AC2101 Notes

Seminar 1 Intro

(Under new FRS) Objective of Financial Reporting:

To provide financial info about the reporting entity that is useful to existing and potential investors,
lenders and other creditors in making decisions about providing resources to the entity.

Information asymmetry between stakeholders

Adverse Selection: One party has more information than the other (information advantage)

To help control Adverse Selection: Valuation Problem

 Convert insider information into useful information for outside investors

 Provide full and timely disclosure of useful information (e.g. Balance Sheet, P/L, etc.)

Moral Hazard: One part’s actions cannot be fully observable by the other

To help control Moral Hazard: Agency Problem

 Provide information useful to control manager shirking and improve corporate governance
 Provide measures to encourage or restrict certain actions (e.g. bonus plans based on target
ROA/ROE; debt covenants restricting dividend pay-outs based on net worth)

Fundamental Qualitative Characteristics (QC) Enhancing Qualitative Characteristics (QC)

1. Faithful Representation 1. Understandability
2. Verifiability
2. Relevance 3. Comparability
4. Timeliness

Recognition, Measurement and Disclosure

Recognition: Process of incorporating an item in an entity’s SFP or Comprehensive Income

1. General Recognition Criteria (under CF):

1. Meet the definition of a financial statement element
2. Probable inflow/outflow of future economic benefit
3. Cost or value can be reliably measured
2. Item Specific recognition criteria
 Found in the accounting standards governing the specific item

Measurement: Process of determining the monetary amount of an item to be recognized and carried in the
financial statements

Disclosure: Accounting standards often require that certain information be disclosed either in the main body
of or in the NTFS.

 Note: Presentation is the way you disclose.

Miller and Mosso (1983)

Relavant Phenomenon (P1) Substitute Phenomenon (P2)

Relevant Attribute (A1) Direct Observation (A1P1) Estimation (A1P2)
Substitute Attribute (A2) Estimation (A2P1) Estimation (A2P2)
Webber (2000)

 SFP fails to capture market value of the firm

 Solutions:
 Satellite accounts (i.e. multiple books/numbers)
 Costly
 Top-down approach using “normalised” earnings
 Based on forecasted earnings
 Subtract “expected earnings” from tangible assets
 Resulting earnings is “knowledge” from intangible assets
 Bottom-up approach using drivers of knowledge
 Technological capabilities index based on R&D investment, patents, citation of
patents, trademarks, etc.

Seminar 2 Accounting Measurements and Income Concepts

Reasons for “Gap” in SFP:

1. Intangible Assets not recognized

2. Historical Cost vs Market Fair Value
3. Inflation

Linsmeier (2011)

 US Savings & Loans -> Historical Cost =>Never recognize loss

 Japan’s Lost Decade -> Historical Cost =>delayed recognition of loss
 Conclusion: Historical Cost not good at reflecting condition of firms

FRS113 Fair Value Measurement

Definition: … the price that would be received to sell an asset (exit price) or paid to transfer a liability (exit
price) in an orderly transaction (not a liquidation or forced sale) between market participants at the
measurement date (current price).

Framework for measuring Fair Value (FRS113 para IN9, para B2)

 Determine the particular asset or liability being measured

 For a non-financial asset, determine the highest and best use of the asset
 Determine the market in which an orderly transaction would take place for the asset or liability
 Determine the appropriate valuation technique to use
o Maximise the use of relevant observable inputs and minimise unobservable inputs.

Fair value measurement of a non-financial asset takes into account a market participant’s ability to
generate economic benefits by using the asset in its highest and best use or by selling it to another market
participant that would use the asset in its highest and best use, taking into account the use of the asset that
is:

 Physically possible
 Legally permissible
 Financially feasible

Highest and best use is determined from the perspective of market participants, even if the entity intends a
different use. (However, an entity’s current use is presumed to be its highest and best use)
Example of highest and best use:
Principal market

<- Bring to market and capitalised in definition of assets

<- Fair Value
<- Entity Specific Cost
Most Advantageous

 Use most advantageous market when there is no obvious principal market

Valuation Techniques:

 Price can be directly observable or estimated using valuation techniques but valuation technique
should maximize use of relevant observable inputs.
o Market approach: Market price of asset
Still highest and best use for
o Cost approach: Cost to create or replace the asset
market (exit price)
o Income approach: Discounted Cash Flows
 Inputs to valuation techniques are categorized into 3 levels known as the Fair Value Hierarchy:
o Level 1 inputs = unadjusted quoted prices in accessible active markets for identical
assets/liabilities
o Level 2 inputs = inputs other than Level 1 that are directly/indirectly observable
o Level 3 inputs = unobservable inputs
 Disclose info to users for assessing
o The valuation technique and inputs used to develop FV measurements
o For recurring FV measurements using Level 3 inputs significantly, their effect on P/L or OCI

Time value of money: it is better to have money now rather than later.

Definition of (net) income in economics:

 Hick’s definition: the maximum amount a man can consume in a period and still be as well off at the
end of the period as he was at the beginning
 Extended to business entity: the amount by which an entity’s net worth has increased during a
period, due allowance being made for any new capital contributed by its owners or for any
distributions made by the entity to its owners.

Implications of income measurement under ideal conditions with certainty:

 Accounting Income =/= Economic Income (but both are same over the life of the firm)
 SFP reflects 100% of entity market value (i.e. Asset NPV=Asset MV)
 SFP is completely relevant and faithfully represented
 SFP have all the relevant info & SPLOCI has no additional info
 Financial reporting is simplified:
o No recognition/measurement/disclosure problems
Seminar 3 Asset Recognition and Measurement

Conceptual Framework:

 Income (= revenue + gain)

Increases in economic benefits during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity, other than those relating to
contributions from equity participants

 Expenses (= expenses + loss)

Decreases in economic benefits during the accounting period in the form of outflows or depletions of
assets or incurrences of liabilities that result in decreases in equity, other than those relating to
distributions to equity participants

Gains/Losses Recognized? In? Accounting Comprehensive Economic

Income Income Income
Realized Yes, P/L √ √ √
Unrealized Yes, P/L √ √ √
Unrealized Yes, Reserve/OCI x √ √
Unrealized No x x √
Other comprehensive income:

 That will not be recycled:

o Changes in Revaluation surplus
o Actuarial G/L on defined benefit plans
 That may be subsequently recycled:
o Translation G/L of foreign operation’s Financial statements
o G/L from re-measuring AFS securities
o Effective cash flow hedge’s G/L

Financial capital maintenance (as per FRS Framework):

 A profit is earned only if the financial amount of the net assets at the end of the period exceeds the
financial amount of net assets at the beginning of the period, after excluding any distributions to,
and contributions from, owners during the period
 Can be measured in nominal monetary units (disregard inflation)
 In simple terms: Take net monetary value at the end of period to subtract net monetary value at
start of period.

Asset Definition and Recognition

 Definition: A resource controlled by the enterprise as a result of past event and from which future
economic benefits are expected to flow to the enterprise
 Recognition Criteria:
1. Meet the definition of asset
2. Probable inflow of future economic benefits
3. Cost can be measured reliably
 Proposed new definition: An asset of an entity is a present economic resource controlled by the
entity as a result of past events.
 Proposed new recognition criteria:
1. If recognising that asset would result in information that is irrelevant, or not sufficiently
relevant to justify the cost of preparing it; or
2. If no measure of the asset would result in a faithful representation of the asset and of
changes in the asset, even if all necessary descriptions and explanations are disclosed.
Accounting treatments of various assets:

FRS 2 FRS 16 (Cost FRS 16 FRS 39 (AFS) FRS 39 (TS)

Inventories model) (Revaluation
Model)
Unrealised G/L NR NR OCI =>RR OCI =>FV G/L P/L => FV G/L
Subsequent R/L =>Sales P/L => G/L RR => R.E. OCI => P/L NR
realisation of Revenue disposal (Recycle)
G/L

Seminar 4 - 7 Leases

Why do businesses choose to lease assets?

For lessee For lessor

a. No down payment (i.e. 100%financing, free up a. Increased sales - more options for customers
cash flow) b. Ongoing business relationship with lessee
b. Avoid risks of ownership (e.g. obsolescence, c. Residual value retained if title does not transfer to
changing economic conditions, physical lessee at end of lease
deterioration)
c. Flexibility - can more easily replace assets in
response to business changes

What are a finance lease and an operating lease? (FRS 17 para.4)

 A finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an asset. Title may or may not eventually be transferred.
 An operating lease is a lease other than a finance lease

Bargain Purchase Option (BPO)

 Option for lessee to purchase the asset at a price that is expected to be sufficiently lower than fair
value at the date the option becomes exercisable
 Reasonably certain, at the inception of the lease, that the option will be exercised by the lessee
 FRS 17 para 4

Bargain Renewal Option (BRO)

 Option for lessee to renew the lease over periods in which the lease rentals are significantly lower
than the expected market rate
 Reasonably certain, at the inception of the lease, that the option will be exercised by the lessee

Lease Term = Non-cancellable lease term +

 Further lease term under BRO or

 Further lease term to exercise BPO

Minimum Lease Payments (MLPs)

 Payments over lease term that the lessee is or can be required to make together with amounts
guaranteed (FRS 17 para 4)
 i.e. Sum of (Annual Lease Payments) + BPO or Guaranteed Residual Value (GRV)

ALP = Fair Value (Asset at start of lease term) – PV (est. recovery value at the end of lease term)
 PV (annuity factor)

Lessor’s estimated recovery at end of lease term:

 BPO
 GRV
 unGRV

Residual value may be:

Guaranteed (GRV), Unguaranteed (unGRV),

 By lessee, party related to lessee, or unrelated  Is that portion of the residual value of the leased
third party asset,
 From the lessee’s point of view, GRV would be o the realisation of which by the lessor is
the value guaranteed by not assured, or
o lessee or a party related to lessee o is guaranteed solely by a party
 From the lessor’s point of view, GRV would be RELATED to the lessor
the value guaranteed by
o lessee or a party related to lessee or
o a third party unrelated to the lessor

For lessor(R) For lessee (E)

a. MLPR = Σ (Annual lease payments) + [GRVR or a. MLPE= Σ (Annual lease payments) + [GRVE or
BPO] BPO]

b. GRVR = RV guaranteed by b. GRVE= RV guaranteed by

 Lessee, a party related to lessee OR a party  Lessee or a party related to lessee
unrelated to lessor

PV of Minimum lease payment (MLP)

= MLP discounted at:

 For lessor: implicit rate

 For lessee: implicit rate or lessee’s incremental borrowing rate, if implicit rate is not known

Classification criteria of finance lease (FRS 17 para 10)

1. End of lease: lessee gets asset? (transfer of ownership)
2. Bargain purchase option (“BPO”)?
3. Most of useful life: lessee uses asset? (“lease term”≥75% of useful life rule)
4. PV of minimum lease payments (“MLPs”): close to asset’s fair value? (recovery of investment ≥ 90%
rule)
5. Asset: specialised nature, only lessee can use it?

Other Indicators of Substantial Transfer of Ownership Risks & Rewards (FRS 17:11)
1. Lessor’s losses borne by lessee upon lessee’s cancellation
2. Gains/Losses from fluctuation of residual fair value accrues to lessee
3. BRO exists

Operating Lease: accounted for as if it is a rental transaction

Finance Lease (Sale):

Lessor’s books Lessee’s books

Lease receivable Lease asset
 Gross investment in the lease(G)  Capitalise: lower of Fair Value or PV(MLP)
 May include Initial Direct Costs (i.e. costs that
Unearned interest income(I) are directly attributable to negotiating and
 Difference between G and PV(G) arranging a lease.)

Net investment in the lease(N) Depreciation

 G less I  Useful life (if there is reasonable certainty that
 Equal to PV(G) the lessee will obtain ownership) or shorter of
 In arm’s length trans., equal to asset’s FV lease term and useful life (if otherwise)
 Note Statement of Financial Position
presentation Lease payable
 Also at lower of Fair Value or PV(MLP)

Interest expense
 Usually using effective interest rate method (i.e.
amortization schedule)
Discount rate = lessor’s implicit interest rate if
known, otherwise, lessee’s incremental borrowing
rate

Investment Property:

 Recognition
o Per general asset recognition principles
 Measurement
o On initial recognition
 At cost comprising purchase price & directly attributable expenditure
o After recognition
 Includes subsequent costs to add to, replace part of or service a property but exclude
day-to-day servicing costs
 To choose either cost or FV model for all IP
 Property interest held by lessee under operating lease can be an IP if
o meets definition of IP
o lessee uses the FV model (FRS 40:6,26,34)
o In this instance, FRS 40 overrides FRS 17 by requiring that the lease be accounted for AS IF
it was a finance lease (FRS 40 para. IN18)

Sales-type Lease:

 Same as finance lease BUT

 Net investment is recorded as sales revenue (Cr sales revenue instead of Cr Asset)
 Net investment is PV(G) @ fair market rate, not discounted rate
 Include (Dr COGS Cr Inventory)

Sales and leaseback (by lessee):

Why does the lessee do it?

 Reduce risks associated with asset ownership

 Reduce uncertainty of future cash flows (like residual value on disposal)
 Raise funds for business operations
 “Improve” financial position

Implications

 Lessee
o Obtains immediate cash inflow from sale of asset to lessor -> gain or loss on asset disposal
(& lower depreciation) -> current P/L
o Incurs future cash outflows from lease -> rental or interest expense -> future P/L
 Opportunities for earnings management–how?
o Using asset in effect as collateral to borrow money but dressed up as an asset sale
o Manipulating selling price (SP) and ALP of asset
 Arrange for SP > FV in return for a higher ALP
 Arrange for SP < FV in return for a lower ALP

Accounting Journal Entries

Steps to do lease questions

1. Find ALP => (FV of leased asset – PV of estimated recoverable amount) / PV of ordinary annuity
2. Operating Lease or Finance Lease?
3. Lessor or Lessee?

Operating Lease (Rental)

Lessor’s books Lessee’s books

Dr Cash Dr Rental expense (=ALP)
Cr Rental income (=ALP) Cr Cash

Dr Depr expense (=FV/useful life) No depreciation

Cr Accum Depr

Finance Lease (Asset Sale)

Lessor’s books Lessee’s books

Steps 1. Find G = MLP + unGRV 1. Find PV(MLP)=
= Sum(ALPs) + GRV + unGRV PV(ALPs) + PV(GRV or BPO)
2. Find N = PV(G) 2. Find Depreciation Expense=
3. Find I = G - N (X – GRV)/ shorter of useful life or lease
4. Do up amortization table term
3. Do up amortization table

Journal At the start of the lease: At the start of the lease:

Entries
Dr Lease receivable (=G) Dr Leased asset X
Cr Asset (=N) Cr Lease payable (X1)
Cr Unearned interest income Cr Cash/Payable (X2, if applicable, no
_____________________________________ cost=0)
During the lease: _____________________________________
X= X1+X2
Dr Cash (= ALP) X1 = Lower[FV or PV(MLP)]
Cr Lease receivable X2 = Lessee’s initial direct costs (costs that
are directly attributable to negotiating and
Dr Unearned interest income arranging a lease)
Cr Interest income _____________________________________
During the lease:
(No depreciation charge)
_____________________________________ Dr Lease payable
G= MLP + unGRV Dr Interest expense
N= PV(G) or Asset’s Fair Value Cr Cash (= ALP)

End of Lease: Dr Depreciation expense

Dr Asset Cr Accumulated Depreciation
Dr Cash (if FV lower than GRV)
Dr Loss on Finance Lease (if unGRV) End of Lease:
Cr Lease Receivable Dr Acc. Depreciation
Dr Lease Payable
Cr Leased Asset

(If applicable)
Dr Loss on Finance lease
Cr Cash

Sales-type Lease (only affects lessor)

 Lessor’s books Lessee’s books (Same as normal finance
lease)
Steps 1. Find G = MLP + unGRV (ALP uses 1. Find PV(MLP)=
discounted rate) PV(ALPs) + PV(GRV or BPO)
2. Find N = PV(G) using fair market rate 2. Find Depreciation Expense=
3. Find I = G - N X/ shorter of useful life or lease term
4. Do up amortization table 3. Do up amortization table

Journal At the start of the lease: At the start of the lease:

Entries
Dr Lease receivable (=G) Dr Leased asset X
Cr Sales (=PV(MLPs) @fair market rate) Cr Lease payable (X1)
Cr Unearned interest income Cr Cash/Payable (X2, if applicable, no
cost=0)
Dr COGS (Cost price)
Cr Inventory X= X1+X2
X1 = Lower[FV or PV(MLP)]
During the lease: X2 = Lessee’s initial direct costs (costs that
are directly attributable to negotiating and
Dr Cash (= ALP) arranging a lease)
Cr Lease receivable
During the lease:
Dr Unearned interest income
Cr Interest income Dr Lease payable
Dr Interest expense
(No depreciation charge) Cr Cash (= ALP)

G= MLP + unGRV Dr Depreciation expense

N= PV(G) or Asset’s Fair Value Cr Accumulated Depreciation

Sales and Leaseback (by Lessee)

1. Determine whether it is Operating Lease or Finance Lease. (assume SLB is genuine for exam)
2. Operating Lease
a. If FV < CA, a loss of CA –FV ->P/L (FRS17:63). Writedown asset to Fair Value
b. If SP=FV, Gain/Losses on disposal -> P/L (FRS 17:61)
c. If SP>FV, excess = SP-FV ->Deferred and amortized over asset usage period/lease term
(FRS 17:61)
d. If SP<FV, Gain/Losses on disposal -> P/L except when loss on disposal is compensated by
below-market ALP -> then deferred & amortized in proportion to ALP over asset usage
period. Gains/Losses on disposal refer to the difference between SP and CA (FRS17:61).
3. Finance lease
a. Lessee retains risks & rewards of asset ownership, not a genuine asset disposal.
b. All SP > CA, i.e. any gains, is deferred and amortised (on a straight line basis) (FRS 17: 59)
c. Where the fair value is less than the CA,
i. if there is an impairment, the carrying amount is reduced to the recoverable amount
in accordance with FRS 36 (FRS 17: 64)
ii. Silent on treatment of loss on disposal (Please refer to discussion in Group
Presentation 3)

Sales and Leaseback (Operating Lease – Seller/Lessee)

Case Journal Entry (FV=CA) Journal Entry (FV>CA) Journal Entry (FV<CA)
SP=FV On disposal: On disposal: Recognize loss
Dr Cash/Receivable Dr Cash/Receivable immediately (P/L):
Dr Acc. Depreciation Dr Acc. Depreciation Dr Loss on disposal
Cr PPE Cr Gain on disposal (FV-CA) (CA-FV)
Cr PPE Cr PPE

Then refer to FV=CA

SP>FV On disposal: On disposal: Recognize loss
Dr Cash/Receivable Dr Cash/Receivable immediately (P/L):
Dr Acc. Depreciation Dr Acc. Depreciation Dr Loss on disposal
Cr Deferred Gain (SP-FV) Cr Gain on disposal (FV-CA) (CA-FV)
Cr PPE Cr Deferred Gain (SP-FV) Cr PPE
Cr PPE
Subsequently (Over Lease Then refer to FV=CA
Term): Subsequently (Over Lease
Dr Deferred Gain Term):
Cr Realised Gain Dr Deferred Gain
Cr Realised Gain
SP<FV NA On disposal: NA
(Profit i.e. Dr Cash/Receivable
FV>SP>CA) Dr Acc. Depreciation
Cr Gain on disposal (SP-CA)
Cr PPE

SP<FV On disposal: On disposal: Recognize loss

(loss i.e. Dr Cash/Receivable Dr Cash/Receivable immediately (P/L):
FV>=CA>SP Dr Acc. Depreciation Dr Acc. Depreciation Dr Loss on disposal
or Dr Loss on disposal (CA-SP) Dr Loss on disposal (CA-SP) (CA-FV)
CA>FV>SP, Cr PPE Cr PPE Cr PPE
not below
market ALP) Then refer to FV=CA
SP<FV On disposal: On disposal: Recognize loss
(loss i.e. Dr Cash/Receivable Dr Cash/Receivable immediately (P/L):
FV>=CA>SP Dr Acc. Depreciation Dr Acc. Depreciation Dr Loss on disposal
or Dr Deferred Loss (CA-SP) Dr Deferred Loss (CA-SP) (CA-FV)
CA>FV>SP, Cr PPE Cr PPE Cr PPE
if below
market ALP) Subsequently (Over Lease Subsequently (Over Lease Then refer to FV=CA
Term): Term):
Dr Realised Loss Dr Realised Loss
Cr Deferred Loss Cr Deferred Loss

Sales and Leaseback (Finance Lease – Seller/Lessee)

 FV=CA FV>CA: FV<CA:
SP > CA On disposal: On disposal: Dr impairment loss
Dr Cash/Receivable Dr Cash/Receivable Cr Acc. Impairment Loss
Dr Acc. Depreciation Dr Acc. Depreciation
Cr Deferred Gain (SP-CA) Cr Deferred Gain (SP-CA) Then refer to FV=CA
Cr PPE Cr PPE

Subsequently amortized in Subsequently amortized in

straight line basis (Over straight line basis (Over
Lease Term): Lease Term):
Dr Deferred Gain Dr Deferred Gain
Cr Realised Gain Cr Realised Gain
SP = CA On disposal: On disposal: Dr impairment loss
Dr Cash/Receivable Dr Cash/Receivable Cr Acc. Impairment Loss
Dr Acc. Depreciation Dr Acc. Depreciation
Cr PPE Cr PPE Then refer to FV=CA

SP < CA On disposal: On disposal: Dr impairment loss

Dr Cash/Receivable Dr Cash/Receivable Cr Acc. Impairment Loss
Dr Acc. Depreciation Dr Acc. Depreciation
Dr Loss on disposal (CA-SP) Dr Loss on disposal (CA-SP) Then refer to FV=CA
Cr PPE Cr PPE

Imhoff et al. (1991)

Implication:

 Debt/Equity:
o Operating lease: No Impact on D/E ratio
o Finance lease: D/E ratio will be significantly higher as D is higher and E is lower in FL
 Profitability (NI + Interest Expense):
o Operating lease: No interest expense. More profitable at the start compared to FL
o Finance lease: Have interest expense. More profitable at the end compared to OL
 Efficiency (ROA):
o Operating lease: Do better than FL because of smaller denominator
o Finance lease: Carries asset in own books hence larger denominator

Seminar 8 - 10 Financial Assets

Fair Value through P&L
 Held for trading securities (HFT)
o Acquired for selling in near term, or
o Identified as part of a portfolio with evidence of short-term profit-taking, or
o A derivative not used as hedging
 Designated by the entity upon initial recognition
o Before 1/1/06 -any financial asset can be designated as FVPL except equity securities
whose fair value cannot be reliably measured
o After 1/1/06 –only under restricted circumstances (see NCKL pp. 619)
 Measurement
o Upon recognition
 At fair value (FRS 39:43)
 Transaction costs are expensed
o At B/S date
 Mark to market (FRS 39:46)
 Unrealized holding G/L -> P&L(FRS 39:55)
Derivative instrument: A financial instrument or contract with all the following 3 characteristics
1. Its value changes in response to a market variable (e.g., interest rate, FI price, commodity price,
foreign exchange rate, and price/credit index)
2. It requires no initial net investment or smaller than would be required for other contracts with similar
response to market variable changes
3. It is settled at a future date
Further, embedded derivatives have to be separately recognized if
(i) economic characteristics and risks of the embedded derivative are not closely related to those of
the host contract,
(ii) a separate instrument with same terms as the embedded derivative would meet the definition of
a derivative, and
(iii) the hybrid (combined) instrument is not “fair value thru P&L”

Held to Maturity:
 Investment in debt securities which the entity has the intentionand the abilityto hold until maturity
date (FRS 39:9)
 Assessment of intention and ability to be done at
o date of recognition and
o each subsequent B/S date (FRS 39:AG25)
 Measurement:
o Upon recognition
 Fair value + transaction costs(FRS39:43)
o At B/S date
 Amortized cost (FRS39:46)
 Tainting rule
o 2 circumstances
 Assessment of intention and ability at B/S date fails, or
 If >an insignificant amount is sold or reclassified before maturity
o Consequences
 All existing HTM re-classified as AFS The difference between the carrying amount
and the fair value shall be recognised in OCI
 Entity (as well as group) cannot have HTM for the next 2 years
o Exception to tainting rule
 Sale of HTM securities close to maturity date (e.g., < 3 months before maturity)
 Holder collected substantially all of the original principal
 Attributable to isolated event beyond control, non-recurring & not reasonably
anticipated (e.g., change in tax laws or capital requirements)

Available for sales (AFS):

  All the remaining
o i.e., not FVPL, HTM and L&R
 Measurement:
o Upon recognition
 Fair value + transaction costs(FRS 39:43)
o At B/S date
 Mark to market (FRS 39:46)
 Unrealized holding G/L ->directly to reserve(FRS 39:55)
o Recap: On disposal
 Recycling/Reclassification (Recall FRS 1)

Loans and Receivables

 Upon Recognition
o Fair value + transaction costs (FRS 39:43)
 At B/S date
o Amortized cost / Cost (FRS 39:46)

Case A: Fair interest rate and repayable in future (Normal Loan)

 Inter-company loans are granted at market interest rate and repayable at a determinable future date

Lender
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable Dr Cash Dr Cash
Cr Cash Cr Interest Income Cr Loan Receivable
Borrower
Upon Recognition: At B/S date: De-recognition:
Dr Cash Dr Interest Income Dr Loan Payable
Cr Loan Payable Cr Cash Cr Cash

Case B: Interest free and repayable in future (Special Terms Loan)

B1: Parent loan to subsidiary (Recognized at amortized cost)

Lender (Parent)
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable Dr Loan receivable Dr Cash
(PV of loan value returned at the Cr Interest Income Cr Loan Receivable
end)
Dr Investment in subsidiary
Cr Cash (Loan Amount)
Borrower (Subsidiary)
Upon Recognition: At B/S date: De-recognition:
Dr Cash (Loan Amount) Dr Interest Income Dr Loan Payable
Cr Capital Reserve Cr Loan Payable Cr Cash
Cr Loan Payable
(PV of loan value returned at the
end)
B2: Subsidiary loan to Parent (Recognized at amortized cost)

Lender (Subsidiary)
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable Dr Loan receivable Dr Cash
(PV of loan value returned at the Cr Interest Income Cr Loan Receivable
end)
Dr Ret. profit/Capital Reserve
Cr Cash (Loan Amount)
Borrower (Parent)
Upon Recognition: At B/S date: De-recognition:
Dr Cash (Loan Amount) Dr Interest Income Dr Loan Payable
Cr Investment in subsidiary Cr Loan Payable Cr Cash
Cr Loan Payable
(PV of loan value returned at the
end)

B3: Subsidiary loan to Subsidiary (Recognized at amortized cost)

Lender (Subsidiary 1)
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable Dr Loan receivable Dr Cash
(PV of loan value returned at the Cr Interest Income Cr Loan Receivable
end)
Dr Ret. profit/Capital Reserve
Cr Cash (Loan Amount)
Borrower (Subsidiary 2)
Upon Recognition: At B/S date: De-recognition:
Dr Cash (Loan Amount) Dr Interest Income Dr Loan Payable
Cr Capital Reserve Cr Loan Payable Cr Cash
Cr Loan Payable
(PV of loan value returned at the
end)

Case C: Repayable undeterminably in future or not repayable

Lender
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable No JE Dr Cash
Cr Cash Cr Loan Receivable
Borrower
Upon Recognition: At B/S date: De-recognition:
Dr Cash No JE Dr Equity Loan
Cr Equity Loan Cr Cash

Case D: Interest Free Loan to employee (Amortized Cost)

Lender
Upon Recognition: At B/S date: De-recognition:
Dr Loan Receivable Dr Loan receivable Dr Cash
Dr Deferred Staff cost Cr Interest Income Cr Loan Receivable
Cr Cash
Impairment of Financial assets

 All financial assets, except “FVPL”, are subject to impairment test at end of each reporting date
(FRS39:58,59)
 Impairment should be recognized only if objective evidence that a loss event(s) affecting estimated
future cash flows has occurred
o See FRS 39:59-61 for examples of objective evidence of loss events
o For investment in shares, significant (usually ~20%) or prolonged decline in FV below its
cost = objective evidence of impairment (FRS 39:61)
 Expected losses from future events are not recognized no matter how likely (i.e., an “incurred loss”
model, not “expected loss” model)
 Proposal to move to an expected loss model in the future under the revised standard

Some examples of objective evidence (FRS 39 para59)

(a)significant financial difficulty of the issuer or obligor;
(b)a breach of contract, such as a default or delinquency in interest or principal payments;
(c)the lender granting to the borrower a concession that the lender would not otherwise consider;
(d)it becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
(e)the disappearance of an active market for that financial asset because of financial difficulties;

Impairment of AFS

 Upon objective evidence of impairment, cumulative loss(in FV reserve) 􀃆recycled to P/L

 Cumulative loss = Current FV –acquisition cost (net of any principal repayment & amortisation) less
any impairment loss previously recognised in P/L
 Subsequent reversal of impairment loss
o Not allowed to be reversed through P/L for investment in equity instrument
o Allowed to be reversed through P/L for debt instrument if the FV increase(s) can be
objectively related to an event occurring after the impairment

Impairment of Financial Assets Carried at Amortized Cost (FRS 39:63-65)

 Applicable to loans & receivables or HTM at amortized cost

 Upon objective evidence of impairment, Loss ->P/L
 Loss = Carrying amount – PV(estimated future cash flows excluding future credit losses not
incurred) @ original effective interest rate
 Subsequent reversal of impairment loss
 Reversed through P/L if the loss decrease(s) can be objectively related to an event occurring after
the impairment but revised carrying amount cannot exceed amount that would have been without
the impairment

Impairment of Financial Assets Carried at Cost (FRS 39:66)

 Applicable to unquoted equity instrument (where FV cannot be reliably measured) and derivative
asset linked to such instrument
 Upon objective evidence of impairment, loss ->P/L
 Loss = Carrying amount – PV(estimated future cash flows) @ current market rate of return for a
similar asset
 Subsequent reversal of impairment loss
o Not allowed to be reversed
De-recognition of Financial Assets

 Derecognize financial asset when (FRS 39:17)

o Contractual rights to FA’s cash flows expire; or
o There is a transfer qualifying for derecognition (FRS 39:20)
 Transfer substantially all the ownership risks & rewards
 Neither transfer nor retain substantially all ownership risks & rewards but did not
retain control

Seminar 11 + 12 Financial Liabilities

Fair Value through P&L

 Held for trading,

o e.g. short sales position, write/sell a call option
o Designated
 Initial Recognition (FRS 39:43)
o Fair value (Using FRS 113 or valuation approach)
 Subsequent Measurement (FRS 39: 47, 55, 56)
o Fair value
o With unrealised gains/losses through P&L

Others

 E.g. Issue a bond

 Initial Recognition (FRS 39:43)
o Fair value adjusted for TRANSACTION COSTS
 Subsequent Measurement (FRS 39: 47, 55, 56)
o Amortized cost @ effective interest rate
o Gains/losses to P/L when derecognized & through amortization process

Derecognition

 A financial liability (or part of) is derecognized when it is extinguished (FRS 39:39,40)
o Contractual obligation is discharged (e.g., payment), cancelled or expired, including
 Legal release from primary responsibility for liability
 Exchanged liabilities with substantially different terms
 Substantial modification to existing liability terms (at least 10% difference in DCF)
 Charged Through P/L
o Dr Bond Payable (old) Cr Bond payable (new) Dr/Cr Gain/Loss

Gaynor et Al.

 Fair Value Gains may indicate credit risks

 As credit risk increases, Fair Value of Bonds Payable may decrease leading to crediting FV gain in
the books which is misleading.
 Credit risks:
o Should be recognized in OCI and will not be subsequently reclassified to P/L (IFRS 9)
 Not due to credit risk changes
o Charged to P/L as per normal
Seminar 13 - 15 Deferred Tax

Tax Base

 TB of an asset = amount that will be deductible for tax purposes against any taxable economic
benefits that will flow to an entity when it recovers the CA of the asset (FRS12:7)
o If those economic benefits will not be taxable, TB of asset deemed equal to CA (FRS12:7)
o Apply to Machinery, etc.
 TB of a liability= CA less any amount that will deductible for tax purposes w.r.t. that liability in future
periods (FRS12:8)
o Apply to Accrued expenses and Provision for warranty, etc.
o For revenue received in advance= CA less any amount of revenue that will not be taxable in
future period (FRS12:8)

1. Asset:
 CA>TB ->Taxable TD (TTD) -> Deferred tax liability (DTL)
 CA<TB ->Deductible TD (DTD) -> Deferred tax asset (DTA)
2. Liability:
 CA>TB ->Deductible TD (DTD) -> Deferred tax asset (DTA)
 CA <TB ->Taxable TD (TTD) -> Deferred tax liability (DTL)

Main source of TD

 Items that does not appear as an asset or liability in the balance sheet but may have a tax base (≠
0)
 Change in accounting policy / correction of error (retrospective method under FRS 8)
o Calculate the cumulative effect (CE) & adjust against the beginning retained profit (BRP)
 If there is DT effect, calculate & charge the Net of tax CE* to BRP
o Amend all comparative figures

Tax Computation

Accounting Income
Minus TD
Minus PD
Taxable Income
Tax rate
Taxable amount

Balance sheet approach

$ CA TB TTD (DTD) TR DTL Prior Bal For the year

Asset/Liability

Loss Carry Forward

 A DTA to be recognized for unused tax losses & credits (includes unused capital allowances)carry
forward to the extent that it is probable that future taxable profit will be available for utilizing the
carry-forwards(FRS12:34)
 Any unrecognized DTA to be reassessed at each reporting date for probable recovery (FRS12:37)
3 possible scenarios:

1. Future taxable profit is probable

 Recognized in year of loss (Illustration 6)
2. Future taxable profit is NOT probable
 Recognized in year of realization (Illustration 7)
3. Sufficient taxable temporary differences
 Recognized to the extent of TTD (Illustrations 8 & 9)

Loss Carry Back (only up to preceding year)

 Journal entry: Dr Current tax receivable (B/S) Cr Current tax expense (P/L)

Measurement of Deferred Tax

1. Current tax: based on current tax rate that have been enacted or substantively enacted by the end
of the reporting period. (FRS12:46)
2. Deferred tax: future tax rate that have been enacted or substantively enacted by the end of the
reporting period. (FRS12:47)

Analytical Check

Total tax expense =

 [Current tax rate*(Accounting profit adjusted for permanent differences)]

 +[Current tax rate*Unrecognised tax losses in the year of origination]
 -[Current tax rate*Utilisation/recognition of previously unrecognised tax losses in the year of
utilization/recognition]
 +DTA from DTD previously unrecognized
 +/- [Adjustments to applicable temporary differences due to change in tax rate]
 + etc.

Disclosure

 Separate tax assets and liabilities unless they are from the same authority and settles tax
asset/liabilities on a net basis
 Separate tax assets and liabilities from normal assets and liabilities

Dollar Amount Percentage

Accounting Profit (in dollar amount) Accounting Profit (in dollar amount)

Tax at XX% Statutory Tax Rate

Tax effect of XXX Tax effect of XXX
Tax expense Effective Tax Rate

Seminar 16 Equity
Substance over form

 Financial instrument to be presented as equity or liability depending on the substance

 FRS 32: classified as equity only
o if there is no contractual obligation to repay,
o if it is to be settled in issuer’s own shares: then fixed number of shares
 Both conditions must be met

Compound instrument:

 “split accounting” by issuer

 (FRS 32: determine the amount of liability first, residual goes to equity)

Seminar 17 Revenue and Customer Loyalty Programmes

CLP, 3 Scenarios:

 Entity supplies awards (Illustration 1)

o Residual Method
o Relative fair value method
 rd
3 party supplies awards and entity is the principal (Illustration 2a)
o Entity should recognize the gross award revenue and the related expense when it fulfils its
obligations in respect of the awards
 rd
3 party supplies awards and entity is the agent(Illustration 2b)
o Entity should recognize the net award revenue when the third party becomes obliged to
supply the awards and becomes entitled to receive consideration for doing so.

Seminar 18 - 20 Construction Contract

Recognition and Measurement

 Construction revenue & costs to be recognized by stage of completion if outcome can be estimated
reliably (FRS11:22).
 For fixed price contract, this means
1. Total contract revenue can be measured reliably
2. Probable inflow of economic benefits
3. Costs to complete & stage of completion can be measured reliably
4. Costs attributable to construction can be clearly identified and reliably measured

Contracts costs comprises

1. Costs that relate directly to the specific contract

2. Costs that are attributable to contract activity in general& can be allocated to the contract
3. Such other costs that are specifically chargeable under the contract terms
4. Reference: FRS 11 paras16-21 (3 Scenarios)
A. Where outcome can be reliably estimated & current estimates indicate an overall net profit
on the project, revenue is recognized progressively based on the stage of completion
B. Where outcome can be reliably estimated & current estimates indicate an overall net loss on
the project, the entire loss is to be recognized immediately
C. Where outcome cannot be estimated reliably, recognized revenue is limited to the cost
incurred (i.e., no profit). An expected loss on the construction contract should be recognised
as an expense.

At the end of each reporting period:

  Step 1: Check the overall profitability of the contract
 Step 2: Compute the percentage of completion
 Step 3: Compute the current construction profit/(loss) for the current period
 Step 4: Compute the construction revenue earned for the current period
 Step 5: Compute the construction costs incurred for the current period

Borrowing Costs

 Borrowing costs incurred directly in respect of acquisition, construction or production of a qualifying

asset should be capitalized as part of the cost of that asset
 Other borrowing costs should be expensed when incurred

INT FRS 115

 Is the agreement within FRS 11 or FRS 18?

 When should revenue be recognized?

FRS 11 if

 Meet the definition of construction contract –“a contract specifically negotiated for the construction
of an asset or a combination of assets” -> buyer able to specify major structural elements of design
before construction begins &/or specify major structural changes during construction
 Percentage of completion (POC) method

FRS 18

 Rendering of services
o Not required to acquire & supply construction materials
o Satisfied FRS18:20 -> Percentage of completion method (POC)
 Sale of goods
o Required to provide services & construction materials
o Buyers have only limited ability to influence the design of the real estate or can only specify
minor variations to the basic design
o Satisfied FRS18:14 continuously -> control & significant ownership risks & rewards
transferred as construction progresses -> Percentage of completion method (POC)
o Satisfied FRS18:14 at a single time -> Completed contract method

Construction Service contract Sale of good contract

contract
Applicable FRS FRS11 FRS18 FRS18
Buyer decides on major structural Y Y N
design
Provision of materials Y N Y
Provision of construction service Y Y Y
Continuous transfer of control, risks & NA NA Y (N)
rewards
Accounting Method POC POC POC (CCM)

Exposure Draft

Core principle
  Recognise revenue to depict the transfer of promised goods or services to customers in an amount
that reflects the consideration which the entity expects to be entitled in exchange for those goods or
services

Steps to apply the core principle:

 Step 1: Identify the contract(s) with the customer

 Step 2: Identify the separate performance obligation(s)
 Step 3: Determine the transaction price
 Step 4: Allocate the transaction price
 Step 5: Recognise revenue when a performance obligation is satisfied

Seminar 21 - 23 Share-based Payment Transaction

Expenses (writing off)

 Generally, there are 3 treatments when a firm “spends money”

A. Amount is provided for before it is incurred (PROVISION)
B. Amount is capitalized when it is incurred& then subsequently amortized (CAPITALISATION
AND AMORTISATION)
C. Amount is expensed when it is incurred (WRITE-OFF)

Employee stock options

 Vesting conditions are conditions that determine whether the entity receives services that entitle
the counterparty, i.e. the employee, to receive cash, other assets or equity instruments of the entity
under a share-based payment transaction.
o Service condition: require counterparty, i.e. employee, to complete a specified period of
service
o Performance condition: require the counterparty, i.e. employee, to complete a specified
period of service & meet specified performance targets
 Market condition (i.e. relating to share price e.g., share price reaching $x)
 Non-market condition (e.g., profit exceeding $x)
 Non-vesting conditions are conditions other than vesting conditions (e.g., contribution from salary
for the purchase of shares, conditions to be fulfilled before vesting period)

Share-based payment transactions (PT):

1. Equity-settled share-based PT
2. Cash-settled share-based PT

Recognition:

 Requires all share-based payment transactions (SBPT) to be recognized in financial statements

 To be recognized when the goods are obtained or as the services are received
 Dr Asset/Expense
 Cr Equity (for Equity-settled SBPT) /Liability (for Cash-settled SBPT)

Measurement (outside scope of FRS 113 Fair Value Measurement):

Equity settled SBPT

 1. To measure the goods/services received, and the corresponding increase in equity, based on fair
value of goods/services received
a. For transactions with parties other than employees, there is a rebuttable presumption that
the fair value of goods/services received can be estimated reliably.
2. If fair value of goods/service cannot be estimated reliably, then measure based on fair value of
equity instrument granted
3. For transactions with employees (e.g., share options granted): measure based on the fair value of
equity instruments granted on grant/measurement date
a. Quite unusual;
b. Based on market prices if available taking into account the terms and conditions upon which
those equity instruments were granted
c. If market prices are not available, to use a valuation technique

For employee share option:

Apply any option pricing model to measure fair value of equity instrument at measurement date/grant date,
taking into account the following:

1. Exercise price of the option increases, FV of ESOs decreases

2. Current price of underlying shares increases, FV of ESOs increases
3. Life of the option increases, FV of ESOs increases
4. Expected volatility of share price increases, FV of ESOs increases
5. Dividend expected increases, FV of ESOs decreases
6. Risk-free interest rate increases, FV of ESOs increases

 The fair value determined on grant/measurement date (after taking into account market conditions
and non-vesting conditions) are not adjusted subsequently unless there is a change in the number
of options eventually vested due to a change in the non-market vesting conditions.

For employee share option:

 Charge over vesting period
o Dr Staff Cost (Expense)
 o Cr Share-based payment reserve
 At Exercise
o Dr Cash
o Dr Share-based payment reserve
o Cr Share Capital
 At Expiration where the remaining options were not exercised
o Dr Share-based payment reserve
o Cr General reserve/retained earnings

Cancellation

 Sometimes, an entity cancels or settles a share option grant during the vesting period, FRS 102
para28a provides that the entity should account for the cancellation or settlement as an
acceleration of the vesting.
 FRS 102 para28b provides that any payment made to the employees should be accounted for as
a share buy-back transaction. To the extent that the payment exceeds the fair value of the equity
instruments granted, the excess shall be recognised as an expense.
 When the entity or counterparty chooses not to meet the non-vesting condition, it should be
treated as a cancellation
 Upon cancellation, the expense should be recognized immediately (instead of over the remainder of
vesting period), i.e. also accelerated vesting

Income Taxes

 Para 68A: In some tax jurisdictions, an entity receives a tax deduction that relates to remuneration
paid in shares, share options or other equity instruments of the entity. The amount of that tax
deduction may differ from the related cumulative remuneration expense, and may arise in a later
accounting period.
 Para 68B: As with the research costs (recall discussion in Deferred Tax Seminars) discussed in
paragraphs 9 and 26(b) of this Standard (i.e. FRS 12), the difference between the tax base of the
employee services received to date (being the amount the taxation authorities will permit as a
deduction in future periods), and the carrying amount of nil, is a deductible temporary difference
that results in a deferred tax asset.
 If companies use treasury shares to fulfil their obligation under the employees’ shares schemes,
IRAS allows tax deduction at the point of exercise.
 Tax deduction is based on the amount actually incurred by the company (i.e., the difference
between the cost to re-acquire the share and the amount paid by the employees under the scheme)

Deferred tax implications of ESO

 Taxable profit may not be equal to accounting profit:

o Tax deduction is based on the amount actually incurred by the company, i.e. intrinsic value,
but accounting uses fair value of the ESOs granted.
o Tax deduction claimed at the exercise date but accounting recognizes staff costs over the
vesting period
 For example, in illustration 1, ESO expenses are accounted for in years 20x1, 20x2,
20x3, but tax-deductible only in 20x4.

Group SBPT

Scenario 1: Involving entity’s own equity instruments

  1A: When an entity grants to its employees, rights to equity instruments of the entity and either
chooses or is required to buy equity instruments (i.e. treasury shares) from another party, the entity
shall account for this SBPT as equity settled
 1B: When an entity’s (S) employees are granted rights to the entity’s equity instruments by its
shareholders (P), and the entity’s shareholders provide the equity instruments needed
o S: Equity-settled
o P: Cash-settled
o Group: Equity-settled
 1C: When an entity’s (S) employees are granted rights to the entity’s equity instruments by the
entity (S), and the entity’s shareholders provide the equity instruments needed
o S: Equity-settled
o P: Cash-settled
o Group: Equity-settled

For SBPT among group entities, the entity receiving the goods or services (in this case, “S”) shall measure
the goods or services received as either an equity-settled or a cash-settled SBPT by assessing:

 The nature of the awards granted, and

 Its own rights and obligations

Scenario 2: Involving parent’s equity instruments

 2A: When a parent grants rights to its equity instruments direct to the employees of subsidiary and
the parent has the obligation to provide the employees of the subsidiary with the equity instruments:
o S: Equity-settled & capital contribution (FRS102:43B)
o P: Equity-settled (FRS102:43C)
o Group: Equity-settled
 2B: When a subsidiary grants rights to its parent’s equity instruments to its employees and the
subsidiary has the obligation to provide its employees with the equity instruments.
o See Illustration 2
o S: Cash-settled(FRS102:43B)
o Group: Equity-settled

Scenario 3: Involving cash-settled SBPT

 3: When a parent is obliged to pay cash to the suppliers/ employees of subsidiary linked to (a) price
of S equity or (b) price of P equity
o S: Equity-settled & capital contribution
o P & Group: Cash-settled (FRS102:43C)

Employee Benefits

Short-term Are employee benefits (other than termination benefits) that are expected to be settled
employee wholly within twelve months after the end of the annual reporting period in which the
benefits employees render the related service (FRS 19 para8) and include such items (FRS 19 paras
5 and 9) as:
 Wages and salaries;
 Short-term paid absences;
 Profit sharing and bonuses;
 Non-monetary benefits
When an employee has rendered service to an entity during an accounting period, the entity
should recognise the undiscounted amount of short-term employee benefits expected to be
paid in exchange for that service:
 As a liability (accrued expense)
 As an expense
Post-
employment
benefits

Other long-
term
employee
benefits

Termination
benefits

Short-term paid absences

 Paid annual leave and sick leave

 Accumulating: those that are carried forward and can be used in the future periods if the current
period’s entitlement is not used in full.
 Recognized when employees render service that increases their entitlement to future compensated
absences
 Non-accumulating
 Recognized when the absences occur

Profit sharing and bonuses

 An entity should recognise the expected cost of profit sharing and bonus plans when and only
when:
 The entity has a present legal or constructive obligation to make such payments as a result of
past events; and
 A reliable estimate of the obligation can be made

Post-employment Benefits
  Are employee benefits (other than termination benefits and short-term employment benefits) which
are payable after the completion of employment (FRS 19 para8) and include such items (FRS 19
paras5 and 26) as:
o Retirement benefits, such as pensions; and
o Other post-employment benefits
 Usually classified as defined contribution plans or defined benefit plans
 Defined contribution plans:
o The entity’s legal or constructive obligation is limited to the amount that it agrees to
contribute to the fund
o To disclose the amount recognised as an expense for defined contribution plans.
o CPF is an example of a defined contribution plan
o Straight forward because
 The reporting entity’s obligation for each period is determined by the amounts to be
contributed
 no actuarial assumptions are required to measure the obligation or expense
 It is measured on an undiscounted basis, except where the obligations are not
expected to be settled wholly before twelve months after the end of the annual
reporting period in which the employees render the related service.

Other Long-Term Employee Benefits

 Other long-term employee benefits are all employee benefits other than short-term employee
benefits, post-employment benefits and termination benefits (FRS 19 para8), not expected to be
settled wholly before twelve months after the end of the annual reporting period in which the
employees render the related service.
 Include: long-term paid absences, long-service benefits, and long-term disability benefits

Termination Benefits

 Are employee benefits provided in exchange for the termination of an employee’s employment as a
result of either an entity’s decision to terminate an employee’s employment before the normal
retirement date; or an employee’s decision to accept an offer of benefits in exchange for termination
of employment (FRS 19 para 8)
 FRS 19 para159 provides termination benefits are dealt with separately from other employee
benefits because the event that gives rise to an obligation is the termination of employment rather
than employee service.
 FRS 19 para165 states that an entity shall recognise a liability and expense for termination benefits
at the earlier of the following:
o When the entity can no longer withdraw an offer of those benefits; and
o When the entity recognises costs for a restructuring that is within the scope of FRS 37 and
involves payment of termination benefits.