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December 2014–June 2015 Edition
STUDY QUESTION BANK
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ACCA
Paper P2 | CORPORATE REPORTING
(INTERNATIONAL)
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ACCA
PAPER P2
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CORPORATE REPORTING
(INTERNATIONAL)
STUDY QUESTION BANK
For Examinations to June 2015
®
©2014 DeVry/Becker Educational Development Corp. All rights reserved.
(i)
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STUDY QUESTION BANK – CORPORATE REPORTING (INTERNATIONAL) (P2)
CONTENTS
Question
Page
Answer
Marks Date worked
1
1001
25
1
1003
22
GAAP AND THE IASB
1
IFRS for SMEs (ACCA J06)
INTERNATIONAL ISSUES
2
Autol (ACCA D02)
3
4
5
6
Substance over Form
Commercial Purpose
Theoretical Principles (ACCA D95)
Creative Accounting (PP 97)
7
8
9
10
11
2
2
3
3
1006
1006
1008
1011
9
20
25
15
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REPORTING FINANCIAL PERFORMANCE
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CONCEPTUAL FRAMEWORK
Meson
Revenue Recognition (ACCA D97)
Meld
Key Changes (ACCA J96)
XYZ (ACCA D98)
4
4
5
7
7
1013
1017
1019
1020
1022
25
25
15
13
25
8
1026
15
9
10
11
12
14
1028
1029
1031
1032
1036
14
12
10
25
10
14
1037
8
14
15
1037
1039
11
20
16
1041
12
16
1044
18
17
1046
19
ACCOUNTING POLICIES, ESTIMATES AND ERRORS
12
Hamilton (ACCA J98)
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NON-CURRENT ASSETS
13
14
15
16
17
Fam
Sponger
Moore
Heywood (ACCA D99)
Defer
IMPAIRMENT OF ASSETS
18
Starsky
FINANCIAL INSTRUMENTS
19
20
Artright (ACCA D04)
Ambush (ACCA D05)
IAS 17 LEASES
21
Arrochar
IFRS 8 OPERATING SEGMENTS
22
AZ (ACCA J99)
IAS 19 EMPLOYEE BENEFITS
23
Kelly
(iii)
CORPORATE REPORTING (INTERNATIONAL) (P2) – STUDY QUESTION BANK
Question
Page
Answer
Marks Date worked
18
19
1049
1051
10
20
20
1052
25
21
1055
25
22
23
1059
1060
15
25
IAS 12 INCOME TAXES
24
25
Hooper (ACCA D98)
Kerensky
PROVISIONS AND CONTINGENCIES
26
Genpower (ACCA D00)
27
Connect
IFRS 2 SHARE-BASED PAYMENTS
28
29
Vident (ACCA J05)
Lima
30
31
Danny
Picant
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REGULATORY FRAMEWORK
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IAS 24 RELATED PARTY DISCLOSURES
24
25
1062
1062
5
4
25
27
1063
1066
25
25
28
1069
12
29
30
1070
1072
12
12
31
32
33
1074
1076
1078
14
15
18
34
34
1080
1081
7
10
35
36
37
38
1082
1083
1085
1087
8
11
9
25
BASIC GROUP ACCOUNTS
32
33
Bacup (ACCA J97)
Holding (ACCA D99)
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GOODWILL
34
Guido Electricals
COMPLEX GROUPS
35
36
H, S and T
Jane
CHANGES IN SHAREHOLDINGS
37
38
39
Harley
Arbitrary
Belt
ASSOCIATES AND JOINT ARRANGEMENTS
40
41
Holly
Assock
FOREIGN CURRENCY TRANSACTIONS
42
43
44
45
(iv)
Bertie
Terry
Jupiter
Mary
Question
Page
Answer
Marks Date worked
39
41
43
1091
1094
1096
25
25
25
45
48
50
50
1098
1103
1105
1106
25
15
10
25
52
1109
25
IAS 7 CASH FLOW STATEMENTS
46
47
48
Ladway (ACCA J98)
Lovey
Gundar Group
49
50
51
52
Webster (ACCA J99)
Heywood Bottlers (ACCA J97)
NFP Organisations
Radan (IAS 33) (ACCA J97)
IFRS 1 FIRST-TIME ADOPTION
53
Eptilon
54
55
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ETHICS AND THE ACCOUNTANT
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ANALYSIS AND INTERPRETATION
Ethical Responsibility
Happy and Healthy
52
53
1111
1112
10
15
54
54
1114
1115
15
25
55
56
57
1119
1122
1124
25
25
25
ENVIRONMENTAL REPORTING
56
57
Principles of CSR
Mucky Mining
FURTHER PRACTICE QUESTIONS
Burley (ACCA D09 adapted)
– Reporting financial performance
Router (ACCA J07) – Changes in shareholdings
Memo (ACCA J04) – Foreign currency transactions
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60
(v)
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(vi)
Question 1 IFRS FOR SMES
International Financial Reporting Standards (IFRSs) are primarily designed for use by publicly listed
companies and in many countries the majority of companies using IFRSs are listed companies. In other
countries IFRSs are used as national Generally Accepted Accounting Principles (GAAP) for all
companies including unlisted entities. It has been argued that the same IFRSs should be used by all
entities or alternatively a different body of standards should apply to small and medium entities
(SMEs).
Required:
Discuss why there is a need to develop a set of IFRSs specifically for SMEs.
(b)
Discuss the nature of the following issues in developing IFRSs for SMEs:
(7 marks)
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(a)
the purpose of the standards and the type of entity to which they should apply;
(7 marks)
(ii)
how existing standards could be modified to meet the needs of SMEs; (6 marks)
(iii)
how items not dealt with by an IFRS for SMEs should be treated.
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(i)
(5 marks)
(25 marks)
Question 2 AUTOL
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Autol, a public limited company, currently prepares its financial statements under local GAAP
(Generally Accepted Accounting Principles).
The company currently operates in the
telecommunications industry and has numerous national and international subsidiaries. It is also
quoted on the local stock exchange. The company invests heavily in research and development which
it writes off immediately. The local rules in this area are not prescriptive. The company does not
currently provide for deferred taxation or recognise actuarial gains and losses arising on defined benefit
plans for employees. It wishes to expand its business activities and raise capital on international stock
exchanges. The directors are somewhat confused over the financial reporting requirements of multinational companies as they see a variety of local GAAPs and reporting practices being used by these
companies including the preparation of reconciliations to alternative local GAAPs such as that of the
United States of America, and the use of the accounting standards of the International Accounting
Standards Board (IASB).
The directors have considered the use of US GAAP in the financial statements but are unaware of the
potential problems that might occur as a result of this move. Further the directors are considering
currently the use of the accounting standards of the IASB in the preparation of the consolidated
financial statements and require advice as to the potential impact on reported profit of a move from
local GAAP to these accounting standards given their current accounting practice in the areas of
deferred tax, research and development expenditure and employee benefits.
Required:
Write a report suitable for presentation to the directors of Autol that sets out the following
information:
(a)
the variety of local GAAPs and reporting practices currently being used by multinational companies setting out brief possible reasons why such companies might
prepare financial statements utilising a particular set of generally accepted accounting
practices.
(6 marks)
©2014 DeVry/Becker Educational Development Corp. All rights reserved. 1
(b)
advice as to whether Autol should prepare a single set of consolidated financial
statements that comply only with US GAAP.
(3 marks)
(c)
the problems relating to the current use of GAAP reconciliations by companies and
whether the use of such reconciliations is likely to continue into the future.
(5 marks)
(d)
the potential impact on the reported profit of Autol if it prepared its consolidated
financial statements in accordance with the accounting standards of the IASB in
relation to its current accounting practices for deferred tax, research and development
expenditure and employee benefits.
(8 marks)
Question 3 SUBSTANCE OVER FORM
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(22 marks)
The accounting profession attaches great importance to the principle of “substance over form”.
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Required:
(a)
Define the term “substance over form”.
(b)
Apply the principle of substance over form to the following transactions, considering
each separately:
(i)
(1 mark)
Axe has a year-end of 31 March. It has entered into a factoring arrangement with
Shotgun Factors in respect of $22,000 of receivables outstanding on 31 March
2013, whereby Axe received cash for 75% of the face value of the debts on that
date.
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Axe will receive a further 24% in respect of debtors paying in April and 23% for
those paying in May, with the amount received diminishing at the rate of 1% per
month thereafter. Shotgun Factors has recourse to Axe for any bad debts. (4 marks)
(ii)
On 5 March 2013, Exe sold goods to Megabank for $18,000 cash and agreed to
repurchase the goods for $19,800 cash on 5 April 2013. Exe also has a year-end of
31 March.
(4 marks)
(9 marks)
Question 4 COMMERCIAL PURPOSE
Once a transaction’s commercial purpose has been established, it is necessary to decide whether the
transaction gives rise to new assets or liabilities, or changes the company’s existing assets or liabilities.
Required:
(a)
Explain briefly how an asset or liability may arise under the “Conceptual Framework
for Financial Reporting” published by the IASB.
(4 marks)
(b)
Discuss the principles behind:
(i)
the recognition of an asset or liability in an entity’s statement of financial
position;
(ii)
the derecognition of an asset.
(7 marks)
Note: Your answer should refer to relevant IASB pronouncements.
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(c)
Mortgage Lend, a subsidiary of Lendco, has sold a portfolio of secured loans to Borrow.
Borrow has financed this purchase by issuing floating rate loan notes that are secured on all
the assets of Borrow. Borrow was set up for the purpose of this transaction and has a small
amount of equity share capital.
Discuss the criteria which would determine how the transaction would be treated in the
financial statements of the above companies.
(9 marks)
(20 marks)
Question 5 THEORETICAL PRINCIPLES
Required:
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The IASB’s Conceptual Framework for Financial Reporting is a set of theoretical principles which are
designed to influence the drafting of future accounting standards. However it can be argued that
accountancy research and accounting theory have no place in the standard setting process and are of
little practical relevance to the accountant. Such terms as “agency theory” and “positive accounting
theory” are meaningless to the practising accountant, and their underlying principles will never have an
impact on accounting practice.
Explain what you understand by the terms “agency theory” and “positive accounting
theory”, discussing whether these theoretical concepts can help explain why a company
chooses a particular accounting policy and why accounting standards change over time.
(13 marks)
(b)
Discuss why accountancy research may appear to have little relevance to the practising
accountant.
(5 marks)
(c)
Discuss the advantages of the IASB’s “Framework” and whether it is too theoretical for
use in the standard setting process.
(7 marks)
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(a)
(25 marks)
Question 6 CREATIVE ACCOUNTING
In producing the Conceptual Framework for Financial Reporting (the Framework) the IASB has had to
address the potential problem that the management of some companies may choose to adopt
inappropriate accounting policies. These could have the effect of portraying an entity’s financial
position in a favourable manner. In some countries, this is referred to as “creative accounting”.
Embedded in the Framework, and a common feature of many recent international accounting standards,
is the application of the principal of “substance over form”.
Required:
(a)
Describe in broad terms common ways in which management can manipulate financial
statements to indulge in “creative accounting” and why they would wish to do so.
(7 marks)
(b)
Explain the principle of substance over form and how it limits the above practice; and
for each of the following areas of accounting describe an example of the application of
substance over form:
(i)
(ii)
(iii)
group accounting;
financing non-current assets;
measurement and disclosure of current assets.
(8 marks)
(15 marks)
Question 7 MESON
Meson is a recently incorporated company. Its business is the development of standard computer
software packages, the sale or “licensing to use” of standard or customised standard software packages
and the design, development and maintenance of bespoke software to order. Payment by customers is
usually in stages over the term of the design-development work. More recently, Meson has
commenced the retailing of computer hardware.
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Meson has also developed a prototype “retail shop” which will aim to sell computer time (on PCs) customers will be able to visit the “shop” and use either their own or Meson’s software to process data,
etc. It is Meson’s aim to establish a nation-wide chain of such shops by licensing interested
entrepreneurs to use the concept and benefit from Meson’s nation-wide advertising campaign. Meson
will supply, in addition to know how and advertising, administrative back up, software and hardware.
Meson is considering alternative methods of charging the independent proprietors of shops, including:
an up-front license fee followed by regular fees based on turnover of the shops;
(b)
no up-front payment but regular fees based on a larger percentage of turnover of the shops.
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(a)
Software and hardware supplied by Meson will be charged on delivery at normal selling prices.
Required:
(a)
Explain what is meant by revenue recognition.
(b)
Prepare a memorandum advising the directors of Meson as to the considerations to be
taken into account in determining a policy for accounting for revenue from:
the design and sale of software and the retailing of hardware;
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(i)
(ii)
the proposed retail shop licensing operation.
(9 marks)
(8 marks)
(8 marks)
(25 marks)
Question 8 REVENUE RECOGNITION
The timing of revenue (income) recognition has been long an area of debate and inconsistency in
accounting. The operating cycle of an entity may involve the following stages:







obtaining an order for goods prior to manufacture;
acquisition of goods prior to manufacture;
production of goods;
obtaining an order for goods in inventory;
delivery of goods;
collection of cash (re: credit sales);
provision of after sales service or warranties.
In many countries the “critical event” approach has traditionally been used to determine the timing of
income recognition. In its Conceptual Framework for Financial Reporting (the Framework) the IASB
identifies “elements” of financial statements. It uses these to determine when income or expenses
occur. These principles also form the basis of revenue recognition in IAS 18 Revenue.
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Required:
In relation to each of the above stages in the operating cycle discuss, giving practical
examples where possible, the circumstances in which the “critical event” may be deemed
to have occurred at that stage.
(12 marks)
(b)
Discuss the criteria used in the Framework to determine when income or expenses arise,
and how they should be reported.
(5 marks)
(c)
Telecast Industries, a public listed company, is preparing its accounts for the year ended 30
September 2012. In May 2012 it bought the rights to a film called “Wind of Change”. It
paid a fixed fee and will not incur any further significant costs or commissions. It has entered
into the following contracts with:
(i)
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(a)
Warmer Cinemas
(ii)
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This is a large company with a chain of cinemas throughout the world. Warmer
Cinemas has negotiated the right to screen the film during the period from 1 July
2012 to 31 December 2012 in as many of its cinemas and as frequently as it
chooses. Telecast Industries will be paid 15% of gross box office receipts.
Big Screen
This is a small company operating a single cinema. Under the terms of the contract
it may screen the film twice a day for the same period as the above contract. It has
paid a fixed fee of $10,000.
(iii)
Global Satellite
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This is a satellite television company that broadcasts to South East Asia. It paid
$4 million in August 2012 for the right to screen the film 10 times at intervals of not
less than one month apart during 2013.
Required:
Applying the recommendations in the Framework and IAS 18 “Revenue” describe how
Telecast Industries should treat the income from each of the above contracts in the
accounting year ended 30 September 2012.
(8 marks)
Note: You are not required to discuss how the cost of the film should be expensed.
(25 marks)
Question 9 MELD
Draft accounts for Meld, a quoted company, for the year ended 30 June 2013 include the following
amounts:
$
Revenue
472,800
Cost of sales and expenses (including interest payable of $15,000)
(376,800)
———–
Profit before tax
96,000
Tax
(28,800)
Dividends paid
(21,600)
———–
45,600
———–
Additional information
Meld acquired an unincorporated business during the year for $12,000. The fair
value of separable net assets acquired was $9,120 and goodwill to the extent of
$576 is to be written off against profits for the year. Revenue and operating
expenses (included in the figures above) for this business since acquisition were
$4,800 and $3,600 respectively.
(2)
The company has been following local GAAP until this year when it gained a
quotation on the London Stock Exchange. They have decided to prepare accounts
according to IFRSs for the purposes of satisfying their reporting obligations under
the listing agreement. In light of differences between the rules in local GAAP and
those in IAS 38 Intangible Assets the directors have decided to change the
company’s accounting policy for research costs from one of capitalisation and
amortisation to immediate write-off of all expenditure as incurred. At present,
research costs are included in the draft figures as follows:
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(1)
Cost Amortisation
$
$
34,560
20,160
3,100
–
–
4,800
———
———
37,660
24,960
———
———
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At 1 July 2012
Costs incurred
Amortisation charged
At 30 June 2013
In July 2012, the company revalued non-current assets which had originally cost
$19,200 to $28,800. Accumulated depreciation at the date of revaluation was
$7,200. At the date of revaluation, the remaining useful economic life of these
assets was five years and depreciation has been charged on the revalued amount for
the year.
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(3)
(4)
At 1 July 2012, capital and reserves comprised
Ordinary share capital
Revaluation surplus (relating to land)
Retained earnings
$
240,000
48,000
168,000
———–
456,000
———–
Required:
Prepare the following for the year ended 30 June 2013, insofar as the information given permits:
(i)
Profit or loss for year;
(ii)
Statement of other comprehensive income;
(iii)
Statement of changes in equity.
Note: Ignore any tax issues, other than that given in the question.
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(15 marks)
Question 10 KEY CHANGES
(a)
Explain how the profit or loss on disposal of an asset is calculated and why this method
is used.
(5 marks)
(b)
Explain the criteria which determine:
(i)
whether an item is recognised in the financial statements;
(ii)
whether an item once recognised, appears in the profit or loss, other
comprehensive income or the statement of changes in equity.
(8 marks)
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(13 marks)
Question 11 XYZ
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XYZ, a limited company, is a well-established family company with 85% of its ordinary shares and
50% of its preferred share capital held by family members. The following summarised statement of
financial position and fair value table refers to XYZ at 30 November 2012:
Carrying amount
$m
Assets
Non-current assets
Tangible assets
Intangible assets
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Current assets
Capital and reserves
Issued capital – $1 ordinary shares
Accumulated losses
Non-current liabilities
10% preferred shares of $1 redeemable at a
premium of 5% ($10m par value)
8% unsecured loan stock 2013
repayable at a premium of 10% ($35m par value)
Current liabilities
Total equity and liabilities
Fair value
$m
45
15
–—
60
55
–—
115
–—
40
–
–—
40
50
–—
90
–—
40
(21)
–—
19
40
(57)
–—
(17)
11
12
38
47
–—
115
–—
39
56
–—
90
–—
XYZ had incurred losses for several years. In 2012 the family had sold a 5% holding in the ordinary
shares to PQ and a further 10% holding to outside interests. Prior to this event, all the ordinary shares
were held by the family. PQ has indicated to XYZ that they wish to increase their interest in XYZ.
XYZ has projected that it will make profits before interest and taxation in the year to 30 November
2013 of $8 million and that this will increase by 25% per annum. The directors of XYZ have decided
to reconstruct the capital of the company and have suggested the following scheme of reconstruction:
The ordinary shares of $1 are to be reduced to 20c shares. Additionally 20 million ordinary
shares of 20c are to be issued for cash. PQ will subscribe for 15 million of these shares and
the family shareholders will purchase the balance.
(ii)
The holders of the ordinary shares not held by the family or PQ will be offered one new 7%
convertible cumulative preferred share of $1 for every two ordinary shares that they own and
their ordinary shares will be cancelled.
(iii)
A merchant bank has agreed to subscribe in cash for $25 million of new 8% (secured on the
tangible assets) loan stock and PQ and the family shareholders will subscribe equally in cash
for $25 million of new unsecured 10% loan stock. Both issues are at par value.
(iv)
The existing preferred shares held by the family will be cancelled and the balance not held by
the family will be repaid along with the 8% loan stock on the following terms:
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(i)
Arrears of accrued preferred dividends included in current liabilities to be cancelled
(2 years);

10% preferred shares repaid at $0·80 per share;

Loan stock repaid at par (there is no accrued interest).
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
The assets and liabilities are to be shown at fair value in the reconstructed statement of
financial position and the directors’ loans of $8 million included in short-term creditors are to
be written off.
(vi)
PQ is to pay a non-equity capital contribution to shareholders funds of $10 million to XYZ in
order to bolster its liquid funds.
(vii)
The bank overdraft included in current liabilities currently stands at $5 million.
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(v)
(viii)
The procedures under the local companies’ legislation have been followed as regards the
varying of shareholders’ rights.
(ix)
Assume income tax at 30%.
Required:
(a)
Prepare a statement of financial position for XYZ after the implementation of the
scheme on the assumption that the proposed scheme was accepted.
(15 marks)
(b)
Discuss the fairness of the above scheme to the parties concerned and the likelihood of
the scheme being accepted. (Candidates should include any relevant computations in
their answers)
(10 marks)
(25 marks)
Question 12 HAMILTON
Hamilton, a public listed company, owns a large 12 storey office block in the financial area of Metro
City which it purchased on 1 April 2010 for $3 million. On that date it had an estimated life of 25
years. The building is currently classified in Hamilton’s statement of financial position as an
investment property under IAS 40 Investment Property. Hamilton does not intend to sell the property.
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The office block has been revalued annually since acquisition on an open market value basis by
Platonic, a firm of professional surveyors. The values have been:
Year ended 31 March
$ million
2011
3.2
2012
3.6
2013
3.6
Hamilton has a policy of adopting these values as the carrying value of the investment. Included in the
report on the valuation for the current year end (31 March 2013) the surveyors noted that over the next
few years there is expected to be a surplus of rented property space in the City and sub-lease rentals are
expected to fall. This in turn is expected to lead to a serious decline in the value of properties like
Hamilton’s.
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In view of this the directors of Hamilton wish to change the accounting policy for the office block to
the cost model as described in IAS 16 Property, Plant and Equipment.
You are given the following extra information:
An article in “Accountancy Update” reported that an important paper in the “Journal of
Valuation Surveyors” had reported dramatic falls averaging 25% in the value of office
property in the City during the last six months of Hamilton’s current reporting year

The draft statement of comprehensive income for the year to 31 March 2013 showed profit
(after tax) of $180,000. In the financial statements for 2012 the profit before any adjustments
in respect of the investment property was $200,000. The retained profit brought forward at
1st April 2011 was $110,000 before any adjustments for the property revaluation. No
dividends have been paid in either year.
Required:
Describe the circumstances in which companies are permitted to change their
accounting policies, and explain whether the change proposed by Hamilton would be
allowed under International Financial Reporting Standards.
(7 marks)
SA
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(a)
PL

(b)
Suggest reasons why the management of Hamilton may wish to change the policy and
present extracts from the financial statements under both possible models to show the
effect two policies would have on the financial statements for the year to 31 March 2013
(include one year’s comparatives) if the value of the property had fallen by 25% (to $2.7
million) in the year to 31 March 2013.
(8 marks)
(15 marks)
Question 13 FAM
Fam had the following tangible non-current assets at 31 December 2011:
Land
Buildings
Plant and machinery
Fixtures and fittings
Assets under construction
©2014 DeVry/Becker Educational Development Corp. All rights reserved. Cost
$000
500
400
1,613
390
91
––––––
2,994
––––––
Depreciation
$000
–
80
458
140
–
––––––
678
––––––
Carrying amount
$000
500
320
1,155
250
91
––––––
2,316
––––––
9
In the year ended 31 December 2012 the following transactions occur:
(1)
Further costs of $53,000 are incurred on buildings being constructed by the company.
A building costing $100,000 is completed during the year.
(2)
A deposit of $20,000 is paid for a new computer system which is undelivered at the year end.
(3)
Additions to plant are $154,000.
(4)
Additions to fixtures, excluding the deposit on the new computer system, are $40,000.
(5)
The following assets are sold:
Depreciation Proceeds
brought forward
$000
$000
195
86
31
2
E
Cost
$000
277
41
Plant
Fixtures
Land and buildings were revalued at 1 January 2012 to $1,500,000, of which land is worth
$900,000. The revaluation was performed by Messrs Jackson & Co, Chartered Surveyors, on
the basis of existing use value on the open market.
(7)
The useful economic life of the buildings is unchanged. The buildings were purchased ten
years before the revaluation.
(8)
Depreciation is provided on all assets in use at the year end at the following rates:
2% per annum straight line
20% per annum straight line
25% per annum reducing balance
SA
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Buildings
Plant
Fixtures
PL
(6)
Required:
Show the disclosure under IAS 16 “Property, Plant and Equipment” that is required in the notes
to the published accounts for the year ended 31 December 2012.
(14 marks)
Question 14 SPONGER
Sponger has been having financial difficulties recently due to the economic climate in its industry
sector. However, its financial director Mr Philip Tislid has discovered that there are a number of
schemes by which he can obtain government financial assistance. Details of the assistance obtained
are as follows:
(a)
Sponger has received three grants of $10,000 each in the current year relating to on-going
research and development projects. One grant relates to the Cuckoo project which
involves research into the effect of various chemicals on the pitch of the human voice. No
constructive conclusions have been reached yet.
The second relates to the development of a new type of hairspray which is expected to be
extremely popular. Commercial production will commence in 2014 and large profits are
foreseen. The third relates to the purchase of high powered microscopes.
10
In 2011 Sponger’s premises were entirely isolated from the outside world for four months
due to the renovation of roads by the local council. All production was lost in that period.
Mr Tislid has been assured by the council’s officers that a $25,000 compensation grant
will be paid on submission of the relevant triplicate form. Mr Tislid had not yet filled in
the form by 31 December 2012.
(c)
Sponger entered into an agreement with the government that, in exchange for a grant of
$60,000, it will provide “vocational experience” tours around its factory, for twelve young
criminals per month over a five year period starting on 1 January 2012. The grant was to
be paid on the date Sponger purchased a minibus (useful life three years) to take the
inmates to the factory and back. The bus was bought and the grant received on 1 January
2012.
E
(b)
The grant becomes repayable on a pro rata basis for every monthly visit not fulfilled.
During 2012 five visits did not take place due to the pressure of work and this pattern is
expected to be repeated over the next four years.
PL
No repayments have yet been made.
Mr Tislid is totally confused as to how to account for these grants.
Required:
Write a memorandum to Mr Tislid explaining to him how he should account for the above
grants in the accounts for the year ended 31 December 2012.
(12 marks)
Question 15 MOORE
SA
M
Moore, an investment property company, has been constructing a new building for the last 18 months.
At 31 December 2011, the cinema was nearing completion, and the costs incurred to date were:
Materials, labour and sub-contractors
Other directly attributable overheads
Interest on borrowings
$m
14.8
2.5
1.3
The building is deemed to be a qualifying asset and therefore any borrowing costs are capitalised as
part of the cost of the building. The amount of borrowings outstanding at 31 December 2011 in respect
of this project is $18m, and the interest rate is 9.5%pa.
During the three months to 31 March 2012 the project was completed, with the following additional
costs incurred:
$m
Materials, labour and sub-contractors
$1.7
Other overhead
$0.3
The company were not able to determine the fair value of the property reliably during the construction
period and so used the allowance within IAS 40 Investment Property to value at cost until construction
was complete.
On 31 March 2012, the company obtained a professional appraisal of the cinema’s fair value, and the
valuer concluded that it was worth $24m. The fee for his appraisal was $0.1m, and has not been
included in the above figures for costs incurred during the 3 months.
The cinema was taken by a national multiplex chain on an operating lease as at 1 April 2012, and was
immediately welcoming capacity crowds. The lease agreement allows for annual revisions, and thus it
was clear that it was worth even more than the valuation at 31 March 2012. Following a complete
valuation of the company’s investment properties at 31 December 2012, the fair value of the cinema
was established at $28m.
Required:
Set out the accounting entries in respect of the cinema complex for the year ended 31 December
2012.
(10 marks)
E
Question 16 HEYWOOD
Required:
PL
The problems of identifying and valuing intangible assets with a view to recognising them on the
statement of financial position has been an area of inconsistent practice that has led to great debate
within the accountancy profession. IAS 38 Intangible Assets was issued in order to try and eliminate
these inconsistent practices.
(a)
Discuss the recognition and initial measurement criteria for intangible assets contained
in IAS 38.
(9 marks)
(b)
On 1 July 2012 Heywood, a company listed on a recognised stock exchange, was finally
successful in acquiring the entire share capital of Fast Trak. The terms of the bid by
Heywood had been improved several times as rival bidders also made offers for Fast Trak.
The terms of the initial bid by Heywood were:
20 million $1 ordinary shares in Heywood. Each share had a stock market price of
$3·50 immediately prior to the bid;
SA
M


a cash element of $15 million.
The final bid that was eventually accepted on 1 July 2012 by Fast Trak’s shareholders.
Heywood had improved the cash offer to $25million and included a redeemable loan note of
a further $25 million that will be redeemed on 30 June 2016. It carried no interest, but
market rates for this type of loan note were 13% per annum. There was no increase in the
number of shares offered but at the date of acceptance the price of Heywood’s shares on the
stock market had risen to $4·00 each.
The present value of $1 receivable in a future period where interest rates are 13% can be
taken as:
at end of year three
at end of year four
$0·70
$0·60
The fair value of Fast Trak’s net assets, other than its intangible long-term assets, was
assessed by Heywood to be $64million. This value had not changed significantly throughout
the bidding process. The details of Fast Trak’s intangible assets acquired were:
(i)
12
The brand name “Kleenwash”; a dish washing liquid. A rival brand name thought
to be of a similar reputation and value to Kleenwash had recently been acquired for
a disclosed figure of $12 million.
A Government licence to extract a radioactive ore from a mine for the next ten
years. The licence is difficult to value as there was no fee payable for it.
However, as Fast Trak is the only company that can mine the ore, the directors
of Heywood have estimated the licence to be worth $9 million. The mine itself
has been included as part of Fast Trak’s property, plant and equipment.
(iii)
A fishing quota of 10,000 tonnes per annum in territorial waters. A specialist
company called Quotasales actively trades in these and other quotas. The price
per tonne of these fishing quotas at the date of acquisition was $1,600. The
quota is for an indefinite period of time, but in order to preserve fish stocks the
Government has the right to vary the weight of fish that may be caught under a
quota. The weights of quotas are reviewed annually.
(iv)
The remainder of the long-term intangible assets is attributable to the goodwill
of Fast Trak.
E
(ii)
Required:
(c)
PL
Calculate the purchase consideration and prepare an extract of the intangible assets of
Fast Trak that would be separately recognised in the consolidated financial statements
of Heywood on 1 July 2012. Your answer should include an explanation justifying your
treatment of each item.
(8 marks)
On the same date, but as a separate purchase to that of Fast Trak, Heywood acquired
Steamdays, a company that operates a scenic railway along the coast of a popular tourist area.
The summarised statement of financial position at fair values of Steamdays on 1 July 2012,
reflecting the terms of the acquisition was:
SA
M
Goodwill
Operating licence
Property – train stations and land
Rail track and coaches
Steam engines (2)
Purchase consideration
$000
200
1,200
300
300
1,000
––––––
3,000
––––––
The operating licence is for ten years. It has recently been renewed by the transport authority
and is stated at the cost of its renewal. The carrying amounts of the property and rail track
and coaches are based on their estimated replacement cost. The carrying amount of the
engines closely equates to their fair value less any disposal costs.
On 1 August 2012 the boiler of one of the steam engines exploded, completely destroying the
whole engine. Fortunately no one was injured, but the engine was beyond repair. Due to its
age a replacement could not be obtained. Because of the reduced passenger capacity the
estimated value in use of the business after the accident was assessed at $2 million.
Passenger numbers after the accident were below expectations even after allowing for the
reduced capacity. A market research report concluded that tourists were not using the railway
because of the fear of a similar accident occurring to the remaining engine. In the light of this
the value in use of the business was re-assessed on 30 September 2012 at $1·8 million. On
this date Heywood received an offer of $900,000 in respect of the operating licence (it is
transferable).
Required:
Briefly describe the basis in IAS 36 “Impairment of Assets” for allocating impairment
losses; and show how each of the assets of Steamdays would be valued at 1 August 2012
and 30 September 2012 after recognising the impairment losses.
(8 marks)
(25 marks)
Question 17 DEFER
E
Your client, a limited liability company, wishes to defer expenditure on development activities where
possible and for as long as possible. The finance director has asked for your advice on the procedures
to set up in order to identify relevant expenditure and comply with best accounting practice.
Required:
Question 18 STARSKY
PL
Draft the contents of a letter to the finance director of the company which addresses his concerns.
(10 marks)
It is a general application of the concept of prudence that the carrying amount of an asset should not be
greater than the amount of cash that it will generate. IAS 36 Impairment of Assets gives guidance on
the application of this principle in particular to non-current assets. Under the rules in IAS 36 an asset
must be written down to its recoverable amount when this is less than its carrying amount. The
standard ensures that impairment loss is measured and recognised on a consistent basis.
Required:
Explain the need for IAS 36.
SA
M
(a)
(b)
(4 marks)
Define and explain the concept of recoverable amount contained within IAS 36.
(4 marks)
(8 marks)
Question 19 ARTRIGHT
Artright, a public limited company, produces artefacts made from precious metals. Its customers vary
from large multinational companies to small retail outlets and mail order customers.
(i)
On 1 December 2011, Artright has a number of finished artefacts in inventory which are
valued at cost $4 million (selling value $5·06 million) and whose precious metal content was
200,000 ounces. The selling price of artefacts produced from a precious metal is determined
substantially by the price of the metal. The inventory value of finished artefacts is the metal
cost plus 5% for labour and design costs. The selling price is normally the spot price of the
metal content plus 10% (approximately). The management were worried about a potential
decline in the price of the precious metal and its effect on the selling price of the inventory.
Therefore it sold futures contracts for 200,000 ounces in the metal at $24 an ounce at 1
December 2011. The contracts mature on 30 November 2012.
The management have designated the futures contracts as cash flow hedges of the anticipated
sale of the artefacts. Historically this has proved to be highly effective in offsetting any
changes in the selling price of the artefacts. The finished artefacts were sold for $22·8 per
ounce on 30 November 2012. The costs of setting the futures contracts in place were
negligible.
14
The metal’s spot and futures prices were as follows:
Spot price
$ per ounce
1 December 2011
30 November 2012
23
21
The company also trades with multi-national corporations. Artright often has cash flow
problems and factors some of its trade receivables. On 1 November 2012 it sold trade
receivables of $500,000 to a bank for a cash settlement of $440,000. The portfolio of trade
receivables sold is due from some of the company’s best customers who always pay their
debts but are quite slow payers. Because of the low risk of default, Artright has guaranteed
12% of the balance outstanding on each receivable and the fair value of this guarantee is
thought to be $12,000.
E
(iii)
Futures price per ounce
for delivery 30 November 2012
$
24
21
Required:
PL
Discuss, using the principles of IAS 39 “Financial Instruments: Recognition and Measurement”
and IFRS 9 “Financial Instruments”:
(a)
whether the cash flow hedge of the sale of the inventory of artefacts is effective and how
it would be accounted for in the financial statements for the year ended 30 November
2012;
(6 marks)
(b)
whether the sale of the trade receivables would result in them being derecognised in the
statement of financial position at 30 November 2012 and how the sale of the trade
receivables would be recorded.
(5 marks)
(11 marks)
SA
M
Question 20 AMBUSH
Ambush, a public limited company, is assessing the impact of implementing the accounting standards
relating to financial instruments. The directors realise that significant changes may occur in their
accounting treatment of financial instruments, however, there are certain issues that they wish to have
explained and these are set out below.
Required:
(a)
Outline in a report to the directors of Ambush the following information how
financial assets and liabilities are measured and classified, briefly setting out the
accounting method used for each category. (Hedging relationships can be ignored.)
(10 marks)
(b)
Ambush loaned $200,000 to Bromwich on 1 December 2010. The effective and stated
interest rate for this loan was 8 per cent. Interest is payable by Bromwich at the end of each
year and the loan is repayable on 30 November 2014. At 30 November 2012, the directors of
Ambush have heard that Bromwich is in financial difficulties and is undergoing a financial
reorganisation. The directors feel that it is likely that they will only receive $100,000 on 30
November 2014 and no future interest payment. Interest for the year ended 30 November
2012 had been received. The financial year end of Ambush is 30 November 2012.
Required:
(i)
Outline the requirements of IAS 39 “Financial Instruments: Recognition and
Measurement” for the impairment of financial assets.
(6 marks)
Answer 1 IFRS FOR SMES
(a)
Need for IFRS for SMEs
PL
E
IFRSs were not designed specifically for listed companies. However, in many countries the main
users of IFRS are listed companies. Until recently SMEs who adopt IFRS had to follow all the
requirements and not all SMEs take exception to applying IFRS because it gives their financial
statements enhanced reliability, relevance and credibility, and results in fair presentation.
However, other SMEs will wish to comply with IFRS for consistency and comparability
purposes within their own country and internationally but wish to apply simplified or different
standards relevant to SMEs on the grounds that some IFRS are unnecessarily demanding and
some of the information produced is not used by users of SME financial statements.
The objectives of general purpose financial statements are basically appropriate for SMEs and
publicly listed companies alike. Therefore there is an argument that there is a need for only one
set of IFRS which could be used nationally and internationally. However, some SMEs require
different financial information than listed companies. For example expanded related party
disclosures may be useful as SMEs often raise capital from shareholders, directors and suppliers.
Additionally directors often offer personal assets as security for bank finance.
The cost burden of applying the full set of IFRS may not be justified on the basis of user needs.
The purpose and usage of the financial statements, and the nature of the accounting expertise
available to the SME, will not be the same as for listed companies. These circumstances
themselves may provide justification for a separate set of IFRSs for SMEs. A problem which
might arise is that users become familiar with IFRS as opposed to local GAAP thus creating a
two tier system which could lead to local GAAP being seen as an inferior or even a superior set
of accounting rules.
Issues to be addressed when developing IFRSs for SMEs
SA
(b)
M
One course of action would be for GAAP for SMEs to be developed on a national basis with
IFRS being focused on accounting for listed company activities. The main issue here would be
that the practices developed for SMEs may not be consistent and may lack comparability across
national boundaries. This may mean that where SMEs wish to list their shares on a capital
market, the transition to IFRSs may be difficult. It seems that national standards setters are
strongly supportive of the development of IFRSs for SMEs.
(i)
The purpose of the standards and type of entity
The principal aim of the development of an accounting framework for SMEs is to provide a
framework which generates relevant, reliable and useful information. The standards should
provide high quality and understandable accounting standards suitable for SMEs globally.
Additionally they should meet the needs set out in (a) above. For example reduce the financial
reporting burden for SMEs. It is unlikely that one of the objectives would be to provide
information for management or meet the needs of the tax authorities as these bodies will have
specific requirements which would be difficult to meet in an accounting standard. However, it is
likely that the standards for SMEs will be a modified version of the full IFRSs and not an
independently developed set of standards in order that they are based on the same conceptual
framework and will allow easier transition to full IFRS if the SME grows or decides to become a
publicly listed entity.
1001
It is important to define the type of entity for which the standards are intended. Companies who
have issued shares to the public would be expected to use full IFRS. The question arises as to
whether SME standards should apply to all unlisted entities or just those listed entities below a
certain size threshold. The difficulty with size criteria is that it would have to apply worldwide
and it would be very difficult to specify such criteria. Additionally some unlisted companies
(e.g. public utilities) have a reporting obligation that is equivalent to that of a listed company and
should follow full IFRS.
PL
E
The main characteristic which distinguishes SMEs from other entities is the degree of public
accountability. Thus the definition of what constitutes an SME could revolve around those
entities that do not have public accountability.
Indicators of public accountability will have to be developed. For example, a listed company or
companies holding assets in a fiduciary capacity (e.g. a bank), or a public utility, or an entity
with economic significance in its country. Thus all entities that do not have public
accountability may be considered as potential users of IFRSs for SMEs.
Size may not be the best way to determine what is an SME. SMEs could be defined by reference
to ownership and the management of the entity. SMEs are not necessarily just smaller versions
of public companies.
(ii)
The development of IFRSs for SMEs as a modification of existing IFRSs
M
Most SMEs have a narrower range of users than listed entities. The main groups of users are
likely to be the owners, suppliers and lenders. In determining the modifications to make to IFRS,
the needs of the users will need to be taken into account as well as the costs and other burdens
imposed on SMEs by the IFRS. There will have to be a relaxation of some of the measurement
and recognition criteria in IFRS in order to achieve the reduction in the costs and the burdens.
Some disclosure requirements, such as segmental reports and earnings per share, are intended to
meet the needs of listed entities, or to assist users in making forecasts of the future. Users of
financial statements of SMEs often do not make such kinds of forecasts. Thus these disclosures
may not be relevant to SMEs, and a review of all of the disclosure requirements in IFRS will be
required to assess their appropriateness for SMEs.
SA
The difficulty is determining which information is relevant to SMEs without making the
information disclosed meaningless or too narrow/restricted. It may mean that measurement
requirements of a complex nature may have to be omitted.
There are, however, rational grounds for justifying different treatments because of the different
nature of the entities and the existence of established practices at the time of the issue of an
IFRS.
(iii)
The treatment of items not dealt with by an IFRS for SMEs
IFRSs for SMEs would not necessarily deal with all the recognition and measurement issues
facing an entity but the key issues should revolve around the nature of the recognition,
measurement and disclosure of the transactions of SMEs. In the case where the item is not dealt
with by the standards there are three alternatives:
1002
(a)
the entity can look to the full IFRS to resolve the issue
(b)
management’s judgement can be used with reference to the Framework and
consistency with other IFRSs for SMEs
(c)
existing practice could be used.
The first approach is more likely to result in greater consistency and comparability. However,
this approach may also increase the burden on SMEs as it can be argued that they are subject to
two sets of standards.
Answer 2 AUTOL
PL
E
An SME may wish to make a disclosure required by a full IFRS which is not required by the
SME standard, or a measurement principle is simplified or exempted in the SME standard, or the
IFRS may give a choice between two measurement options and the SME standard does not allow
choice. Thus the issue arises as to whether SMEs should be able to choose to comply with a full
IFRS for some items and SME standards for other items, allowing an SME to revert to IFRS on a
principle by principle basis. The problem which will arise will be a lack of consistency and
comparability of SME financial statements.
Report to the Directors of Autol, a public limited company
International Reporting Practice
Although some multi-national companies still prepare their financial statements in accordance with local
GAAP, this practice can be a major disadvantage if the company wishes to raise capital internationally.
Local GAAPs do not command the same confidence internationally as UK, US GAAPs and the IAS/IFRS.
(a)
Current Reporting Practices
SA
M
Global capital markets and multi-national companies are requiring a uniform set of accounting
practices for comparability purposes. It is unfortunate that different accounting practices are
used in different geographical locations. It is time for consensus and the production of one
international GAAP. However, there are a variety of GAAPs currently in use by multinational
companies. Some companies simply prepare their financial statements under US GAAP as this
gives access to the US capital markets. In certain industrial sectors this can be beneficial as the
US rules (e.g. in the area of revenue recognition) may be geared more specifically to the nature
of their business (e.g. in the case of software development companies). Additionally, companies
may use US GAAP because it was seen as the most detailed and stringent regulatory system in
operation and for many analysts was seen as a much clearer accounting framework. This opinion
is still shared by many users and thus would appear to reduce the risk of investment. Also if
financial statements are prepared under local GAAP, a US GAAP reconciliation would have to
be prepared in order to access the US capital markets.
However, the reliance on US GAAP has been tarnished over the years since 2000 with the
accounting scandals relating to Enron, Worldcom and other major companies being identified as
slightly frugal with their accounting practices.
Some companies publish dual financial statements prepared under local and US GAAPs. Other
companies produce reconciliations from local GAAP to IAS/IFRS but this latter practice is
somewhat rare at the moment. Finally GAAP reconciliations are not exclusively to US GAAP as
some companies, reflecting their listing or operating environments, provide reconciliations to
other GAAPs. For example HSBC discusses different treatments of impairment and long term
investments under local and Hong Kong GAAP and provides a full local to US GAAP
reconciliation.
1003
Certain companies seem to mix GAAPs, choosing the accounting practice which suits their own
needs. Reed Elsevier’s financial statements are prepared in accordance with applicable local and
Dutch GAAP. Royal Dutch/Shell prepares its results under GAAP in the Netherlands and the
US which it claims is substantially consistent with local GAAP. Other companies produce one
set of accounts using local GAAP for compliance purposes and another set of financial
statements utilising US GAAP or IAS/IFRS for international purposes. This happens for
example in Germany.
PL
E
Thus it can be seen that a variety of practices are in use by multi-national companies. The vast
majority of companies who want access to international capital markets prepare reconciliations
to US GAAP. This practice will make any transition to IFRS more difficult as the cost of
developing the expertise and training required in order to utilise US GAAP has been already
incurred by many companies and there will be a reluctance to incur the additional cost to convert
to IFRS.
The SEC in USA now allows companies presenting their financial statements under IFRS a US
listing without the need for a 20F reconciliation to US GAAP. There are also many accountants
in the US who believe that the way forward is for the US to fully adopt IFRS and do away totally
with US GAAP. There was a roadmap in place that would see US companies fully adopting
IFRS by 2014, however, with a change in government in the USA and as a result of the financial
crisis it now looks unlikely that there will be full convergence in the near future.
(b)
Preparation of US GAAP financial statements
M
There would be certain difficulties in preparing a single set of consolidated financial statements
which complies only with US GAAP. The financial statements may not comply with the local
Companies Act and thus could not be taken as the statutory set of financial information. A set of
financial statements complying with local GAAP would have to be lodged with the regulatory
authorities although often this may allow US GAAP or possibly IAS/IFRS to be used. The
shareholders also would be likely to be entitled to receive a copy of the financial statements
complying with local GAAP. The best advice is to either prepare dual financial statements
incorporating both US and local GAAP results, or to produce a statement reconciling local to US
GAAP. Further the cost of preparing dual financial statements is quite high and this must be
considered in your deliberations. Additionally with the advent of recent accounting scandals in
the US, the reputation of US GAAP has been a little tarnished.
SA
A point to note is that any company that wishes to have its stock listed on a US exchange then
the directors must comply with the Sarbanes Oxley act, which will require them to sign off the
accounts as representing faithfully the transactions for the period.
(c)
Use of GAAP reconciliations
The use of GAAP reconciliations is varied and not controlled by any form of regulation. Many
reconciliations are not included in the scope of the auditor’s report which should reduce their
credibility although in reality it does not appear that this is the case.
It is likely that GAAP reconciliations will be used for several years to come. There is little hope
of complete consensus on international accounting practice in the short term, particularly in view
of the differences in US GAAP, local GAAP and IFRS. The IASB are working closely to
eliminate local differences but it seems that even in this environment, differences in practice are
bound to remain (e.g. in the area of deferred taxation).
1004
In Europe, the European Commission has endorsed the use of IFRS throughout the European
Union and since 2005 has required IFRS be used for the consolidated financial statements. This
“Euro GAAP” will aid the harmonisation process but the next step is to align US GAAP with
“Euro GAAP”. This will involve a significant degree of detailed discussion which will not be
easily resolved. Hence, companies that wish to utilise the capital markets in the US will have
little option but to provide reconciliations to alternative GAAPs.
It should be noted that Europe has not endorsed all documentation issued by the IASB meaning
that there are in effect two versions of IFRS, those issued by the IASB and those issued by the
IASB that have been endorsed by the European Union.
(d)
Potential impact
PL
E
The location and nature of the information disclosed about alternative GAAPs is varied and
diffuse. Companies generally show these disclosures in the notes to the financial statements or
in an appendix but many scatter the information throughout the accounts. The nature of the
financial information varies also with some companies showing merely a reconciliation of profit
whilst others show a reconciliation of shareholders’ funds, or a statement of cash flows, or a
discussion of the differences, or a statement of financial position or even other non-financial
information. The lack of consensus about the location and nature of the information shown is a
problem area.
Being in the telecommunications industry, having a group structure will mean that there may be
significant effects on the financial statements under IFRS. The main areas relating to your
company where divergence may occur in respect of three areas are:
Development expenditure – under IFRS development expenditure must be capitalised.
However, under IFRS, the criteria for recognition are quite rigorous and the
development expenditure may not qualify. In any event as your company currently
writes off development expenditure, the impact of the IFRS may be to equalise the
development expenditure and match it against future revenues, thus possibly reducing
the volatility of this element of the financial statements.
M
(i)
Employee benefits – the IFRS requires actuarial gains and losses on any defined
benefit obligations to be recognised in profit or loss, with any changes in the fair value
of plan assets recognised in other comprehensive income. The difference in the present
value of the plan obligation and the fair value of the plan assets will be recognised as a
net asset/liability in the entity’s own statement of financial position. Thus it can be
seen that this recognition and disclosure could have a major impact on the reported
profit under IFRS.
SA
(ii)
(iii)
Deferred Tax – the IFRS uses the full provision method to determine the liability and
the IFRS is based on temporary differences. The potential impact on profitability
could be quite significant as the IFRS requires a provision for deferred tax based on a
“balance sheet” approach whereby most temporary differences are accounted for.
Some accounting systems would not require the recognition of deferred tax on
revaluation of assets, if there was no intent on realising the revaluation surplus, IAS 12
would require recognition of this temporary difference.
I hope that the above discussion helps in the understanding of the current complex reporting
structures being used by multi-national companies.
1005
Answer 3 SUBSTANCE OVER FORM
(a)
Substance vs form
The term substance over form relates to the principle that accounts should show the commercial
or economic effect of an entity’s transactions rather than their strict legal form.
(b)
Transactions
(i)
Axe
PL
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Initially, Axe has receivables of $22,000. This represents an asset as Axe has the rights to the
future benefits (i.e. the cash receipts) and the related risks (i.e. non-payment). When Axe factors
the receivables, it retains significant risks, as Shotgun has recourse for non-payment. It also
retains access to future benefits in the form of expected further cash receipts. Consequently,
although the debts have been factored, in substance Axe retains the asset and the receivables
should remain on the statement of financial position until paid in full.
The $16,500 received from Shotgun on 31 March is in substance a loan secured on the debtors,
repayable out of the cash receipts from them. The 1% of the gross debtors per month retained by
Shotgun is in effect interest on the loan. When payment is received from the debtor, the full
amount should be credited to debtors and the “interest” charged to profit or loss over the period
for which the loan is outstanding.
(ii)
Exe
M
Exe initially owns an asset (inventory) with access to future benefits (i.e. sale proceeds) and risk
(obsolescence). By transferring legal title to Megabank, Exe does not dispose of the risks and
benefits of ownership as it has agreed to repurchase the inventory at a later date.
The substance of the arrangement is that Exe has obtained a loan secured on the inventory. The
repurchase price of the inventory is 10% higher than the sale price and the difference represents
interest on the loan. To account for the transaction in accordance with its substance, the goods
should remain in inventory at the lower of cost and net realisable value, and no sale is recorded.
The obligation to repurchase the inventory is treated as a short term creditor for $19,800. $1,800
is charged to profit or loss as interest for March 2013.
SA
Answer 4 COMMERCIAL PURPOSE
(a)
Asset and liability definition
Once a transactions commercial purpose has been determined, it is necessary to ascertain
whether a new asset or liability has arisen or whether the entity’s existing assets or liabilities
have changed. An asset is defined in the IASB’s Conceptual Framework for Financial
Reporting (Framework) as a resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity.
The control over the rights to economic benefits entails the right to obtain the future economic
benefits relating to the asset and the ability to restrict the ability of others to access those
benefits. Management of the assets is not the same as control. Management of the assets is the
ability to direct the use of the asset as a fund manager may do. However, the fund manager will
not gain the economic benefits from those assets. Evidence of whether an entity is exposed to
the risks associated with the asset is taken as evidence that the entity has access to the asset’s
future economic benefits. Therefore if the entity controls the rights to the economic benefits an
asset may arise.
1006
A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits. If an
outflow of funds arises as a result of an obligation then a liability will arise. If the entity is
unable to avoid the outflow of funds either legally or commercially, then such an obligation will
exist. Where this obligation is contingent on the outcome of a future uncertain event, a liability
will not necessarily be recognised. Such an obligation will be accounted for under IAS 37
Provisions, Contingent Liabilities and Contingent assets. A liability will arise where the future
event confirms a loss already estimated with reasonable accuracy at the time of the financial
statements.
Principles of recognition/derecognition
PL
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(b)
The IASB’s Framework sets out the recognition criteria for assets and liabilities. An item that
meets the definition of an element of the financial statements is recognised if:
(i)
it is “probable” that any future economic benefit associated with the item will flow to
or from the entity; and
(ii)
the item has a cost or value that can be measured with reliability.
An item that does not meet the recognition criteria should not be recognised, but may warrant
disclosure when knowledge of the item is relevant to users. The Framework gives no guidance
on the meaning of the word “probable” but utilises the word consistently throughout the IASB’s
standards in order to avoid further confusion. The notion of reliable measurement is seldom a
problem and IFRS as a norm usually require initial recognition at cost.
M
Additionally there are further criteria to be taken into account for recognition of a financial asset
or liability under IFRS 9 Financial Instruments. A financial asset or liability is recognised when
the entity becomes party to the contractual provisions of the instrument.
Derecognition is the opposite of recognition. It concerns the question of when to remove assets
and liabilities from the statement of financial position. In simple terms assets should be
derecognised when the entity has eliminated the risks and rewards associated with the asset and
management are unable to exert any control of the use of the asset. A liability is normally
derecognised when the specific obligation is discharged, cancelled or expires.
Criteria discussion
SA
(c)
Securitisation of assets is often used by originators of secured loans to package assets together to
sell to a sparsely capitalised company. Securitisation often makes use of “special purpose
vehicles” (SPV). The general test for derecognition has been set out in IFRS 9 and has been
discussed above.
A considerable degree of judgement may be required in determining when an asset or liability
should be removed from Mortgage Lend’s statement of financial position. Often the originator
of such a transaction retains some or all of the credit risk while transferring all other benefits and
risks. If the fair value of the obligation to bear losses can be measured reliably by taking into
account historical and other factors, and is not substantial, relative to the fair value of the
accounts receivable, then Mortgage Lend can treat the transaction as a sale and remove the
secured loans from the statement of financial position.
1007
However, if the fair value of the recourse cannot be measured reliably or is substantial compared
to the secured loans, then substantially all of the risks and rewards associated with the secured
loans have not been transferred. Often the originator may be subject to the interest rate risk and
as this is difficult to measure reliably, it is difficult to justify derecognition from the statement of
financial position.
Thus the approach to recognition (and derecognition) of secured loans revolves around the risks
and rewards retained being measurable and insubstantial. Unlike the UK accounting standards,
there is no conceptual equivalent to a “linked presentation”. Thus assets and liabilities are either
recognised or derecognised.
PL
E
It would appear from the brief facts of the case set out that Borrow has access to all the future
risk and rewards of ownership of the secured loans and therefore because there does not appear
to be any limitation to the loss which can be sustained, recognition of the transaction on the
statement of financial position of Borrow seems appropriate.
In the context of the group accounts of Lendco, the important consideration is the nature of the
relationship between Borrow and the group. If Borrow is independently owned by a third
unrelated party who has the risks and rewards of Borrow’s net assets, then derecognition may be
appropriate. If Borrow is a subsidiary or quasi-subsidiary of Mortgage Lend, then recognition of
the item will be made in the group accounts with the asset and liability being separately
presented.
Answer 5 THEORETICAL PRINCIPALS
(a)
Terms
M
The essence of an agency relationship is that one or more people employ one or more persons as
agents.
SA
The persons who employ others are the principals and those who work for them are called the
agents. In an agency situation, the principal delegates some decision-making power to the agent
whose decisions after both parties. This type of relationship is quite common in business life.
For example, the shareholders of a company delegate the stewardship function to the directors of
a company. The reasons why agents are employed will vary but generally an agent may be used
because of the special skills offered, or because of information the agent possesses or to release
the principal from the time committed to the business.
Agency theory assumes that principals and agents wish to maximise their own best interests
subject to constraints imposed by the agency relationship. The principal and agent are likely to
have different objectives because of different attitudes and because the agent’s actions are likely
to be not necessarily in the best interests of the principal. Thus the principal will choose a
structure for the agency relationship which ensures that when the agent is maximising his or her
best interests, he or she automatically maximises the principal’s best interests. For example,
directors may be paid part of their salary in the form of performance related pay because this will
act as an incentive for them to maximise the shareholders’ wealth in the form of profits. It is
always possible in this type of a relationship that dysfunctional behaviour can occur by the agent.
The agent may under-perform or award themselves large salary increases or even pursue a wide
variety of non-pecuniary benefits such as foreign travel or company cars. The principal will
therefore try to limit the agent in this type of behaviour by incurring “monitoring costs”. These
monitoring costs will be the setting up of internal audit departments, budgetary controls and
linking salary to the performance of the agent. Additionally, the agent may be required to enter
into “bonding activities” which seek to guarantee that the agent will not exploit the principal.
1008
These bonding activities may include contractual limitations on the power of the agent and
agreeing to the appointment of a “Big 4” firm of external auditors.
PL
E
Agency theory helps explain partially why companies make decisions which do not always
conform to the expectations of maximising shareholders wealth. It helps explain the reasons why
company directors have an interest in changing accounting standards as standards affect the
calculation of profit which in turn influences the directors’ remuneration. It also explains
partially why directors engage in creative accounting practices. When the performance of a
business is being evaluated by parties outside the business for monitoring/stewardship purposes,
there is pressure on management to report flattering results. The financial statements are used as
a basis for profit distribution to different interest groups and creative accounting is attractive if
one interest group (the director or agent) is in a better position to determine the figures in the
financial statements which are to be presented to the rest of the interest groups (creditors,
shareholders).
Positive accounting theory sets out to explain and predict how accounting procedures affect a
company and provides an insight into the factors that influence a manager’s choice of accounting
procedures. Positive accounting theory is descriptive and looks to develop theories which are
descriptions of what happens in the “real world”. The positive approach looks to why
accounting practices have developed in order to explain or predict accounting phenomena. It
seeks to find the matters that may influence rational factors in accounting by trying to develop a
theory to explain observed practices in accounting. The normative approach seeks to determine
a theory that explains what should be occurring in accounting practice.
M
Positive accounting theorists such as Watts and Zimmerman have argued that there are many
factors which affect the reactions of management to potential changes in accounting standards.
These include the maximisation of the manager’s income and the political sensitivity of the
entity. It is important for companies such as British Gas not to be seen to be making too much
profit. British Gas used to publish their current cost accounts as their main accounts presumably
because the profit figure is less under CCA and the capital employed is larger. Thus the return
on capital employed will be smaller than under historical cost accounting.
SA
Further, other factors which appear to influence managers in their choice of accounting policy
are the effects on the company’s ability to conform to conditions imposed by debt
covenants/debentures and whether the image or economic reality of the company is better shown
by the particular accounting policy.
Positive accounting theory is not without its critics but it has apart to play in the “real world”. It
is important to test empirically how individuals and companies will react to proposed accounting
standards, and the way this body of individuals has reacted to actual accounting standards.
Accounting standards should not be set without gauging the reaction of preparers of accounts.
Creative accounting practices could be reduced if more positive testing of the reactions of
persons to standards was undertaken.
(b)
Accountancy research
It is not unusual to find that when researchers indicate that a certain procedure should be adopted
in practice, their recommendations may not always be taken into account. Many writers have
commented on the considerable size of the gap between practice and research in accounting. It
can be argued that the results of research are only useful when they meet the immediate needs of
the practitioner or can be used to explain and justify current practice. Thus the gap could be
reduced if more academics commented on the EDs issued by the IASB. At present very few
submissions are made by academics to the IASB on practical issues.
1009
Many practitioners argue that much of the academic research has little practical relevance and
that researchers are in a world of their own creating their own reality.
The two parties may have different criteria for judging the relevance and success of research.
Practitioners want quick solutions to practical problems, researchers offer long-term solutions.
PL
E
Many practitioners do not have a research tradition, not having undergone an academic
accounting course or undertaken a research based programme of study. Thus they are unlikely to
appreciate the ethos and value of accounting research. The practitioners have habits of thought
that have been conditioned over years and thus may find it difficult to change their thought
patterns. Some might argue that accounting research could radically alter existing accounting
practice and this could be contrary to the interests of practitioners who require flexibility and
self-regulatory mechanisms in accounting.
However, the professional bodies are increasingly funding fundamental research to be
undertaken on their behalf. It appears that the professional bodies feel that the commissioning of
research is important. It would seem that the profession is keen to maintain its public credibility
and image. Some research projects recently undertaken may have had little perceived practical
relevance. This factor may be one of the causes of the lack of appreciation of the role of
researchers by practitioners. Research has a role to play in the development of the profession.
However, one of the problems which will have to be solved is the mutual lack of appreciation of
researchers and practitioners of each other’s needs. Research has often appeared to practitioners
as uninteresting, unreadable and unintelligible.
(c)
Advantages of the framework
The following are reasons often put forward as to the advantages of the IASB’s “Framework”:
M
The Framework provides the IASB with a body of principles that should help to produce
standards that are more internally consistent.
The Framework helps to reduce subjectivity in the preparation of financial statements.
If a particular procedure is not the subject of an accounting standard, then the Framework can
provide guidance and produce a consistency of treatment between companies.
SA
The Framework provides structure and direction to financial accounting and reporting and limits
the areas where preparers of accounts can use their judgement.
Understandability of financial statements is enhanced by the Framework because of the use of a
common set of objectives and terminology. This also improves confidence in financial reporting.
The definition and qualitative characteristics of financial statements are extremely important in
this regard.
It could be argued that the Framework enhances comparability of financial statements because it
limits the alternatives available. However, there is no guarantee that there will be a reduction in
alternatives, but it will form a coherent basis for standard setting.
1010
Answer 6 CREATIVE ACCOUNTING
(a)
Manipulation of financial data
PL
E
Creative accounting is not a term that has a definition; however various commentators have
described some doubtful accounting practices as “creative accounting”. Such practices may be
used by a company’s management to make its financial statements appear more favourably
different from what would be commonly acceptable. It must be appreciated that the accounting
policies in question are not “illegal” and they may even be permitted by accounting standards.
The problem lies in their inappropriate application. For example, if management classified a
lease as an operating lease rather than a finance lease this could dramatically change the structure
of the statement of financial position with assets and liabilities being excluded. Creative
accounting is undesirable and, at its worst, is a form of deception.
In the statement of comprehensive income there are generally two aspects to profit manipulation
or creative accounting; that of inflating profits, and that of profit smoothing.
Inflating profit
There are several techniques of achieving this (e.g. management may attempt to avoid certain
costs being put through the statement of comprehensive income). Reserve accounting for losses
is a good example of this, however IAS 1 on presentation of financial statements aims to reduce
the incidence of reserve accounting as all gains and losses must now be included in the statement
of comprehensive income. Another example is treating future reorganisation costs relating to an
acquisition as a reduction of the acquired entity’s net assets.
Profit smoothing
M
The timing of revenue recognition can lead to profit smoothing. Some examples of profit
smoothing are regarded as acceptable. For example recognising stage profits in relation to
construction contracts (IAS 11) is common practice, whereas other methods such as “selling” and
later repurchasing maturing inventories are generally considered undesirable. The IASB has
issued an exposure draft which if it becomes a standard will not recognise profit on a
construction contract until the end of the contract, thereby eliminating a practice that at present
does allow profit smoothing.
SA
In the statement of financial position creative accounting has mainly been used to improve “key”
reported ratios such as financial gearing, profitability and liquidity ratios.
It is important to stress that such accounting policies and practices are not illegal and must be
distinguished from fraud. Deliberately overvaluing closing inventories would improve profits
and liquidity but this would be fraud, not creative accounting. Although creative accounting may
not be illegal, it generally prevents the financial statements of an entity from showing a “true and
fair view” or “presenting fairly the financial position”.
Creative accounting has also been used to describe less sinister practices. The modern world has
many new and complex financial transactions for which existing standards may not be
appropriate because such transactions did not exist when the statements were produced. As a
company’s management has to account for these complex transactions it has to “create” an
accounting policy.
1011
There are obvious explanations of why management may participate in manipulating financial
statements. Perhaps the most obvious is that of self-interest: management may be remunerated
(partly) in the form of a bonus based on the level of profit. Other reasons may be that creative
accounting can, in the short term, increase the market price of a company’s shares, again with
obvious benefits. A company with high gearing will find further borrowing difficult and
expensive. In extreme cases high gearing may breach debt covenants. It is therefore beneficial
to the company and its shareholders to reduce gearing in these circumstances.
(b)
Principles of substance over form
(i)
PL
E
Accounting standards and corporate laws have to be written in “form” which describes the issues
and defines accounting treatments for particular topics. In addition to the legal form, they often
have a spirit or “substance”. The IASB believes that in order for financial statements to
represent faithfully that which they purport to represent, accounting transactions should be
recorded by reflecting their substance or economic reality whether or not it this is also the legal
form of the transaction. The substance of a transaction is not always easy to determine, for
guidance it is necessary to look at which parties to the transaction bear the substantial risks and
rewards relating to it.
Group accounting
There are several areas of current group accounting regulations that are based on the concept of
substance:
probably the most important is that the definition of a subsidiary (IFRS 10) is based on
control rather than purely ownership. Where an entity is controlled by another, then
the controlling entity can ensure that the benefits accrue to itself and not to other
parties.

IFRS 3 Business Combinations states that a business combination must be accounted
for as an acquisition using acquisition accounting and the results of the combining
entities amalgamated as if they were one.
(ii)
Financing non-current assets
M

SA
The most common example of the application of the principle of substance over form in relation
to the financing of non-current assets is in the area of leasing (IAS 17 Leases). In the legal form
the hirer of an asset (lessee) under a lease does not own the asset until an option to purchase is
exercised. Where this occurs, it is normally at the end of the agreement. In some countries the
definition of a lease specifically prevents ownership from passing to the lessee. Regardless of
the legal position, IAS 17 states that where a lease “transfers substantially all the risks and
rewards incident to ownership” the asset must be included on the lessee’s statement of financial
position as a finance-leased asset, as too must the leasing obligation. This is despite the fact that
the lessee does not currently, or may even never, legally own the asset.
Sometimes an entity may sell a non-current asset that it owns to a finance house and lease it back
for use in the business. If the essence of the lease is that it is a finance lease, then the asset is
effectively treated as not having been sold and the transaction is treated as a secured loan.
1012
(iii)
Measurement and disclosure of current assets
PL
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Factoring of trade receivables is an area where close attention must be paid to the substance of
the arrangements. When trade receivables are “sold” to a factor, often a finance house, the
substance is usually determined by examining which party will bear the risk of no or slow
collection. If the trade receivables are sold without recourse this would mean the finance house
must bear the cost of the bad debts. As such this would be a genuine sale and the trade
receivables would be removed from the seller’s statement of financial position. If the
receivables are sold “with recourse” then the seller must bear the expense of bad debts. In this
case the “sale” is simply a financing arrangement and the proceeds of the “sale” should be shown
as a liability. The above is a simplification of what in practice are often very complex
arrangements.
Another common example in relation to the current assets is the sale and repurchase of
inventories. Where a company deals in maturing inventories, then, whilst they are maturing, it
may sell these inventories to a finance house with an option to repurchase them at some future
date. The repurchase price will be designed to repay the original “sale proceeds” and give the
finance house a return on funds lent to the seller. The inventories are not likely to leave the
premises of the seller. Clearly this is a financing arrangement, not a commercial sale, and should
be treated as such.
Answer 7 MESON
(a)
Revenue recognition
M
Accounting is based on the accruals concept, whereby costs are matched with the income they
generate. Under this convention it is important to decide exactly when revenue may be
recognised so that the appropriate costs may be matched to it. For example, costs of producing
goods are carried as an asset (inventory) until sold – the point at which a sale takes place must
therefore be established.
IAS 18 Revenue considers the criteria for revenue recognition. It states that a transaction
involving the sale of goods should generally be “achieved” when:
the seller of goods has transferred to the buyer the significant risks and rewards of
ownership, significant acts have been completed and the seller retains no managerial
involvement/effective control over the goods; and
SA


no significant uncertainty exists regarding the consideration to be paid, costs in
producing/purchasing the goods and the extent to which goods may be returned.
Generally the criteria will be satisfied when:

the product or service has been provided to the buyer;

the buyer has recognised the liability to pay for the goods or services, and the seller has
recognised that ownership of goods has passed to the buyer;

the buyer has made clear a willingness to settle the liability;

the monetary value of the goods or services has been established.
Prior to these criteria having been met, there may be no guarantee that the product will be
produced without flaw, or that, if perfect, a buyer will be found.
1013
Should recognition be delayed until later in the business cycle (e.g. until receipt of cash) the
accruals concept may not be followed.
IASB’s Conceptual Framework for Financial Reporting, considers the incorporation of items
into primary financial statements. In essence, to be recognised, an item must meet the definition
of an element of the financial statements, be reliably measured in monetary amount and there
must be sufficient evidence that the change in assets or liabilities inherent in the item has
occurred. Before recognising a gain it must be earned (i.e. “completed”) and realised (i.e.
existence and amount is well evidenced).
Memorandum
To:
From:
Date:
Subject:
The directors of Meson
A.N. Accountant
5 May 2013
Accounting for revenue in Meson
PL
E
(b)
Find enclosed a list of considerations to be taken into account in determining a policy for
accounting for revenue from Meson’s business activities.
(i)
General considerations for revenue recognition
M
International accounting standard (IAS18) adopts what is known as the critical event approach to
revenue recognition when dealing with sale of goods and the rendering of services. What this
essentially requires is sales are not recognised until such time as all significant risks and rewards
of ownership have transferred from the seller to the buyer and that all uncertainties regarding the
earnings cycle have been removed. This approach is an application of prudence whereby
revenues are not recognised until they are reasonably certain. The standard gives criteria, set out
below, which determine when these two critical events have taken place.
Transfer of risks and rewards of ownership
All significant acts of performance have been completed by the seller.

All effective control or managerial involvement in the goods is relinquished by the
seller.
SA


The payment of the debt does not depend on the buyer deriving revenue from the sale
of goods.
Removal of uncertainties
The standard states that recognition should be deferred until uncertainties in respect of the
following have been removed:


the collection of the debt;
the extent to which the goods may be returned.
Therefore it is necessary to establish at which point in the earnings cycle both significant risks
and rewards of ownership pass to the buyer and any significant uncertainties are removed.
1014
(ii)
Design and sale of software and the retailing of hardware
The first conditions to consider are the phases of Meson’s sales cycle which will vary depending
on whether the software is “off-the shelf” (customised or standard) or else made to order.
Bespoke software to order




Customer orders software.
Meson develops software (and receives stage payments).
Customer takes delivery of software (and makes final payments).
Meson provides maintenance service.
PL
E
The key decision making criteria will be as follows:

At which point in the cycle does ownership pass and are all uncertainties removed.

If it is once the product has been developed and accepted by the customer the point of
delivery will represent the critical event for revenue recognition.
Due to the fact that Meson is developing software to customer order it may be appropriate to
depart from the above critical event approach and instead adopt what is known as the accretion
approach whereby revenue is recognised during the period of development, rather than when the
product is complete. This approach would be allowed if the development of the software met the
conditions found in IAS 11 Construction Contracts. Essentially this would require the
following:


an irrevocable contract;
certain profit on the contract overall.
M
If these conditions were satisfied then the revenue could be recognised on a percentage
completion basis (i.e. if a development was say 60% complete at the end of the reporting period
then 60% of the total contract price could be recognised as revenue and matched against 60% of
the costs expected to be incurred).

The existence of after sales maintenance costs present additional considerations.
SA
If the sales price includes an amount to cover maintenance costs then this portion should be
deferred and matched against the provision of that service.
Off the shelf




Software is developed.
Customer orders software.
Customer takes delivery of software.
Customer makes payment for software.
The key point in the cycle is at what point has Meson performed its duties and receipt of cash is
certain.
This will normally occur at the point of delivery unless:
(i)
(ii)
There are doubts as to the collectability of the debt.
The goods are held on a “trial” period.
1015
In which case, recognition would be deferred until the latter of those dates, as until this point
uncertainties still exist.
Retailing of hardware
The critical point for sale of hardware will be when Meson has transferred ownership to the
customer (per the criteria in (a) above) and has made the product available to the customer by
delivering to their premises or by collection. Again, consideration needs to be given to:
(i)
(ii)
doubts as to the collectability of the debt;
whether any right of return is possible during a probationary period.
(c)
PL
E
Again, existence of (i) or (ii) will defer recognition until that date.
Retail shop licensing operation
Up front license fee
Based on the observations of Meson’s software operations the company should not recognise the
license fee until such time as the services to which it relates have been performed by Meson and
as a result no uncertainty exists as to the collectability or non-repayment of the fees.
Essentially the fee could cover the following:
(i)
(ii)
the initial costs of setting up a shop (including a proportion of advertising spend);
a fee for the licensing rights.
M
The amount of the license fee relating to (i) above should be recognised as soon as Meson has
provided all services necessary for the shop to commence operations.
The proportion of the license fee relating to the licensing rights may also be recognised
immediately if the following conditions are satisfied:
Meson has performed all of its duties under the franchise agreement.
The licensee has no cancellation rights.
The regular fees are sufficient to cover the cost of providing the on-going licensing
service.
SA
(a)
(b)
(c)
Revenue recognition should be deferred until the completion of (a) and (b) and if (c) is not
satisfied then a proportion should be deferred and matched against the cost of providing
licensing services (i.e. know how, advertising, administrative costs).
Regular fees

Should be recognised in the period that they fall due (i.e. at the end of the period in
which the licensee made the sale).
Sale of software and hardware

1016
Should be recognised once the goods have been delivered to the licensee.
Answer 8 REVENUE RECOGNITION
(a)
Revenue recognition at stages in operating cycle
Obtaining an order prior to manufacture
This would be an unlikely place for the critical event to occur. Obtaining an order for a large or
long-term construction contract is often very important and gives some measure of reassurance in
matters such as employment security and even going concern. However as there would be so
much uncertainty involved with regard to the final outcome of such contracts it would not be
prudent to recognise income or profit at this point.
PL
E
Acquisition of goods or raw materials
For most industries this event is a routine occurrence that could not be considered critical.
However where this is a very difficult task, perhaps due to the rarity or scarcity of materials, then
it may be critical. A rare practical example of this is in the extraction of precious metals or gems
(e.g. gold and diamond mining). Because gold is a valuable and readily marketable commodity
the real difficulty in deriving income from it is obtaining it, thus this becomes the critical event
in such circumstances.
Production of goods
M
Again for most industries this is routine and not critical. There are some industries where, due to
a long production period, income is recognised during the production or manufacturing period.
The most common example of this is the treatment of long-term construction contracts under IAS
11 Construction Contracts. A less well known example of this “accretion approach” is found
where natural growth occurs such as in the growing of timber: In this industry market prices are
available at various stages of growth and income may be recognised at these stages.
Obtaining an order for goods that are in inventory
SA
This is getting near to the point when most of the uncertainties in the cycle have either been
resolved or are reasonably determinable. The sales/marketing department of a company would
probably consider this as the critical event; however, recognition is usually delayed until
delivery.
Delivery/acceptance of the goods
For the vast majority of businesses this is the point at which income is recognised, and it usually
coincides with the transfer of the legal title to the goods. There are still some uncertainties at
this point. For example, the goods may be faulty or the customer may not be able to pay for
them. However past experience can be used to quantify and accrue for these possibilities with
reasonable accuracy. Occasionally goods are delivered subject to a “reservation of title” clause;
however, this is usually ignored for the purpose of revenue recognition.
Collection of cash
With the obvious exception of cash sales, IAS 18 Revenue says revenue recognition should only
be delayed to this point if collection is perceived to be uncertain, particularly difficult or risky.
Income (and profits) from high risk credit sale agreements may be one example of this, another
possibility is sales made to overseas customers where the foreign government takes a long time
to grant permission to remit the consideration. Particular problems may also arise when dealing
with countries that have non-convertible currencies.
1017
After sales service or warranties
This serves as a reminder that not all the risks and associated costs are resolved when cash is
received. For some products such costs can be significant (e.g. in the supply of new motor
vehicles or rectification work on construction contracts) however it is normally possible to
estimate these costs and provide for them at the time of the sale. Unless the obligations go
beyond normal warranty provisions, it would be unrealistic, and may cause distortions, if income
was not recognised until such obligations had elapsed (IAS 18).
(b)
Framework criteria
PL
E
The Framework approaches income and expense recognition from a balance sheet perspective.
The definition of income encompasses both revenue and other gains, whilst that of expense
includes losses. Recognition of gains and losses takes place when there is an increase or
decrease in equity other than from contributions to, or withdrawals of, capital. Thus increases in
economic benefits in the form of inflows or enhancements of assets or decreases in liabilities
result in income or gains; and decreases in assets or increases in liabilities results in expenses or
losses.
The above definitions identify the essential features of assets and liabilities, but they do not
attempt to specify the criteria that need to be met before they are recognised. Recognition is the
process of incorporating in the financial statements an item that meets the definition of an
element (e.g. an asset or a gain). It involves both a description in words and an assignment of a
monetary amount. An item meeting the definition should be recognised if:

it is probable that any future economic benefit associated with the item will flow to or
from the entity; and

the item has a cost or value that can be measured (in monetary terms) with reliability.
(c)
M
The above are generally regarded as tests of realisation or of being earned. Failure to recognise
such items in the financial statements is not rectified by disclosures in the notes or explanatory
material. However such treatment may be appropriate for elements meeting the definitions of an
item, but not its recognition criteria (e.g. a contingency).
Telecast industries
Warmer Cinemas
SA
(i)
Although the “performance” side of this contract is complete from Telecast Industries’ point of
view, the income is only earned as the film is shown. Therefore Telecast Industries should
accrue for 15% of Warmer Cinemas box office revenues from this film for the period 1 July
2012 to the year-end of 30 September 2012. The only problems here would be prompt access to
the relevant information from Warmer Cinemas and the possibility, which is probably remote, of
a bad debt.
(ii)
Big Screen
In this case the income is a fixed fee and not dependent on any future performance from either
party to the contract. Therefore, applying the criteria in the Framework and IAS 18, Telecast
Industries should recognise the whole of the $10,000 in the current year even though some of the
screenings may take place after the year-end.
1018
(iii)
Global satellite
A traditional view of this contract may be that $4 million has been paid by Global Satellite to
screen the film 10 times and Telecast Industries should therefore recognise $400,000 each time
the film is screened. If this were the case it would mean that no income would be recognised in
the current year. However if the IASB’s principles described above are considered:
the film is complete and the rights to it are owned by Telecast Industries; – a contract
has been signed;

the consideration has been received; and

Telecast Industries have no significant future obligations to perform.
PL
E

This would appear to meet all of the criteria for income recognition and thus the whole of the $4
million should be recognised in the current year.
Answer 9 MELD
Extracts from the financial statements for the year ended 30 June 2013
(i)
Profit or loss
Revenue
Cost of sales and expenses (W)
Operating profit
Interest payable and similar charges
M
Profit before taxation
Tax
Profit for the financial year
(ii)
$
472,800
(360,676)
———–
112,124
(15,000)
———–
97,124
(28,800)
———
68,324
———
Statement of other comprehensive income
SA
Profit for the financial year
Unrealised surplus on revaluation of non-current assets
(28,800 – (19,200 – 7,200))
Total recognised gains and losses relating to the year
1019
$
68,324
16,800
———
85,124
———
(iii)
Statement of changes in equity
Share
capital
$
At 1 July 2012
As previously stated
Prior year adjustment
At 30 June 2013
WORKING
–
Retained
earnings
$
Total
$
48,000
–
———
48,000
168,000
(14,400)
———–
153,600
216,000
(14,400)
———–
201,600
16,800
68,324
(21,600)
3,360
———–
203,684
———–
85,124
(21,600)
–
———–
265,124
———–
PL
E
As restated
Comprehensive income
for the year
Dividend
Transfer of realised profits
240,000
–
———
240,000
Revaluation
reserve
$
–
———
240,000
———
(3,360)
———
61,440
———
Cost of sales and expenses
M
Per question
Interest reclassified
Goodwill written off
Change of accounting policy re development costs
Amortisation
Expenditure incurred
$
376,800
(15,000)
576
(4,800)
3,100
———–
360,676
———–
Answer 10 KEY CHANGES
(a)
Calculation of profit or loss on disposal
SA
The profit or loss on the disposal of an asset is calculated as the difference between the net sale
proceeds and the net carrying amount, whether carried at historical cost (less any write downs) or
at valuation. The reason for this approach to determining the profit or loss on the disposal of an
asset lies in the balance sheet approach to the recognition of gains and losses set out in the IASB
Framework document. The IASB defines gains and losses as being increases and decreases in
equity (other than dividends and new share issues). Consequently once an asset has been
revalued in the statement of financial position, any subsequent transactions must be based on this
value.
1020
(b)
Criteria
(i)
Recognition
For an item to be recognised in the financial statements it must meet certain criteria. These
criteria are that the item must meet the definition of an element of the financial statements and
fulfil the following criteria:
it is probable that any future economic benefit associated with the item will flow to or
from the entity;

the item can be measured reliably.
PL
E

Thus, before an item can appear in the statement of comprehensive income it must meet the
definition of a “gain” or a “loss”. Also a transaction or event must have occurred which has
resulted in a gain or loss, and this transaction must be capable of measurement. Where a change
in assets is not offset by an equal change in liabilities a gain or loss will result, (unless the
change relates to the owners of the entity).
(ii)
Which component
Gains or losses should be recognised in the statement of comprehensive income. Gains which
are earned and realised are recognised in the profit or loss section whilst gains which are earned
but not realised are recognised in other comprehensive income. Examples of items that are
recognised in other comprehensive income are:
revaluation gains or losses on non-current assets;
gains or losses on financial assets at fair value through other comprehensive income;
certain foreign exchange differences, as identified in IAS 21.
M



The same gains and losses should not be recognised twice. A revaluation gain on a non-current
asset should not be recognised a second time when the asset is sold. This latter point explains
the logic of the definition set out in part (b) of the answer.
SA
For a gain to be earned there must be no material event to be performed. For example, the
performance under a contract must have been completed. For a gain to be realised, a transaction
which is measurable must have occurred, or a “capital” item (e.g. non-current asset or debenture)
must have been sold/redeemed resulting in cash or cash equivalents, or a liability must have
ceased to exist.
Those gains and losses relating to the exchanges differences will be reclassified through profit or
loss when the related asset is disposed of, this means that a gain will be recognised in profit or
loss for the period with a corresponding reduction in other comprehensive income. The
revaluation surplus on non-current assets cannot be reclassified but the surplus can be transferred
to retained earnings, this would be done through the statement of changes in equity. Also the
cumulative gain on financial assets at fair value through other comprehensive income is not
reclassified under IFRS 9, although the previous standard, IAS 39, did require reclassification of
similar financial assets.
The statement of changes in equity will include the impact of changes in accounting policy and
prior period errors, in accordance with IAS 8, and it will also include transactions with owners
such as a dividend distribution or the issue of new shares.
1021
Answer 11 XYZ
(a)
Statement of Financial Position after reconstruction
$m
Non-current assets
Current assets
Total assets
11.2
PL
E
Capital and reserves
Issued share capital
Capital contribution
Less capital reserve
10
(4.2)
–––––
Non-current liabilities (note vi)
Current liabilities
(1)
Capital reduction
$m
32
2
0.8
8
5.5
1.5
3
––––––
52.8
SA
M
Ordinary shares of $1
Preferred shares dividend
Outside shareholders holding of ordinary shares
Directors’ loans
Family preferred shares
Preferred shares redeemed – balance
Loan stock balance
Less:
Outside shareholders holding converted to preferred shares (4m × 0.5)
Net assets written down
– intangible
– tangible
– current assets
Increase in current liabilities
Accumulated losses
Balance
1022
5.8
–––––
17
52
41
–––––
110
–––––
Total equity and liabilities
WORKINGS
$m
40
70
–––––
110
–––––
(2)
(15)
(5)
(5)
(9)
(21)
––––––
57
––––––
(4.2)
––––––
(2)
Ordinary shares
Opening balance
Less
Reduction to 20c shares
Outside shareholders offered preferred shares
Add shares issued for cash
Redeemable preferred shares
Opening balance
Less
Capital reduction – family shares
Preferred shares redeemed – cash
Outside preferred shares cap. reduction
Closing balance
(4)
M
SA
Less:
preferred shares (5m at 80c)
Loan stock at par
(5.5)
(4)
(1.5)
––––––
0
––––––
(5)
4
25
25
10
––––––
59
(4)
(35)
––––––
20
––––––
Current liabilities
Balance
Fair value adjustment
Directors’ loans
Bank overdraft
Arrears of preferred dividend
(6)
$m
11
Cash (overdraft)
Opening balance
Cash from ordinary shares
Loan stock proceeds
– bank
– family
Capital contribution – PQ
(5)
(32)
(0.8)
4
––––––
11.2
––––––
PL
E
(3)
$m
40
47
9
(8)
(5)
(2)
––––––
41
––––––
Non-current liabilities
Non-current liabilities comprise the two issues of loan stock $50m and the new preferred stock
$2m i.e. $52m.
1023
(b)
Fairness of the scheme
The proposed capital reduction scheme has a different impact depending on the nature of the
relationship with XYZ.
Preferred shareholders (outside)
PL
E
At present the preferred shareholders are not receiving payment of dividends although if the
profit forecast is accurate, then dividends may become payable in several years’ time. There is
no asset backing for the preferred shareholders as the creditors will require payment before any
excess is paid to the preferred shareholders and given the fair values of the assets, this seems to
be unlikely. Thus a payment of 80c per share seems to be quite acceptable in the light of the
above comments.
8% Unsecured loan stock
The future cover for loan interest will be
$8 million
= 2.86
$2.8 million
This cover is reasonably satisfactory but is dependent on future profits being earned. Similarly
the asset cover for the loan stock is quite poor as the loan stock is unsecured and would rank
alongside the other creditors in the event of liquidation.
Historic
Fair value
$m
$m
Total assets (excluding intangible)
100
90
Total liabilities
85
95
Cover
1.25
0.95
M
Thus when the asset cover is based on fair values there are not sufficient assets to cover the loan
stock and current liabilities. Additionally some of the short-term current liabilities (tax, wages)
may rank for priority of repayment before the loan stockholders. Thus an offer of redemption at
par value without any premium would seem to be acceptable.
Non-controlling interest (10%) – ordinary shares
SA
There will be no asset backing for the ordinary shares and possible future earnings without the
reconstruction scheme would be:
$m
Profit before tax and interest
8
Less: loan stock interest
(2.8)
––––
5.2
Less: taxation (at 30%)
(1.6)
––––
3.6
Less: preferred dividend
1.0
––––
2.6
––––
Earnings per share (40 million shares)
6.5c
––––
1024
However the debit balance on the accumulated reserves is likely to have to be eliminated before
any dividends are paid and together with the lack of asset backing, the non-controlling interest
are unlikely to object to the scheme especially as there are conversion rights attached to the
preferred shares and the fact that the preferred shares are cumulative.
Majority shareholding
PL
E
These persons are subscribing the additional risk capital. The control of the company is likely to
change.
Before scheme
After scheme
Shares
%
Shares
%
(m)
(m)
Family
34
85
7.8
70
5
3.4
30
PQ
2
Others
4
10
–
–
–––
–––
–––
–––
40
100
11.2
100
–––
–––
–––
–––
Although the family still maintains control, PQ now has a substantial interest in the company and
is likely to want representation on the board of directors. Additionally the family is loaning the
company $12.5 million without any security and similarly PQ is giving the company a capital
contribution of $10 million and loaning the company $12.5 million without security. The family
and PQ are receiving a higher rate of interest than the merchant bank because of a lack of
security on the loans.
M
The forecast profit for the future based on the projected profit would be
Profit before interest and tax
Less loan stock interest (2,500 + 2,000)
SA
Less taxation 30%
Less preferred dividend
Available for ordinary shareholders
Capital invested
Return on capital invested
2013
$000
8,000
(4,500)
––––––
3,500
(1,050)
––––––
2,450
(140)
––––––
2,310
––––––
11,200
20.6%
2014
$000
10,000
(4,500)
––––––
5,500
(1,650)
––––––
3,850
(140)
––––––
3,710
––––––
33.1%
2015
$000
12,500
(4,500)
––––––
8,000
(2,400)
––––––
5,600
(140)
––––––
5,460
––––––
48.8%
Thus if the projected profit is accurate, then the return on capital invested is good. PQ must
presumably be looking to take over the company, particularly as it has been prepared to make a
capital contribution without any interest. (In PQs books this contribution will be included in the
–cost of the investment– in XYZ) It appears therefore that the scheme will be acceptable to all
parties including the merchant bank which is providing a secured loan. The scheme also
provides sufficient working capital for the maintenance of operations.
1025
Answer 12 HAMILTON
(a)
Change in accounting policy
IAS 40 requires that all investment properties be measured at cost at initial recognition.
An entity with an investment property then has a policy choice for subsequent measurement.
Investment properties must be carried using either the “fair value model” or the “cost model” as
described in the standard. Hamilton appears to be using the fair value model. Under this model
the carrying value of the property is its fair value at each year-end. Any changes in fair value are
taken to profit or loss.
PL
E
Tutorial note: This process is known as “marking to market”.
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors advocates that in order
for financial statements to be comparable over a period of time the consistent application of
accounting policies is important. However there are circumstances where the principle of
consistency should be departed from:

a new accounting standard may render a previous accounting policy no longer
appropriate/acceptable; or

if the change will result in a more appropriate presentation of events and transactions
leading to more relevant and reliable financial statements.
(b)
M
In this case Hamilton has proposed a change in policy. The only grounds for this change are that
the new policy will result in a fairer presentation. However this is unlikely to be the case in the
circumstances described. The motivation of the directors seems to be to protect the statement of
comprehensive income from adverse movements rather than to achieve fairer presentation.
Reasons and effect
From the information in the question it seems that the future fall in the value of the property is
prompting the change in policy. Because the company is carrying the property as an investment
at its market value, any fall in the market value must be recognised.
SA
However, if the property was classified as property under IAS 16 then, although the asset must
be depreciated, it need only be written down if its value is impaired. Thus the directors of
Hamilton may be intending to avoid a write down against profits on the basis that the fall in the
market value is not a decline in the recoverable amount of the properly. The directors may
expect the market value to recover in the future, or that the value in use (based on receipt of
rental income) of the asset has not fallen below the carrying value. Thus a change in accounting
policy would avoid reporting a loss in the year to 31 March 2013.
The effect on the financial statements would be:
Fair value model
The retained profit at the start of year ended 31 March 2012 should be $310,000 if the property is
accounted for using the fair value model. This is $110,000 plus the surplus on the property
($3.2m – 3.0m).
1026
Assuming the properly had fallen in value by 25% this would mean a fall of $900,000 (25% of
$3.6m) in the year to 31 March 2013. This should be charged to profit or loss as shown below:
Profit or loss;
Profit before revaluation profit (loss)
Revaluation surplus (loss) on investment
Profit (Loss) for year
Retained profit b/f
$000
2012
200
400
–––––
600
310
–––––
910
–––––
2,700
–––––
190
–––––
3,600
–––––
910
–––––
PL
E
Retained profit c/f
$000
2013
180
(900)
–––––
(720)
910
–––––
190
–––––
Statement of financial position:
Investment property (3,600 – 900)
Retained profit
Change in accounting policy to cost model
IAS 8’s treatment of a change in accounting policy is to prepare the financial statements as if the
new policy had always existed. This involves restating the comparative accounts, and the
retained profits b/f in the comparative accounts:
M
Profit or loss:
Profit before depreciation (per question)
Depreciation
Profit for year
Retained profit b/f
Prior period adjustment (2011 depreciation)
2013
180
(120)
–––––
60
70
–
Restated loss b/f
SA
Retained (restated) profit c/f
Statement of financial position:
Property, plant and equipment at cost
Accumulated depreciation
Retained profits
1027
2012
200
(120)
–––––
80
110
(120)
____
–––––
130
–––––
(10)
–––––
70
–––––
3,000
(360)
–––––
2,640
–––––
130
–––––
3,000
(240)
–––––
2,760
–––––
70
–––––
Answer 13 FAM
Accounting policies
(a)
Property, plant and equipment is stated at historical cost less depreciation, or at valuation.
(b)
Depreciation is provided on all assets, except land, and is calculated to write down the cost or
valuation over the estimated useful life of the asset.
The principal rates are as follows.
2% pa straight line
20% pa straight line
25% pa reducing balance
PL
E
Buildings
Plant and machinery
Fixtures and fittings
Non-current asset movements
Cost/valuation
Cost at 1 January 2012
Revaluation adjustment
Additions
Transfers
Disposals
Plant
and
machinery
$000
900
600
–
100
–
———
100
1,500
———
$000
1,613
–
154
–
(277)
———
1,490
$000
390
–
40
–
(41)
——
389
———
——
M
Cost at 31 December 2012
2012 valuation
Land
and
buildings
Depreciation
At 1 January 2012
Revaluation adjustment
Provisions for year (W2)
Disposals
SA
At 31 December 2012
Carrying amount
At 31 December 2012
At 31 December 2011
80
(80)
17
–
——
17
——
1,583
———
820
———
458
–
298
(195)
——
561
——
929
———
1,155
———
Fixtures,
fittings,
tools and
equipment
Payments on
account and
assets in the
Total
course of
construction
$000
$000
91
2,994
–
600
73 (W1)
267
(100)
–
–
(318)
——
———
64
2,043
1,500
——
———
140
–
70
(31)
——
179
——
–
–
–
–
——
–
——
210
——
250
——
64
——
91
——
678
(80)
385
(226)
——
757
——
2,786
———
2,316
———
Land and buildings have been revalued during the year by Messrs Jackson & Co on the basis of an existing
use value on the open market.
1028
The corresponding historical cost information is as follows.
Land and buildings
$000
Cost
Brought forward
Reclassification
900
100
———
1,000
———
Carried forward
Carried forward
Carrying amount
WORKINGS
(1)
80
10
———
90
———
PL
E
Depreciation
Brought forward
Provided in year
910
———
$000
53
20
——
73
——
Additions to assets under construction
Deposit on computer
$000
M
(2)
600
Depreciation on buildings
+ (100  2%)
40
2% straight line depreciation is equivalent to a 50 year life.
The buildings are ten years old at valuation and therefore
have 40 years remaining.
SA
Depreciation on plant (1,613 + 154 – 277)  20%
Depreciation on fixtures (390 + 40 – 41 – 140 + 31)  25%
17
298
70
Answer 14 SPONGER
To
From
Date
MEMORANDUM
Philip Tislid, Sponger
Bill Smith, Accountant
27 January 2013
Subject Accounting for government assistance received by Sponger
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance requires that no
grant should be recognised until there is reasonable assurance that the enterprise will comply with the
conditions attaching to them and that the grants will actually be received. The IAS covers forgivable
loans and non-monetary grants.
1029
(a)
Research and development grants
The general principle of IAS 20 is that grants should be matched in the profit or loss with the
expenditure to which they are intended to contribute. They should not be credited directly to
shareholders interests.
Cuckoo project
Hairspray project
PL
E
The expenditure on the Cuckoo project is research and therefore is written off as incurred
under IAS 38 Intangible Assets. Accordingly the grant of $10,000 should be credited to profit
or loss in the years in which the expenditure to which it relates is incurred.
The Hairspray project appears to satisfy the criteria of IAS 38 for deferral of development
expenditure, and thus may be carried forward as an intangible asset until commercial
production commences (2014). It will then be amortised to profit or loss over the period of
successful production. Technological and economic obsolescence create uncertainties that
restrict the time period over which development costs should be amortised.
As the project is not yet fully completed the costs that have been capitalised as an intangible
asset will be tested for impairment at each period end.
The grant of $10,000 relating to it will therefore also be carried forward as deferred income,
and will be released to profit or loss in line with the amortisation of the development
expenditure. The balance of $10,000 will appear in the statement of financial position at 31
December 2012 under current and non-current liabilities as appropriate.
Grants relating to assets can either be:
–
deducted from the carrying amount of the asset (i.e. being recognised over the
useful life of the asset by means of a reduced depreciation charge).
M
set up as deferred income and recognised in profit or loss over the useful life of the
asset (to match the depreciation charge), or
Compensation grant
SA
(b)
–
IAS 20 states that grants receivable as compensation for expenses or losses already incurred
should be recognised as income when they become receivable. They cannot be taken back to
prior periods, as their receipt does not constitute correction of a prior period error or a change
in accounting policy.
However, in order to apply the prudence concept, the standard requires grants not to be
recognised until conditions for receipt have been satisfied and receipt is reasonably assured.
In this situation the conditions for receipt, namely filling out the triplicate form, have not been
fully satisfied and therefore the grant should not be recognised in the accounts at 31
December 2012.
1030
(c)
“Vocational experience” grants
(i)
General accounting
This grant relates not to specific expenditure but to a non-financial objective.
The terms of the grant suggest that it is effectively earned at a rate of $1,000 per visit,
and therefore it should be credited to income at that rate. In the year to 31 December
2012 the credit will be $7,000. Amounts to be recognised in future periods will be
carried forward as deferred income.
(ii)
PL
E
The grant is not spread over the life of the bus as it does not specifically contribute to
its cost.
Repayments
A repayment of $5,000 is due relating to unfulfilled visits in the current year and
should be provided for. However, as this is expected to recur in each of the next four
years, provision also needs to be made in total for repayments relating to twenty further
unfulfilled visits.
A contingent liability should be disclosed relating to the potential repayment of the
grant relevant to the visits in future periods which are expected to take place.
(iii)
Amounts for the financial statements
Statement of comprehensive income
$
7,000
Grants received (7  $1,000)
M
Statement of financial position
$
7,000
21,000
Current liabilities (1  7  $1,000)
Non-current liabilities (3  7  $1,000)
Provision for grant repayment (5  5  $1,000)
25,000
SA
Note to the financial statements
There is a contingent liability in respect of potentially repayable government grants of
$28,000.
Answer 15 MOORE
Costs incurred in the 3 months to 31 March 2012
Dr
Dr
Dr
$m
1.7
Asset under construction
Cr
Cash/Creditors
1.7
Cr
Cash/Creditors
0.3
Cr
Interest expense
0.43
$m
0.3
0.43
1031
WORKING
Outstanding borrowings
Interest for 3 months
$18m
$18m × 3/12 × 9.5% = 0.43m
Accumulated costs at the date of transfer into investment properties
$m
18.6
2.43
Investment property at cost
21.03
Dr
PL
E
Costs to 31 December 2011 (14.8 + 2.5 + 1.3)
Costs to 31 March 2012 (1.7 + 0.3 + 0.43)
$m
3.97
Investment property
Cr
Profit or loss
$m
3.97
Being the increase from cost to fair value on completion of the property.
Tutorial note: The receipt of the professional valuation at 31 March 2012 has not improved the
profit earning potential of the asset. The valuation itself is also irrelevant since IAS 40 states
that initial recognition should be at cost.
At 31 December 2012
Dr
Investment property
Cr
Profit or loss
(28 – 24)
$m
4
$m
4
M
Being the increase in fair value following first subsequent re-measurement.
Answer 16 HEYWOOD
(a)
Recognition criteria
IAS 38 Intangible Assets requires that an intangible asset should only be recognised if:
it is probable that future economic benefits specifically attributable to the asset will
flow to the entity; and

the cost of the asset can be measured reliably.
SA

The recognition and initial measurement of intangible assets is considered in the following
circumstances:
As separate acquisitions
This is where an intangible asset is purchased separate to any accompanying assets. This is the
most straightforward circumstance and there are no particular difficulties in describing and
recognising the asset. There may be some complications in determining the purchase
consideration for the intangible asset if it is in the form of shares or other non-cash
consideration. However in most circumstances it is usually readily determinable and is often in
cash. Examples of this type of acquisition would be the purchase of the copyright to a song or
book, or some computer software.
1032
As part of a business combination
PL
E
Here the situation is more complex. In an acquisition, the acquiring company will usually obtain
all of the net assets of the acquired company for an amount of purchase consideration. The basic
principle in IFRS 3 Business Combinations is that all assets, including intangibles, should be
recorded at their fair values at the date of acquisition. It is often difficult to determine whether
the fair value of an intangible asset can be measured with sufficient reliability for the purpose of
separate recognition. If there is a separate and active market in the intangible asset this could be
used to determine its fair value. However for most intangibles there cannot be an active market
as the intangible will be unique (e.g. a brand name) and a condition for an active market is that
the assets are homogeneous. Another possible method of estimating the cost of an intangible is
to discount the net future cash flows attributable to it. The problem with this approach is that it
is rare for cash flows to be attributable to a single asset; they are usually earned from assets in
combination (tangible and intangible). Thus, while it may be possible to identify separate
intangibles as part of an acquisition, it is often difficult to reliably attach a cost or fair value to
them. In these circumstances such intangible assets cannot be separately recognised and will be
included in goodwill.
Internally generated goodwill
M
There is no doubt that internally generated goodwill and other intangibles exist (e.g. a brand
name), but in order for them to be recognised a cost would have to be placed on them. This is
difficult. In the past costs such as advertising and even staff training have been suggested as
examples forming part of the cost of internal goodwill. Alternatively the difference between the
market value of a business as a whole, often based on a total market capitalisation figure, and the
carrying value of its identifiable assets could be considered to be a measure of the internal
goodwill of the business. However this value could fluctuate greatly in a short space of time and
cannot be considered as the “cost” of the goodwill. IAS 38 does not consider that any of these
methods can be used to reliably measure internal goodwill and therefore concludes that it cannot
be recognised.
Granted intangible assets
SA
An intangible asset may be acquired from a government or other third party for a nominal fee or
even for free. An example of this may be aircraft landing rights. If an active market, as
described above, exists for such rights, this may be used to determine its fair value. This is likely
to be rare. In the absence of an active market the cost (which may be zero) together with any
expenses that are directly attributable to preparing the asset for use will be the carrying amount
on initial recognition of the asset.
1033
(b)
Fast Trak
$m
Net tangible assets
Intangible assets – fishing quota
– brand
– Licence
– goodwill
Net assets/purchase consideration
64
16
12
9
19
–––
56
–––
120
–––
PL
E
Notes:
Purchase consideration:
shares 20 million $4
cash
loan note 25 million $0·60
$m
80
25
15
–––
120
–––
IFRS 3 Business Combination requires intangible assets acquired as part of a business
combination to be recognised separately from goodwill. The standard requires that any
intangible that is identifiable, either through separation or contractually, and whose fair value is
identifiable at the date of acquisition will be recognised as a separate asset and not subsumed in
the value of goodwill.
Kleenwash
M
A brand, almost by definition, is unique; however IAS 38 says that where similar assets have
been bought recently this may be used as a basis for determining a “reliable” value. Presumably
this applies to brands.
Government licence
SA
Prior to IFRS 3 being revised in 2008 it is highly likely that this licence would not have been
recognised as an identifiable intangible asset, the licence would have been subsumed in the
goodwill value.
IFRS 3 states that an acquirer shall recognise, separately from goodwill, the identifiable
intangible assets acquired in a business combination. An intangible asset is identifiable if it
meets either the separability criterion or the contractual-legal criterion. In this situation the
licence is not capable of separation but has arisen due to a legal contract.
IFRS 3 requires the intangible to be recognised at its fair value. In this example the only value
we have is that of the $9 million arrived at by the directors. If this value can be justified, maybe
through future cash flows, then the licence can be recognised at this value. However, it is highly
likely that some form of external verification of the value should be sought before accepting the
director’s value.
The standard does also say that it is possible that the value of the licence and the asset to which it
relates (mine) could be recognised as a single asset for reporting purposes if the useful lives of
the two assets are similar.
1034
Fishing quota
This appears to satisfy the definition of an active market, therefore the fair value is 10,000 ×
$1,600 = $16 million. The quota may well be classed as an intangible asset with an indefinite
life as the quota is for an indefinite period of time. If this were the case the quota would be
capitalised and tested annually for impairment, the quota would not be amortised. If Heywood
followed the revaluation model for subsequent measurement then if the price per tonne were to
increase above $1,600 the asset would be revalued with any increase in value being recognised in
other comprehensive income.
Goodwill
PL
E
If the government were to impose a finite life on the quota then from that point in time the asset
would have a finite life and would be amortised over the life of the quota imposed by the
government.
This is the excess of the purchase consideration over the net tangible and separate intangible
assets.
(c)
Steamdays
IAS 36 Impairment of Assets says that an impairment loss for a cash-generating unit should be
recognised if its recoverable amount is less than its carrying amount. An impairment loss for a
cash-generating unit should be allocated in the following order:
(i)
(ii)
to the goodwill of the unit; then
to other asset on a pro rata basis, based on their carrying amounts.
M
In allocating an impairment loss as above, the carrying amount of an individual asset should not
be reduced to less than the highest of:
(i)
(ii)
(iii)
its fair value less costs to sell;
its value in use (if separately determinable); and
zero
SA
The IASB has concluded that there is no practical way to estimate the recoverable amount of
each individual asset (other than goodwill) as they all work together as a single unit. Nor do they
believe that the value of an intangible asset is necessarily more subjective than a tangible asset.
Assets:
1 July
$000
200
1,200
Goodwill
Operating licence
Property
– train stations
and land
300
Rail track and coaches
300
Steam engines
1,000
––––––
3,000
––––––
First
loss
$000
(200)
(200)
(50)
(50)
(500)
––––––
(1,000)
––––––
1035
Revised assets:
1 August
$000
nil
1,000
250
250
500
––––––
2,000
––––––
Second
loss
$000
(100)
(50)
(50)
––––––
(200)
––––––
Revised assets:
30 Sept
$000
nil
900
200
200
500
––––––
1,800
––––––
Notes:
The first impairment loss of $1 million:
$500,000 must be written off the engines as one of them no longer exists and is no
longer part of the cash-generating unit

the goodwill of $200,000 must be eliminated; and

the balance of $300,000 is allocated pro rata to the remaining net assets other than the
engine which must not be reduced to less than its fair value less costs to sell of
$500,000.
PL
E

The second impairment loss of $200,000:

the first $100,000 is applied to the licence to write it down to its fair value less costs to
sell;

the balance is applied pro rata to assets carried at other than their fair value less costs
to sells (i.e. $50,000 to both the property and the rail track and coaches).
Answer 17 DEFER
Tutorial note: The letter style in this answer seeks to apply the principles of IAS 38 rather than simply
regurgitate them.
Deferred development expenditure
M
Thank you for your enquiry in which you requested advice concerning the procedures which should be
introduced in order to identify the cost of an intangible asset arising from development and ensure
compliance with best accounting practice. My recommendations are based on IAS 38 Intangible Assets.
IAS 38 requires that development expenditure be recognised as an asset if, and only if, certain criteria are
demonstrated. Research costs, and development costs which do not meet all the criteria should be
recognised as an expense when they are incurred. Accordingly my recommendations are as follows.
Guidelines to distinguish research based activities from development activities
SA
IAS 38 defines development as the application of research findings (or other knowledge) to a plan or
design to produce new or substantially improved materials, products, processes, etc. Research is work
undertaken to gain new scientific or technical knowledge and understanding.
IAS 38 criteria for asset recognition are satisfied for identified development costs
These criteria, which must be demonstrated, are set out in the Standard. For example, there must be an
intention to complete and use or sell the intangible asset. If any of the criteria are not satisfied you must
write off the expenditure.
If, however, all the criteria are demonstrated, then the expenditure must be deferred (i.e. capitalised).
Amortisation period and method for development expenditure recognised as an asset
IAS 38 requires that an intangible asset should be amortised on a systematic basis over the best estimate of
useful life. In determining useful life, reference should be made to such factors as expected usage of the
asset, typical product life cycles, technical obsolescence and expected competition. Where there are rapid
changes in technology (e.g. computer software) useful life is likely to be very short.
1036
The straight-line method should be used unless another method better reflects the pattern in which the
asset’s economic benefits are consumed.
IAS 38 disclosure requirements
Useful lives or amortisation rates and amortisation methods.

Gross carrying amount and accumulated amortisation at beginning and end of period.

A reconciliation of the carrying amount at the beginning and end of the period showing additions, etc.

The aggregate amount of research and development expenditure recognised as an expense during
the period.
Answer 18 STARSKY
(a)
Need for IAS 36
PL
E

Why IAS 36 was necessary
IAS 16 has long required that property, plant and equipment should not be carried in financial
statements at more than its recoverable amount. It defined this as the higher of the amount for
which it could be sold and the amount recoverable from its future use. However, there was very
little guidance as to how and under what circumstances the recoverable amount should be
identified or measured. IAS 36 gives such guidance.
(b)
Concept of recoverable amount
Recoverable amount
M
IAS 36 defines recoverable amount as the higher of fair value less costs of disposal and value in
use.
Fair value less costs of disposal is the amount at which an asset could be disposed of, less any
direct selling costs.
SA
Value in use is the present value of the future cash flows obtainable as a result of an asset’s
continued use, including those resulting from its ultimate disposal.
The definition takes into account management’s ability to choose whether to sell or keep the
asset when provided with the information about fair value less costs of disposal and value in use.
The decision is based on the cash flows that can be generated by following each course of action.
An entity will not continue to use the asset if it can realise more cash by selling it and vice versa.
This means that when an asset is stated at the higher-of net realisable value or value in use it is
recorded at its greatest value to the entity.
Answer 19 ARTRIGHT
(a)
Futures contracts and sale of inventory
The hedge is a cash flow hedge of the metal inventory. Hedge accounting must follow strict
criteria before it can be used. Management must identify, document and test the effectiveness of
the hedge. The hedged item and instrument must be specifically identified. The gains and losses
on the hedged item and instrument should almost fully offset each other over the life of the
1037
hedge. The effectiveness of the hedge must be tested regularly through its life and should fall
within the range 80 – 125% over its life.
The risk being hedged with a cash flow hedge is the potential volatility in the inventory selling
price. Changes in the fair value of the hedging instrument are deferred in a “hedging reserve” in
equity and reclassified through profit or loss when the hedged transaction impacts on income
(IAS 39). Before this method of accounting can be used in this scenario, the effectiveness of the
hedge must be tested.
PL
E
The change in the fair value of the futures contracts over the period is $600,000 (200,000 ounces
× $24–$21) and would be recorded initially in other comprehensive income and included in a
hedging reserve. The change in the selling price of the inventory is $500,000 i.e. $5·06m minus
$4·56m. (200,000 × $22·8)
The effectiveness of the hedge is
600
(i.e. 120%).
500
This falls within the acceptable range of the effectiveness test.
Thus if hedge accounting is used the futures contracts would be recorded at fair value when
taken out on 1 December 2011 ($4·8 million). On the subsequent settlement of the contracts for
$21 per ounce a gain of $600,000 would be recorded in profit or loss having been transferred
from the hedging reserve. The purpose of hedge accounting is to ensure that gains and losses on
the hedging instrument are recognised in the same performance statement as the gains and losses
on the hedged item. Hence the gains and losses on the instrument will be recorded in the
hedging reserve until the sale of the artefacts.
$000
4,560
(4,000)
––––––
560
M
Statement of comprehensive income (extract)
Revenue – artefacts ($22·8 × 200,000)
Cost of sales
SA
Profit on futures contracts from
Hedging reserve (200,000 × $24 – $21)
(b)
600
––––––
1,160
––––––
Derecognition of a financial asset – factoring of receivables
The question arises as to whether the sale of the receivables should result in them being
derecognised in the statement of financial position. Artright has in effect transferred control of a
financial asset and in doing so has created a new financial liability. The new liability should be
recognised at fair value. The provision of the limited guarantee creates the new liability.
Because Artright has transferred the control over the receivables and the bank has the contractual
right to receive cash payments from the trade receivables and Artright, then the transaction
should be derecognised and treated as a sale. The sale would be recorded as follows:
Cash received
Loss on disposal – profit or loss
Receivables (sold)
Liabilities (fair value of guarantee)
1038
DR
$000
440
72
CR
$000
500
12
––––
512
––––
––––
512
––––
Answer 20 AMBUSH
Report to the Directors of Ambush, a public limited company
(a)
Classification of financial instruments and their measurement
PL
E
Financial assets and liabilities are initially measured at fair value which will normally be the fair
value of the consideration given or received. Transaction costs are included in the initial
carrying value of the instrument unless it is carried at “fair value through profit or loss” when
these costs are recognised in profit or loss.
Financial assets and financial liabilities are covered by IFRS 9, which requires that all financial
assets are classified into one of three categories. The standard states the following:
On initial recognition a financial asset should be measured at fair value.
For any asset that is not measured at fair value through profit or loss then the initial value of the
asset will include transaction costs that are directly attributable to the acquisition of the asset.
Subsequent measurement
An entity shall then measure the financial asset at either fair value or amortised cost, dependent
upon the entity’s business model.
Categories of financial assets
M
Amortised cost
The asset shall be measured at amortised cost if both of the following conditions are met:
The asset is held within a business model whose objective is to hold assets in order to
collect their contractual cash flows.

The contractual terms of the asset give rise to cash flows that are solely payments of
principal and interest on the principal.
SA

On initial recognition an asset may be designated at fair value through profit or loss if it will
eliminate or significantly reduce an accounting mismatch.
This means that all debt instrument assets, unless designated at fair value through profit or loss,
are measured at amortised cost.
Any gain or loss on derecognition, impairment or reclassification shall be recognised in profit or
loss along with any investment income generated by the asset.
Fair value through profit or loss
All other financial assets will subsequently be measured at fair value.
Any changes in fair value will be recognised in profit or loss as well as any profit or loss on
derecognition.
1039
Fair value through other comprehensive income
At initial recognition an entity may elect to present any changes in fair value through other
comprehensive income in respect of an investment in equity instruments of another entity, as
long as the investment is not held for trading.
This election is permanent and cannot be changed at a later date.
Any changes in fair value will be recognised in other comprehensive income, on disposal of the
asset any cumulative gain or loss WILL NOT be reclassified through profit or loss.
PL
E
IFRS 9 states the following about the measurement and recognition of financial liabilities:
A financial liability shall be recognised only when an entity becomes a party to the contractual
provisions of the instrument.
The liability, if classed at amortised cost, will initially be recognised at fair value less any
directly attributable transaction costs.
If the liability is classed at fair value through profit or loss any relevant transaction costs will be
charged immediately to profit or loss.
Subsequent measurement
Most financial liabilities will subsequently be measured at amortised cost using the effective
interest method.
The groups of financial liabilities that are not measured at amortised cost will include:

Commitment to provide a loan at below-market interest rate – these liabilities will be
measured at the higher of the amount determined under IAS 37 and the initial amount
recognised less any cumulative amortisation.
(i)
Impairment of financial assets
M
Those at fair value through profit or loss (to include derivatives) – they shall be
measured at fair value.
SA
(b)

IAS 39 requires an entity to assess at the end of each reporting period whether there is any
objective evidence that financial assets are impaired and whether the impairment impacts on
future cash flows. Objective evidence that financial assets are impaired includes the significant
financial difficulty of the issuer or obligor and whether it becomes probable that the borrower
will enter bankruptcy or other financial reorganisation.
Only financial assets measured at amortised cost fall within the impairment requirements of IAS
39.
If any objective evidence of impairment exists, the entity recognises any associated impairment
loss in profit or loss.
1040
Only losses that have been incurred from past events can be reported as impairment losses.
Therefore, losses expected from future events, no matter how likely, are not recognised. A loss
is incurred only if both of the following two conditions are met:

there is objective evidence of impairment as a result of one or more events that
occurred after the initial recognition of the asset (a “loss event”), and

the loss event has an impact on the estimated future cash flows of the financial asset or
group of financial assets that can be reliably estimated
(ii)
PL
E
For financial assets measured at amortised cost, impaired assets are measured at the present
value of the estimated future cash flows discounted using the original effective interest rate of
the financial assets. Any difference between the carrying amount and the new value of the
impaired asset is an impairment loss.
Accounting for impairment loss
There is objective evidence of impairment because of the financial difficulties and reorganisation
of Bromwich. The impairment loss on the loan will be calculated by discounting the estimated
future cash flows. The future cash flows will be $100,000 on 30 November 2014. This will be
discounted at an effective interest rate of 8% to give a present value of $85,733. The loan will,
therefore, be impaired by ($200,000 – $85,733) i.e. $114,267.
Tutorial note: IAS 39 requires accrual of interest on impaired loans at the original effective
interest rate. In the year to 30 November 2013 interest of 8% of $85,733 (i.e. $6,859) would be
accrued.
Answer 21 ARROCHAR
(1)
M
Extracts from notes to the financial statements for the year ended 31 December 2012
Operating profit
SA
After charging
Depreciation on plant and machinery
held under finance leases
After crediting
Sale and leaseback deferred income
(2)
Alternative 1
$000
Alternative 2
$000
48
——
56.0
——
–
——
23.3
——
Interest payable and similar charges
Alternative 1
$000
30
——
Finance charges under finance leases
1041
Alternative 2
$000
40
——
E
PL
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