ACCA IFRS

International Financial Reporting Standards

Module 1

The nature and operations of the IASB

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Module 1 introduction – The nature and operations of the IASB The International Accounting Standards Committee was founded in 1973 after a conference in Sydney in 1972. The IASC was formed through an agreement made made by the professional accountancy bodies from Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom with Ireland, and the United States of America.

Module 1 – The nature and operations of the IASB

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The accounting “rule makers” in these countries were in many cases not the professional accountancy bodies, e.g. in France, Germany and Japan the government is in charge of rules. In considering the requirements for international accounting standards, it was was regarded as too difficult for governments to reach agreement – so the accountancy bodies have worked together to try to devise a consistent set of global guidelines. In 2001, the IASC was re-constituted into a private-sector independent standard setter and the IASC Foundation Foundation was formed. The IASC Foundation now now has 19 trustees. The main operating arm of the IASC Foundation is the Board (IASB) of fourteen members. The Board operates on the basis of a simple majority vote and each Board member has one vote. The Trustees appoint appoint the IASB Board Members.

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The structure of the IASB


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The Trustees

There are 19 Trustees including including the chairman. The Trustees have the responsibility for the governance, the raising of funds and the public perception of the IASB. Standards Advisory Council

This body is designed to meet three times a year to give strategic advice to the Board, (formerly the International Accounting Standards Committee - IASC), and provide a wider forum for participation in in the process of standard setting. It has approximately 45 members who have diverse geographical and functional backgrounds. Board

The Board has 14 members. members. The chairman is Sir David Tweedie, who was formerly chairman of the UK's UK's Accounting Standards Standards Board. Several of the members have liaison responsibilities for national standard setters: Australia and New Zealand, Canada, France, Germany, Japan, UK, UK, and US. The IASB is extremely extremely keen on following open due process in its standard setting. The Board issues International International Financial Reporting Reporting Standards (IFRS) but has adopted all of the previous IASs issued by its predecessor body (IASC).

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International Financial Reporting Interpretations Committee (IFRIC)

The International Financial Reporting Interpretations Committee (IFRIC) was r econstituted in December 2001 to consider accounting issues that are likely to receive unintended or unacceptable treatment in the absence of any any other form of guidance. In order to develop interpretations, the IFRIC will consult similar national bodies which have been nominated by the Member Bodies.


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The predecessor body was called the Standing Interpretations Committee (SIC) and many of their statements still provide authoritative authoritative guidance. The pronouncements of IFRIC/SIC have the same authority as a standard of the IASB.

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Extant Standards of the IASB The following list outlines the International Accounting Standards (IASs) as they exist at 31 March 2004. If you want to review a specific standard, click on the IAS number below: IAS 1

Presentation of Financial Statements

IAS 2

Inventories

IAS 7

Cash Flow Statements

IAS 8

Accounting Policies, Changes in Accounting Estimates and Errors

IAS 10

Events After the Balance Sheet Date

IAS 11

Construction Contracts

IAS 12

Income Taxes

IAS 14

Segment Reporting

IAS 16

Property, Plant and Equipment

IAS 17

Leases

IAS 18

Revenue

IAS 19

Employee Benefits

IAS 20

Accounting for Government Grants and and Disclosure Disclosure of Government Assistance Assistance


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IAS 21 The Effects of Changes Changes in Foreign Exchange Rates IAS 23

Borrowing Costs

IAS 24

Related Party Disclosures

IAS 26

Accounting and Reporting by Retirement Benefit Plans

IAS 27

Consolidated and Separate Financial Statements

IAS 28

Investments in Associates

IAS 29

Financial Reporting in Hyperinflationary Economies

IAS 30

Disclosure in the Financial Statements of Banks and Similar Financial Financial Institutions

IAS 31

Interests in Joint Ventures

IAS 32

Financial Instruments: Disclosure and Presentation

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IAS 33

Earnings Per Share

IAS 34

Interim Financial Reporting

IAS 36

Impairment of Assets

IAS 37

Provisions, Contingent Liabilities and Contingent Assets

IAS 38

Intangible Assets

IAS 39

Financial Instruments: Recognition and Measurement

IAS 40

Investment Property

IAS 41

Agriculture

IFRS1 IFRS2 IFRS3 IFRS4 IFRS5


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First time Adoption of International Financial Reporting Standards Share based Payment Business Combinations Insurance Contracts Non-current assets held for sale and discontinued discontinued operations

You will note that a number of standards seem to be missing, e.g. IASs 3, 4, 5, and 6. This is because they have been replaced by later standards, e.g. IAS 3 (which related to consolidated financial statements) was replaced by the much more detailed standards 27, 28 and 31. The above standards are examined in more detail in later modules in this course as follows, in the order dealt with: Module 3 (Presentation and profit) IASs 1, 8, 18, and IFRS2 Module 4 (Asset recognition and measurement) IASs 16, 38, 40, 36, 23, 20, 2, 11, 17, 32, 39 and 41 Module 5 (Accounting for liabilities) IASs 37, 10, 19, 12 Module 6 (Group accounting) IASs 27, 28, 31, 21 and 29, IFRS3 Module 7 (Disclosure standards) IASs 7, 14, 24, 33, 34, 35, 30, IFRS1, 4 and 5 In addition to those standards that have been deleted, as explained above, this course does not deal with IAS 26, which is a specialist standard on accounting and reporting by retirement benefit plans.

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The extant standards will be subject to change because of the need to bring national and international accounting standards standards into line. This is referred to as the 'convergence process'.


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The latest standard (IFRS5 ‘Non-current assets held for sale and discontinued operations’) was approved in March 2004. The application dates of standards are normally somewhat after their date of publication, e.g. IFRS5 came into force for accounting years beginning on or after January 1st 2005.

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The Framework A major item in the list of publications is the "Framework for the Preparation and Presentation of Financial Financial Statements" of 1989. This establishes the purpose of financial financial statements and the major principles principles lying behind their preparation. The Framework suggests that the main purpose of financial statements is to give information to users (particularly investors) so that they can can make financial financial decisions. The most useful information would therefore be that which enables the prediction of future cash flows. flows. It is clear from this that the purpose of financial statements is little to do with taxation or management accounting. The context is that companies and users are presumed to be living in an international world so that comparisons need to be made across national borders. This also implies implies that national laws including tax laws are ignored when international standards are are being drafted. A key function of the Framework is to to underpin the standards. Often the Framework is used where there is no standard in a particular particular area. For example 'Off Balance Balance Sheet Finance.'


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The Framework is particularly designed to be used by the Board itself when preparing standards but is also addressed to companies and auditors when preparing financial statements in accordance with IAS/IFRS. One of the key components of the Framework is the definition of the five main elements of financial statements. In the balance sheet, three elements can be found: An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

Equity does not need to be defined separately because it is just the arithmetical difference between total assets and total liabilities.

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The Framework stresses the definitions of asset and liability such that the definitions of income and expense are secondary i.e. for example, an expense is defined as an increase in a liability or a decrease in an asset. This is different from conventional accounting in most countries where in practice accounting is focussed on the definitions of income and expenses based upon the accruals concept.


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To help explain this, let’s take a look at an example. Imagine that a business needs to repair a piece of equipment on the 20th February February 20x3. The company has a financial year running from 1st January to 31st December. Is the repair bill an expense of financial year 20x2 or of 20x3? Some accounting systems, such as the German system, would treat this as an expense of 20x2, as the wear and and tear that caused caused the equipment to breakdown was in 20x2. Not only this, but the repair is tax deductible in 20x2 if so charged. The conventional definition of an expense of year X is that it is a payment made in any year that relates to year X . In this case, it could be argued, that the the expense relates to 20x2. If this is the case, case, then at the end of financial year 20x2, a debit has to appear in the accounts for the repair expense, and a credit as a provision for the repair. repair. This will mean that the balance balance sheet on 31st December 20x2 will show a liability for the “provision for repair”. While it is difficult to say that this way is “wrong”, it is certainly different from the practice pr actice of many other countries, including the UK. The Framework suggests that that you should ask ask the question “Is there a liability?” on the 31st December 20x2. The answer is “no”. Therefore there is no need for a double entry and so no expense. This is clearer. Note also that IAS 37 'Provisions, Contingent Liabilities and Contingent Assets' would not allow a provision to be made for this amount. The application of the asset/liability Framework is changing conventional accounting practice. The Framework is very similar to that developed in the US in the late 1970s by the FASB and similar to that adopted by the UK's ASB in the 1990s.

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Working with Stock Market Regulators Activity at the IASC up until the late 1980s was the codifying of best practice, including many national options. options. In other words, in order to achieve a ¾ majority of the Board Board it was often necessary to allow more than one practice within within an IAS. From 1989 things began to improve. First, with a Framework established, it was much easier to arrive at a clearly correct answer for many accounting problems so that certain options just did not fit the Framework and could be excluded. Secondly, in 1989 an an agreement was reached with with the world body of stock stock market regulators (IOSCO). (IOSCO). IOSCO came to the view that it would be useful to have a single accounting language for the world, particularly for capital markets, and decided that the best place to start was with the IASC’s standards. However, in 1989 there were too many options and too many gaps in the standards.


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IOSCO asked the IASC to remove as many options as possible and and fill the gaps. In return IOSCO would hope to allow the use of IASs on all the world’s stock markets for foreign companies. At present many stock stock exchanges do allow allow the use of IASs for foreign companies and sometimes sometimes domestic companies. For example, the London Stock Exchange allows foreign companies to use IASs although UK companies must still follow UK rules according to UK law. law. However, the major international exception to this is is that, in the US, the Securities and Exchange Commission (the US member of IOSCO) requires foreign companies to prepare US GAAP financial statements or to reconcile to US GAAP if they are to be listed on an American exchange. The IASC was spurred on by this agreement and spent the whole of the 1990s trying to satisfy IOSCO with a major programme of revised and new standards. standards. The programme ended with IAS 40 in early 2000 and IOSCO began looking at the so-called “core standards” at the end of 1999. In 2000, IOSCO recommended IASs IASs to its members members for foreign registrants. However, the SEC has still not made a decision, but recently there have been moves as part of the convergence process to bring US US GAAP into line line with IASs. IOSCO published a report in 2000 setting out the main issues that that it still had to with IAS's. The report is that of the IOSCO Technical Committee.

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Projects in progress The IASB has many many projects currently in progress. Before an IFRS is issued the Board publishes an Exposure draft (ED) on the subject area so that comments can be received on the document. The Board always publishes an exposure draft on an 'invitation to comment' basis before finalising its position on a particular project.


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Current projects include 'Business Combinations II', 'Leases’ and ’Revenue recognition'. The IFRIC also publishes draft interpretations for comment before finalising an interpretation. All final interpretations have to be approved by the IASB.

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Frequently asked questions - and answers! Who, or which country, was the main driving force behind the creation of the IASC?


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Lord Benson, who had been President of one of the UK accountancy bodies, was the driving force. The IASC grew out of a research group of the UK, the US, Canada and Australia. Is there anything particularly significant about the founding date of 1973 for the IASC?

1973 was the year that the UK joined the Common Market (now EU). The EU had various accounting requirements which the UK did not like! Perhaps the IASC was seen as a counter-balance to harmonisation run from Brussels. Who chooses the IASC Trustees and Board?

The 17 original trustees were chosen in 2000 by a nominating body which included the chairman of the SEC and the president of the World Bank. Any retiring trustee is now replaced by a new trustee chosen by the remaining trustees. The Board members are chosen by the Trustees. Is the Framework anything like the UK's Statement of Principles?

Yes, the Framework is closely in line with that of the US standard setter (the FASB) of the late 1970s and the UK's Statement of Principles also clearly derives from this source. Are the IASB's standards always in line with the Framework?

Not exactly. The Framework was written after after some of the standards. Also, sometimes, practical or political political necessity forces forces the Board to stray from the Framework. However it is a useful basis for the development of standards, and is being used more and more as the basis for IFRS.

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Module 2 – The status and use of IASs around the world

 Module 2

The status and use of IASs around the world

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Module 2 introduction – The status and use of IASs around the world


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In 1998, G7 Finance Ministers and Central Bank Governors pledged that private sector institutions in their countries should comply with w ith international principles and practices. They called upon a global initiative to ensure that this occurred. The IASB has no mechanism for demanding that companies apply their standards. Nevertheless IASs are in use extensively around the world in a variety of different ways and for a variety of different reasons. Some examples of this can be seen in the following: Adoption exactly (or closely) by national standard setters (e.g. those in Nigeria, Malaysia, Hong Kong and Singapore), followed by compliance by companies. companies . Use of elements of IASs by companies in countries where national rules are incomplete or flexible. For example, financial statements of companies in Italy will contain elements from IASs. IASs. Use of national rules with a reconciliation to IASs, for example Nokia of Finland. Finland . Deliberate full use of IASs by choosing options within national rules. For example, many listed companies in France in the late 1990s published consolidated IAS compliant statements. statements. Use of IASs instead of (or in addition to) national rules, perhaps because there is a reconciliation to national rules or there is another set of financial statements in accordance with national rules, for example Deutsche Bank prepared two sets of financial statements in the late 1990s Many countries already use IAS as their own or with amendment for local legislation. Important developments are taking place in the European Union (EU) where all listed companies in the EU will have to prepare their consolidated financial statements using IAS by 2005. Multinational companies, partly in response to this, this, are looking to use IAS in preparing their financial statements.

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The IASB roadmap The IASB has come a long way since its inception in 1973. A brief list of the major developments that have marked the life of the IASC is set out below:


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The IASC was founded in 1973 by accountancy bodies from nine countries Activity up until the late 1980s was the codifying of best practice, including many national options 1989 saw the publication of a conceptual Framework and initial discussions with IOSCO 1990s: gradual adoption of IASs as national standards, particularly by Commonwealth countries 1993: ten revised standards, in force in 1995 1994+: adoption of IASs by a number of continental companies for consolidated statements 1995: agreement between the IASC and IOSCO on list of core standards 1998: laws to permit use of IASs in France, Germany and Italy 1998: the IASC passes last major core standard (IAS 39, financial instruments) 1999: the IASC IASC decides on reform; reform; welcomed by SEC, etc. 2000: IOSCO recommends use of IAS to its members members 2000: EU Commission proposes compulsory use of IAS for listed companies' consolidated statements by 2005 2001: European Commission present legislation to require use of IAS for all listed companies no later than 2005 2001: Trustees bring the new constitution into effect. IASB is responsible for setting standards which are now named International Financial Reporting Standards.

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The annual IASB bound volume and its use In order to gain maximum advantage from this course, and before you go any further, you should have with you the bound volume of International Financial Reporting Standards 2004. You can purchase this direct from the IASB web site (www.iasb.org.uk) (www.iasb.org.uk)


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This contains the text of the current international standards and the interpretations of the IFRIC. It also contains the text of the Framework and a glossary of terms used used in IASB documents. From time to time, time, this course will will direct you towards particular standards to carry out short exercises.

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Frequently asked questions - and answers! Which national standards are closest to the IASB's?


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Because of the convergence projects undertaken by the IASB, the ASB (Accounting Standards Board) in the UK, and the FASB (Financial Accounting Standards Board) in the US, UK and US GAAP have have moved closer to the IASs. However some national standards (e.g. Malaysia, Singapore) actually mirror the IAS and thus these standards are the closest to IAS. Does the UK allow the use of IASs?

UK companies are required to follow the UK Companies Acts. Acts. Legal counsel's opinion is is that it is generally necessary for companies to comply with UK standards in order to give a true and fair view. Basically, UK companies are not allowed to depart from UK standards in order to obey IASs. An analogous conclusion is even clearer in the United States. However, from 2005, UK listed companies will be required to use IAS for their consolidated statements and there will be a need to change Company Law in order for this to take place. Is it necessary to comply with "grey-letter" guidance in an IAS?

Yes, in order to claim compliance compliance with IASs. The "Big Four" audit firms have agreed to treat grey letter as compulsory compulsory for the purposes of their audits. However, there is a "fair representative override", as examined examined in Module 3 of this course. This is known in some countries as the 'true and fair view override.' What version of the English language is used by the IASB: British or American?

The language used is generally the British version of the English language although many of the terms used are are American in origin. For example 'trade receivables' instead instead of 'debtors' and 'inventory' instead of 'stock'.

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Module 3 - Presentation and profit

 Module 3

Presentation and profit

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Module 3 introduction - Presentation and profit This module begins the process of looking at IASs on a topic-by-topic basis. This module deals with three standards: .


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Presentation of Financial Statements - IAS 1 Revenue - IAS 18 Accounting Policies, Changes in Accounting Estimates and Errors - IAS 8

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Presentation of Financial Statements - IAS 1 (revised December 2003)


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The following represent the key points from the standard: This standard contains several aspects taken from the Framework, including that the purpose of financial reporting is to give useful information to investors for the purposes of making economic decisions (paragraph 5). The standard states that there are five components of financial statements, as follows (paragraph 7): Balance sheet Income statement Statement of changes in equity Cash flow statement Accounting policies and explanatory notes A statement of changes in equity must show (para 96/97): (a) profit/loss for period (b) items recognised directly in equity (c) total income/expense for period (d) effects of changes in accounting policies or errors Also the following may be shown in the statement or in the notes: (a) capital transactions with owners (b) movement in profits (c) reconciliations of movements in share capital and reserves IAS 1 requires that financial statements should present fairly the financial position, performance, and cash flows of an enterprise. It is said that nearly always this will be achieved by compliance with the requirements of the standards. However, in what are said to be extremely rare circumstances, it may be necessary to depart from such a requirement in order to achieve a fair presentation. IAS 1 requires departure in such circumstances, but with extensive disclosures, including the financial impact of the departure from the standard.

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The two main requirements of accounting information are that it should be relevant and reliable. As part of being reliable, financial statements should represent faithfully the results and position, should reflect economic substance not merely legal form, should be free from bias, should be prudent, and should be complete in all material respects . Several other principles are said to be normally required, such as going concern, accruals, consistency and materiality.


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The off-setting of assets and liabilities is not allowed except where another standard requires or permits it. Income and expense items should not be offset except where a standard requires or permits (paragraphs 32 and 33). IAS 1 generally requires that comparative information for the previous period should be disclosed for all numerical information in financial statements (paragraph 36). It is not necessary to present assets and liabilities on the basis of the distinction between current items and non-current items (paragraph 51/52). IAS 1 does not lay down particular formats for financial statements but does have minimum requirements for the presentation of items on the face of the financial statements (paragraphs 68 to 95). There are, however, illustrative illustrative financial statements in an Appendix. •

Disclosure is required in the notes of accounting policies followed

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Disclosure of ‘extraordinary items’ is prohibited

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A liability or asset is current if it will be settled within the company’s normal operating cycle, or is due to be settled within twelve months after the balance sheet date. The normal operating cycle cycle could be longer than than twelve months

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Exercises - IAS 1 Throughout the course exercises will be set which you should complete before moving on.


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Should the going concern convention be ignored when a significant part of the reporting entity is thought not to be a going concern?

The going concern convention should be related to the whole of the reporting entity. So the fact that part of a reporting entity might not be a going concern should not change the use by the preparer of the going concern convention. However, the fact that part of the enterprise is not a going concern may well lead to the need for the impairment of assets (see IAS 36 later) or the recognition of provisions (see IAS 37 later). Is consistency of accounting policies from year to year required?

IAS 1 (paragraph 27) does not address consistency of accounting policies but consistency of presentation. The policy issue is dealt with in IAS 8 but a rather similar conclusion would be arrived at for both presentation and policies. The conclusion is that consistency is required unless there is a change to a better practice, or there is a change in an accounting standard. Of course, management would only choose to change its presentation or policies if it thought that the result was beneficial. Can a loan which is expected to be paid back in four months be a noncurrent liability?

Although IAS 1 does not require the use of the current/non-current distinction, such distinction is allowed and non-current is defined in several possible ways including by reference to a one-year cut off. For a loan expected to be paid back within four months, there could still be classification as a non-current liability if the original term of the loan was for a period of more than one year and there is an intention to take advantage of an agreement to re-finance. This can be found in paragraph 63 of IAS 1.

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Revenue - IAS 18 The following represent the key points that you should take from the standard:


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Revenue is to be measured at the fair value of the consideration received. This includes, where material, discounting, if the consideration will be received in the future (paragraphs 9 and 11). Revenue should be recognised when risks, rewards and control have passed (paragraph 14). When the outcome of a process of revenue earning can be reliably measured, revenue should be recognised by stage of completion, otherwise only to the extent of expenses recoverable (paragraphs 20 and 26). There are also general rules for the recognition of interest, royalties and dividends. None of these rules would be surprising in most countries (paragraph 30).

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Accounting Policies, Changes in Accounting Estimates and ErrorsIAS 8


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The following represent the key points that you should take from the standard:. standard: . The standard specifies how accounting policies are to be determined in the absence of a specific standard or interpretation (paragraph 10) The standard requires consistency in the selection and application of accounting policies (paragraph 13) Changes in accounting policies are to be dealt with retrospectively. Disclosure is required of an impending change of accounting policy as a result of a new standard that has not yet come into effect (paragraph 30) Changes in estimates should be recorded prospectively in the income statement in appropriate periods (paragraph 36). The correction of material errors should be treated as a prior year adjustment. (paragraph 42). A change in accounting policy is allowed if it is required by a change in an accounting standard, or if the change is to a more appropriate policy (paragraph 14). Changes in policy caused by change in an IAS should be dealt with in accordance with the requirements of that IAS.

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IFRS1 ‘First time Adoption of International Financial Reporting Standards’


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This IFRS deals with the situation where a company adopts IFRSs for the first time. A first time adopter is one that makes an explicit and unreserved statement of compliance with IFRS. If accounts have been published previously that comply with IFRS, then this standard cannot be used. All IFRS must be complied with on adoption and it will mean that some previous GAAP assets and liabilities liabilities may be derecognised under IFRS1. Similarly new assets and liabilities may be recognised under IFRS1. Some assets and liabilities may need re reclassifying classifying under IFRS1. IFRS1. For example redeemable preferred shares may be equity under previous GAAP but under IFRS1 would be liabilities. The measurement of the assets and liabilities should be based on the IFRS in force at the date of first time adoption. Thus if a company adopts IFRS IFRS for the first time on 31 December 20X5, the IFRS in force at that date would be used in the financial statements for the year ended 31 December 20X5, 31 December 20X4 (comparative figures), and to calculate the opening balances as at 1 January 20X4. Any adjustments to the assets and liabilities in the move from previous GAAP to IFRS should be recognised in retained earnings. There are optional exceptions to the rule that all assets and liabilities should be restated under IFRS. These relate to business business combinations, property, plant and equipment, investment property, employee benefits, foreign translation reserves. There are also mandatory exceptions to the rule as regards derecognition of financial instruments and hedge accounting (IAS39) If previous estimates used in financial statements are consistent with IFRS, then they should not be changed. There are many disclosure requirements required by IFRS1 including the requirement to use IFRS1 in the interim financial statements in the year of first time adoption. ACCAdemy.com

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Frequently asked questions - and answers!


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Is there a "true and fair override" o verride" in IASs?

IAS 1 talks of fair presentation rather than true and fair view. However, there is an override, which is said to be necessary only in very ve ry rare circumstances. Substantial disclosures are required. What is the status of IFRIC interpretations?

IASB gives IFRIC interpretations the same status as standards. That is, they must be complied with. Suppose that a company has entered into a binding contract to sell an asset soon for a fixed amount. Can any implied gain be recorded?

The Framework would appear to suggest that the gain is both relevant and reliable information. However, IAS 18 requires control to be passed, so it seems that the gain cannot be recorded at the time of the contract.

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International Internatio nal Financial Reporting Standards

Module 4 – Asset recognition recogniti on and measurement

 Module 4

Asset recognition and measurement

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Module 4 introduction – Asset recognition and measurement The treatment of assets involves a three-stage process: .


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Is the item an asset? Should the item be recognised (recorded) in the balance sheet? How should the asset be valued/measured? The first question takes us back to the IASB Framework where the definition of asset is: "a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise"

It should be noted that an asset is not necessarily something which is owned but which is controlled. One example of an implication of this is that a lessee might treat an item as an asset even though it is not owned by the lessee. Of course, for an item to be an asset at all, it must produce some future benefit to the enterprise. However, not all of an enterprise's assets should be recognised in the balance sheet. Some of them cannot be measured with sufficient reliability to be included. It is necessary to have some measure of either cost or value. Having decided to recognise an asset there might then be several ways in which it could be valued, such as depreciated cost or current market value. Each IAS/IFRS on the subject of assets deals with both recognition and measurement. There are also usually many requirements relating to disclosures d isclosures of these issues.

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This module considers the following standards:. standards: . Recognition of Property Plant and Equipment - IAS 16


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Intangible Assets - IAS 38 Investment Property - IAS 40 Impairment of Assets - IAS 36 Borrowing Costs - IAS 23 Accounting for Government Grants and Disclosure of Government Assistance - IAS 20 Inventories - IAS 2 Construction Contracts - IAS 11 Leases - IAS 17 Financial Instruments: Disclosure and Presentation - IAS 32 Financial Instruments: Recognition and Measurement - IAS 39 Agriculture – IAS 41

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Property Plant and Equipment (PPE) - IAS 16 The main elements of this standard are as follows:


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An asset should initially be recognised at its cost, which includes all those costs of bringing it to its present condition and location, ready for productive use (paragraph 15). Costs are subsequently recognised if it is probable that future economic benefits will flow. PPE can be measured at cost (with depreciation, see below) but the assets may be revalued to fair value. This alternative must be used continually at each balance sheet date and must be applied to a whole class of assets rather than to an individual asset only. A class of assets is a heading on a balance sheet, such as "land and buildings". "fair value" means the amount for which the asset could be exchanged by knowledgeable and willing parties in an arm's length transaction. This is different from net realisable value because that amount is net of various items including costs of sale If the revaluation model is used, then revaluation gains and losses should be taken to equity and recorded in the statement of changes changes in equity. If a revaluation increase reverses a revaluation decrease of the same asset and the decrease has been charged as an expense, then the increase should go to the income statement. In the opposite case, where there is a revaluation surplus on an asset, any revaluation deficit should be charged against this surplus until the surplus is used up. Remember these rules apply to the same asset not different ones. (paragraphs 39 and 40) The carrying amount of an asset should be depreciated over its useful life. The depreciable amount takes account of the residual value expected at the end of the useful life. This value should be measured at the price level ruling when the cost or value of the asset was determined and reviewed at least at each financial year end (paragraph 51) The gain or loss on the disposal of an asset is calculated as the difference between the proceeds and the carrying amount. Since the latter could be based on either cost or revaluation, the gain on sale would be lower if an asset had been revalued upwards. The gain or loss should be included in profit or loss (paragraph 68) but not recognised as revenue. IAS36 should apply in determining whether PPE is impaired.

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Exercise - IAS 16 You should refer to the text of the standard when answering exercises.


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A company bought some land for £15m in 1980, revalued it at various dates up to £23m, and sold it for £21m in 20x2, but did not receive any cash until 20x3. Ignoring tax, the profit/loss recorded in 20x2 should be: a. zero b. +£6m c. -£2m d. +£21m

The answer is c. -£2m. The gain/loss is calculated as the difference between the proceeds, £21m, and the carrying amount, £23m. Note that this implies that the revaluation element is never recorded as a gain in income.

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Intangible Assets - IAS 38 The main elements of this standard are as follows:




As with any other asset, intangible items should be recognised where there is a probable future benefit that can be measured reliably (paragraph 21). With intangibles this may be more difficult than for tangible assets. Certain items are therefore not recognised. For example, internally generated goodwill cannot easily be traced back to a transaction and therefore the cost or value is difficult to measure; it is not even clear that the enterprise has control over it, consequently it is not to be recognised as an asset (paragraph 48). Also research expenditure cannot be capitalised for similar reasons (paragraph 54). The same applies to several other internally generated assets, such as brands (paragraph 63). Development expenditure that meets certain criteria should be capitalised. One of the conditions is that there is a technically feasible project that can be separately measured (paragraph 57). Just as tangible assets are allowed to be revalued by IAS 16, so intangibles may be revalued, but there are some restrictions. Intangibles can only be revalued with reference to an active market that involves many buyers and sellers and publicly available prices (paragraphs 75, 81 and 82). This makes it difficult in practice to revalue most intangibles. Intangible assets should be carried at cost less amortisation and impairment losses if the cost model is is used. If they are carried at a revalued amount, amount, then amortisation and impairment losses should be deducted from the carrying amount. The useful life of the intangible asset asset has to be determined by the company. If it is finite then the asset is amortised amortised over that life. If it is indefinite, then the asset asset must be tested annually for impairment (IAS36)

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

Can brand names be capitalised?

If the brand is internally generated, then the answer is clearly "no", because this is specified within the standard. However, brands can be obtained in other ways, e.g. by purchasing the brand from another company either by itself or as part of a larger acquisition. When a brand is purchased by itself it is clear that it should be capitalised at cost. If it is purchased as part of an acquisition, then an attempt should be made to allocate part of the purchase cost to the brand. For example, the Coca Cola brand name cannot be treated as an asset by the Coca Cola Company that created it. However, if a company bought the name Coca Cola in Switzerland for $10m then it should be capitalised at cost. If another company bought the whole of the Coca Cola company including the brand, then part of the total acquisition cost might be allocated to the brand name. Can development expenditure be revalued upwards?

The whole point of development expenditure is that it is designed to create something of particular benefit to the enterprise, which implies that the asset is in some way unique. Therefore there can be no active market or published price for the item, so it cannot be revalued.

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Investment Property - IAS 40 This standard and IAS 39 (see later) replace the old standard on investments, IAS 25. ..




Investment property is property held to earn rentals or for capital appreciation or both. An enterprise should decide whether it wishes to follow the cost model or a fair value model for all its investment property (paragraph 30). Under the cost model, the property is measured at depreciated cost less impairment losses. The fair value model includes taking gains and losses to income (paragraph 28). In the fair value model, individual properties whose fair value cannot be reliably measured should also be measured at cost (paragraph 53). When a property changes from investment property to owner occupied or to inventory, the property's cost for subsequent accounting should be its fair value at the date of its change of use. (paragraph 57). For those enterprises that choose the cost model, there must be disclosure in the notes of fair value (paragraph 79). An entity must apply its chosen model to all its investment property.

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Impairment of Assets - IAS 36 The main elements of this standard are as follows:




This standard applies to most assets, but not to inventories because they are already valued at the lower of cost and net realisable value, which takes into account any loss of value (paragraph 2). The process of applying this standard begins by looking at each asset at each balance sheet date for any indication of impairment such as physical damage or fall in selling price of the product made with the asset (paragraphs 8 to 17). Normally one would expect no indication of impairment, but in cases where there is, an enterprise must then test whether there is an impairment. This involves comparing the "carrying amount" of the asset with its "recoverable amount", which is the higher of its selling price and value in use. The value in use is the discounted present value of the future net cash flows expected to relate to the asset or cash generating unit. A cash generating unit is simply the smallest element of a company that can independently generate revenue/cash flow (paragraph 6). For many assets it may be impossible to measure specific cash flows relating to them, so it becomes necessary to do the exercise with the smallest group of assets for which independent cash flows can can be measured. This group of assets is a "cash generating unit" (paragraph 6). There is a series of rules on cash flow projections designed to stop an enterprise from being too optimistic (paragraphs 30, 33, 39, 44, 50, and 52). The cash flows should, of course, be discounted and the discount rate should be pre-tax and asset-specific (paragraph 55). The extent to which the carrying value is in excess of the recoverable amount is the measure of the impairment loss. This should be charged immediately to the income statement (paragraph 60). However, there are some special rules relating to assets that have previously been revalued upwards.

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The allocation of an impairment loss to the various elements of a cash generating unit should first be against any goodwill and then pro rata to other assets in the unit (paragraph 104).




Impairment losses should be reversed if there has been a change in the estimates used to determine the recoverable amounts (paragraph 117). No reversal of an impairment loss for goodwill is allowed

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

Will an asset's recoverable amount usually be selling price o r value in use?

For most non-current assets remaining in a balance sheet, there is presumably no immediate intention to sell them. This implies that the value in use is above the selling price otherwise it would make sense to sell them. Consequently the recoverable amount is usually the value in use.

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Case study – Impairment This case study is loosely based on a real example. Suppose that a Malaysian company, Goodtimes Co, prepares its statements according to IAS/IFRS. It has a flow of net profit as follows: Year Yea r 20x 20x0 0 Net profit (RMB 570 million)

20x1

20x2

20x3

20x4

630

102

610

590



In the 20x2 Annual Report, the following was noted: "In December 20x2 a review of our assets indicated that the value of the oil and gas operations in our Sector B production area was lower than we had previously been estimating. Management carried out an impairment test of our oil and gas pipelines by comparing their carrying value with the present value of the expected net cash flows. This resulted in a write down of RMB650 million, and an impairment loss of that size was charged to income." What sort of estimates are involved in impairment tests?

The impairment is being calculated under the rules of IAS 36, which requires annual impairment review, followed by tests where there is any indication of impairment. The test requires a comparison of carrying value with recoverable amount, which is the higher of selling price and value in use. The former is unlikely to be relevant because there is no market and no intention to sell. It would normally be lower than the value in use, which is measured as the discounted expected net cash flows. It is presumed here that the "cash generating unit" is the pipeline system. However, the estimates of value in use rely on knowing the life of the pipeline to the present owner, the disposal proceeds, the cash flows in and out over the future life, and a suitable pre-tax discount rate. IAS 36's paragraphs 30 to 57 discuss all this, but there is still considerable room for manoeuvre.

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Do you think that there is any incentive for management to overstate or understate the impairment loss?

The impairment loss for 20x2 is so large in the context of the five year run of profits that analysts would probably have to ignore it on the grounds of "unusual" / "abnormal" / "non-recurring". Once the management realises this, they might as well make the loss as big as possible so that future depreciation expenses are lower and gains on disposal higher.




Also the management will look at the tax implications of increasing/decreasing an impairment loss.

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Borrowing Costs - IAS 23 The main elements of this standard are as follows:




This standard examines the issues of whether the costs of borrowing should be added to the capitalised cost of an asset. For example, if an enterprise is constructing its own office building, what are the "costs"? It is clear from IAS 16 (above) that these costs would include the bricks, the labour to put the bricks on top of each other, the architect's fees, and so on. However, do they include the interest cost on money borrowed to build the building? IAS 23's benchmark treatment is that interest should be treated as an expense. However, the allowed alternative is to capitalise directly attributable borrowing costs (paragraphs 7, 11 and 17). SIC 2 addresses the question whether IAS 23 would allow the benchmark treatment for some assets but the allowed alternative for others. It concludes that capitalisation results from a state of mind and therefore should be applied throughout the enterprise or not at all. IAS 23 specifies the dates on which capitalisation should start and stop (paragraphs 20, 23 & 35). IAS23 was originally going to be revised under the IASB’s ‘Improvements Project’ but the IASB decided not to eliminate at present the choice element in capitalising borrowing costs.

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Accounting for Government Grants and Disclosure of Government Assistance - IAS 20




The main elements of this standard are as follows: IAS 20 requires that government grants should be recognised only when there is reasonable assurance that the enterprise will comply with any conditions attached to them and that the grants will be received (paragraph 7). Grants should be recognised as income over periods that enable them to be matched against the costs being compensated (paragraph 12). Grants related to assets should be presented in the balance sheet either as deferred income or as a deduction from the related assets (paragraph 24).

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

An enterprise has received a government grant relating to an asset which is expected to last for ten years. It is highly probable that the conditions of the grant will continue to be met. Does the Framework suggest the same recognition requirement as IAS 20?

Under the Framework there can be only three elements in a balance sheet: assets, liabilities and equity. It is clear that the grant cannot be an asset since it has a credit balance. In the example above it also seems not to fit the definition of a liability. Therefore it must be part of equity. Since the money is already in the bank, it is not clear why the grant is not income. Consequently it is not clear that IAS 20 is in accordance with the Framework, and many people think that IAS 20 should be revised.

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Inventories - IAS 2 The main elements of this standard are as follows:




IAS 2 requires the age-old rule of the lower of cost and net realisable value (paragraph 9). Net realisable value is the estimated selling price in the ordinary course of business less any estimated costs of completion and sale (paragraph 6). The scope of the IAS is all inventories except work-in-progress (IAS11), financial instruments (IAS39), and biological assets (IAS41) IAS2 allows the FIFO FIFO or weighted average cost formulas (paragraph 25). The LIFO formula which had been allowed prior to the 2003 revision of IAS2 is no longer allowed. Costs of inventories comprise all costs of purchase, conversion and other costs incurred in bringing the inventories to their present location and condition.

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Construction Contracts - IAS 11 The main elements of this standard are as follows:




This standard relates to specifically negotiated contracts for the construction of assets. It requires that when the outcome of the contract can be estimated reliably, then the revenues and costs should be recognised at each balance sheet date by reference to the stage of completion of the contract (paragraph 22). Any loss expected should be recognised immediately. There is criteria to help determine whether these estimates can be reliably made, including that the costs and revenues of the contract must be separately identifiable (paragraphs 23, 24). When the outcome of a contract cannot be estimated reliably, revenue should be recognised only to the extent of contract costs that will probably be recoverable, and contract costs should be recognised when they are incurred. Again, expected losses should be recognised immediately (paragraph 32).

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Leases - IAS 17 The main elements of this standard are as follows:




This standard requires the capitalisation of finance lease assets and liabilities at the lower of the fair value of the asset and the discounted minimum lease payments (paragraph 20). A finance lease is one that transfers substantially all the risks and rewards associated with the leased asset to the lessee (paragraph 4). There are a number of suggestions about how it is possible to identify a finance lease but no numerically based criteria of the proportion of value or life (paragraphs 8 and 9). The depreciation period for the capitalised leased assets is to be consistent with any other assets as under IAS 16 (paragraph 27). Operating leases (i.e. those leases which are not finance leases) should be treated as rentals. Operating lease rental payments should be recognised on a straight-line basis over the life of the lease, even where the lease is written with low rentals at the beginning and high rentals later (paragraphs 33 to 35 and 49 to 56). Lessors should recognise a lease as finance or operating in a mirror image way. Consequently, although the lessor owns the th e assets involved in a finance lease, the balance sheet shows a receivable rather than the leased asset. Lessors should recognise income as a constant periodic rate of return on the net investment in the lease (paragraph 39). If a sale and lease back transaction results in a finance lease, any income should be deferred and amortised over the lease term (paragraph 59).

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

Is the definition of a finance lease consistent with the Framework's definition of asset and liability?

It would appear that the lessee of a finance lease does have items satisfying the definitions of both asset and liability. liability. However, the same can be said for the lessee lessee of an operating lease. For example, an operating lessee has signed a contract with the lessor promising to pay lease payments. This is an obligation and therefore a liability. In conclusion, all leases leases involve the lessee having an asset asset and a liability. The IASB and other standard setters have now acknowledged this and propose to change the accounting standards in the fairly near future. The IASB is undertaking undertaking 'active research' into lease accounting. It seems that the consensus will be that operating leases should be recognised on the balance sheet.

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Financial Instruments: Recognition and Measurement - IAS 39 The main elements of this standard are as follows:




Because of the complexity of accounting for financial instruments, IAS 39 was given a lengthy implementation period. As for IAS 32, IAS 39 does not cover investments in subsidiaries, associates and joint ventures or employee benefits obligations (paragraph 2). The initial recognition of a financial asset or financial liability should be at its cost, which should be measured as the fair value of the consideration given or received. This should include transaction costs . After initial recognition, financial assets, including derivatives, should be measured at their fair value except for the following types (paragraph 46): loans and other receivables originated by the enterprise and not held for trading, held to maturity investments and non derivative financial laibilities (e.g. loans made by a bank as accounted for by the bank) should be measured at amortised cost using the effective interest rate method investments in equity instruments with no reliable fair value should be measured at cost Financial assets and liabilities designated as hedges should use th e specific rules in IAS39 Trading and derivative liabilities should also be measured at fair value (paragraph 93). Comment: This requirement to measure certain assets and liabilities at fair value is

similar to the US standard (SFAS 115) which introduced this revolutionary requirement shortly before IAS 39. It raises the problem of what to do with the gains and losses implied by the continual re-valuations. Conventional accounting before this and most local GAAP’s do not allow gains to be recorded until the point of sale. Since this is still the case under IAS 39 for those investments held to maturity, management may prefer to treat their investments as held to maturity, thereby postponing gains and losses until they want them, whereupon the assets can be sold and bought back again if necessary.

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IAS 39 requires that trading and derivative gains and losses should go immediately to the income statement whereas other gains and losses can either be taken to income or to equity through the statement of changes in equity.




IAS39 requires financial assets to be classified as: (i)

financial assets at fair value through profit and loss

(ii)

available for sale financial assets

(iii)

loans and receivables

(iv)

held-to-maturity investments.

These categories are used to determine how a financial asset is treated in the financial statements. Those assets at at fair value through profit and loss are further split into ‘designated’, which means that on initial recognition the company identified them to be valued at fair value with changes to profit and loss, or ‘held for trading’ which includes all derivatives and assets held to make short term profit. Financial liabilities also have two classifications: ‘Designated’ and ‘held for tr ading’. These categories have the same meaning as for financial assets. Financial assets should be reviewed for impairment at each balance sheet date. Hedge accounting means designating a hedging instrument so that its change in fair value is offset against the change in fair value of a hedged item. For example, if an enterprise has committed to pay an amount of foreign currency in six months time, it might buy the currency in advance in order to avoid the risk of the foreign currency rising in value before the date of payment. Hedge accounting involves designating the advance purchase as designed to fulfil the future obligation. Hedge accounting is allowed under certain conditions such as that there is formal documentation in advance and the hedge is effective.

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

How can an auditor tell whether a financial asset is held for trading or or available for sale?

It is impossible to tell by looking at a financial asset (which is represented merely by a piece of paper) whether it is, for example, available for sale or trading. This depends upon the intentions of the management, which are not auditable. Consequently, IAS 39 requires the management to designate the assets into the appropriate category on the date of purchase.

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Agriculture - IAS 41 The main elements of this standard are as follows:




It covers all biological assets to the point of harvest (paragraph 1). Biological assets are measured at each balance sheet date at their fair values less point-of-sale costs (paragraph 12). Agricultural produce is measured measured at harvest at fair value less point-of-sale costs. This becomes the cost of inventory (paragraph 13). Gains and losses go to income (paragraphs 26 and 28). If fair value is not reliably determined, then measure at cost (paragraph 30). Government grants are treated as income when their conditions are met (paragraph 34).

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Case study – Investments Suppose that a Czech company, Hrad Hr ad and Co, prepares its financial statements according to IAS/IFRS. It has a 31 December year end. In February 20x3, it buys some investments for the first time: K100 million of traded government debt and K50 million of traded company debentures. All the debt has a 20x8 or later maturity. Under IAS 39, these investments must be designated at purchase as (a) held-to-maturity, (b) available for sale, (c) loans and receivable, or (d) financial assets at fair value through profit and loss. By the middle of December 20x3, the fair fair value of the government debt has fallen to K80 million, but the corporate debt has risen to K60 million.



The company's profits before any gains or loans on investments are as follows: Year Net profit (K millions)

20x0

20x1

20x2

20x3 (estimate)

35

29

31

19

In February 20x3, before it is clear how successful the trading year will be, how will management designate the investments?

It would seem to be in the interests of management to designate as many investments as possible as held-to-maturity (although this is not possible for equities, that have no maturity date). This is because gains and losses can then be avoided until they are needed. It is presumably management's objective to show a gently rising trend of profits rather than a volatile one, assuming that the company is interested in the reaction of investors. So, perhaps management would designate all the investments as held-to-maturity and therefore use the cost basis for valuation. Before the end of year, what might management do with the investments?

By the end of the year, it becomes clear that trading has been unusually bad. Management will then be tempted to sell the corporate debt, but not the government debt, in order to record a gain of K10 million, which will largely make up for the operating problems.

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What results will follow from these actions?

If a company does sell held-to-maturity investments before maturity, IAS 39 requires it to abandon the held-to-maturity category for all investments. This means that the government debt would have to be reclassified at the year end. If it were then called available-for-sale, the loss could be taken to equity until later sale .

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Frequently asked questions - and answers! What is the difference between "fair value" and "net realisable value" (NRV)?




NRV is a market price net of selling costs. Fair value is a market price with costs neither deducted or added. For some assets (e.g. buildings) in some countries, transaction costs could be a large percentage. Because revaluation increases subsequent depreciation and decreases gain on sale, would this not discourage revaluation?

It is not the IASB's intention to discourage the use of relevant current values. A transfer can be made from revaluation reserve to accumulated reserves of the increase in the depreciation charge. This maintains 'realised' profits at the the same level. IAS 16's rule on the calculation of the gain on revalued assets seems to mean that some realised gains never appear in the income statement. Can this be right?

That is, indeed, the implication, implication, as is the case in the UK. However, the gain does appear in the "statement of changes in equity". This problem is one of many that may lead to a merger of the income statement statement and the statement statement of changes in equity. However, see the point raised in the answer to the previous question.

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If investment properties and other investments can (or must) be valued at fair value, why can this not be the case for inventories that are about to be sold in an active market?




IAS 2 exempts mineral ores, so gold stocks could be valued at market price, for example. It is possible that the IASB will examine this major issue in the next few years. years. The IASB is currently looking at at Extractive Industries. The major problem is that the sale could could always be cancelled and therefore profit be taken on an incomplete transaction.

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Module 5 - Accounting for liabilities

 Module 5

Accounting for liabilities

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Module 5 introduction - Accounting for liabilities This module deals with a number of IASs that give rise to the recognition of liabilities: .




Provisions, Contingent Liabilities and Contingent Assets - IAS 37 Events after the balance sheet date - IAS 10 Employee Benefits - IAS 19 Income Taxes - IAS 12

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Provisions, Contingent Liabilities and Contingent Assets - IAS 37 The main elements of this standard are as follows:




This standard excludes certain items such as financial instruments that were dealt with by IASs 32 and 39 discussed in an earlier module and also excludes executory contracts where both sides of the contract are equally unperformed (paragraph 1). A basic feature of IAS 37 is that it defines provisions as liabilities of uncertain timing or amount. That is, a provision must meet the definition of liability as found in the Framework that there should be an expectation of an outflow of resources, a past event and at the balance sheet date a legally enforceable obligation to a third party or a constructive obligation (paragraph 10). A provision should be recognised in the balance sheet when it meets the definition of a liability, where there is a probable outflow of resources and, the extra feature as usual for the recognition of assets and liabilities, is that there should be a reliable estimate (paragraph 14). Once a provision has been recognised it should be measured at the best estimate of the future outflow. This means that it is also required to discount the numbers where this would be material, at pre-tax discount rates assuming that the provision is measured in pre-tax terms (paragraphs 36,45 and 47). Any expected gains from disposals of assets related to the setting up of provisions should be ignored, but reimbursements, for example from insurance contracts, should be accounted for (paragraphs 51 and 53). There should be no provision for future operating losses, but there may be provision for onerous contracts (paragraph 63). There are a number of explanations about restructuring provisions in the context of this standard, but they make it clear that such provision should not be set up unless there is an obligation at the balance sheet date (paragraph 72).

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A contingent liability is defined in two different ways. Firstly, it includes possible obligations and secondly existing obligations at the balance sheet date which are unrecognisable because they will probably not lead to an outflow or are not able to be measured reliably (paragraph 10). Contingent liabilities should be disclosed where they are material in size and not remote.




Contingent gains should not be recognised, but should be noted where material (paragraph 31).

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

A provision can only be recognised when there is an obligation at the balance sheet date. Should one recognise a provision for the possible loss of a law case?

At first sight the possible loss of the law case might seem to be a contingent liability that should therefore not be recognised. However, the wrong act that has led to the enterprise being taken to court was committed in the past, and if the enterprise is likely to lose the case then an obligation does exist at the balance sheet date and there is an expectation of future outflows of cash. This implies that the enterprise must consult its lawyers and estimate whether it is likely to lose the case and then estimate, as well as possible, the size of the liability and then provide for it. The amount should, of course, be discounted if that would be material. This is rather like recognition of a payable creditor; in such a case it does not take a creditor to sue one in court in order to be forced to recognise that one has an obligation.

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Case study - Provisions, Contingent Liabilities and Contingent Assets



The facts below are loosely based on a real case, but the company, year and exact numbers have been changed. Newberg is a German company. Newberg's income statements for 20x0 and 20x1 are shown below, as are some accounting policies and notes: Consolidated statements of income (in billions Euro)

Sales Cost of goods sold

20x0

20x1

32 (10)

38 (12)

22 (8) (5) (2) (1)

26 (10) (6) (2) (1)

6 3

7 3

9

10

-

(9)

-

(6)

. Gross profit

Marketing and distribution Research and development Administrative Other expenses . Operating profit

Non-operating income . Results before special charges and taxes

. Special charges

Acquired in-process research and development Restructuring .

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Taxes

On result before special charges Benefit from special charges

(2) -

(2) 3

7

(4)



. Net income (loss)

Extracts from significant accounting policies and notes Basis of preparation of financial statements The consolidated financial statements of

the Newberg Group are prepared in accordance with International Accounting Standards. Consolidation policy. The consolidated financial statements of the Group include the

parent and the companies which it controls (subsidiaries). Control is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Control is normally evidenced when the Group owns, either directly or indirectly, more than 50% of the voting rights of a company's share capital. Changes in group organisation. On 24 June 20x1, a subsidiary of Newberg entered into

an agreement with the shareholders of Orange Limited to purchase all of the issued and outstanding common shares. Completion of the transaction was not possible until certain regulatory clearances had been obtained. In view of the overall materiality of the transaction and the advanced state of the integration planning, the consolidated financial statements of the Group give effect to the acquisition of Orange Limited as of 31 December 20x1. Obtaining clearance from the regulatory authorities caused a delay in completing the transaction. These final clearances were received on 24 February 20x2 and the purchase of the shares was completed on 10 March 20x2.

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The acquisition was accounted for under the purchase method of accounting. Accordingly, the cost of the acquisition, including expenses incidental thereto, was allocated to identifiable assets and liabilities and to in-process research and development based on their estimated fair values. The portion p ortion of the acquisition cost allocated to in-process research and development was charged in full against income. This approach is consistent with the Group's accounting policy for research and development costs. After consideration of these items, the excess of the acquisition cost over the fair values was recorded as goodwill.




Do you think that a provision for restructuring costs should have been set up at 31 December 20x1? (Other questions on this case will be asked in Module 6)

According to IAS 37, a provision should be set up when: (i) there is a probable expected outflow, (ii) it can be measured reliably, (iii) there is a past event, and (iv) there is an obligation. In this case, perhaps the first two criteria could be satisfied. It is not clear whether there is a past event, and it seems most unlikely that there was an obligation. The latter could only be set up by committing the company irrevocably to transferring resources to a third party. The exact facts would need to be examined. However, since the subsidiary (Orange) does not seem to have been controlled by the balance sheet date, it seems unlikely that the Group could have created a liability in it. (Note IFRS3 ‘Business ‘Business Combinations’ Combinations’ states that in applying the the purchase method, an acquirer must not recognise provisions for future losses or restructuring costs expected to be incurred as a result of the business combination. combination. These must be treated as post combination expenses)

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Events After the Balance Sheet Date - IAS 10 The main elements of this standard are as follows:




IAS 10 was published in revised form in December 2003 The standard deals with two types of event that occur after the balance sheet date. First, adjusting events, which are those that provide information concerning conditions which did exist at the balance sheet date. These should lead to recognition changes, that is changing the numbers in the balance sheet. The second type of post balance sheet events are non-adjusting events. These give information about conditions that did not already exist at the balance sheet date and they should not lead to changes to the numbers in the balance sheet, but, if material, to disclosures in the notes (paragraphs 17 to 22). An example of an adjusting event is further information about the collectibility of trade receivables (debtors) at the balance sheet date. This enables a company to more accurately measure the amount receivable. An example of a non-adjusting event would be the destruction of some of one's assets accidentally, perhaps by fire, after the balance sheet date. If dividends on ordinary shares are proposed, but not declared, after the balance sheet date then these should not be recognised as liabilities. (paragraph 12). Whether or not an enterprise is a going concern should be assessed at the stage at which the financial statements are being prepared, which is, of course, after the balance sheet date. If it is determined that an enterprise is not a going concern, then that assumption should be abandoned even if the events leading to the conclusion occurred after the balance sheet date. This of course does not apply if only part of the enterprise is not a going concern. The reporting unit is the whole of the enterprise and the status of going concern should be assessed for that whole reporting enterprise (paragraph 14).

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

Can proposed dividends be a liability?

A proposed dividend could certainly be a liability if it has been approved at the Annual General Meeting, but this will not have happened by the time that the financial statements are prepared. This led IAS 10 to conclude that proposed dividends should not be accrued. However, dividends on preference shares might be considered in certain circumstances to be at least constructive obligations, and the standard does not deal with these. Preference shares are treated as the same as debt under IASs.

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Employee Benefits - IAS 19 The main elements of this standard are as follows:




This standard applies to all employee benefits not just to pensions (paragraph 1). The standard deals with such issues as accounting for accumulating compensated absences and for bonus plans. In each case the standard requires an enterprise to establish whether there is a liability at the balance sheet date and to account for any liability (paragraphs 14 and 17). In a country with special forms of employee benefit systems such as multi-employer plans and government plans, these should be accounted for as other plans on the basis of their legal and institutional arrangements (paragraphs 29 and 36). Defined contribution plans present few difficulties for accounting but the standard does cover them (paragraph 44). Defined benefit plans are much more complicated, and a large part of the standard deals with them. Constructive obligations as well as written contractual ones should be accounted for (paragraph 52). Employee benefit liabilities are measured as the arithmetical sum of four elements. First, there is the present value of the obligation minus the fair value of any plan assets. But two other elements are included in the measurement of the liability because of other requirements of the standard. The liability includes actuarial gains not recognised less past service costs not recognised (paragraph 54). Under certain circumstances an employee benefit asset can be recognised but there are limits on the size of this asset (paragraph 58). When calculating the value of the obligation, which was the first element to be included in the liability, as noted above, the projected unit credit method should be used and a discount rate measured by reference to interest rates on high quality corporate bonds (paragraphs 64 and 78). Actuarial gains and losses are allowed to be recognised immediately or can remain unrecognised to the extent that they fall within a "corridor" which is equal in size to 10% of the larger of the obligation or the fund (paragraph 92).

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To the extent that gains and losses fall outside the corridor they must be recognised over the remaining average service lives of the employees in the plan (paragraph 93).




Past service costs which are caused, for example, if the benefits in the plan are increased, should be recognised immediately if they are already vested, but otherwise over the average period until the benefits become vested (paragraph 96).

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

Do possible future pay rises give rise to a present liability for pensions?

The issue is not whether future pay rises give rise to a present liability. The liability exists anyway and the future pay rises are a part of correctly estimating the size of the liability. Therefore the best estimate of future pay rises should be taken into account. Why should a pension liability include any of the actuarial gains (paragraph 54)?

The liability has to include those actuarial gains that are not recognised yet because otherwise the arithmetic will not add up. Unrecognised gains are credit balances so they have to be recorded somewhere. When a defined benefit plan is enhanced, when should the cost of improving the benefits for existing pensioners be recognised?

For existing pensioners, liabilities are presumably already vested, consequently past service costs should be recognised immediately against income.

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Income Taxes - IAS 12 The main elements of this standard are as follows:




This standard largely concerns accounting for deferred tax. It changed the basis of calculation to "temporary differences", which are calculated by reference to the difference between the tax basis and the financial reporting basis of assets and liabilities, instead of "timing differences", which are based on tax and book differences for revenues and expenses (paragraph 5). Deferred tax liabilities should be recognised for all temporary differences, except those relating to non-deductible goodwill amortisation and the initial recognition of certain assets and liabilities in transactions that affect neither accounting profit nor taxable profit. Deferred tax assets should similarly be recognised assuming that future taxable profit is probable. Deferred tax assets include, of course, those arising on tax loss carry forwards (paragraphs 24 and 34). There are also special rules for investments in subsidiaries, associates and joint ventures. They amount to saying that temporary differences that are unlikely to reverse where the investor is in control of that process (for example, by being able to stop the payment of dividends) need not be accounted for (paragraphs 39 and 44). The measurement of deferred tax assets and liabilities should be based on tax rates that are expected to apply, but that generally means current tax rates, although future rates can be used where they have been enacted (paragraphs 47 and 51). Deferred tax amounts should not be discounted. At first sight, this seems surprising because other liabilities are required to be discounted (see IAS 37). However, discounting would require knowledge of when temporary differences would reverse, which would require a large amount of guesswork (paragraph 53). The double entry for the creation of deferred tax assets and liabilities should be charged to income or to the statement of changes in equity depending upon the location of the amounts to which the deferred tax relates (paragraphs 58 and 61). Deferred tax assets should be presented on the balance sheet separately from deferred tax liabilities (paragraphs 69 and 74).

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

A deferred tax liability is recognised on the revaluation of an asset that is intended for continuing use in the business. Does this meet the Framework's definition of liability?

The UK view on this question is that such an amount does not meet the Framework’s definition of a liability because at the balance sheet date there is no legally enforceable obligation of the enterprise to pay any tax. However, the IAS view is that you could also see the deferred tax liability as a value adjustment against the related asset. Therefore it should be recognised recognised in the financial financial statements.

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Case study - Deferred tax Suppose that a British company, Acrobat, applies IFRS. It purchases a machine for £10,000 in early 20x0. The machine is expected to last for ten years and to have no residual value. The accounting year is the calendar year. The company is fairly small and is able to claim 40% tax depreciation (capital allowances) in the year of purchase.



Suppose also, that Acrobat buys land at £3m in early 20x0, and revalues it to fair value of £5m at 31 December 20x0. What are the "temporary differences" in 20x0? What would be the "timing differences"?

The temporary differences are: (i) Machine

. (ii) Land

Financial reporting basis of asset: 10000 - 1000 = Tax base of asset : 10000 - 4000 =

Financial reporting basis of asset = Tax base of asset =

£9000 £6000 £3000 £5m £3m £2m

The timing differences would be: (i) Machine

Tax depreciation: Financial reporting depreciation :

£4000 £1000 £3000

.

(ii) Land

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Tax revenue : Financial reporting revenue :

0 0 0

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IFRS2 ‘Share-based payment’ This illustrates the point that all timing differences are included in the total of temporary differences, but there are some extra things (e.g. the revaluation of assets) that lead to temporary differences but not timing differences




A share-based payment is a transaction in which the company received goods or services in exchange for share capital or a liability based on the company’s shares, ie a cash payment based on the change in the company’s share price. IFRS2 applies to all entities and there is no exemption for private or small companies. It is important to differentiate between shares issued to acquire a company which is accounted for under IFRS3 ‘Business Combinations’ and shares issued for employee services accounted for under IFRS2. The issue of shares or rights to acquire shares requires an increase in equity and the debit entry will be an expense when the goods or services are consumed. consumed. If the share issue is linked to past services, then the value of the shares given to the employees will be expensed immediately. If the issue of shares relates to a future vesting period, then the value of the shares should be expensed over that period. For example, if a company grants a director 200 share options on 1 January 20X6, and these vest after two years, and assuming each option has a value of $3 at the date of the grant, then at 31 December 20X6, the accounting entry would be: $ Debit Share Option expense (1 year) 300 Credit Equity 300 IFRS2 applies to all equity based payments granted after 7 November 2002 which was the date that the exposure draft was issued. issued. Thus any schemes set up earlier than that date are exempt from its requirements.

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Frequently asked questions - and answers! If a company's board of directors has decided on a restructuring, should the company not make a provision for fo r the restructuring, redundancy costs, etc?




It depends on the facts. In some cases, a board decision does not create an obligation to a third party, and the board could change its mind. In such cases, IAS 37 does not allow a provision. This may not be "prudent" but this is overridden by the need to comply with the Framework's definition of a liability. Surely it gives useful information to the users of financial statements to show a proposed dividend as a liability?

IAS 10 is based on the idea that it is not useful to show something as a liability that is not in accordance with the definition of a liability. The information about the proposed dividend can be given in the notes, and the amount can be shown separately in equity What would be the effect of moving towards the IAS basis for companies for pension accounting in countries which have not adopted IAS?

There would probably be greater volatility of pensions figures, because of the use of current rather than long-run discount rates.

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Module 6 – Group accounting

 Module 6

Group accounting

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Module 6 introduction - Group accounting This module covers six IASs that concern the preparation of consolidated financial statements and covers a few other issues relating to investments within groups. The first to be dealt with (IAS 27) deals with the definition of a subsidiary and the general rules of full consolidation. Then, IFRS3 deals with business combinations, including the treatment of goodwill. IAS 28 and IAS 31 deal with associates and joint ventures, respectively. IAS 21 and IAS 29 deal with items related to foreign currency and what to do when subsidiaries operate in hyperinflationary circumstances.

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Consolidated and Separate Financial Statements - IAS 27 The main elements of this standard are as follows:




A "subsidiary" is defined as an enterprise controlled by another. Control can of course arise without the necessity for the ownership of more than half the voting shares in another enterprise (paragraph 4). A parent is exempted from the preparation of consolidated accounts if it is itself a wholly owned or virtually wholly owned subsidiary (paragraph 10). Subsidiaries should be excluded from consolidation when they are controlled only temporarily with a view to disposal within 12 months from acquisition and management is actively seeking a buyer (paragraph 16). Any difference between the reporting date of the parent and the reporting date of a subsidiary should not exceed three months (paragraph 27). Uniform accounting policies are required for the preparation of financial statements. (paragraphs 28 and 29). If different accounting accounting policies are used used by the members of the group, appropriate adjustments should be made in the group accounts. De-consolidation of a subsidiary should occur on the date that the investment ceases to control the subsidiary. (paragraph 24). In parent company financial statements, investments in entities can be accounted for in several ways: at cost, using the equity method ( IAS 28), or as available-for-sale investments ( IAS 39) (paragraphs 31 and 32).

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

How are unconsolidated subsidiaries valued?

Subsidiaries cannot be excluded under IAS 27 on the grounds that they are dissimilar from the rest of the group or are operating under severe long term restrictions on the transfer of funds (paragraph 20). Any subsidiaries that are excluded should not be treated by the equity method, but should be treated as investments in accordance with IAS 39 (see paragraph 16 of IAS 27). How should one value a subsidiary that was acquired with the intention of being sold within 12 months?

The subsidiary should be excluded from consolidation. However, management must must be actively seeking a buyer. Can minority interests be presented inside of shareholders' funds?

The standard requires that minority interests should be presented separately in the consolidated balance sheet within equity but separately from the parent shareholders’ equity. According to the Framework, credit credit balances must either be equity or liabilities, so minority interests must be part of equity, but not the parent's share of equity.

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Business Combinations - IFRS3 The main elements of this standard are as follows:




The first issue to address add ress within this standard is that a business combination is always to be treated as an acquisition. The basic requirement of the standard is that combinations should be treated as acquisitions as always it is possible to identify an acquirer (paragraph 14). Uniting of interests are not allowed. The cost of the acquisition is the fair value of the consideration given including any contingent consideration (paragraphs 27 and 34). In an acquisition, assets and liabilities of the acquiree should be brought in at fair value not at their previous book value. In applying the ‘purchase’ method, an acquirer must not recognise provisions for future losses or restructuring costs as a result of the business combination (paragraph 41). An intangible item acquired, including in process research and development projects, must be recognised separately from goodwill if it meets the definition of an asset and its fair value can be measured reliably reliably (paragraph 45). Contingent liabilities must must be recognised if their value is reliably measurable (paragraph 47). Goodwill arising on an acquisition is the difference between the fair value of the consideration and the fair value of the net assets acquired. Such goodwill should not be amortised but must be tested for impairment at least annually in accordance with IAS36 (paragraph 54) Negative goodwill can arise where there is a bargain purchase or the purchase of future losses. Before deciding that negative goodwill has arisen, IFRS3 requires the acquirer to reassess the fair value of the net assets acquired and consideration given in order to ensure their accuracy. accuracy. If negative goodwill has arisen, then it must be recognised immediately in the income statement as a gain (paragraph 56). The expenses of an acquisition are added into the fair value of the purchase price.

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Exercise - IFRS3 You should refer to the text of the standard when answering exercises.




Can goodwill be amortised under IFRS3?

No, goodwill must be tested at least annually for impairment using IAS36. When should negative goodwill could be recognised immediately as income?

The standard requires that before negative goodwill can be recognised as income, the values given to the net assets acquired and the price paid need to be reaffirmed. If the values are found to be correct, then the whole amount goes to the income statement. The IFRS wants to ensure that errors have not occurred in the valuation and that the negative goodwill has arisen out of a bargain purchase or because of the fair valuation of items not normally fair valued, eg deferred tax balances.

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Case study - Business Combinations and Subsidiaries This case study once again reviews Newberg and the details that were presented to you in Module 5.



The company, Newberg, is German. Its income statements for 20x0 and 20x1 are shown below, as are some accounting policies and notes: Consolidated statements of income (in billions Euro)

Sales Cost of goods sold

20x0

20x1

32 (10)

38 (12)

22 (8) (5) (2) (1)

26 (10) (6) (2) (1)

6 3

7 3

9

10

-

(9)

-

(6)

. Gross profit

Marketing and distribution Research and development Administrative Other expenses . Operating profit

Non-operating income . Results before special charges and taxes

. Special charges

Acquired in-process research and development Restructuring

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Taxes

On result before special charges Benefit from special charges

(2) -

(2) 3

7

(4)



. Net income (loss)

Extracts from significant accounting policies and notes Basis of preparation of financial statements The consolidated financial statements of

the Newberg Group are prepared in accordance with International Accounting Standards. Consolidation policy. The consolidated financial statements of the Group include the

parent and the companies which it controls (subsidiaries). Control is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Control is normally evidenced when the Group owns, either directly or indirectly, more than 50% of the voting rights of a company's share capital. Changes in group organisation. On 24 June 20x1, a subsidiary of Newberg entered into

an agreement with the shareholders of Orange Limited to purchase all of the issued and outstanding common shares. Completion of the transaction was not possible until certain regulatory clearances had been obtained. In view of the overall materiality of the transaction and the advanced state of the integration planning, the consolidated financial statements of the Group give effect to the acquisition of Orange Limited from 31 December 20x1. Obtaining clearance from the regulatory authorities caused a delay in completing the transaction. These final clearances were received on 24 February 20x2 and the purchase of the shares was completed on 10 March 20x2.

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The acquisition was accounted for using the purchase method of accounting. Accordingly, the cost of the acquisition, including expenses incidental thereto, was allocated to identifiable assets and liabilities and to in-process research and development based on their estimated fair values. The portion p ortion of the acquisition cost allocated to in-process research and development was charged in full against income. This approach is consistent with the Group's accounting policy for research and development costs. After consideration of these items, the excess of the acquisition cost over the fair values was recorded as goodwill.




At what date did Orange become a subsidiary?

As the company notes, a subsidiary is a controlled enterprise. Control would appear to have arisen in February or March 20x2. The company notes that at the end of 20x1, there was integration planning. At what date did Newberg start consolidating Orange?

Newberg consolidated Orange at the stroke of midnight on the 31 December 20x1. That is, there was no effect on the group operating income, but a full effect on the balance sheet. It seems a remarkable coincidence that there was no control on the 30 December 20x1, but full control before 1 January 20x2. Is Newberg's treatment of purchased R&D in line with IFRSs?

The acquired in-process R&D has been separately identified on 31 December 20x1 and then immediately expensed in that year. IFRS3 requires intangible assets to be recognised as an asset separately from goodwill if it meets the definition of an asset, is either separate or arises from contractual or legal rights and its fair fair value can be measured reliably. The intangible should be carried at cost/valuation less amortisation and any impairment losses. The intangible should not not be expensed if it meets the definition in IAS38/IFRS3.

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Accounting for Investments in Associates - IAS 28 The main elements of this standard are as follows:




The standard defines an associate as an enterprise over which the investor has significant influence, which is the power to participate in financial and operating policy decisions (paragraph 2). This is presumed to exist where the investor owns twenty percent or more of the voting equity in the investee. As for subsidiaries, associates are to be excluded when they are acquired and are held for resale within twelve months of acquisition acquisition (paragraph 13). If there are severe long-term restrictions on the transfer of funds, this does not justify not using the equity method when significant influence still exists. Associates are to be included in consolidated financial statements by using the equity method (paragraph 13). IAS28 requires that unrealised profits and losses should be eliminated in proportion (paragraph 22). In the separate financial statements of an investor, associates can either be held at cost, or in accordance with IAS39.

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Joint Ventures - IAS 31 The main elements of this standard are as follows:




A joint venture results from a contractual agreement between two or more parties for activities exercised under joint control (paragraph 3). IAS 31 envisages three types of joint ventures: operations, assets and entities (paragraphs 13, 18 and 24). Operations and assets are accounted for by identifying which of the venturers controls the assets and liabilities. For joint venture entities the standard permits alternative treatments proportionate consolidation (paragraph 30), and the equity method (paragraph 38). As for subsidiaries and associates, when a venture is acquired with a view to disposal within twelve months then IAS31 does not require proportionate consolidation or equity accounting. . Gains and losses between a venturer and the venture should be recognised in proportion (paragraphs 48 and 49).

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

Is proportionate consolidation consistent with the Framework?

Although IAS 31 allows the use of proportionate consolidation, there seems to be doubt that this is consistent with the Framework in the case of joint venture entities. Since the venturer has to agree with the other venturers on major issues, it seems that any individual venturer does not control the assets (or any proportion of the assets) of the venture. Consequently it might appear that no part of the assets should be consolidated.

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The Effects of Changes in Foreign Exchange Rates - IAS 21




The main elements of this standard are as follows: It is important to distinguish between foreign currency transactions and the translation of foreign currency financial statements of overseas investees. Transactions involving foreign currencies are recorded at the rate of exchange ruling on the date of the transaction. Subsequently any non-monetary items should continue to be recorded at that exchange rate (paragraphs 23). Monetary items resulting from past transactions should be translated at the closing rate at each balance sheet date, and the resulting gains and losses should be taken to income immediately (paragraphs 23 and 28). However, exchange differences on the net investment in a foreign entity should be recognised in the group accounts as a separate component of equity, and will be recognised in profit and loss on disposal of the net investment. IAS21 sets out two definitions of ‘currency’. The currency of the the environment in which a company operates is called the ‘functional’ currency and the currency in which the financial statements are presented is called the ‘presentation’ currency. Only one translation method is used for for foreign operations. Assets and liabilities liabilities are translated at the closing closing rate. Income and expenses at the rate at the date of the transaction (average rate). Exchange differences go to a separate component of equity and are recognised in the income statement on disposal of the entity. Special rules apply for foreign entities operating in hyper inflationary conditions (IAS29 also applies).

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Financial Reporting in Hyperinflationary Economies - IAS 29 29 This standard should be applied by any enterprise that reports in the currency of a hyperinflationary economy. Hyperinflation is not specifically defined, but an indication would be where there is a cumulative inflation rate of one hundred percent or more over three years. For most countries this would not apply at present. However, groups might have a subsidiary in such a country, which is why this standard has been included here in this module on group accounting.




The main elements of this standard are as follows: IAS 29 requires the financial statements of a hyperinflationary enterprise to be restated into current measuring units (paragraph 8). If the enterprise is using historical cost financial statements, this suggests the application of a general price index to non-monetary items. Even those enterprises using current cost accounting would need to re-express certain numbers using a measuring unit current at the balance sheet date. A gain or loss on the net monetary position should be included in net income and disclosed separately (paragraph 9).

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Frequently asked questions - and answers! If a continental European company adopts IASs/IFRSs for its consolidated statements, does this change its tax bills?




It depends. In some countries, for example Germany, German GAAP is used for tax purposes. In the UK, accounts accounts drawn up under IFRSs IFRSs can be used used for tax purposes. If a foreign subsidiary is using non-IAS/IFRS policies, what happens on consolidation?

The policies have to be corrected for consolidation, usually by consolidation adjustments rather than by changing the foreign statutory accounts. Group accounting policies should be consistent. Do the parties to a joint venture each need to own exactly the same proportion of shares?

No. There is nothing to stop a 30/30/40 arrangement, for example.

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Module 7 – Disclosure standards

 Module 7

Disclosure standards

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Module 7 introduction – Disclosure standards This module concerns a number of IASs/IFRSs that do not affect the recognition and measurement of items in the balance sheet and income statement.




However, in the case of certain standards, they do affect the presentation of numbers in the main financial statements. This is particularly obvious for the first standard (IAS 7) which concerns the major statement on cash flows. In most other accounting standards dealt with in the previous modules there are many disclosure requirements which on the whole have not been discussed so far in the course, but which you could examine by going to the end of each accounting standard where there is a section on disclosures. This module discusses the seven IASs that relate to disclosure: Cash Flow Statements - IAS 7 Segment Reporting - IAS 14 Related Party Disclosures - IAS 24 Earnings Per Share - IAS 33 Interim Financial Reporting - IAS 34 IFRS5 - Non-current assets Held for Sale and Discontinued Operations Disclosures in the Financial Statements of Banks and Similar Financial Institutions IAS 30 IFRS4 - Insurance Contracts

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Cash Flow Statements - IAS 7 The main elements of this standard are as follows:.. follows: ..




This standard requires an enterprise to present cash flow statements as an integral part of its financial statements (paragraph 1). Cash flows should be reported classified into three main headings: operating, investing and financing activities (paragraph 10). The statement should reconcile to "cash and cash equivalents". Cash equivalents are somewhat vaguely defined as short-term highly liquid investments that are readily convertible to known amounts of cash, but there is no exact limit on maturity dates on such investments. Cash flows can be calculated either directly by observing cash receipts and payments, or indirectly by adjustments for such items as non-cash amounts (paragraph 18). Actual or average exchange rates should be used for cash flows from a foreign subsidiary (paragraph 26). Cash flows from interest or dividends either received or paid can be classified as either operating, investing or financing (paragraph 31). Non-cash transactions should not be included in the statement of cash flows, but should be disclosed in the notes (paragraph 43).

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Segment Reporting - IAS 14 The main elements of this standard are as follows:




This standard concerns note disclosures on a segmental basis. It is compulsory for those enterprises with securities that are publicly traded (paragraph 3), but is only required for consolidated financial statements in those cases where parent and consolidated statements are in the same document (paragraph 6). An enterprise should identify its primary segment basis by noting the dominant source of its risks and their nature. Normally, this primary basis of segmentation will be confirmed by observing the management structure and internal management reporting (paragraphs 26 and 27). The primary basis will be either by line of business or by geographical market. An enterprise should report on a primary basis a large number of items including, segment revenue (that excludes extraordinary items), interest and dividend income, and gains on the sale of investments (paragraphs 16 and 51). The segment result should also be reported as well as segment assets and segment liabilities. A number of other disclosures on a primary basis are also required. Reportable segments should comprise at least ten percent of total revenue or total result or total assets (paragraph 35). Segment information should be prepared using the same accounting policies as for external financial reporting (paragraph 44).` For the secondary reporting basis, there is a rather shorter list of disclosure requirements including revenue, total carrying amount of segment assets and total cost in the year to acquire segment assets (paragraphs 69 to 72).

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

Would "high inflation" vs. "low inflation" be a good basis of geographical segmentation?

In order to answer this question one should look at paragraph 9 of IAS 14. This states that a segment is a distinguishable component of an enterprise subject to risks and returns different from other segments. The question asks whether such a segment basis might compare high inflation inflation with low inflation. inflation. It seems that possibly this would be a suitable basis because paragraph 9, under geographical segments, refers to, among other things, similarity of economic and political conditions and currency risks, both of which might be said to be connected to amounts of inflation. However, the list of items says “ factors that should be considered in identifying segments include” so there is a great deal of room for manoeuvre. Generally speaking the business and geographical segments are usually determined by reference to the organisational units for which information is reported to the Board of Directors.

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Related Party Disclosures - IAS 24 The main elements of this standard are as follows:




A related party is defined in terms of control, joint control, or significant influence, but some exemptions are granted. (paragraph 11). The standard requires the disclosure of transactions between related parties. Transactions include those that are carried out at arm's length (paragraphs 12 to 22). The standard also requires the disclosure of control relationships even when there are no transactions (paragraph 12).

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Earnings Per Share - IAS 33 The main elements of this standard are as follows:




Like IAS 14, this standard is only mandatory for those enterprises with publicly traded securities, and parent company reports can be exempted (paragraphs 2 and 4). "Earnings" is defined as the net profit from the income statement but after deduction of dividends on preference shares (paragraph 12). The disclosure of earnings per share should be done on the basis of a "basic" and a "diluted" calculation. For the "basic" calculation the earnings should be divided by the weighted average number of ordinary shares outstanding during the period (paragraph 19). This should be adjusted for such things as bonus issues which change the number of shares (paragraphs 26). Diluted earnings per share is calculated by dividing earnings by the number of shares adjusted for all dilutive potential ordinary shares (paragraphs 30 and 31). Shares are dilutive when their conversion would decrease net profit per share (paragraph 41). Earnings per share should be disclosed even if the amount is negative (paragraph 69).

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Interim Financial Reporting - IAS 34 The main elements of this standard are as follows:




This standard is not mandatory and no frequency of reporting is prescribed (paragraph 1). The standard is designed to be used by those companies that are required by regulatory authorities or stock exchanges to present interim reporting on a half yearly or quarterly basis. If reporting is to be described as in compliance with international standards then the rules of IAS 34 should be followed. IAS 34 requires condensed versions of all four primary statements (see IAS 1) to be disclosed, and earnings per share (paragraphs 8 and 11). The minimum content of these condensed financial statements is specified (paragraph 16). Comparative figures for previous interim periods and previous full years are specified. This is fairly complicated in the case of quarterly reporting (paragraph 20). The same accounting policies are required in the interim reporting as for annual reporting, although changes in accounting policy might be made at the interim stage rather than waiting for a year end. The frequency with which interim reporting is carried out must not be allowed to affect the annual result (paragraph 28). For interim reporting, the use of year end practices with respect to whether items should be anticipated or deferred is required (paragraphs 37 and 39). That is, interim reports should largely be seen as periods in their own o wn right.

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

Once development expenditure has been expensed it cannot subsequently be capitalised (see IAS 38). Does this fit with IAS 34, paragraph 29?

At first sight this question uncovers a difficulty. Let us take the example of a company that does not do interim reporting and discovers by the year end that it has passed the threshold for the capitalisation of development expenditure. In practice the question might be asked near the year-end whether the appropriate reliability has been established for capitalisation. Perhaps the whole year's expenditure would then be capitalised. If interim reporting were carried out on a half yearly basis it might be clear by half way through the year that the criteria for capitalisation had not been achieved. Consequently all the expenditure in the half year could not be capitalised either then or later. In order to reconcile the requirements of IAS 34 with those of IAS 38 it is necessary to carry out continuous appraisal of when appropriate criteria are met and then capitalise expenditure only from that date onwards.

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IFRS4 ‘Insurance Contracts’ IFRS4 applies to virtually all insurance contracts and was introduced so that Insurance companies could comply with IFRS in 2005. Many aspects of accounting by insurance insurance companies were incompatible with IFRS.




The IFRS exempts an insurer temporarily from some requirements of IFRS including the ‘Framework’ document. The IFRS prohibits provisions for claims that are not in existence at the reporting date. For example provisions for future catastrophes that have not yet occurred. It also requires reinsurance assets to be impairment tested and an ‘adequacy’ test for liabilities. It prohibits the offsetting offsetting of insurance liabilities against related related reinsurance assets. The IFRS is designed as a stop gap measure until a more comprehensive standard can be agreed upon.

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Non-current assets held for sale and discontinued operations – IFRS5




The IFRS introduces the concept of a ‘disposal group’, which is a group of assets and liabilities that will be transferred in a transaction. Also the classification ‘held for sale’ is introduced and this relates to an asset or disposal group which is is to be disposed of through sale. Certain conditions have to be met before assets can be classed as ‘held for sale’. Assets or disposal groups classed as ‘held for sale’ are valued at the lower of the carrying amount and fair value less costs costs to sell (paragraph 15). Such assets are not depreciated (paragraph 25). Assets classified as ‘held for sale’ must be shown separately on the face of the balance sheet (paragraph 38). A discontinued operation occurs when the operation meets the criteria to be classified as ‘held for sale’ or when the operation has been disposed of. The results of discontinued operations have to be shown separately on the face of the income statement (paragraph 33) and if the discontinued criteria are met after the balance sheet date, then the discontinuance cannot be retrospectively classified as such in the balance sheet.

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Exercise - IFRS5 You should refer to the text of the standard when answering exercises.


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If shares are to be sold such that a subsidiary becomes an associate, can that be a discontinued operation?

There is a difficulty here with respect to the reporting entity. One view is that if a subsidiary becomes an associate then it used to be controlled by the group and this is no longer the case. case. Therefore the subsidiary/holding company company relationship has been discontinued so that it can qualify as a discontinued operation. Another view is that an associate still carries on the business of the group to some extent, so that it cannot be a discontinued operation. A discontinued operation under IFRS5 (paragraph 32) should represent a major line of business, or geographical area of operations, or is a subsidiary acquired with the intention of resale. Also the operations and and cash flows should be clearly distinguishable. Thus it is unlikely that a sale sale of shares would fit these criteria. criteria. However, they could meet the criteria as an asset which is ‘held for sale’ and this must be shown separately on the face of the balance sheet.

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Disclosures in the Statements of Banks and Similar Financial Institutions - IAS 30


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This fairly old accounting standard requires only disclosures rather than recognition and measurement standards. It has been recognised that it is due for an overhaul as soon as possible... possible...

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Frequently asked questions - and answers! Does a parent company have to produce a cash flow statement if its group has produced one?


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Yes, if the parent is required to (or wishes to) comply with IAS. This is different from UK requirements. Why does IFRS5 refer to "discontinued" "discontinued" rather than "discontinuing" operations?

Because IFRS5 requires disclosures to begin when the operation has been sold or is ‘held for sale’. Discontinuing operations could have occurred under IAS35 ‘Discontinuing Operations’ simply when the directors had approved and announced a disposal plan. A discontinued operation is now defined in terms of a more definite set of actions having been completed, for example the group of assets must be available for immediate sale not a future sale.

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Module 8 – Forthcoming projects

 Module 8

Forthcoming Forthcoming projects

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Module 8 introduction – Forthcoming projects The IASB has several projects in progress at at any one time. time. The main proposals relate to business combinations where the IASB wish to stop the amortisation of goodwill and outlaw uniting of interests interests accounting. New proposals on accounting for share share based payment have been issued also.


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Future ED/IFRS are expected on the following: Insurance contracts (Phase II) Revenue Recognition, Recognition, Liabilities, Liabilities, and Equity: Concepts Consolidations (including Special purpose entities) Convergence issues (IFRS and US GAAP) Reporting Comprehensive Income Accounting Standards for Small and Medium-Sized En tities Business Combinations (Phase II) Leases Measurement

Currently the US, UK and the IASB are working closer together in order to achieve greater convergence of accounting practices.

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Frequently asked questions - and answers! What sort of issues might be included in a new standard on business combinations?


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Recognising the minority’s share of goodwill How to treat successive purchases of shares in an acquisition Issues relating to the measurement of the purchase consideration and measurement of the net assets acquired (for example over what period can the fair value of the net assets acquired be revised). Is the US likely to adopt IASs?

The major differences between IASB and US rules will probably be reduced in the next few years, and the SEC may then accept IASs/IFRSs for foreign registrants.

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Course conclusion Well, that's it, you should now have an understanding of International Financial Reporting Standards.


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You will notice from Module 2 that IASs are already used in different ways around the world. For example, in several continental European countries, countries, many large companies have already departed from national rules in order to move to International Financial Reporting Standards. This is the beginning of the end of international international accounting differences at the level of the consolidated statements of listed companies. The EU has stated that by 2005 all companies wanting to be listed on a stock exchange should prepare their consolidated financial statements in line with IAS/IFRS. We are living in the era of the gradual disappearance of national national standards. In the medium term, UK standards will converge with IASs/IFRSs; and in the long-run even US standards will be merged into IASs. You should look out for newspaper reports (e.g. Financial Times and Wall Street Journal) as this story unfolds. Also, ACCA's journal, Accounting & Business frequently has articles on IAS/IFRS.

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ACCA IFRS

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