount and is based on the expected manner of recovery or settlement of the
carrying amount of assets and liabilities, using the basis of taxation enacted or substantively enacted by the
financial statement date. Deferred tax assets are not recognized where it is more likely than not that the assets
will not be realized in the future. The evaluation of deferred tax assets' recoverability requires judgements to
be made regarding the availability of future taxable income.
Management assesses the available evidence to estimate if sufficient future taxable income will be generated
to use the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the
loss incurred in the period prior to the period ended 30 November 20X7. Such objective evidence may limit
the ability to consider other subjective evidence such as projections for future growth.
Deferred taxes are one of the most difficult areas of the financial statements for investors to understand.
Thus, there is a need for a clear explanation of the deferred tax balances and an analysis of the expected
timing of reversals. This would help investors see the time period over which deferred tax assets arising from
losses might reverse. It would be helpful if the company provided a breakdown of which reversals would have
a cash tax impact and which would not.
Application of deferred tax rules to Holls

As the proposed tax law was approved, it is considered to be enacted. Therefore, the rate of 25% should be
used to calculate the deferred tax liability associated with the relevant items which affect deferred taxation.
At 30 November 20X7, Holls has deductible temporary differences of $4.5 million which are expected to
reverse in the next year. In addition, Holls also has taxable temporary differences of $5 million which relate to
the same taxable company and the tax authority.
Holls expects $3 million of those taxable temporary differences to reverse in 20X8 and the remaining $2 million
to reverse in 20X9. Thus, a deferred tax liability of $1.25 million ($5 million x 25%) should be recognized and
as $3 million of these taxable temporary differences are expected to reverse in the year in which the
deductible temporary differences reverse, Holls can also recognize a deferred tax asset for $0. 75 million ($3
million x 25%).
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The recognition of a deferred tax asset for the rest of the deductible temporary differences will depend on
whether future taxable profits sufficient to cover the reversal of this deductible temporary difference are
expected to arise. An entity is permitted to offset deferred tax assets and deferred tax liabilities if there is a
legally enforceable right to offset the current tax assets against current tax liabilities as the amounts relate to
income tax levied by the same taxation authority on the same taxable entity.
After the enactment of a new tax law, when material, Holls should consider disclosing the anticipated current
and future impact on their results of operations, financial position, liquidity, and capital resources. In addition,
Holls should consider disclosures in the critical accounting estimates section of the management commentary
to the extent the changes could materially affect existing assumptions used in making estimates of tax-related
balances. Changes in tax laws and rates may affect recorded deferred tax assets and liabilities and the effective
tax rate in the future.
Ethics
RENSHU (SEP/DEC 2021)
Background
Renshu Co develops gaming apps for which customers are encouraged to buy enhancements and add-ons to
play more effectively. The company's current financial year end is 31 December 20X8. The following exhibits,
available below, provide information relevant to the question:
1 Loans to customers - describes the ethical issues related to authorizing loans to customers.
2 Acquisition of assets - sets out the accounting for the acquisition of intangible assets that do not constitute
a business.
3 Payments for the app - describes the accounting for and derecognition of intangible assets.
This information should be used to answer the question requirements within your chosen response option(s).
Exhibit 1 -Loans to customers
The financial accountant of Renshu Co, an ACCA member, is responsible for overseeing the authorization of
small loans of up to $500 to customers for use on their gaming app, Jammy Play. He is paid a commission
based upon the number of loans granted in a period. The effective interest rate on the loan is approximately
1076% per annum. However, if the loan is paid back within one month, there is no interest charged. Customers
apply for short-term loans via an online portal which gives them an instant decision as to whether the loan is
approved. Artificial intelligence (Al} systems, which have been subject to frequent cyberattacks, are used in
this process. Currently, the laws on consumer credit in the jurisdiction only allow such loans where the credit
worthiness of the applicant has been checked.
There are two groups of customers (group A and B) who have different social demographics. The financial
accountant has full knowledge of the Al system and knows that the credit approval system is positively biased
in the favor of group A. He defends this practice by saying that it gives group A a chance to improve their
financial position. Group A is known to have less wealth than group Band is less likely to be able to afford to
pay back the loan within a month.
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Exhibit 2 - Acquisition of assets
Renshu Co has purchased a company which comprised a customer database and a number of
domain names which do not constitute a business. Therefore, Renshu Co has to allocate the
purchase price to the individual identifiable assets in accordance with IFRS 3 Business
Combinations.
The customer database relates to a contractual arrangement whereby Renshu Co receives a

commission for referring customers to online gaming websites. Renshu Co either receives an
up-front payment for every customer referred to the gaming websites or it receives a share
of revenue streams based on the referred customer's further usage.
The acquired assets also included a number of domain names for websites which have gaming
content.
Renshu Co had arbitrarily allocated the purchase price for the company to the two intangible
assets, domain names and customer databases, on a 50:50 basis.
Exhibit 3 - Payments for the app
Renshu Co develops new gaming apps in conjunction with other companies. When acquiring
a stake in these projects, Renshu Co makes an up-front payment and agrees a series of further
payments based upon the fulfilment of certain defined objectives in the process, both before
and after the app is given final government approval.
Prior to the current year, the payments made have been accounted for as an acquisition of
separate intangible assets as the price paid reflected its belief that expected future economic
benefits would flow to Renshu Co. The probability recognition criterion in IAS 38 Intangible
Assets was considered to be met.
However, in the year to 31 December 20X8, Renshu Co revised its strategic plan and decided
that all previously capitalized payments to date were to be derecognized and expensed as
research and development costs. This reversal of the current accounting treatment has arisen
due to concerns that the payments did not meet the criteria for recognition as intangible
assets and also that the costs will not be recovered in full. Renshu Co considered this action
to be a change in an accounting estimate and, therefore, recognized the amounts
prospectively by recharging the payments to profit or loss.
Required:
(a) Discuss the ethical and professional dilemmas for the financial accountant in overseeing
the loans made to customers and the appropriate actions to be taken. (8 marks)
(a) Discuss whether the customer databases and domain names should be recognized under IAS
38 Intangible Assets and how the purchase price should have been allocated in accordance
with IFRS 3 Business Combinations.
(4 marks)
(C) Advise Renshu Co on the accounting treatment of the payments for the app in the year
ended 31 December 20X8 on the assumptions that the amounts:
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• did meet the recognition criteria for an intangible asset, or
• did not meet the recognition criteria for an intangible asset. (6 marks)
Professional marks will be awarded in part (a) for the quality of the discussion. (2 marks)
(Total: 20 marks)
Answer
RENSHU (MAR/JUN 2022)
(a) Ethical and professional dilemmas
The financial accountant must ensure that the artificial intelligence (Al) system complies with applicable laws
and regulations. For Renshu Co, this means that the system must take into account the laws on consumer
credit. This is a fundamental principle of professional behavior.
There is a requirement for the Al system to be robust from a technical perspective and be secure against a
cyber-attack and data leakage. Al should adhere to ethical principles and values, including fairness and
explicability. It is morally unacceptable to provide credit to group A as it appears that this group cannot afford
to repay the loan. It could be argued that providing credit to group A could lead to stabilizing or improving an
individual's position. Alternatively, it could lead to the reverse whereby the individual spends the money on
gaming and defaults on the loan.
The bias in the granting of loans to group A is such that the financial accountant knows that this group is
unlikely to repay the amounts on time and, therefore, the individuals will be subject to a high interest charge
on the loan. The financial accountant should act with integrity and be straightforward and honest in all
professional and business relationships. Acting ethically would preclude the targeting of group A. He should
be straightforward and honest and not allow bias to override his professional judgement.
The financial accountant has the responsibility to oversee loans and therefore he should ensure that the
system uses the same score threshold for granting credit to both groups of individuals in order for the process
to be fair. The likelihood of the approval of the loan from Renshu Co should be based on credit-worthiness
using the same criteria for all individuals thus ensuring demographic parity. Renshu Co should have systems
which build and calibrate separate score card models for the two groups to ensure that they have the same
positive rate of acceptance.
It may be necessary to develop systems which segment a population. However, in this case, there is a difficulty
that arises due to the application of a clear-cut label based around social demographics. It is possible to create
segments based upon social demographics but the financial accountant of Renshu Co should not allow the use
of such a feature for ethical and legal reasons. The financial accountant is demonstrating a lack of integrity
and a degree of self-interest by defending the use of the Al system.
He receives a commission based upon the number of loans approved which will influence his decision making.
Also, there is a moral dilemma for the financial accountant as he authorizes loans to customers who use the
money on the gaming app and the loan interest rate is extortionate at 1076% per annum.
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The financial accountant should consider his position with the company. He is in a situation where there are
many moral dilemmas. He should revisit and reflect upon the ethical guidelines which should be used as a
basis for his professional conduct. Once he has reflected upon his position, he could discuss it further with his
superior and try to change company policy but this is unlikely to happen. If company policies remain steadfast,
he should consider contacting ACCA for advice which may include disassociating himself from Renshu Co and
leaving the company.
(b) Customer databases and domain names
The arbitrary allocation of the purchase price to the two intangible assets is inaccurate.
Renshu Co has a present right to receive future cash flows under the contractual arrangement in relation to
the customer database and therefore, in accordance with IAS 38 Intangible Assets, an intangible asset should
be recognized for the customer database as it is probable that the expected future economic benefits will flow
to Renshu Co.
In addition, Renshu Co also acquired domain names for websites which have gaming content. This acquisition
will satisfy the separability criterion for recognition in IAS 38 and should therefore be recognized as an
intangible asset.
The arbitrary allocation of the purchase price on a 50:50 basis to the domain names and customer database
is not in accordance with IFRS 3 Business Combinations. New purchase price allocations for the separate
intangible assets should be carried out in accordance with IFRS 3 whereby the purchase price should be
allocated to the individual identifiable assets and liabilities on the basis of their relative fair values. The fair
value of the separate intangible assets should be identified using appropriate valuation techniques in
accordance with IFRS 13 Fair Value Measurement:
(c)
Payments for the app IAS 38 requires an entity to recognize an intangible asset if it is probable that the future
economic benefits which are attributable to the asset will flow to the entity, and the cost of the asset can be
measured reliably.
(i) If the payments met the criteria for recognition of intangible assets, then according to IAS 38, the
intangible asset should have been recognized prior to the current period.
The intangible asset should be derecognized only on disposal or when no future economic benefits
are expected from its use or disposal. It seems that neither of these tests for derecognition have been
met by Renshu Co. Therefore, it is not appropriate to derecognize the intangible assets.
If there are doubts over the recoverable amount of the intangible asset, then Renshu Co should
assess whether the intangible assets are impaired at 31 December 20X8, in accordance with IAS 36
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Impairment of Assets. If Renshu Co considers that the intangible assets' carrying amounts exceed
their recoverable amounts, then the company should recognize an impairment loss in profit or loss.
For any apps that are now generating an economic benefit for Renshu, amortization should be
charged to the profit or loss over the expected useful life of the asset.
(ii) Renshu Co should have considered whether the recognition criteria in IAS 38 or the recognition
criteria for internally generated intangible assets were fulfilled at the time Renshu Co capitalized the
intangible assets prior to the current period. If in the current period it is discovered that the criteria
were not met and the payments should have been expensed, Renshu Co will have to recognize a prior
period error correcting the effects retrospectively, as if the error had never occurred. This would
mean adjusting the opening balance of each affected component of equity (likely to be retained
earnings) for the earliest prior period presented and the other comparative amounts disclosed for
each prior period.
The reclassification of intangible assets to be expensed as research and development costs does not
constitute a change in an accounting estimate. Estimates must be revised when new information
becomes available which indicates a change in circumstances upon which the estimates were formed.
However, the payments for the app are not estimates of the cost of developing the assets. Thus, if
the payments were intangible assets, then they should be recognized and tested for impairment. If
the payments did not qualify as intangible assets, then the amount s should be related as prior period
errors.
Question 2
STENT (SEP/DEC 2019}
Stent Co has a year end of 30 September 20X9 and the unaudited draft financial statements report an operating
loss. In addition to this, debt covenant limits based on gearing are close to being breached and the company is
approaching its overdraft limit.
The accountant has been in her position for only a few months and the finance director has recently commented
that 'all these accounting treatments must be made exactly as I have suggested to ensure the growth of the business
and the security of all our jobs'. Both the finance director and the accountant are fully qualified members of
ACCA.
Required:
Discuss the ethical issues arising from the scenario, including any actions which the accountant should take to
resolve the issues. (7 marks)
Professional marks will be awarded in this question for the application of ethical principles. (2 marks)
Answer
Ethical aspects
The ACCA Rulebook contains the bye-laws, regulations and Code of Ethics and Conduct, which every ACCA
member should follow. The accountant may feel pressured by the finance director's comments on job security
given the accountant has only been in her position for a few months. The accountant should comply with the
fundamental ethical principles set out in the ACCA Rulebook: to act with integrity, objectivity, professional
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competence and due care, confidentiality and professional behavior. The accountant should be mindful of any
threats to these fundamental ethical principles. In doing so, the accountant should consider the relevant facts, the
ethical issues involved, the fundamental principles which are threatened, whether internal procedures exist which
mitigate the threats, and what alternative courses of action could be taken.
In this case, all fundamental ethical principles with the exception of confidentiality appear under threat. The
finance director appears to be allowing bias and undue influence from the pressures imposed by debt covenant
gearing and overdraft limits into the choice of accounting treatment, rather than following accounting standards.
The company is in a precarious posit ion, reporting losses in the year. The finance director should act
professionally, in accordance with applicable technical and professional standards, comply with relevant laws
and regulations, and avoid any action which discredits the profession.
The accountant faces an intimidation threat to objectivity given the comments from the finance director, who
presumably has an influence over career prospects. Assuming the accountant wishes to keep her job, this
intimidation threat also gives rise to a self-interest threat to objectivity.
Before acting, the accountant should speak with the finance director, try to confirm the facts, and discuss the
treatment with the finance director and explain the risks of non-compliance. A record of conversations and actions
should be kept. Stent Co may also have internal procedures which mitigate the threats. It may be that the finance
director is not technically up-to-date, in which case a safeguard would be to undergo continuing professional
development. If the finance director refuses to comply with accounting standards, then it would be appropriate
to discuss the matter with other directors or an audit committee (if applicable), to seek a solution, then seek
professional advice from ACCA, and consider legal advice if necessary. A final consideration for the accountant,
if matters cannot be satisfactorily resolved, would be resignation.
Question 3
AGENCY GROUP (SEP /DEC 2021)
Background
The Agency Group manufactures products for the medical industry. They have been suffering increased
competition and, therefore, have sold a license to distribute an existing product. They have also developed a
new product which they hope will improve their market reputation. They have recently employed an ACCA
student accountant. The year end is 31 December 20X7.
Ethical issues and foreign exchange

On 1 October 20X7 the finance director, Ms Malgun, a financial accountant, recruited Mr Raavi as an ACCA
student accountant on a temporary employment contract which can be terminated by either party without
reason. Mr Raavi has found it difficult to find employment and accepted the risk attached to the employment
contract. However, the jurisdiction has laws which protect employees from termination due to discrimination.
Mr Raavi has been told by Ms Malgun that there has been a global slowdown in business and that the biggest
uncertainty is customer demand. She has therefore impressed upon Mr Raavi that the company profitability
targets are based upon achieving 30% higher net profit than their nearest competitors. Ms Malgun is partly
remunerated through profit-related pay. Ms Malgun has been under significant pressure from the board of
directors to meet performance targets and would normally prepare the year-end financial statements.
However, for the current year end, she has delegated this task to Mr Raavi.
Mr Raavi has included in profit or loss the foreign exchange gains arising on the retranslation of a foreign
subsidiary which is held for sale. Mr Raavi has emailed Ms Malgun informing her of the accounting treatment.
Although Ms Malgun is an expert in IFRS standards, she did not comment on this incorrect accounting
treatment of the foreign exchange gain. After the financial statements had been published, Ms Malgun
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disciplined Mr Raavi for the incorrect accounting treatment of the foreign exchange gains. However, despite
this, she is prepared to make his employment contract permanent.
Required
Discuss any ethical issues raised by Ms Malgun's actions regarding her management of Mr Raavi.
(6 marks)
Answer
Although Mr Raavi is a student accountant, he is bound by the same ethical codes as a qualified accountant. Mr
Raavi is employed on the basis that either he or Agency Co can choose to terminate his employment for no
reason. Even though the jurisdiction has laws which protect such employees from termination due to
discrimination, it can be argued that the ability to terminate employment benefits the employer more than the
employee. Thus, a primary issue is whether this type of employment contract is fair to the employee and whether
it can result in unethical behavior.
It can be argued that fear of termination acts as a motivation for Mr Raavi to act unethically and that this type of
employment has provided Mr Raavi with an opportunity as he had struggled to be employed. It is arguable
whether fear of losing his job is an effective motivator for Mr Raavi. Also, allowing employees to be arbitrarily
dismissed amounts to treating them with very little respect. The employer's ability to terminate a contract without
reason undermines Mr Raavi's potential to set and achieve goals for himself. Mr Raavi's ability to terminate
employment without cause, on the other hand, has comparatively little effect on the company's ability to set and
achieve its goals.
Competitive markets are more likely to see unethical behavior especially if unethical behavior benefits the
organization. Accountability can have a major influence on ethical behavior. People may behave unethically if
they do not have responsibility for their actions. Mr Raavi is only an ACCA student accountant and therefore
would not bear the ultimate responsibility for the inaccurate accounting for foreign exchange gains. Ms Malgun
obviously knew that the accounting was inaccurate but because it benefited the company and helped the
performance targets, she was prepared to overlook it. Also, this can be an unintended consequence of performance
related pay as Ms Malgun is partly remunerated through pay related to profit targets. However, in order to
preserve her position, she disciplined Mr Raavi after the financial statements had been published, thus displaying
a lack of integrity and professional values in her dealings with Mr Raavi and stakeholders.
Ms Malgun should not have left the preparation of the year-end financial statements to Mr Raavi as he is a student
accountant and has only been with the company for 3 months. She has significant experience and expertise in
their preparation. Work pressure can influence ethical behaviors. Difficult performance goals and time pressure
make unethical behavior more likely. When employees are under pressure, this not only affects their wellbeing
and motivation, but also their behaviors. Ms Malgun is an expert in IFRS standards and should have ensured that
she allocated some time to assist Mr Raavi in the preparation of the year-end financial statements. It is the
responsibility of both Ms Malgun and Mr Raavi to engage in fair and accurate reporting with regard to the
truthfulness of the data they provide as well as its completeness.
It is ethically important for accountants to present the financial information in a way which is clear and honest.
Competition can influence unethical behaviors. Individuals are more inclined to engage in unethical behaviors
when their organization is in competition with other organizations or they have been given targets which have to
be met. When unethical behaviors leads to a gain for a company, managers choose less severe disciplinary
measures for their employees. Thus, although Ms Malgun knew of the error in the financial statements, she only
reprimanded Mr Raavi after the financial statements had been published and even then, she then offered him a
full-time contract instead of his current temporary contract.
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Strategic Business Reporting

2 IAS 19 – Employee Benefits 03

IFRS 2 – Share Based Payments 12

IAS 16 – Property, Plant & Equipment 23

9 IAS 10 – Event after reporting date 32

10 IAS 36 – Impairment of Assets 34

11 IAS 37 – Provisions, Contingent Liabilities and Contingent Assets 36

12 IAS 24 – Related Party Disclosures 38

13 IFRS 5 – Non-current Held for Sale and Discontinued Operations 40

14 IFRS 8 – Operating Segments 42

15 IAS 12 – Income Tax 44

16 IFRS 15 – Revenue from Contract with Customers 51

17 IAS 32 – Presentation of Financial Instruments 66

18 IFRS 9 – Financial Instruments 75

19 Derivates and hedging 88

23 Step/Piecemeal Acquisition 147

24 Disposal Of Interest in Subsidiary 153

26 IAS 21 – Effects of Foreign Currency Changes 167

28 IFRS-10 – Definition of controls 182

2 IAS 37 – RUBUL (SEP/DEC 10 IAS 12 -Income Hill and co

5 IFRS 2 and 13 - LUPLOID 13 Consolidation STERLING

Interpretation of financial statements

Employees Stability of the company Profitability and cash position

Customers The entity’s ability to Growth record

Government The entity’s contribution to Revenue and profit

STRATEGIC BUSINESS REPORTING (SBR) | By Zubair Saleem

General public Environmental and social Environmental and social

Criticisms of financial reporting

Little insight into future

Other factors like governance, management style, risk to which

5.Estimates /professional judgement

STRATEGIC BUSINESS REPORTING (SBR) | By Zubair Saleem

IAS 19 - EMPLOYEE BENEFITS

1-Post Employment Benefits

Accounting for Defined benefit Pension Plan

Dr Interest Expense xx (P/L)

6. Past Service Cost: Past service cost is recognised as an adjustment to the

Dr Expense xx (P/L) (b) When the entity recognises related

Company Name Company Name

Profit and loss Non-current asset

Long term liability

Note 1 charge to profit and loss

Note 2 charge to other comprehensive income

Reconciliation of PV of defined Reconciliation of PV of defined Reconcile the movement in the

Net obligation as at 1 XXX

Defined benefit plan- Practice Question

Present value of pension plan obligation at 31 December 16m

Note. Assume contributions and benefits were paid on 31 December

Defined benefit plan- Practice Question (BBP Example)-Assignment

Discount rate: 10% (each year)

The following figures are relevant.

Past Service Cost

Asset ceiling Test

although some defined benefit pension plans show a surplus.

If a defined benefit plan is in surplus

a. the amount calculated as normal (per earlier examples and illustrations)

The following information relates to a defined benefit plan:

2-SHORT-TERM EMPLOYEE BENEFITS

✓ Wages ▪ When an employee has rendered service to an entity during an