ACCA Paper P2

ACCA Paper P2

(International & UK) Corporate Reporting

Class Notes

June 2013

2 www.studyinteract ive.org

© Interactive World Wide Ltd, January 2013

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Contents PAGE

INTRODUCTION TO THE PAPER 5

CHAPTER 1: BASIC GROUPS 25

CHAPTER 2: COMPLEX GROUPS 45

CHAPTER 3: FOREIGN CURRENCY TRANSLATION 57

CHAPTER 3: GROUP CASH FLOW STATEMENTS 69

CHAPTER 5: CORPORATE SOCIAL RESPONSIBILITY AND CURRENT ISSUES 83

CHAPTER 6: PERFORMANCE REPORTING 123

CHAPTER 7: PROVISIONS 131

CHAPTER 8: NON CURRENT ASSETS 139

CHAPTER 9: LEASES 149

CHAPTER 10: EMPLOYEE BENEFITS 155

CHAPTER 11: SHARE BASED PAYMENTS 161

CHAPTER 12: FINANCIAL INSTRUMENTS 167

CHAPTER 13: TAX 187

CHAPTER 14: UK CORPORATE REPORTING 201

APPENDIX: SUGGESTED SOLUTIONS TO QUESTIONS AND EXAMPLES 209

ACCA STUDY GUIDE 311


Introduction to the

paper

INTRODUCTION TO THE PAPER


AIM OF THE PAPER

The aim of the paper is to test your understanding of financial reporting and probably more importantly to test your ability to solve problems in accounting scenarios that are every bit as messy as real life.

FORMAT OF THE EXAM PAPER

The syllabus is assessed by a three hour paper-based examination. The paper has 15 minutes reading time. There are four questions of which you must do three as follows:

Section A (Compulsory Case Study)

(q1) The case will be based around a group scenario. There will be 35 marks of numbers and 15 marks of narrative.

(50 marks)

Section B (Choice of 2 from 3 questions)

(q2) Focus. Typically the second question in the exam focuses on a single technical subject, such as pensions, financial instruments or deferred tax. Often this question requires thorough technical knowledge.

(25 marks)

(q3) Mix. Usually there are roughly 5 mini scenarios, each valued at 5 marks and covering a wide range of financial reporting issues. These questions require problem solving and usually far less technical knowledge than question two.

(25 marks)

(q4) Current Issues and CSR. Whether you call this question “Corporate Social Responsibly”, “pure narrative” or another less polite phrase, there is no getting away from the very low technical content and the very high potential for letting your pen wander across a whole range of ideas. These questions have to be seen to be believed. So look at the chapter on Corporate Social Responsibility to get a feel for their style.

(25 marks)

In reality, the examiner plays with the flavour of the B section. For example, in June 2010 the examiner reversed the usual order of the middle two questions, so that q2 was mix and q3 was focus. Often the style of question 2, 3 and 4 can be so similar as to make distinction irrelevant.



RECENT EXAM CONTENT

Question Dec 2009 June 2010 Dec 2010 June 2011 Dec 2011 June 2012 1 (groups) Grange

B/S with lots of change of ownership, plus ethics

Ashanti Enormous comprehensive income statement with discussion on creative accounting

Jocatt Solid cfs very like Warrburt plus presentation and ethics

Rose Fairly straight b/s consolidation with a foreign sub and transfers

Traveler Straight b/s with segments and ethics

Robby Group B/S with plenty going on, plus a difficult discussion of derecognition

2 (focus)

Key Impairment

Seltec Hedging and intangibles

Margie Tricky sbp.

Lockfine First time adoption

Decany Horrid group reorg

William Lovely mix of leases, pensions, sbp & provisions

3 (mix)

Burley Mix of revenue, intangibles and other issues in the energy business

Cate Mix of dt, groups, benefits and other issues

Greenie Good mix of provisions, associates and sbp

Alexandra Classic mix question with usual suspects

Scramble Challenging mix with lots of intangibles

Ethan Technical mix of goodwill, dt, FVO and equity

4 (current issues)

Financial instruments Discussion of development of FI

Holcombe Leasing including leaseback

Whitebirk Lovely SME question based on article

Grainger Lovely FI question addressing IFRS9 and current issues

Venue Lovely revenue development

Royan Surprise subject of provisions

Actually, in June 2010 the order of q2 and q3 was reversed. And in June 2012 there were two mix.



INTERNATIONAL EXAMINABLE DOCUMENTS

For the official list of examinable documents check out the P2 web page under “examinable documents”. You will find detail there. All the examinable standards are covered herein. But frankly, P2 is not a list of documents to learn and regurgitate. P2 is about understanding and applying. The examiner perceives financial reporting as being largely problem solving and so rarely expects regurgitation of standards.

UK STREAM

Some students may wish to consider the UK stream. Do not do so without reading the chapter at the end of the notes on the UK stream. This stream does require extra work and this extra work is unlikely to be of use to you in your career unless you have a specific need for the UK stream syllabus.

Please read the final chapter for further information.



INTERACTIVE STUDENT ADVICE

The following is advice aimed at students using the on-line media to do battle with P2.

Firstly, I would advise that you treat this course as if it were a classroom course. Set an evening each week (or a half day each weekend) to study the subject. Sit yourself in front of your computer with paper, pen, calculator and these notes and copy what I am doing as if you and I were in class together.

Then rework the questions from the recorded lectures until you are happy with them. Any parts you are unsure about: review the relevant recording and rework the problem a couple of times.

Once you are satisfied with your understanding of the essentials as recorded to video, then provided time allows work the supplementary questions that have not been recorded. There are answers to all the questions in the back, but obviously it’s the answers to the unrecorded questions that will interest you most.

If you are really stuck, then post your problem to the discussion board. See if you can help others with their problems posted to the discussion board. I will review the boards when I can and point you and others in the right direction. My advice is that the little things with which you struggle are often so minor as to be near irrelevant. Concentrate on the big picture, make sure you can do all the basics and when you come back to the same question for the third or fourth time, the tricky issues that seemed hard then will resolve themselves.

Emails. Really I should not be corresponding through email as this denies other students the opportunity to see our correspondence. I can see that email is very tempting, but it is against the spirit of Interactive. You guys are supposed to interact with one another as well as with me. This is why the discussion board is the way to communicate.

When it comes to the text book, my advice is be wary. The text has been based on the following notes, however, it has not been authored by me. Of course, it is absolutely fine in theory to read widely in order to widen your knowledge. But in practice, because you have so little time before you will be in the exam hall sitting the P2 exam, my advice is stick to these class notes and you will benefit from the focus. There is everything you need to know in these notes and copious practice questions. So avoiding other sources will avoid the frustrations of differing opinions and other problems associated with drawing from text books.

Finally, I wish you very good luck with your online studies and with the exam at the end of term.



INTERACTIVE LECTURE SEQUENCE

The main course is made up of 10 modules, followed by a revision course. Officially, the course starts 13 weeks before exam session. So the first week starts approximately on the last weekend in February or August as appropriate. Then it is recommended that you follow the following sequence steadily working through the syllabus. This sequence is simply that used by the evening course students studying in the classroom.

Interactive week

Chapter Subject

1 1 Basic Groups 2 2 Complex Groups 3 3 Foreign Currency Translation 4 4 Group Cash Flow Statement 5 5 Corporate Social Responsibility 6 6 Performance Reporting 6 7 Provisions 7 8 Non Current Assets 7 9 Leases 8 10 Employee benefits 8 11 Share based payments 9 12 Financial Instruments 10 13 Tax 11, 12, 13 Revision

However, the great thing about interactive is its flexibility. In the past, interactive management have made the whole course available from the start and it is my understanding that this will continue to be the case. So it is possible to mould the timetable to suit your own needs. In the past, some students have whizzed through the course in order to start their revision a little early. Others have bitten off big chunks of the syllabus in one week and then left their studies for a week. So please use the above sequence as guidance only.

Some students even start the interactive programme before the official course start date. This is absolutely fine. But be warned, if you do this you may find that you are looking at last term’s videos and that the updates have not been uploaded. That is not a problem, as you can always review the new videos when they become available at the official start date.



VIDEO SCHEDULE

The following is the video schedule for interactive as at the start of term. It gives you a very good idea of what you will expect to see online.

Note the video style in the left column. I have used two styles of recording. First there is talking head. This style of video is an introduction to the subject. It is intended to give you a feel for the subject without going into the detail. Then there is worked example. As the name suggests, I use an example to illustrate the technical points I wish to make and draw out the detail.

P2 Introductory Session

Introduction to paper P2

Title Syllabus reference

Video style

Aim of the paper Talking head

Outline of the syllabus Talking head

Format of the exam Talking head

Structure of P2 interactive Talking head

Study style recommendations Talking head

Interacting on interactive Talking head



P2 Session 1 Chapter 1

Basic Groups


Video style

Introduction to groups D1a,b,c,d,e,f,g,h Talking head

Basic groups & Q Peddle D1a,b,c,d,e,f,g,h Worked example

Roll forward & Q Peddle (revisited)

D1a,b,c,d,e,f,g,h Worked example

Impairment & Q Terra D1a,b,c,d,e,f,g,h Worked example

Changes in Ownership & Q Top D1a,b,c,d,e,f,g,h plus D2a,b

Worked example

Changes in Ownership & Qs Toy, Love & Rock

D1a,b,c,d,e,f,g,h plus D2a,b

Worked example

Relationship standards About 25 minutes D1a,b,c,d,e,f,g,h Talking head




Complex Groups


Video style

Introduction to complex groups D1a Talking head

Vertical group (Q Hendrix) D1a Worked example

D group (Q Dee) D1a Worked example

Question Rodney (explanation) D1a Worked example

Question Rodney (calculation) About 45 minutes D1a Worked example

Changes in group structure Remove D3a, b Talking head

Introduction to changes in group structure

About 10 minutes D3a, b Talking head

Changes in group structure (Q Desperate (a)(i) )

About 30 minutes D3a, b Worked example

Changes in group structure (Q Desperate (a)(ii) part one)


Changes in group structure (Q Desperate (a)(ii) part two)


Changes in group structure (Q Desperate (b) )





Foreign Currency Translation


Video style

Introduction to foreign currency translation

D4a, b Talking head

Foreign transactions (Q Feature) D4a, b Worked example

Foreign subsidiaries (Q Kenya) D4a, b Worked example

Forex (Q Xenon) D4a, b Worked example


Group Cash Flow Statements


Video style

Introduction to cfs D1i Talking head

Working a cfs (Q Duke) Remove D1i Worked example

Formatting a cfs (Q Squire) Roughly 10 minutes

D1i Worked example

Working a cfs (Q Squire) Roughly 45 minutes

D1i Worked example



P2 Session 5 Chapter5

CSR & CI


Video style

Professional ethics A1a, b and A2a, b and A3a, b

Talking head

The framework for financial reporting

B1a, b, c and B2a, b

Talking head

Current reporting issues H3a and F2a Talking head

Convergence H2a, b and F1a Talking head

Environmental and social reporting

H1a, b, c Talking head

Appraisal G1a, b and G2a, b, c, d

Talking head

Specialised entities and specialised transactions

E1a and E2a, b, c

Talking head

Small and medium entities C11a, b, c, d, e Talking head

Current issues exam questions A,B,C,E,F,G,H Talking head




Performance Reporting


Video style

Performance reports & revenue C1a, b, c Talking head

Revenue example C1a, b, c Worked example

Held for sale and discontinued operations

C2a, b + D2a, b Talking head

Segments C5a, b Talking head

Discontinued example C2b + D2a, b Worked example


Provisions


Video style

Provisions C8a, b Talking head

Events after the reporting period C8c, d Talking head

Related party disclosure C9a, b Talking head

Provisions exercises C8,a,b,c,d + C9a,b

Worked example




Non-current assets


Video style

Non current asset basics C2a Talking head

Investment Properties C2c Talking head

Intangibles C2d Talking head

Non current asset examples C2a, c, d Worked example


Leases


Video style

Lease accounting C4a Talking head

Sale and leaseback C4b Talking head

Leases exercises C4a, b Worked example


Employee benefits


Video style

Pension accounting C6a, b, c, d Talking head

Pension exercises Remove C6a, b, c, d Worked example

Pension exercise (Q Contact) About 25 minutes C6a, b, c, d Worked example




Share based payments


Video style

Share based payment obligation C10a, b Talking head

Share based payment exercises C10a, b Worked example


Financial instruments


Video style

Financial instrument classification C3a, b, c, d, e, f Talking head

FA carried at amortised cost C3a, b, c Worked example

FA carried at fair value C3a, b, c Worked example

Fair Value Option About 15 minutes C3a, b, c, d,e,f Worked example

Fair Value Measurement About 20 minutes C3a, b, c, d, e, f Worked example

Impairment of FI About 30 minutes C3a, b, c, d, e, f Worked example

Hedging About 30 minutes C3a, b, c, d, e, f Worked example




Tax

Title New (date recorded)

Old (source video)

Syllabus reference

Video style

Deferred Tax Formula C7a,b Worked example

Conceptual basis of deferred tax C7a,b Worked example

Specific temporary differences C7a,b Worked example

Group temporary differences C7a,b Worked example

Sbp & Tax losses C7a,b Worked example


UK Corporate Reporting

Title New (date recorded)

Old (source video)

Syllabus reference

Video style

Introduction to P2 Corporate Reporting

P2 UK syllabus Talking Head

UK legislation for financial reporting

P2 UK B3a Talking Head

UK financial reporting divergence P2 UK C2f, C4c, C5c, C6e, C7e, C9c, C11f, D1j

Talking Head



FULL TIME LECTURE SEQUENCE

Short Term

The course is made up of 11 days.

Day Chapter Subject 1 1 Basic Groups 2 Complex Groups 2 2 Complex Groups Continued 3 Foreign Currency Translation 3 4 Group Cash Flow Statement 5 Corporate Social Responsibility 4 6 Performance Reporting 7 Provisions 8 Non Current Assets 5 9 Leases 10 Employee benefits 11 Share based payments 6 12 Financial Instruments 13 Tax 7 Q2 revision 8 Q3 revision 9 Q4 revision 10 Q1 revision 11 Re-revision



EVENING & WEEKEND LECTURE SEQUENCE

The course is made up of 10 modules. Each module equates to one evening on the evening course or one session (morning or afternoon) on the weekend course. Therefore, evening five equates to weekend morning three.

Evening Lecture

Weekend Lecture Chapter Subject

1 Day 1 morning 1 Basic Groups 2 Day 1 afternoon 2 Complex Groups 3 Day 2 morning 3 Foreign Currency Translation 4 Day 2 afternoon 4 Group Cash Flow Statement 5 Day 3 morning 5 Corporate Social Responsibility 6 Day 3 afternoon 6 Performance Reporting 6 Day3 afternoon 7 Provisions 7 Day 4 morning 8 Non Current Assets 7 Day 4 morning 9 Leases 8 Day 4 afternoon 10 Employee benefits 8 Day 4 afternoon 11 Share based payments 9 Day 5 morning 12 Financial Instruments 10 Day 5 afternoon 13 Tax

Revision

The course above covers all the knowledge that is required for P2. It also makes extensive use of exam questions. But in order to be ready for the way the P2 exam freely mixes the subjects, it is highly recommended you book a revision course to sharpen your exam technique.

It is based on class question practice of past exam questions with focus on the subjects tipped for your exam. I do much of the work, then you get a shot at questions yourself. So maybe I will do a past question 3, then you will have a shot at the next past question 3 and finally I will show you how that question should be done.

There are two revision courses available, the four day course and the two day course. Both cover roughly an exam’s worth of past exam questions each day. Therefore, the four day course is simply twice the number of past exam questions that are covered in the two day course. There is no padding whatsoever, in fact even four days seems barely adequate to cover this vast and challenging analytical subject. So the four day course is the full course and the two simply highlights selected from there.

Question Based Course

This course is completely different to the above. In the above revision, we do questions, but I do most of the work. In the question based course, you do a past exam question, I then mark it, in order principally to work on your exam technique.

These courses usually run after the classic revision courses, in the last week before exams, but the decision as whether they run and when will be taken after these notes are printed.



DRAFT REVISION SEQUENCE

These are the questions that I (Martin) am thinking of doing in revision in the London classrooms. They are subject to change, as I develop my ideas over the term. But they should give an idea of the plan.

Of course, other lecturers in other locations will and should use their own sequence. Furthermore, the interactive students will have their own questions based on the material and the online videos. However, I hope the following is useful to all students as an idea of what might be useful preparation for the coming exam

London Full time revision sequence in draft The actual sequence will be developed closer to the time and therefore slightly different to the following. However, the following will give students a good idea of what to expect.

Day Subject Kit Q Exam Q Question Name 1 Deferred Tax 10 2(focus) Panel Financial instruments June2009 2(focus) Aron Pensions 12 2(focus) Savage 2 Mixed standards June 2011 3(Mix) Alexandra Mixed Standards 20 3(Mix) Wader Mixed Standards June2010 3(Mix) Cate Group cfs Dec 2010 1(Groups) Jocatt 3 Groups Handout 4(Current) Orangutan SMEs Dec2010 4(Current) Whitebirk Fair Value Handout 4(Current) Fairy Queen Group B/S June 2011 1(Groups) Rose 4 Group B/S June2009 1(Groups) Bravado Group B/S Dec2009 1(Groups) Grange Group I/S June2010 1(Groups) Ashanti 5 Financial Reporting Dec2008 4(Current) High Quality Mixed Standards Dec2010 3(Mix) Greenie Segments & revenue June2008 2(focus) Norman



London Two Day Revision Sequence in draft The actual sequence will be developed closer to the time and therefore slightly different to the following. However, the following will give students a good idea of what to expect.

Day Subject Kit Q Exam Q Question Name 1 Deferred Tax 10 2(focus) Panel Financial instruments June2009 2(focus) Aron Group B/S June2009 1(Groups) Bravado Group I/S June2010 1(Groups) Ashanti 2 Mixed standards June 2011 3(Mix) Alexandra Mixed Standards 20 3(Mix) Wader Groups Handout 4(Current) Fair Value Handout 4(Current)

London Four Day Revision Sequence in draft The actual sequence will be developed closer to the time and therefore slightly different to the following. However, the following will give students a good idea of what to expect.

Day Subject Kit Q Exam Q Question Name 1 Deferred Tax 10 2(focus) Panel Financial instruments June2009 2(focus) Aron Pensions 12 2(focus) Savage Group cfs Dec 2008 1(Groups) Warrburt 2 Mixed standards June 2011 3(Mix) Alexandra Mixed Standards 20 3(Mix) Wader Mixed Standards June2010 3(Mix) Cate Group B/S June 2011 1(Groups) Rose 3 Groups Handout 4(Current) SMEs Dec2010 4(Current) Whitebirk Fair Value Handout 4(Current) Group B/S Handout 1(Groups) 4 Group B/S June2009 1(Groups) Bravado Group B/S Dec2009 1(Groups) Grange Group I/S June2010 1(Groups) Ashanti


Chapter 1

Basic groups

CHAPTER 1 - BASIC GROUPS


CHAPTER CONTENTS

RELATIONSHIPS --------------------------------------------------------- 27

SUBSIDIARY 27

ASSOCIATE (& JOINT VENTURES) 27

INVESTMENT 27

THE DEVELOPMENT OF ACCOUNTING FOR GOODWILL 29

PROCESS OF DEVELOPMENT 29

GOODWILL IMPAIRMENT ----------------------------------------------- 30

IMPAIRMENT 30

RECOVERABLE VALUE 30

IMPAIRMENT OF SUBSIDIARY 30

CHANGES IN OWNERSHIP ---------------------------------------------- 32

CHANGES IN OWNERSHIP FURTHER ILLUSTRATED 34

SUBSIDIARY FOR DISPOSAL 35

RELATIONSHIP STANDARDS ------------------------------------------- 36

IFRS 10 36

IFRS 11 36

IAS 28 37

IFRS12 37

STUDENT ACCOUNTANT MAGAZINE ARTICLE------------------------- 42



RELATIONSHIPS

This chapter covers the process of consolidation required in a group containing parent, subsidiary and associate. So this chapter covers study guide entry D1a, b, c, e, f, g, h.

The process is determined by the relationships between the entities. There are three relationships between entities:

● control

● influence

● passive.

The ideas are studied briefly below and in more detail in the Relationship Standards section later in this chapter.

Subsidiary When a parent has control of another entity, then that entity is known as a subsidiary and is consolidated using acquisition accounting.

This means the subsidiary’s assets and liabilities are added to those of the parent.

Associate (& Joint Ventures) When a parent has influence over another entity, then that entity is known as an associate and is brought into the group fs using equity accounting.

This means the group fs include a share of the profit on the income statement and a share of the net assets on the statement of financial position (in the UK we show three lines on the P&L, share of operating profit, finance and tax).

A joint venture is an entity over which the parent has joint control. Despite its name, joint control is taken to mean very significant influence. So a JV is accounted for as a 50% associate. There has never been a question in which students were required to consolidate a joint venture.

Investment When a parent has no relationship with another entity, then that entity is known as an investment and brought into the fs using investment accounting. This means that the shares are carried at fair value. Investment accounting is covered in much more detail later, in the chapter on financial instruments.



Question: Peddle

The following are the summarised accounts of Peddle (P), Saddle (S) and Andlebar (A) for the year.

Income Statements (Profit and loss accounts)

P S A $’000 $’000 $’000 Revenue 500 400 300 Operating Costs (200) (210) (100) ___________ __________ __________

Operating profit 300 190 200 Interest Expense (50) (20) (10) ___________ __________ __________

Profit before tax 250 170 190 Tax (80) (60) (50) ___________ __________ __________

Profit for the financial year 170 110 140 Retained profit brought forward 500 200 300 ___________ __________ __________

Retained profit carried forward 670 310 440 ___________ __________ __________

Statements of financial position (Balance Sheets)

P S A $’000 $’000 $’000 Investment in S (80%) 260 - - Investment in A (30%) 120 - - Net assets 390 360 470 ___________ ___________ __________ 770 360 470 ___________ __________ __________

Share Capital (nominal $1 each) 100 50 30 Retained Earnings 670 310 440 ___________ ___________ __________ 770 360 470 ___________ __________ __________

The shares in Saddle and the shares in Andlebar were acquired on the first day of the year. Goodwill has an infinite life and has suffered no impairment.

It is the group’s policy to value the non-controlling interest at fair value. The fair value of the non-controlling interest in S at acquisition was $60,000.

Required:

Prepare the consolidated income statement (profit and loss account) and consolidated statement of financial position (balance sheet).



The development of accounting for goodwill Until 2009, Goodwill disclosed on the statement of financial position was ‘our’ goodwill (that is until recently goodwill has shown ownership). This is often called ‘partial goodwill’ (or ‘proportional goodwill’). There is a newly reissued IFRS (IFRS3 (2008 revised)) that recommends goodwill disclosed be changed to the entire goodwill of the entity (so that goodwill would then show control). This is in order to make goodwill consistent with the rest of the statement of financial position where we already use control. This recommendation is usually called ‘full goodwill’. However, the new IFRS continues to allow partial goodwill, making the whole situation very confused.

Process of development The process of development is undertaken by the International Accounting Standards Board (IASB). There are three phases ending with an IFRS. The three phases are as follows:-

DP Discussion Paper ED Exposure draft IFRS Financial reporting standard



GOODWILL IMPAIRMENT

Some groups questions require students to conduct an impairment review on the subsidiaries at the year end. This results in a goodwill impairment.

Impairment An impairment occurs if the recoverable value of an asset falls below the carrying value.

Recoverable value This is the higher of VIU and NRV.

● VIV = Value in use

● NRV = Net realisable value (more strictly this is actually phrased as “fair value less cost to sell which is essentially the same idea as NRV)..

Impairment of subsidiary Goodwill impairment is identified by looking at the impairment of the whole subsidiary.

Question: Fakenstock

A parent, Fakenstock, bought 100% of the equity of a sub at the year start for $900m. Share capital was $100m, retained earnings were $400m and retained profits for the year were $200m.

Goodwill has in infinite life and an impairment review of the sub at the first year end revealed a value in use (VIU) of $780m and net realisable value (NRV) of $350m.

Required:

Goodwill.



Question: Terra

A parent, Terra, buys 70% of a sub for $800m at the year start, when the share capital is $50m, retained earnings are $350m and a fair value adjustment (FVA) of $100m is required on machines with a life of five years. The fair value of the non-controlling interest is $317m

During the year the sub made profits retained of $50m and the sub sold goods valued at $12m to the parent with a margin of 25%; one third of which is still in inventory in the parent.

Goodwill has an infinite life and a year end review reveals a value in use (VIU) of $360m and net realisable value (NRV) of $666m.

It is the group’s policy to value the non-controlling interest at fair value (full goodwill).

Required:

Goodwill and NCI.



CHANGES IN OWNERSHIP

This is found in the study guide under paragraph D2a.

A parent may simply buy or sell shares. However, the group viewpoint is quite different. A group only acquires a sub when it gets control and only sells a sub when it loses control. Other share exchanges are simply changes in ownership and result in transfers. The examiner has written an article on this element of IFRS3. It was available at accaglobal.com within the P2 section under “Technical Articles” when this document went to print. It was published in February 2009. The following illustrative questions take their inspiration from that article.

Question: Top

At the year start, Top acquired a 15% interest in Dog at a cost of $15m. At the year end Top acquired a further 40% interest in Dog at a cost of $60m and obtained control. The fair value of the initial 15% interest at this time was $21m and the fair value of the NCI was $58.5m. The fair value of the identifiable net assets was $100m. The group has recently changed the policy of recognising the non-controlling interest from valuation at fair value of identifiable net assets (partial goodwill) to valuing at fair value as indicated by market price at acquisition (full goodwill).

Required:

Goodwill.

Question: Toy

At the year start, Toy acquired 75% of Boy for $300m. The fair value of the identifiable net assets of Boy at the point of acquisition was $180m. The fair value of the NCI was $80m. The group has the policy of recognising the non-controlling interest at fair value.

Required:

(a) Goodwill.

At the year end, Toy acquires a further 5% of Boy for $24m. Boy has made profits and grown by $20m over the year and therefore the carrying value of identifiable net assets of Boy is $200m at the year end.

Required:

(b) Transfer from NCI and reduction in controlling interest.



Question: Love

At the year start, Love acquired 90% of Rat for $450m. The fair value of the identifiable net assets of Rat at the point of acquisition was $380m. The fair value of the NCI was $45m. The group has the policy of recognising the non-controlling interest at fair value.

Required:

(a) Goodwill.

At the year end, Love disposes of 10% of the equity of Rat for $55m and so reduces its ownership to 80%. Rat has made profits and grown by $20m over the year and therefore the carrying value of identifiable net assets of Rat is $400m at the year end.

Required:

(b) Transfer to NCI and increase in controlling interest.

Question: Rock

At the year start, Rock acquired 60% of Star for $360m. Star had identifiable net assets with a fair value of $400m at acquisition and the fair value of the NCI was $200m. Rock has the policy of valuing NCI at the fair value of identifiable net assets, but on this occasion it chooses to recognise NCI at fair value.

At the year end, Rock sells 15% of Star for $150m and loses control, but retains influence through its remaining 45% ownership. The fair value of the associate retained is measured at $420m.

At the year end Star had identifiable net assets of $430m. The growth of $30m had been reported through the income statement.

Required:

Profit on disposal to be recognised in the income statement.



Changes in ownership continued Frankly, this basic accounting technique is such a cornerstone of group financial reporting that it is worth repeating. Here are four supplementary questions covering acquisition, disposal and the two transfers. Assume that full goodwill applies throughout.

Question: Lady Gaga

At the year start, Lady acquired a 10% interest in Gaga at a cost of $25m. At the year end Lady acquired a further 45% interest in Gaga at a cost of $120m and obtained control. The fair value of the initial 10% interest at this time was $27m and the fair value of the NCI was $110m. The fair value of the identifiable net assets was $150m.

Required:

Goodwill.

Question: Adam Ant

At the year start, Adam acquired 70% of Ant for $460m. Ant had identifiable net assets with a fair value of $300m at acquisition and the fair value of the NCI was $200m.

At the year end, Adam sells 25% of Ant for $250m and loses control, but retains influence through its remaining 45% ownership. The fair value of the associate retained is measured at $410m.

At the year end Ant had identifiable net assets of $330m. The growth of $30m had been reported through the income statement.

Required:

Profit on disposal to be recognised in the income statement.



Question: Iggy Pop

At the year start, Iggy acquired 70% of Pop for $350m. The fair value of the identifiable net assets of Pop at the point of acquisition was $110m. The fair value of the NCI was $138m.

Required:

(a) Goodwill.

At the year end, Iggy acquires a further 10% of Pop for $55m. Pop has made profits and grown by $20m over the year and therefore the carrying value of identifiable net assets of Pop is $130m at the year end.

Required:

(b) Transfer from NCI and effect on controlling interest.

Question: Busta Rhymes

At the year start, Busta acquired 90% of Rhymes for $440m. The fair value of the identifiable net assets of Rhymes at the point of acquisition was $180m. The fair value of the NCI was $40m.

Required:

(a) Goodwill.

At the year end, Busta disposes of 15% of the equity of Rhymes for $90m and so reduces its ownership to 75%. Rhymes has made profits and grown by $40m over the year and therefore the carrying value of identifiable net assets of Rhymes is $220m at the year end.

Required:

(b) Transfer to NCI and effect on controlling interest.

Subsidiary for disposal This is study guide entry D2b.

As you might imagine, a subsidiary acquired exclusively with a view to subsequent disposal is still a subsidiary and must be consolidated for the short period of control.



RELATIONSHIP STANDARDS

There are various standards that govern group accounting and they are very rarely directly examined. However, it is possible that a question could expect a student to know a little of their content.

IFRS 10 IFRS 10 Consolidated Financial Statements defines control and tells us how to consolidate. Control is defined as the power to direct activities with exposure to variable returns. So the definition includes both the old ideas of risks and rewards and the new ideas of being able to make things happen. The new definition is so simple that it is hoped that it will be very difficult for parents to possess subsidiaries and ignore them. This was a big part of the Enron fraud and brought accounting for subs into disrepute.

Consolidation is essentially adding performance and position to the parent with adjustments (see Question Peddle for mechanics).

IFRS 11 IFRS 11 Joint Arrangements looks at entities under joint control. Joint control exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. Joint control occurs when you and I together have control of another entity but individually have only influence. There are two arrangements:-

Joint operations In a JO, you and I share control of the operation, but my assets are mine and your assets are yours. The accounting follows the substance. My assets go on my balance sheet and yours on yours.

Joint Venture In a JV, you and I share control and everything else as well. Joint control is seen as very very significant influence. So a JV is simply accounted for as an associate. The detail of associate accounting remains in old IAS 28.

Incorporation It is not always true, but usually incorporation gives away the underlying nature. JVs are incorporated and JOs are not.



Example: You and I

An example may help make it clear. You and I are working together selling petrol. We go into Japan and we both put $100m each into a newly incorporated company that will build a refinery and buy oil to refine and sell to the Japanese. You will have half the shares and I will have the other half. We also go into Russia. We agree to share the revenue half and half. But you put your Russian refinery into the deal and I put my trans-Siberian pipeline in. We agree that your refinery remains yours and my pipeline remains mine, although to repeat, the revenue is to be shared half and half.

Japan

The Japanese joint arrangement is a JV. Everything is shared 50/50. Nothing is yours absolutely and nothing is mine absolutely. Everything belongs to the JV and the JV belongs to us half and half. Backing this conclusion up is the incorporation of the JV.

So the Japanese arrangement will be recorded as a 50% associate in my books and the same in yours.

Russia

But the Russian deal is quite different. It is a JO. The pipeline is mine and not yours. The refinery is yours and not mine. We share the revenue and so operate jointly but we do not share everything.

So the pipeline will stay on my b/s and the refinery will stay on yours.

IAS 28 IAS 28 Associates defines significant influence as the power to participate and requires equity accounting for associates (including JVs). Equity accounting is essentially recognising a share of the associate profit in the i/s and a share of net assets in b/s. Equity accounting is also described as an equity investment initially recorded at cost and is subsequently adjusted to reflect the investor's share of the net profit or loss of the associate (see Question Peddle for mechanics).

IFRS 12 IFRS 12 Disclosure of Interests in Other Entities is a very cute piece of standard setting. The above standards define control, joint control and influence and together make it difficult to fake a relationship. But IFRS 12 makes it that bit harder. IFRS 12 requires that a parent lists all the entities with which it has a relationship and explain the basis of the parent conclusion. So the parent must list all its subs and say why it believes it has control and list all its associates and say why it believes it has influence and not control. This makes it even harder to pretend a sub is an associate.



Supplementary Question: Freddie

The following question looks at disposal in the context of the i/s.

On 1 January four years ago, Freddie acquired 80% of the shares of Mercury for $500,000. Mercury had share capital of $100,000 (nominal $1 each) and had reserves of $200,000. No shares have been issued since acquisition. At acquisition, the fair value of the net assets was $320,000. The fair value adjustment related to inventory, that was sold immediately after the acquisition.

Goodwill has been tested for impairment at each year end since acquisition. No goodwill has been impaired since then. It is the group’s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s net assets.

The income statements for the year ended 31 December in the current year are as follows:

Freddie Group Mercury $’000 $’000 Revenue 900 240 Operating costs (500) (100) ___ ___ Operating profits 400 140 Dividend income 80 - Finance costs (20) (10) ___ ___ Profit before tax 460 130 Tax (110) (30) ___ ___ Profit after tax 350 100 ___ ___ Interim dividend paid 70 20 Opening retained earnings at the current year start 5,000 340

Freddie sold half of its holding in Mercury on 1 July in the current year. Freddie received cash proceeds of $430,000, but this has been recorded in a suspense account on the statement of financial position. The group accounts of Freddie group have been prepared and are presented above. However, the accounts of Mercury have not yet been consolidated because of the mid year disposal.

Freddie retains influence over Mercury via its remaining shareholding. The fair value of the associate retained is measured at $420,000 at disposal.

Mercury paid the interim dividend in cash on 17 April in the current year prior to the disposal.

Required:

Prepare the consolidated income statement for the year ended 31 December.



Classic question: Hebrides (parent sub associate with goodwill impairment)

The following question is an excellent illustration of the basic techniques, but watch out, it does use proportional goodwill instead of the more usual full goodwill, in order to keep you on your toes.

Exactly half way through the year, Hebrides acquired 80% of the share capital of Skye and 30% of the share capital of Aran. Hebrides acquired Skye by way of share for share exchange. Hebrides issued five of its own shares for two Skye shares. The market value of Hebrides’ shares was $5 on that day. The share issue has not yet been recorded. Aran shares were acquired for $500,000 cash consideration.

It is the group’s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s net assets.

The summarised draft financial statements are as follows:

Income Statement or Profit and loss account for the year ended 31 March Hebrides Skye Aran $’000 $’000 $’000

Revenue 11,000 3,600 1,820 Cost of sales (6,000) (2,600) (1,400) _____ _____ ___

Gross profit 5,000 1,000 420 Operating expenses (2,500) (420) (220) _____ _____ ___

Operating profit 2,500 580 200 Interest (700) (280) (70) Dividends received from Skye 32 _____ ___ ___

Profit before tax 1,832 300 130 Tax (832) (100) (30) _____ ___ ___

Profit after tax 1,000 200 100 Dividends paid (400) (40) (0) _____ ___ ___

Profit retained 600 160 100 Retained profit brought forward 9,000 600 400 _____ ___ ___

Retained profit carried forward 9,600 760 500 _____ ___ ___



Statement of financial position as at 31 March Hebrides Skye Aran $’000 $’000 $’000 $’000 $’000 $’000 Non current assets Land & building 9,000 2,000 800 Plant & machinery 4,000 1,500 700 Investment in Aran 500 Investment in other shares 600 300 50 ______ _____ _____

14,100 3,800 1,550 Current assets Inventory 1,100 300 70 Receivables 1,500 150 170 Bank 300 70 40 _____ ___ ___

2,900 520 280 _____ ___ ___

Current Liabilities Trade 900 140 60 Corporation tax 700 100 30 _____ ___ __

1,600 240 90 _____ ___ __

1,300 280 190 Non Current Liabilities Loan (2,800) (3,020) (940) ______ _____ _____

12,600 1,060 700 ______ _____ _____

Share capital ($1 nominal each) 1,000 200 160 Share premium 2,000 100 40 Retained earnings 9,600 760 500 ______ _____ ___

12,600 1,060 700 ______ _____ ___



The following information is relevant:

(1) At acquisition the fair value of all Aran’s assets was reasonably represented by the book value. The same was true of Skye with the exception of some land and plant. These had fair values of $400,000 and $300,000 above book values. The plant had a remaining life of five years. Depreciation is charged to cost of sales.

(2) In the post acquisition period Skye sold goods to Hebrides at $120,000. Transfer transactions were calculated to give a margin of 20% (mark up of 25%). Skye held five sixths of these goods in inventory at the year end.

(3) Goodwill related to the Skye acquisition was subject to a brief impairment review and this was sufficient to confirm that there was no impairment. However, a similar review of the goodwill related to Aran revealed that there may be an impairment. So a more detailed review was conducted which revealed a value in use of $790,000 and a net realisable value of $560,000. Goodwill impairment is separately discloseable on the face of the income statement.

(4) The current account between Hebrides and Skye did not agree due to cash in transit from subsidiary to parent of $4,000. Hebrides recorded a receivable of $25,000 at the year end. Dividends were paid in the last month before the year end.

Required:

Income statement (Profit or loss report) and statement of financial position (balance sheet) for the group for the year ended 31 March.



STUDENT ACCOUNTANT MAGAZINE ARTICLE

Business Combinations as a Current Issue

This is an article I (Martin Jones) did for the Student Accountant Magazine. It was published in the May 2009 edition. It was a response to the two examiner articles which appeared in the Student Accountant Magazine in February and April 2009. The idea was to bring to life the technicalities covered by those examiner articles. The published version of this article can be found online by going to the ACCA website and delving into the Student Accountant Magazine archive to find the May issue. I (Martin Jones) have written a bucket load of articles for Student Accountant. So if you ever find yourself with time for study after you have worked these class notes, then go to the relevant articles section of the ACCA P2 webpage.

Current issues

Current issues are at the heart of P2 corporate reporting and permeate the entire exam. But it is the last question, Q4 that really delves into the political and intellectual mire that is current issues in financial reporting. Traditionally, this question has been the best answered over the years. However, in recent sittings the focus question, Q2 has caught up. This article is aimed at putting the current issues question back out in front.

The article will first take you through some of the hot topics in financial reporting. But then, by using an illustrative question, the article will show you how to use this information to formulate an answer to a current issues question. Here is your whirlwind tour of current issues.

The framework

The examiner’s advice is that if you are not sure where to start your answer to a current issues question, then start with the framework. So that is where I’ll start.

The framework for financial reporting sets out the conceptual basis for the development of standards and is itself based on the elements of assets and liabilities. To paraphrase the framework “an asset/liability is a right/obligation to a future economic outflow/inflow.” This focus on financial position has permeated all the standards issued in recent years and continues to dominate the current issues.

But the framework also talks to us of other concepts, such as relevance, reliability and entity.

Fair value

Which brings us smoothly to the hot topic in financial reporting, fair value. In order to make the position statement a genuine statement of financial position rather than simply a balance sheet, the IASB have been pushing financial reporting towards fair value. Fair value accounting attempts to present all assets and liabilities at market value and as such is highly subjective. But the IASB are prepared to accept the reduced reliability in favour of the increased relevance.

Convergence

Also red hot is the subject of convergence, which the IASB interpret essentially as the convergence of IFRS with American accounting. This process has taken a major boost over recent months with the United States of America Securities and Exchange Commission coming out in favour of fair value and the IASB.



Business combinations

Tangled up in the process of convergence is the project to make sense of group accounting. The IASB have long accepted that the American slant on groups was tuned better to the entity concept and the reality of acquisitions. So the IASB issued and reissued IFRS3 Business Combinations in order to reflect this. But perhaps the rarity of non-controlling interest in the US has led to the IASB creating unnecessary complications as regards the NCI goodwill. These complications are discussed below.

Management commentary

But the spiralling complexity of financial reporting has led to most companies translating the financial statements into a more digestible report tagged on to the financial statements in the annual report. This management commentary is largely unregulated at the moment, but the IASB have a standard under development that once issued will produce some standardisation in management commentaries.


Chapter 2

Complex groups

CHAPTER 2 - COMPLEX GROUPS


CHAPTER CONTENTS

VERTICAL GROUP STRUCTURE ----------------------------------------- 47

CHANGES IN GROUP STRUCTURE -------------------------------------- 53



VERTICAL GROUP STRUCTURE

This chapter covers study guide entry D1a.

This occurs when a sub buys a sub-sub. Vertical group structure can often lead to a non-controlling interest greater than 50%. The examiner has written an article on this element of IFRS3. It was available at accaglobal.com within the P2 section under “Technical Articles” when this document went to print. It was published in April 2009. The following illustrative questions take their inspiration from that article.

Question: ACR

Parent A buys 60% of entity C which in turn buys 60% of entity R.

Required:

Calculate the non-controlling interest in the group.

Question: PDQ

P buys 75% of entity D which buys 64% of Q.

Required:

Calculate the non-controlling interest in the group.

Question: Hendrix

Hendrix (H) acquired shares in Seventy (S), which in turn acquired shares in Super Seventy (SS) many years ago. At acquisition reserves in S and SS were $60,000 and $30,000 respectively. Goodwill has been subject to an impairment review at each year end since acquisition. However, no impairment has occurred.

It is the group’s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s net assets (partial goodwill).

The Statements of financial position are as follows:

H S SS $‘000 $‘000 $‘000 Investment in S (14,000 shares) 60 Investment in SS (6,000 shares) 50 Net assets 300 200 100 ___ ___ ___ 360 250 100 ___ ___ ___ Share capital ($1 each) 30 20 10 Retained earnings 330 230 90 ___ ___ ___ 360 250 100 ___ ___ ___

Required:

Group statement of financial position.



Question: Dee (slight return)

At the year start, on 1 January Mersey (M) bought 40% of Irwell (I).

On 1 July Dee acquired 75% of M and 25% of I.

Goodwill has not been impaired. It is the group’s policy to value the non-controlling interest at fair value. Fair value of the nci and reserves were as follows:

Fair value of nci Reserves

1 Jan 1 July 1 Jan 1 July

M 49 62 90 100 I 72 83 135 150

The Statements of financial position at 31 December are as follows:

D M I $‘000 $‘000 $‘000 Investment in M 200 Investment in I 70 80 Net assets 600 112 180 ___ ___ ___ 870 192 180 ___ ___ ___ Share capital ($1 each) 100 20 10 Retained earnings 770 172 170 ___ ___ ___ 870 192 180 ___ ___ ___

Required:

Group statement of financial position for the D group.



Exam question: Rodney

The following draft statements of financial positions relate to Rodney, a public limited company, Del, a public limited company, and Trigger, a public limited company, as at 30 November:

Rodney Del Trigger $m $m $m Non-current assets Tangible 1,230 505 256 Investment in Del 640 - - Investment in Trigger 160 100 -

_____ ____ ____

2,030 605 256

_____ ____ ____

Current assets Inventory 300 135 65 Trade receivables 240 105 49 Cash at bank and in hand 90 50 80

_____ ____ ____

630 290 194

_____ ____ ____

Total assets 2,660 895 450

_____ ____ ____

Equity Share capital 1,500 500 200 Share premium 300 100 50 Revaluation reserve - - 70 Retained earnings 625 200 60

_____ ____ ____

2,425 800 380 Non-current liabilities 135 25 20 Current liabilities 100 70 50

_____ ____ ____

Total equity and liabilities 2,660 895 450

_____ ____ ____

It is the group’s policy to value the non-controlling interest at fair value.

The following information is relevant to the preparation of the group financial statements:

(i) Rodney had acquired eighty per cent of the ordinary share capital of Del on 1 December three years ago, when the retained earnings of Del were $100 million. The fair value of the non-controlling interest was $154m at acquisition. The fair value of the net assets of Del was $710 million at that date. Any fair value adjustment related to inventory and these had been realised by the current year end. There had been no new issues of shares in the group since the current group structure was created.

(ii) Rodney and Del had acquired their holdings in Trigger on the same date as part of an attempt to mask the true ownership of Trigger. Rodney acquired forty per cent and Del acquired twenty-five per cent of the ordinary share capital of Trigger two years ago. The fair value of the non-controlling interest in Trigger was $149m at acquisition. The retained earnings of Trigger on that date were $50 million and those of Del were $150 million. There was no revaluation reserve in the books of Trigger at acquisition. The fair values of the net assets of Trigger at acquisition were not materially different from their carrying values.



(iii) The group operates in the pharmaceutical industry and incurs a significant amount of expenditure on the development of products. These costs were formerly written off to the income statement as incurred but then reinstated when the related products were brought into commercial use. The reinstated costs are shown as ‘Development Inventory’. The costs do not meet the development criteria in IAS 38 Intangible Assets for classification as intangibles and it is unlikely that the net cash inflows from these products will be in excess of the development costs. In the current year, Del has included $20 million of these costs in inventory.

(iv) Del had purchased a significant amount of new production equipment early in the year. The cost before trade discount of this equipment was $50 million. The trade discount of $6 million was taken to the income statement. Depreciation is charged on the straight line basis over a six year period.

(v) The policy of the group is now to state tangible non-current assets at depreciated historical cost. The group changed from the revaluation model to the cost model under IAS 16 Property, Plant and Equipment at the current year start and restated all of its tangible non-current assets to historical cost in that year except for the tangible non-current assets of Trigger. These had been revalued by the directors of Trigger on the first day of the current year. The values were incorporated in the financial records creating a revaluation reserve of $70 million. The tangible non-current assets of Trigger were originally purchased on 1 December two years before the current year end, at a cost of $300 million. The assets are depreciated over six years on the straight line basis. The group does not make an annual transfer from revaluation reserves to the retained earnings in respect of the excess depreciation charged on revalued tangible non-current assets. There were no additions or disposals of the tangible non-current assets of Trigger for the two years to the current year end.

(vi) The goodwill resultant from the Del acquisition was impairment tested at the first and second year end after acquisition and again at the current year end. The first and second impairment reviews revealed no problems. However, the current review identified a recoverable value of $809m for Del. There has been no impairment in Trigger goodwill since acquisition.

Required:

Prepare a consolidated statement of financial position of the Rodney Group as at 30 November.

(35 marks)

(ACCA December 2002 rewritten)



Past Exam Question Adjusted: Complex Groups: Ronnette

The following draft statements of financial positions relate to Ronnette, a public limited company, Tommy, a limited company, and Jimmy, a limited company, as at 30 November:

Ronnette Tommy Jimmy $m $m $m Non-current assets Property plant and equipment 1,800 406 250 Investment in Tommy 900 - - Investment in Jimmy 220 400 -

_____ ____ ____

2,920 806 250

_____ ____ ____

Current assets Inventory 540 160 165 Trade receivables 140 150 140 Cash at bank 190 50 180

_____ ____ ____

870 360 485

_____ ____ ____

Total assets 3,790 1,166 735

_____ ____ ____

Equity Share capital 500 300 100 Share premium 300 100 50 Retained earnings 2,630 676 525

_____ ____ ____

3,430 1,076 675 Non-current liabilities 230 20 10 Current liabilities 130 70 50

_____ ____ ____

Total equity and liabilities 3,790 1,166 735

_____ ____ ____

It is the group’s policy to value the non-controlling interest at fair value.

The following information is relevant to the preparation of the group financial statements:

(i) Ronnette had acquired seventy per cent of the ordinary share capital of Tommy on 1 December three years ago, when the retained earnings of Tommy were $200 million. The fair value of the non-controlling interest was $354m at acquisition. The fair value of the net assets of Tommy was $700 million at that date. Any fair value adjustment related to machines with a life of 10 years.

(ii) Ronnette and Tommy had acquired their holdings in Jimmy as part of an attempt to mask the true relationship with Jimmy. Ronnette acquired twenty per cent and Tommy acquired forty per cent of the ordinary share capital of Jimmy both on the same day two years ago on 1 December at the start of the previous accounting period. The fair value of the non-controlling interest in Jimmy was $449m at acquisition. The retained earnings of Jimmy on that date were $400 million and those of Tommy were $350 million. The fair values of the net assets of Jimmy at acquisition were not materially different from their carrying values. There had been no new issues of shares in the group since the current group structure was created.



(iii) The goodwill resultant from the Tommy acquisition was impairment tested at the first and second year end after acquisition and again at the current year end. The first and second impairment reviews revealed no problems. However, the current review identified a recoverable value of $1,374m for Tommy. There has been no impairment in Jimmy goodwill since acquisition.

(iv) The group operates in the pharmaceutical industry and has had problems with some of its products. Tommy holds inventory carried at cost of $60million, which at the year end was estimated to be worth $50million, but in the event the goods were sold for $40million shortly thereafter.

(v) Ronnette had purchased a significant amount of new production equipment early in the year. The cost before trade discount of this equipment was $80 million. The trade discount of $8 million was taken to the income statement. Depreciation is charged on the straight line basis over a four year period.

(vi) At the year start, Ronnette negotiated the early repayment of a $10m loan. The liability is included in non current liabilities, but now a contract has been signed agreeing to the repayment one month after the new year start plus an early repayment fee of $1m.

(vii) Immediately prior to the year end Ronnette have publicly accepted responsibility for an environmental issue. The estimated rectification costs are $3m, but lawyers advise that Ronnette have a very strong legal position and it is unlikely that any legal action would be able to prove any negligence by Ronnette. In spite of this, Ronnette have every intention to take responsibility for the rectification following the public announcement and make payment shortly after the new year start. Ronnette are also considering a further payment of $1m to implement improvements across the country to prevent such accidents occurring again but have made no announcement as regards these considerations.

Required:

(a) Prepare a consolidated statement of financial position of the Ronnette Group as at 30 November. (Round answer to nearest $1million.)

(35 marks)

(ACCA December 2002 rewritten)



CHANGES IN GROUP STRUCTURE

This is study guide entry D3a, b. The subject is properly called “group reorganisations” in IAS27. The subject is sometimes referred to by the somewhat old fashioned phrase “reconstructions”. However, students are advised to avoid using this phrase in the context of group reorganisations as the ACCA uses the phrase “entity reconstruction” to discuss the very different subject of changes in financial structure, discussed separately in chapter 5.

This rarely examined area of the syllabus relates to the change a parent may make in group structures. Occasionally a parent may want to move its subs around within a group. This only works if there is no nci. You are simply expected to know that whilst this does affect the individuals in the group it has no effect on the group fs. The rest comes down to double entry skills.

The possibilities There are three in particular:-

(1) Simple to vertical

One of the subs buys a sub from the ultimate parent.

(2) Vertical to simple

A sub parent sells a sub-sub to the ultimate parent.

(3) New ultimate parent

A new ultimate parent is created in the space between the original ultimate parent and the ultimate shareholders.

The effect As discussed above, because all these group reorganisation schemes have no effect on the underlying assets and liabilities, there is no effect on the group fs.

The individual entity fs Now this is the really challenging part of group reorganisation. The reorganisations have no effect on group fs, but they have substantial effects on the individual entities. There is nothing to learn in this context. The examiner will tell you what to record in a list of instructions. This is illustrated by the question Desperate which follows. However, you will have to be able to turn the instructions into double entry in order to execute the relevant reorganisation plan in the question. This will be a very stiff test of your double entry.

Truth is you will have to be brilliant at double entry to survive one of these questions. Almost certainly you will have to be so good at double entry that you can keep all the debits and credits in your head. The examiner is brilliant at double entry; but before selecting one of these questions in the exam, you must be sure that your technical expertise with debits and credits matches that of the examiner.



Desperate

Desperate public limited company owns all of the shares of Meaty Limited and Needy Limited. The group operates in Moon flights which is currently a depressed market. Needy has made losses and is short of cash. In order to address the problem, group directors propose the following plan:-

(1) Meaty will purchase the whole of Needy share capital for $160m in cash. When Desperate receives the cash Desperate will then lend that cash to Needy as a long term loan.

(2) Meaty will purchase land from Needy and pay by assuming a loan from Needy and issuing non-voting equity shares. The land has a fair value of $20m and an exit carrying value of $12m. The loan has a book value of $7m. The issued non-voting shares have a nominal value of $5m.

(3) Meaty will pay a dividend of $33m to Desperate to reduce the accumulated reserves of Meaty.

(4) Meaty will cut costs by a programme of redundancy. According to a detailed plan approved by the board and discussed with labour unions the redundancies will be spread over two years. The cost in the first year is $11m and the cost in the second is $24.2m. The discount rate is 10%. Further Desperate will incur costs of $1m to execute the plan.

The statements of financial position of Decany and the subsidiaries were as follows at the year end but before the plan was executed:-

Desperate Meaty Needy $m $m $m Non-current assets 400 200 100 Cost of investment in Meaty 100 Cost of investment in Needy 150 Current assets 300 400 30 ___ ___ ___ 950 600 130 ___ ___ ___ Share capital 100 20 5 Retained earnings 400 240 5 Non-current liabilities 200 120 90 Current liabilities 250 220 30 ___ ___ ___ 950 600 130 ___ ___ ___



Required:

(a) (i) Set out the requirements in IAS27 Separate Financial Statements as regards the payment of dividends from a subsidiary to a parent and as regards group reorganisation and apply those requirements to the individual entities in the Desperate group.

(5 marks)

(ii) Prepare the individual entity statements of financial position for all three entities as they would appear after the execution of the plan. (15 marks)

(b) Discuss the key implications of the plan on the group. (5 marks)

(25 marks)

Note: this question is based on the exam question Decany from December 2011 and gives you a very good idea of the standard of question to expect on group reorganisations. Unless you feel very confident with this question, you should be prepared to write off a question like this if it appears in your exam, and consider the rest of the exam compulsory.


Chapter 3

Foreign currency translation

CHAPTER 3 – FOREIGN CURRENCY TRANSLATION


CHAPTER CONTENTS

INTRODUCTION TO FOREIGN CURRENCY TRANSLATION ----------- 59

FOREIGN TRANSACTIONS ---------------------------------------------- 59

FOREIGN SUBSIDIARIES ----------------------------------------------- 61



INTRODUCTION TO FOREIGN CURRENCY TRANSLATION

This chapter addresses the process of translating foreign currency information into the home currency (IAS 21). So this chapter addresses study guide entries D4a, b.

This chapter answers two questions:

(1) Foreign transactions

‘How do I account for my foreign transactions?’

(2) Foreign subsidiaries

‘How do I account for my foreign subsidiaries?’

FOREIGN TRANSACTIONS

The process of translating individual foreign transactions is referred to by the rather clumsy expression “the individual company stage” within the IFRSs.

Foreign transactions are translated into the home currency and foreign monetary items on the statement of financial position are re-translated at the year end.

This can be shown particularly well using the equity style of statement of financial position presentation:

Non current assets x Non-monetary Translate Current assets items and leave Inventory x Receivables x Bank x Monetary Translate and Liabilities < 1 year (x) items retranslate Liabilities > 1 year (x) ___

xx ___



Question: Furtive

A company buys a machine on three months credit from France for €50,000 just before the year end of 31.12. It takes delivery on 15.12. The rates are as follows:

Date Rate

Delivery (15.12) $1: €1.25 Y/e (31.12) $1: €1.30

Required:

Journals.

Question: Feature

A company buys a fixed asset on three months credit two weeks before the year end for 90,000 Roubles. Rates are as follows:

Date Rate

Delivery $1: 10 Roubles Y/e $1: 9 Roubles

Required:

Journals.

Question: Feature (continued)

The company pays the creditor on schedule in the new year.

Date Rate

Year start $1: 9 Roubles Payment $1: 9.2 Roubles

Required:

Journals.



FOREIGN SUBSIDIARIES

Group stage

A foreign subsidiary needs translation before consolidation:

Statement Rate

Statement of financial position Closing rate Profit and loss Average rate

Goodwill

Goodwill is a subsidiary asset so from the parent point of view it’s a foreign asset.



Question: Kenya

Kenya owns 90% of the ordinary shares of a foreign subsidiary, Malawi, which has the functional currency of the kwacha. The subsidiary was acquired at the start of the current accounting period for 1,200,000 kwachas, when its reserves were 700,000 kwachas.

At the date of the acquisition the fair value of the net assets of the subsidiary were 1,000,000 kwachas. This included a fair value adjustment in respect of land. The land has not been sold.

Goodwill is estimated to have an infinite life, but has not been impaired. It is the group’s policy to value the non-controlling interest at fair value. The fair value of non-controlling interest at acquisition was 133,000 kwachas.

Statement of financial position Kenya

Shillings ‘000

Malawi Kwachas

‘000 Investment in Malawi 500 Other Net Assets 17,500 1,100 18,000 1,100 Share capital 70 50 Reserves 17,930 1,050 18,000 1,100 Income statement Kenya

Shillings ‘000

Malawi Kwachas

‘000 Revenue 28,000 1,700 Operating Costs (22,500) (1,160) Profit before tax 5,500 540 Tax (1,900) (190) Profit after tax 3,600 350 Relevant exchange rates are: Date Exchange rate (Kwachas to 1 Shilling) Year start 2.4 Year end 2.1 Weighted average for year 2.2

Required:

Prepare a consolidated statement of financial position, consolidated income statement and a consolidated movement on reserves.

Note: round figures to the nearest 1,000.

Note to students

The consolidated movement in reserves is very rarely examined. A full answer is in the back of the notes. Also it is possible the examiner might revert to the partial assumption for foreign subsidiaries. The IFRS guidance on foreign goodwill is very weak and the detailed mathematics is very messy, so the examiner might prefer to avoid the problems by utilising partial goodwill. So the answer looks into this possibility too.



Exam question: Xenon

Xenon (X) owns 60% of Gallium (G), a company situated in a foreign country. The currency of this country is the Kram (Kr). X acquired G at the beginning of the year, on 1 January.

It is the group’s policy to value the non-controlling interest at fair value. The fair value of non-controlling interest at acquisition was Kr1,466m.

Income statement for current year ended 31 December

X G $m Krm

Revenue 4,000 8,000 Cost of sales (2,500) (4,000) _____ _____

Gross profits 1,500 4,000 Operating expenses (500) (1,000) _____ _____

Operating profit 1,000 3,000 Dividends received 60 Interest expense (100) (300) Interest income 40 100 _____ _____

Profit before tax 1,000 2,800 Tax (300) (1,000) _____ _____

Profit after tax 700 1,800 Extraordinary item (200) _____ _____

Profit transferred 700 1,600 _____ _____

Reserve Movement

Accumulated profits brought forward 1,140 1,200 Dividends paid (100) (800) Profit transferred 700 1,600 _____ _____

Accumulated profits carried forward 1,740 2,000 _____ _____



Statement of financial position as at 31 December

X G $m Krm Non current assets Investment in G 440 Tangible 3,000 1,800 Current assets 2,000 2,200 Current liabilities (1,000) (1,000) Non current liabilities (1,200) (700) _____ _____

3,240 2,300 _____ _____

X G $m Krm

Share capital 1,000 100 Share premium 500 200 Reserves 1,740 2,000 _____ _____

3,240 2,300 _____ _____

(1) The dividends were paid by G at the year end and received by X on that day.

(2) G has applied local GAAP, but has made some attempt to adapt to IFRS. As a result, the subsidiary has written off research previously capitalised as an extraordinary item prior period adjustment in the sum of Kr100 million. The remainder of the extraordinary item is the recognition of a fall in value of some plant that was damaged during the year.

(3) The fair value of the net assets of G at acquisition was Kr2,000 million after taking into account the removal of capitalised research discussed above. Goodwill is unimpaired. The increase in the fair value of G over carrying value is attributable to machines which are depreciated over five years on the straight line basis.

(4) During the year, X sold $30 million in goods to G at a margin of 20%. All of the goods had been utilised in production by the year end, but only one half of the relevant finished goods have been sold. G received the goods on 16 June and paid on 17 July. The foreign exchange difference remains in current liabilities.

(5) X made a loan of $50 million to G immediately after the acquisition on 1 January. This is still outstanding at the year end. The parent has recorded the asset in current assets. The subsidiary has recorded the liability in non current liabilities at the rate ruling at the year start.

(6) The following exchange rates are relevant:

Kram to $1

1 January 5 16 June 6 17 July 6.5 31 December 8 Weighted average for year 7



Required:

(a) Prepare the income statement and statement of financial position for the group for the current year. (30 marks)

(b) Prepare a movement in consolidated reserves for the current year. (5 marks)

(35 marks)

(ACCA June 1998)

(Note: round to the nearest million)

Note to students

The consolidated movement in reserves is rarely examined. A full answer is in the back of the notes.



Exam question: Xtreme

Xtreme (X) acquired 70% of Golf (G) at the beginning of the year, on 1 January. G is situated in a foreign country. The currency of this country is the Kram (Kr).

It is the group’s policy to value the non-controlling interest at fair value. The fair value of non-controlling interest at acquisition was Kr1,888m.

Income statement for current year ended 31 December

X G $m Krm

Revenue 500 800 Cost of sales (200) (400) _____ _____

Gross profits 300 400 Operating expenses (100) (100) _____ _____

Operating profit 200 300 Interest expense (10) (30) _____ _____

Profit before tax 190 270 Tax (90) (100) _____ _____

Profit after tax 100 170 Extraordinary item (70) _____ _____

Profit transferred 100 100 _____ _____

Reserve Movement

Accumulated profits brought forward 3,000 2,000 Profit transferred 100 100 _____ _____

Accumulated profits carried forward 3,100 2,100 _____ _____



Statement of financial position as at 31 December

X G $m Krm Non current assets Investment in G 1,100 Tangible 3,000 1,700 Current assets 2,300 2,200 Current liabilities (1,100) (1,000) Non current liabilities (1,200) (700) _____ _____

4,100 2,200 _____ _____

X G $m Krm

Share capital 1,000 100 Reserves 3,100 2,100 _____ _____

4,100 2,200 _____ _____

(i) G has applied local GAAP, but has made some attempt to adapt to IFRS. As a result, the subsidiary has recorded an extraordinary item in the sum of Kr70 million. This extraordinary item is the recognition of a fall in value of some plant that was damaged during the year.

(ii) The fair value of the net assets of G at acquisition was Kr2,500 million. Goodwill is unimpaired. The increase in the fair value of G over carrying value is attributable to machines which are depreciated over ten years on the straight line basis.

(iii) During the year, X sold $20 million in goods to G at a margin of 20%. All of the goods had been utilised in production by the year end, but only one half of the relevant finished goods have been sold. G received the goods on 16 June and paid on the same day.

(iv) X made a loan of $4 million to G immediately after the acquisition on 1 January. This is still outstanding at the year end. The parent has recorded the asset in current assets. The subsidiary has recorded the liability in current liabilities at the rate ruling at the year start.

(v) X purchased some land in a different foreign country with the currency of the dinar on 17 July. The land is held for speculating purposes. X paid Dinar 110 million. X classified the property as property plant and equipment and so included the balance at cost in tangible non current assets above. However, a surveyor gave a value of Dinar 180 million at the year end.

(vi) The following exchange rates are relevant:

Kram to $1 Dinar to $1

1 January 4 9 16 June 3 10 17 July 3.5 11 31 December 6 12 Weighted average for year 5 10.1



Required:

(a) Prepare the income statement and statement of financial position for the group for the current year. (Note: round to the nearest million)

(35 marks)

(ACCA June 1998)

This question is based on the classic ancient foreign sub question from 1998, but has pillaged widely from more recently examined components of forex.


Chapter 4

Group cash flow statements

CHAPTER 4 – GROUP CASH FLOW STATEMENTS


CHAPTER CONTENTS

INTRODUCTION TO CFS ------------------------------------------------- 71

EXAM QUESTIONS ------------------------------------------------------- 72



INTRODUCTION TO CFS

The statement of cash flows is literal. This chapter addresses its preparation and so refers to study guide entry D1i.

Here are a few introductory questions to remind you how to calculate the cash flow from incomplete records:

Example 1 Non current assets

The following information was extracted from the financial statements of an entity:

Current Comparative Non current assets 900 700 Revaluation gain 70 Impairment 30 Depreciation 60 Disposal at net book value 40 Finance lease additions 10

Required:

Calculate the cash flow additions.

Example 2 Tax


Current Comparative Corporation tax 400 350 Deferred tax 110 120 Income statement charge 410 Tax liability in sub disposal 20

Required:

Calculate the cash flow payment to the tax authorities.

Example 3 Associate


Current Comparative Investment in associate 900 670 Share of associate profits in P&L 430 Forex gain on foreign associate 40

Required:

Calculate the cash flow dividends received from the associate.



EXAM QUESTIONS

Now all that is required is to do some exam questions to practice the techniques.

Exam question: Squire

The following draft financial statements relate to Squire, a public limited company:

Draft group statement of financial position at 31 May

Current Comparative Non-current assets $m $m Intangible 80 65 Tangible 2,630 2,010 Investment in associate 535 550 Retirement benefit asset 22 16

_____ _____

3,267 2,641

_____ _____

Current assets Inventories 1,300 1,160 Trade receivables 1,220 1,060 Cash at bank and in hand 90 280

_____ _____

2,610 2,500

_____ _____

Total assets 5,877 5,141

_____ _____

Capital and reserves Nominal share capital 200 170 Share premium 60 30 Revaluation reserve 92 286 Retained earnings 508 505

_____ _____

860 991 Non-controlling interest 522 345 Non-current liabilities 1,675 1,320 Provisions for deferred tax 200 175 Current liabilities 2,620 2,310

_____ _____

Total equity and liabilities 5,877 5,141

_____ _____



Draft group income statement for the year ended 31 May

$m Revenue 8,774 Cost of sales (7,310)

_____

1,464 Distribution and administrative expenses (1,030)

_____

Profit from operations 434 Share of operating profit in associate 65 Interest expense (84)

_____

Profit before tax 415 Income tax expense (including tax on associate $20million) (225)

_____

Profit for the period 190 _____

Profit attributable to: Equity members of the parent 98 Non-controlling interest 92

_____

Profit for the period 190

_____

Draft statement of changes in controlling interest equity for the year ended 31 May

$m Opening Shareholders' Funds 991 Profit for period attributable to equity members of the parent 98 Dividends paid (85) Foreign exchange difference of associate (10) Reversal of revaluation surplus (194) New shares issued 60

____

Closing Shareholders' Funds 860

____



The following information relates to Squire:

(i) Squire acquired a seventy per cent holding in Hunsten, a limited company, during the year. The fair values of the net assets acquired were as follows:

$m Tangible non-current assets 250 Inventories and work in progress 70 Receivables 100 Payables (90) Provisions for onerous contracts (30)

____

300

____

The purchase consideration was $200 million in cash and $50 million deferred consideration which is payable next year. The deferred consideration attracts market rate interest which has been paid and included in interest expenses. The provision for the onerous contracts was no longer required at the year end as Squire had paid compensation of $30 million in order to terminate the contract during the year. The intangible asset in the group statement of financial position comprises goodwill only. An impairment loss has been recognised during the year in respect of goodwill on another different previously acquired and wholly owned subsidiary and this impairment was charged to the income statement within cost of sales. It is the group’s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s net assets.

(ii) There had been no disposals of tangible non-current assets during the year. Depreciation for the period charged in cost of sales was $129 million.

(iii) Current liabilities comprised the following items:

Current Comparative $m $m Trade payables 2,355 2,105 Interest payable 65 45 Taxation 200 160

_____ _____

2,620 2,310

_____ _____

(iv) Non-current liabilities comprised the following:

Current Comparative $m $m Deferred consideration for purchase of sub 50 - Liability for the purchase of tangible non-current assets

355 -

Loans 1,270 1,320

_____ _____

1,675 1,320

_____ _____

(v) The retirement benefit asset increased due to a substantial cash investment during the year. The only other retirement benefit issue was a charge of $20m to the income statement within cost of sales.



Required:

Prepare a group cash flow statement using the indirect method for Squire group for the year ended 31 May.

The note regarding the acquisition of the subsidiary is not required.

(35 marks)

(ACCA June 2002)



Exam question: Ducky Group

The following draft financial statements relate to the Ducky Group:

Draft group statement of financial position at 31 May Current Comparative $m $m

ASSETS Non-current assets Goodwill 78 92 Tangible 2,473 1,248 Investment in associate 545 550 ____ ____

3,096 1,890 ____ ____

Current assets Inventories 734 622 Trade receivables 689 601 Cash and cash equivalents 57 205 ____ ____

1,480 1,428 ____ ____

Total assets 4,576 3,318 ____ ____

EQUITY AND LIABILITIES Equity

Ordinary shares of $1 100 60 Share premium account 185 75 Revaluation reserves 90 10 Retained earnings 1,218 725 ____ ____

1,593 870 Non-controlling interest 157 107 ____ ____

1,750 977 Non-current liabilities

Deferred Tax 390 417 Redeemable preference shares 200 230 Loans 1,005 570 ____ ____

1,595 1,217 Current liabilities 1,231 1,124 ____ ____

Total equity and liabilities 4,576 3,318 ____ ____




$m Revenue 9,425 Cost of sales (7,878) ____

Gross profit 1,547 Distribution and administrative expenses (757) ____

Profit from operations 790 Income from associates 98 Interest income 23 Interest expense (45)

___

Profit before taxation 866 Tax (213)

___

Profit for the period 653 ___ Profit attributable to: Controlling interest 584 Non-controlling interests 69

___


___


Share capital

Share premium

Revaluation reserves

Retained earnings Total

$m $m $m $m $m Balance opening 60 75 10 725 870 Surplus on revaluation 80 80 Net profit for members 584 584 Dividends paid (78) (78) Exchange difference on foreign associate (13) (13)

Issue of share capital 40 110 150

___

__

__

___

___

Balance closing 100 185 90 1,218 1,593

___

__

__

___

___



The following information is relevant to the Ducky Group:

(i) Ducky acquired a 90% per cent holding in Prince during the year. The fair values of the assets of Prince on that day were as follows:

$m Non-current assets (tangible) 172 Inventories 33 Trade receivables 27 Cash and cash equivalents 3 Trade payables (22) Taxation (13) ___

200 ___

The purchase consideration was $204 million and comprised 20 million ordinary shares of $1 in Ducky (valued at $4 each) and the remainder in cash. An impairment loss has been recognised on the goodwill arising on another previously acquired wholly owned subsidiary acquisition and is included in cost of sales. It is the group’s policy to value the non-controlling interest at the fair value which at acquisition was $22m.

(ii) The remainder of the shares issued during the year were issued for cash during a rights issue. Ducky had allotted 20 million ordinary shares for cash during this issue.

(iii) The tangible non-current asset movement for the period included the following amounts at net book value.

$m Disposals 40 Depreciation 51

The disposal resulted in a profit on disposal of $7million, included in cost of sales.

(iv) Current liabilities comprised the following items:

Current comparative $m $m

Trade payables 1,003 913 Interest accrual 6 9 Taxation 222 202 ____ ____

1,231 1,124 ____ ____

(v) The increase in the loans during the year was related to the issue of loan stock partly for cash and partly to finance the purchase of raw materials valued at $70 million.

(vi) The exchange differences included in the statement of changes in equity relate to the foreign associate. There was a dividend from the associate during the year.

(vii) The preference share dividends are always paid in full on 31 May each year and are included in interest in the income statement. Part of the preference capital was redeemed during the year.



Required:

Prepare a group cash flow statement using the indirect method for the Ducky Group for the year ended 31 May.

The notes to the cash flow statement are not required.

(35 marks)

(ACCA June 2000 rewritten)



Exam question: Duke Group

The following draft financial statements relate to the Duke Group:

Draft group statement of financial position at 31 May Current Comparative $m $m

ASSETS Non-current assets Goodwill 90 83 Tangible 1,239 1,010 Investment in associate 780 270 ____ ____

2,109 1,363 ____ ____

Current assets Inventories 750 588 Trade receivables 660 530 Cash and cash equivalents 45 140 ____ ____

1,455 1,258 ____ ____

Total assets 3,564 2,621 ____ ____

EQUITY AND LIABILITIES Capital and reserves

Ordinary shares of $1 100 70 Share premium account 85 15 Revaluation reserves 30 10 Retained earnings 200 103 ____ ____

415 198 Non-controlling interest 250 150 Non-current liabilities

Deferred Tax 200 230 Redeemable preference shares 100 130 Interest-bearing borrowings 1,098 700 ____ ____

1,398 1,060 Current liabilities 1,501 1,213 ____ ____

Total equity and liabilities 3,564 2,621 ____ ____




$m $m Revenue 7,310 Cost of sales (5,920) ____

Gross profit 1,390 Distribution and administrative expenses (757) ____

Profit from operations 633 Income from associates 98 Interest income 34 Interest expense (37) (3)

___ ___

Profit before taxation 728 Tax (including tax on associates $15 million) (213)

___

Profit for the period 515 ___ Attributable to: Equity holders of the parent 418 Minority interests 97

___


___


Share capital

Share premium

Revaluation reserves

Retained earnings Total

$m $m $m $m $m Balance opening 70 15 10 103 198 Surplus on revaluation 20 20 Net profit for period 418 418 Dividends paid (126) (126) Exchange difference: on foreign equity (195) (195)

Issue of share capital 30 70 100

___

__

__

___

___

Balance closing 100 85 30 200 415

___

__

__

___

___

The following information is relevant to the Duke Group:

(i) Duke acquired an eighty per cent holding in Regent during the year. The fair values of the assets of Regent on that day were as follows:

$m Non-current assets (tangible) 60 Inventories 30 Trade receivables 25 Cash and cash equivalents 35 Trade payables (20) Taxation (30) ___

100 ___

The purchase consideration was $97 million and comprised 20 million ordinary shares of $1 in Duke (valued at $4 each) and $17 million in cash. An



impairment loss has been recognised on the goodwill arising on this acquisition and is included in cost of sales. It is the group’s policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiary’s net assets.

(ii) The remainder of the shares issued were issued for cash during a rights issue. Duke had allotted 10 million ordinary shares for cash during this issue.

(iii) The tangible non-current asset movement for the period included the following amounts at net book value.

$m Disposals 30 Depreciation 39

The disposal resulted in a profit on disposal of $15million, included in cost of sales.

(iv) Current liabilities comprised the following items:

Current Comparative $m $m

Trade payables 1,193 913 Taxation 308 300 ____ ____

1,501 1,213 ____ ____

(v) Included in non-current liabilities (interest bearing borrowings) is a bill of exchange for $100 million (raised during the year) which was given to a supplier on the purchase of non current tangible assets and which is payable on in five years.

(vi) The exchange differences included in the statement of changes in equity relate to the foreign associate. There was no dividend income from the associate during the year. Instead, a huge cash injection was required to support the associate.

(vii) The preference share dividends are always paid in full on 31 May each year and are included in interest in the income statement. Part of the preference capital was redeemed during the year.

Required:

Prepare a group cash flow statement using the indirect method for the Duke Group for the year ended 31 May.

The notes to the cash flow statement are not required.

(35 marks)

(ACCA June 2000 rewritten)


Chapter 5

Corporate social responsibility and

current issues

CHAPTER 5 – CORPORATE SOCIAL RESPONSIBILITY AND CURRENT ISSUES


CHAPTER CONTENTS

CORPORATE SOCIAL RESPONSIBILTY --------------------------------- 85

PROFESSIONAL ETHICS ------------------------------------------------- 85

THE FRAMEWORK FOR FINANCIAL REPORTING ---------------------- 86

CURRENT REPORTING ISSUES ----------------------------------------- 86

CONVERGENCE ----------------------------------------------------------- 87

ENVIRONMENTAL AND SOCIAL REPORTING -------------------------- 87

APPRAISAL --------------------------------------------------------------- 87

SPECIALISED ENTITIES AND SPECIALISED TRANSACTIONS ------- 88

SMALL AND MEDIUM ENTITIES ---------------------------------------- 89

RELEVANT RECENT ARTICLES ------------------------------------------ 90

IVORY TOWER IFRS COLUMN ------------------------------------------ 91

CURRENT ISSUES EXAM QUESTIONS --------------------------------- 115

IFRS FOR SMES --------------------------------------------------------- 119



CORPORATE SOCIAL RESPONSIBILTY

Corporate Social Responsibility (CSR) and Current Issues (CI) are phrases used by the examiner and other commentators to address the broad subjects of corporate governance, the reporting of information to users within that framework of corporate governance and the development of standards to ensure that communication is clear and understandable.

The subject of CSR+CI is examined in question 4 of the exam, which requires a largely narrative answer. The examiner himself does not distinguish particularly between the subcomponents of CSR+CI.

The subject is of almost infinite width, so it important not to overexpand your knowledge at the cost of solid basics. Just get your head around the basics and then make sure you have the techniques required to discuss accounting through a narrative answer. You will get the basics of CSR and CI through reading the following chapter. You will get the techniques required to discuss accounting using a narrative answer by practicing the three questions in this chapter. The questions are Value Relevance, World Energy and Mineral. There are detailed answers in the back. The basics are as follows.

PROFESSIONAL ETHICS

This is study guide entry A1a, b and A2a, b and A3a, b.

Directors are required to take a professional attitude to their responsibility to communicate. Deliberate deviation from fair reporting is often called “creative accounting” and is in direct contradiction to corporate social responsibility.

Clearly, financial reporting requires that the directors present financial statements that show a true and fair view. This in turn requires that the directors adopt a professional and ethical behaviour. This area of corporate social responsibility is widely referred to as “corporate governance” and whilst it is regularly examined in passing, the examiner does not require detailed knowledge of regulation.



THE FRAMEWORK FOR FINANCIAL REPORTING

This is syllabus area B1a, b, c and B2a, b.

The framework for financial reporting (referred to as The Statement of Principles in the United Kingdom) requires that financial statements communicate performance, position and cash flow for an entity to user. So of course, the framework requires an income statement, statement of financial position and cash flow statement. However, the framework leans heavily towards the statement of financial position and so the key concept in financial reporting is the definition of an asset/liability.

To paraphrase the framework “an asset/liability is the present right/obligation to a future economic inflow/outflow”. This definition is central to the development of financial reporting standards.

Fair Value However, as we all know, the values of assets and liabilities as represented on the statement of financial position are rarely a reflection of the true worth. This is because accounting is coming from a system of financial reporting called “Historical Cost Accounting” (HCA), which as the name suggests, is based on historical costs. Financial reporting is moving towards a system called “Fair Value Accounting” (FVA). As the name suggests, this uses the real economic value of assets and liabilities on the statement of financial position in order to better reflect a true and fair view of financial position.

At present we use a mix of both HCA and FVA, and so our present system is called “mixed accounting”. But obviously this inconsistent system cannot persist and the move towards FVA is one of the main areas for development at the International Accounting standards Board (IASB).

CURRENT REPORTING ISSUES

This is study guide entry H3a and F2a.

So the framework leads us to current developments. Having settled on a framework for financial reporting, with its focus on assets, liabilities and fair value, the International Accounting Standards Board (IASB) must drive us towards these goals. There is an enormous amount on these current reporting issues in the Ivory Tower articles that follow, within this chapter.



CONVERGENCE

This is study guide entry H2a, b and F1a.

Probably the single largest political issue in current developments above is convergence. An enormous driver of current issues is the desire to create standards that are acceptable worldwide.

Companies and counties are increasingly adopting international financial reporting standards (IFRS). This process is called “convergence”. It is widely accepted that it is a good thing for companies and the users of the financial statements because of the increased global consistency that results.

The practicalities of swapping from local standards to international financial reporting standards are dealt with in IFRS1 First time adoption of IFRS. This lays out the rules that apply during the two year process of implementation of IFRS. Essentially it requires that you adopt the IFRS for the year of adoption and go back and restate the comparatives to make them comparable. But the standard also requires that in the year of adoption you also calculate the local profit you would have had under the old accounting system. Then the standard requires that you disclose in the notes a reconciliation of that local profit to the actual international profit.

ENVIRONMENTAL AND SOCIAL REPORTING

This is study guide entry H1a, b, c.

There has been a movement towards environmental and social reporting (ESR) since the 1990s and the quality of ESR continues to improve.

ESR is simply the reporting of company relationships with the wider world around them. It uses words and pictures and appears in company annual reports as part of the wider section called the management commentary. The commentary is literal. The management use this section of the annual report to communicate financial environmental and social performance.

There is a development project on management commentary that is trying to develop a standard that will introduce a standardised format for commentary to increase comparability. However, the IASB and the wider world appear to have lost interest in the project.

APPRAISAL

This is study guide entry G1a, b and G2a, b, c, d.

A large part of P2 is appraisal. As you start your revision you will discover that the questions require you to analyse the issues laid out in the scenario and appraise the accounting. So as you work your way through the remainder of the course and build up your knowledge, be aware that in the exam you will be expected to apply that knowledge in an analytical appraisal of the scenario.

There is no detailed requirement for formal appraisal tools such as EPS or ROCE. An awareness of these ratios is more than enough. All you need is the ability to read a story and tell a story in response.



SPECIALISED ENTITIES AND SPECIALISED TRANSACTIONS

This is study guide entry E1a and E2a, b, c.

An overview is more than enough for the above. You are not expected to know any unique quirks that might apply to unusual entities like government departments, charities or banks. But you are expected to know that all entities face similar accounting problems and all entities use the same IFRS to solve their problems.

This is examined by placing the exam scenarios in an industry like retail, football, manufacture or charity. The examiner expects you to know that the answer is the same independent of the industry.

You are also expected to be able to identify an entity that is struggling to survive. Further you should be aware of the classic entity reconstruction to avoid liquidation. This is the debt equity swap. A debt financier may accept equity in exchange for debt to help the borrower to survive a cash flow crisis. This was a favourite technique of governments during the recent financial crisis. The borrower simply moves the debt from liabilities into equity.



SMALL AND MEDIUM ENTITIES

This covers study guide entry C11a, b, c, d, e and E2a, b, c.

But another big political issue is the accounting for SMEs. It is widely accepted that IFRS are bulky and the presentation of fs using IFRS is a substantial bureaucratic burden. Large companies are big enough to shoulder this burden, but small and medium companies feel this expense disproportionately because of their size.

So many countries have utilised a two tier accounting system widely called “big GAAP little GAAP” (generally accepted accounting principles). Each country has set a threshold above which companies are required to produce full fs using full IFRS (or equivalent) and below which companies are required to produce reduced fs with less disclosure. This makes SME accounting much cheaper in these countries.

The IASB have until recently ignored this issue. However, following extreme pressure, they have reviewed the problem and a Standard has resulted. It proposes that all companies should be able to produce reduced fs, provided they are not public interest companies (that is, not quoted or offering financial services). So unless your company is quoted or offering financial services, then it is an SME and can produce reduced fs.

However, the IFRS for SMEs has been widely criticised because the reduced fs are very little reduced from the full fs. This means that even if your company qualifies as SME, you will produce fs just as bulky as would have been required had your company failed to qualify.

Simplifications Some of the main simplification in the IFRS for SMEs are as follows:-

(1) Goodwill recognition

Partial method recognition is required (see Basic Groups Chapter).

(2) Goodwill amortisation

Amortisation is required (over 10 years) to avoid the annual impairment test.

(3) PPE Model

Only the cost model is allowed.

(4) Investment Property Model

Only the fair value model is allowed.

(5) Borrowing Costs

The capitalisation of finance cost on PPE is not allowed.

(6) Development

Development is written off like research.

Article An article at the end of this chapter written by the examiner gives more detail.



RELEVANT RECENT ARTICLES

There is almost an infinite amount of information on this vast subject available on the web. There is therefore a substantial risk that spending a large amount of time on this subject at this point will prove fruitless and frustrating. My advice is therefore look at the Ivory Tower articles below, then complete the following three past exam questions to get a flavour of this style of question and then move on.

But should you wish to spend more time in this area, the three sources to consider are:-

Source Information

Accaglobal.com Go to the P2 past exams and look at past question 4s.

Iasb.org Go to the IASBs own webpage and look under ‘work plan’ for what they are up to at the moment.

Iasplus.com Go to this wonderful, but sprawling, website for commentary on what the IASB are up to.



IVORY TOWER IFRS COLUMN

As you may know, I write the monthly column on the development of IFRS for PQ magazine. These articles are targeted at students trying to get a feel for current issues and their corporate social responsibility angle. Here are a few recent editions. Please keep up with the column by signing up to receive PQ at pqaccountant.com.

The articles are all aimed at giving P2 students a flavour of current issues, in order to give them the edge when addressing those tricky current issues questions in the P2 exam.



November 2009 This is the first bulletin from the ivory tower of the IASB on Cannon Street London. Still dominating the minds of all those involved in standard setting, that is the big companies, the politicians and the standard setters themselves, is the financial crisis and resultant recession. It’s led to a long hard look at the financial reporting of financial instruments and fair value and led to development projects that I can look at later.

But frankly that can wait, because I want a mention for the IFRS for SMEs. In any other year this new standard would be the daddy. But when it came out on 9 July this year it was welcomed with the deafening silence of apathy. I think this is a great shame as, whilst this may not be the most exciting accounting ruling to come out of the ivory tower, it sure has come a long way. The story of the development of this standard is news worthy in its own right. First the IASB tried to dodge the whole subject of financial reporting for small and medium entities. Then when they were bullied into developing a standard by the politicians, they were hammered for drafting a little GAAP that barely differed from the big GAAP of the full IFRSs. Well the issued standard has come out at 10% of the full IFRSs and the quiet acceptance of the interested parties speaks volumes for its quality and simplicity.

In truth, I hoped the IASB would have hacked into big GAAP more. I would have liked to have seen the removal of deferred tax and share based payment from SME accounting. But at least, these two have been streamlined and this along with many other simplifications of full IFRS makes the IFRS for SMEs worthy of a fanfare…

December 2009 The International Accounting Standards Board (IASB) and the United States Financial Accounting Standards Board (FASB) have had their collective heads bashed together over the development of standards on financial instruments at a meeting in Connecticut in October. However, I can only see this as a good thing.

The two boards, responding to extreme pressure from government, banks and an array of other interested parties, have been accelerating their development of standards to replace the ludicrously complex existing rules on financial instrument accounting. However, from the start they decided to work separately. Here is a quote from the exposure draft proposing to replace horrendous IAS39: “It is not uncommon for the boards to deliberate separately on joint projects and then subsequently to reconcile any differences in their technical decisions.”

At the time I asked myself “How does deliberating separately constitute a joint project?” But I did rather assume they knew what they were doing. I went along to the IASB on Cannon Street in London on 24 July to look in on the joint meeting with the FASB that was supposed to facilitate the reconciliation of differences. Frankly I was gobsmacked. Neither party seemed to know what the other was doing. At one point having listened to Bob Herz and others from the FASB explain their solution to financial instrument accounting, David Tweedie turned to his technical director and asked “does that roughly equate to what we are doing?” To which the response was “yes roughly”!

As you have gathered David Tweedie is my hero, so this was all a bit of a shock to me. I can only guess, but I think maybe both the IASB and the FASB knew that there proposals were such an improvement on existing accounting that the market would accept the divergence.



But now for the good news. The market has simply refused to accept this divergent standard setting and both boards have accepted that divergence is unacceptable. To me this is fantastic news. This proves that the business world really believes in convergence. Perhaps the only bad news is that we might have to wait a little longer until we have a replacement standard for financial instruments.

February 2010 As you may have seen in the financial press recently, David Tweedie confirmed his intention not to stand for re-election to the role of chairman of the IASB. I don’t think this came as a surprise to any interested party. However, I suspect that one or two may have felt some pang of regret to see that come autumn 2011, there would be no Scottish battleaxe to bang heads together and make things happen in the world of international financial reporting.

I think that there will be plenty of movement between now and then, not least the increasing convergence of the US financial reporting system on IFRS. But while David Tweedie himself is in the press so much, I would like to briefly give a flavour of the man and his achievements, as far as I can as a distant admirer. As I have mentioned before, David Tweedie is my hero, so don’t expect this commentary to be objective.

David Tweedie started standard setting in 1990 (as I started accounting). His first role was as chairman of the UK ASB and he quickly got about the gruesome task of cleaning up UK standards. He shook up the financial reporting system by introducing conceptual rules for much abused ideas, such as substance, provisions and discontinued operations. It was during this period that he earned the memorable nickname of “the most hated accountant in Britain”, following an article by the Scotsman newspaper.

Then since 2001, David has been chairman of the IASB, of course, where he takes the role to mean leadership, rather than technical wizard. Under his stewardship the key developments have been political, but no less astonishing. As we all know, IFRS are now the gold standard for accounting standards, following widespread adoption in Europe and elsewhere.

But the prize has always been the US and it does appear now inevitable that Washington will rubber stamp IFRS soon. But sadly it also appears inevitable that this will occur after David Tweedie has retired. Still at least, as he said recently himself, he will have the consolation of more time to terrorise his grandchildren.

March 2010 “Cohesiveness” – now there is a word for you. It is the property of connecting together like a well attuned nuclear family, according to one of the many online dictionaries that I checked out. You wouldn’t think it was possible to debate this one word for three hours, would you? But somehow the IASB managed this astonishing feat at a recent IASB board meeting that I attended.

I stood behind one of the other delegates at the same meeting as he queued for his coffee at the sandwich shop next door during the break in the middle of this session. He complained to his friend that he had rarely been so bored in his life and that he was sure his ears were bleeding and that his stomach was threatening to leap into has skull and strangle his brain so that he did not have to return to listen to the other half of the debate.



So why are the IASB so excited by this word? Well it is a new concept that they are introducing to the presentation project. This project, which has been rumbling on for a number of years, is building up steam now and looks like coming to a head soon. The IASB want all three financial statements to hang together logically so that information can be cross referenced. This is what they mean by “cohesiveness”. For example, the IASB want users to be able to look at sales and know how much was unpaid by customers and how much was paid by customers. At present users can of course look at receivables on the position statement to answer the first query. But the cash from customers does not appear on the cash flow statement, so that will have to change.

I think this as laudable aim and that cohesiveness is a concept that will take its place amongst the other honourable concepts like substance, relevance and reliability. But I can also see that is going to change the way we present our financial statements, so be prepared for that.

April 2010 The time has come to tell the story of Long Tails and Revenue. Revenue recognition has been a thorn in the side of the International Accounting Standards Board (IASB) since they took over the job of standard setting in 2001. However, the IASB let this problem slide until the USA made revenue a condition of convergence. Not unreasonably, the Americans said they would not adopt IFRS until the IFRS for the biggest most important figure on the whole financial statements was clarified. The IASB are obsessed by convergence; indeed David Tweedie, Chairman of the IASB has made USA adoption of IFRS his last goal before his retirement in June 2011. So the IASB have turned their big brains to the revenue problem.

But what is the problem? Well, there is no problem with simple sales. Everybody knows and understands the accounting for supermarket sales, for example. When the till goes “beep”, the revenue is recognised. The problem arises with long tail revenue stories. A good example of this is the recent Lady Gaga world tour. Much of the tour costs are incurred up front, with stage settings and air tickets costing a fortune during development. Then the revenue comes in over the extended “long tail” of the tour itself. So how should Lady Gaga account for this revenue stream under current rules? Using existing standards, she has countless choices and innumerable further questions to consider. Should she view this revenue as equivalent to a construction contract or should she use basic revenue rules? Should she consider discounting the cash flows? Should she consider the non-refundability of tickets? Lady Gaga could answer these questions in any number of ways, all giving different revenue results for the same revenue stream.

The IASB have proposed a solution that is both consistent with their obsession with the balance sheet and radical in the extreme. They propose to recognise revenue by ignoring revenue. Instead they propose to look at revenue problems as growing assets. They propose that Lady Gaga must focus on the asset at the year start, remeasure that asset at the year end; then the tour revenue would simply be the difference. The solution is almost poetic in its simplicity; but like many simple answers it is brutal in its effect. So the proposal has many long tail revenue earners running around to avoid having their revenue shunted to the final year of the tail.



May 2010 David Tweedie recently commented in an interview by PQ published in the December 2009 issue that his proudest piece of technical writing is the solution to the leasing problem currently under development by the IASB. These ideas were discussed between the International Accounting Standards Board (IASB) and the USA Financial Accounting Standards Board (FASB) during their joint meeting in April 2010.

So what is the problem that this clever piece of accounting solves? Well to answer that we have to go back 30 years! 30 years ago, Duran Duran were offending the senses with New Romantic flounces adorned by hair gel poodle coiffure and the use of leases to push finance off the balance sheet was rife. Because a lease involves the lessor retaining the legal title to an asset, lessees were able to pretend that assets they were using were nothing to do with them. But more importantly lessees were able to push the related finance off the balance sheet. In 1982 IAS17 Leases stopped the worst of these abuses by bringing finance lease obligations onto the position statement. At the time it was heralded as a brilliant blow for truth and honesty in financial reporting; so nobody was too upset that the obligations for operating leases stayed off the balance sheet.

However, 30 years later the FASB has pointed out that even operating leases involve obligations and it makes no sense to allow these obligations to be ignored. The IASB have held up their hands and admitted that all leases are essentially the same and that the distinction between finance and operating leases was a political expedient used at the time. So the IASB has proposed one single form of lease accounting and proposed that the terms finance and operating lease are abandoned. Specifically the IASB have proposed that we recognise an obligation to the lease instalments and a corresponding asset that represents the right to use the asset over the lease life.

This was the heart of the discussions between IASB and FASB during April 2010. Not surprisingly, the Americans loved it and it looks like another feather in David Tweedie’s overcrowded cap and another step towards convergence of USA financial reporting on IFRS.

June 2010 The International Accounting Standards Board (IASB) are working there way through the development project on financial instruments. Last on the agenda is hedge accounting and the IASB are turning their big brains to this issue early whilst finalising the accounting for financial asset impairment. They are clearly not comfortable with the subtleties of hedging; their opinions on the matter veer wildly from one extreme to another. I suspect they need a little training.

Well who could be more knowledgeable on the subject of hedging than the recently discredited world snooker champion John Higgins? You may have read that Higgins is alleged to have called his bookmaker during the final to bet against himself. Showing a clear understanding of the principle of hedging, he is quoted as saying “I just want to cover myself” and “I don’t want to walk away without anything”.

You see that is the principle of hedging; when confronted by a fear of something going against you, you bet on the very thing that you fear. It is used by instant coffee companies who fear a price rise in coffee beans. They bet on that very fear, then if prices do rise, they lose on the coffee but win the bet. It is used by airlines that fear a price rise in aviation fuel, they bet on a fuel price rise. Again the result



is that they are now neutral to fuel price movements, because if they lose in one hand, they will win in the other.

Which eloquently explains the problem for John Higgins. You see, sports stars are not supposed to be neutral as to whether they win or not. So the snooker governing body have suspended John and he may need a new career. In which case, where better to start than in training the IASB in the principles of hedging.

July 2010

There sure is a bucket load of standards coming through at present, giving me ample choice of issues to discuss. I think I will choose one of my favourites. It is control. This issue is actually not such a big deal for us European accountants. We have been applying this concept for many years. But it is a massive big deal in the United States and the politics of this concept played a big part in the Enron story.

Control is the relationship between parent and sub. That entity over which the parent has control is called a sub and must be consolidated with the parent to provide group financial statements for users. Control is exactly what you think it is; it is the ability to push the other guy about without having to argue with anyone else. But you cannot put a definition like that in an International Financial Reporting Standard (IFRS). So a development project is developing words to describe this relationship. Currently IFRS define control as “the power to govern the financial and operating policies of an entity” (IAS27para4). Frankly, though not brilliant, that definition is adequate. The problem lies not in the definition above but in the system of group accounting used in the US. Essentially, in the US a sub is defined not by the concept of control but by a list of specific rules. So for example, one of many of these specific rules is that a US parent has a sub if it owns the majority of the voting shares. The problem with this prescriptive style of rule writing was beautifully illustrated by Enron. Enron found ways to control their subs that were not on the list. So they then shunted liabilities and losses into these subs and then pushed those liabilities off the group balance sheet and those losses off the group income statement by gleefully claiming these subs were not subs because the relationship was not on the list. Clever? Certainly. Cynical? Undeniably.

So the US wishes to switch to conceptual reporting and wishes to adopt the concept of control. Rather than write their own definition, the US would prefer the International Accounting Standards Board (IASB) improve their existing definition of control and then the US will adopt IFRS. So the IASB have proposed that control is the “power to direct activities”. It is typically punchy and looks set to become part of our cannon of concepts before the year is out.

August 2010

I have been writing this column on developing financial reporting under the title “News from the Ivory Tower” for a year now. So it is probably time to remind readers where the title derives. International Financial Reporting Standards (IFRS) are the rules that govern the preparation of financial statements. IFRS are developed by the International Accounting Standards Board (IASB) in their offices on the traffic island of 30 Cannon Street, London. Frankly this off white office block surrounded by seven lanes of psychotic London traffic on all sides does look somewhat like an ivory tower.

But also there is the mythical historical metaphor. In ancient mythical times there have been many kings who have ruled their subjects by issuing laws from the



isolation of their ivory tower inside their palaces without ever knowing the people for whom the laws were written. There is something of this isolation in the story of the teenage Buddha first travelling outside of his father’s palace walls to be shocked by the poverty of his people. There is even more of this isolation in the story of the last emperor of China living inside the Forbidden City in the early years of the twentieth century. But to say that the IASB behave like this is harsh in the extreme. It may sometimes feel like IFRS are thrown at us by the IASB from the confines of their ivory tower without reference to our needs, but in truth, one of the great strengths of the IASB has been their outreach.

And the product of one outreach project is the proposal to change the presentation of the cash flow statement (CFS). Currently the CFS published by all entities (and examined by all examiners) starts effectively with the operating profit. This method of preparation is called the indirect method and has simply grown out of a culture of doing CFS that way that started in the early 1990s. Investors have pointed out to the IASB that it makes no sense to start a CFS with operating profit. After all, nobody would ever start an income statement with operating profit and deny the user the chance to understand sales and costs unless they were deliberately trying to hide something. So the IASB have taken this on board and propose to require the direct method. The direct method requires that the CFS begin with cash from customers to be consistent with the income statement which of course already starts with sales to customers.

September 2010 Financial reporting and politics are of course indistinguishable. But here is an instance of the politics of central government mixing with the politics of financial reporting to exasperate even the most patient accountant.

During the early phases of the last economic crisis there was much scare-mongering scape-goating nonsense about fair value. The big commercial banks tried to blame their investment errors on fair value and accounting. Central governments worldwide, most notably in the United States and the United Kingdom, slapped the banks down and roundly accused them of blatant buck-passing. But the central governments did criticise the International Accounting Standards Board (IASB) for the over-complexity of the relevant International Accounting Standard (IAS39 Financial Instruments).

The IASB took this criticism on the chin and instantly got to work tidying up financial instrument accounting. The result was IFRS9. It was heralded as a massive improvement on the old IAS39 and was available for early adoption in November of last year, 2009.

Now here is the sting. The European Union say that no accounting rule can be adopted in the EU until they have rubber stamped it. They have not rubber stamped IFRS9 yet and there is no indication that they are going to even think about thinking about the matter any time soon.

So there you go. Central government demands change. The accountants deliver the change. Then another bit of central government forbid that the requested change can be used. No wonder David Tweedie, chairman of the IASB, looks forward to his imminent retirement and playing with his grandchildren.

October 2010 As I write this, today is a Monday and tomorrow the International Accounting Standards Board (IASB) debate the impairment of financial instruments at the Ivory



Tower in the heart of London. I shall go along, as I do regularly, because I am an accounting train spotter. The subject of impairment of financial instruments is probably the hot topic at the moment, making it highly examinable, especially at ACCA P2 where the examiner likes to bring hot topics into his final question. So I shall give you a flavour of the story.

However, it is not an easy topic and has been a problem even for the big brains at the IASB. It is also a highly localised problem that is particularly important to the banks. We all know that banks are just businesses, like manufacturers, retailers or schools; but somehow it never works out like that. As we saw from the banking troubles of the last recession, anything involving banks becomes highly politicised and so it is with the impairment of financial instruments.

Loan assets, like for example mortgage loan assets held by banks, are carried at amortised cost. Usually, this means face value. However, clearly if the customer gets into financial difficulty and the cash flowing into the bank starts drying up, then the face value of the loan asset no longer represents the true value of the asset. So the bank puts through an impairment. So far none of this is contentious. What is contentious is how the impairment is measured. To measure the impairment the bank must consider the fair value of the asset and because loan assets are just future cash inflows, the process of discounting comes in. This is where the contentiousness arises. Some banks under certain circumstances use one discount rate; other banks in very similar circumstances use another discount rate. You will know from your past studies that the discount rate used in a discounted cash flow makes a massive difference to the present valued derived. So I expect the debate to get fairly heated tomorrow.

November 2010 I would like to talk to you about deferred tax. This is a difficult subject to get a handle on because it makes so little sense. It is also difficult to get a feel for the development project because there is so little interest in deferred tax in the ivory corridors of the ivory tower of the International Accounting Standards Board (IASB) in London.

So I will start at the beginning. Deferred tax was developed in the 1970s when matching was the concept and profit was the figure. The profit or loss report was utterly dominant and the balance sheet was just a sheet that balanced. Because tax legislation was largely based on cash flow accounting in the 1970s, the timing of tax charges in the taxman’s books often lagged behind the timing of income in the accountant’s books. So the accountants at the time decided to recognise an accounting tax charge to match up the tax charge with the income in the year of the income. These early accountants could have called this “matching tax”, but they called it “deferred tax”. Because double entry has two entries, when these accountants recognised the deferred tax charge on the profit or loss, they were obliged to recognise the deferred tax creditor on the balance sheet. They knew perfectly well that the creditor was not a real liability, but they did not care, as they had no interest in the balance sheet.

When the IASB took over financial reporting at the turn of the millennium and brought with them their fanatical vision of returning financial reporting to its roots by focussing on position, they boldly renamed the balance sheet “the statement of financial position”. This created many problems and the deferred tax creditor was just one. Of course the IASB know that deferred tax is not a real liability, but they also know that removing it from the cannon of standards would cause an almighty



great ruckus. So in the short term they are simply trying to make the accounting for this nonsense liability consistent worldwide in preparation for convergence.

December 2010 One could write a book about the creative accounting at Enron; to compliment the countless hundreds that have been written about the ethics, the psychology and the mayhem that was the Enron fraud. Indeed, perhaps I should. If I did write that book, then I would reserve the position of honour to the creative accounting based on the derecognition of subsidiaries. Enron manipulated its revenue, lied about its costs and blew smoke in the eyes of its gullible shareholders; but most famously Enron used entities that it called “special purpose vehicles” to hide its worsening position. These cutely named entities had the special purpose of taking liabilities off the balance sheet and losses off the profit or loss report.

These entities were genuine subsidiaries, but Enron were able to utilise the weak definition of a subsidiary prevalent in the USA to treat these entities as outsiders and therefore derecognise the liabilities and losses that they shunted into these entities. Andrew Fastow, the brilliantly inventive CFO with the dodgy moral compass, was taking advantage of the rules based accounting used in the USA.

When the dust settled on the Enron case, the US standard setters were honest enough to hold up their hands and accept that the US accounting criteria for subsidiary recognition was too weak. But they also recognised that the IFRS criteria based on control was the way forward. So rather than develop the issue themselves, the US asked the International Accounting Standards Board (IASB) to improve on the existing IFRS definition of control. Of course, the IASB were keen to do so, as this improvement would bring US adoption of IFRS closer.

This project is coming to an end and the result is the powerfully simple phrase “the power to direct activities”. This new definition of control is so fiendishly difficult to wriggle around that all parties are hopeful that the sub derecognition scam will be consigned to the history books. Well, that is the hope!

January 2011 I frequently get asked questions about the language of liabilities; questions about words like contingencies, provisions and probable. These questions are perfectly reasonable because the language is confusing and unnecessarily complex. The International Accounting Standards Board (IASB) recognise this and are working on a project to simplify liability accounting. At present, uncertain cash outflows are referred to as contingent liabilities and are accounted for roughly as follows:-

Liability (outflow)

Probable Provide

Possible Disclose

Remote Ignore

An example would help to bring the above to life. Say you are running a newspaper and are being sued by two of the recent X Factor finalists. Katie Waissel is suing for £100,000 and has an 80% chance of beating you in court and Matt Cardle is suing for £200,000 but only has a 10% chance. Well under current rules, you would say the Katie outflow is probable and therefore the newspaper would



provide for all £100,000. But you would say the £200,000 is a remote contingent liability and therefore you would ignore it. You would probably feel vindicated in this accounting; you would probably feel it was right.

However, as the IASB are keen to prove, this accounting is nonsense. It’s only because accountants have been doing it so long that it feels right. A 10% chance of winning £200,000 is far from worthless. If you think it is, the you best avoid speculating on the markets! Equally a 10% chance of losing £200,000 is far from nothing.

The IASB proposal is to measure all liabilities at fair value. Using this model the newspaper would recognise a far more meaningful 80% of £100,000 and 10% of £200,000. This would also mean no more worrying about whether the cash flow was probable, possible or remote.

February 2011 Fair value; there is a loaded expression. We accountants bandy the term about freely; but what is value and what is fair? These questions are central to the development of financial reporting at the International Accounting Standards Board (IASB) and central to their ideas on the underlying meaning of financial reporting.

The messianic message from the IASB is that the way to communicate how things are going in a business is to measure its position at the year end and then calculate its performance based on the growth since last year end. For this system to work, we must measure the values at the year end fairly. Initially at the turn of the millennium, IASB had a look at the clever ideas used by financial management such as discounted cash flow and liked what they saw. But in the end they decided all that fancy discounting was too expensive to do and too easy to manipulate. So as you know, fair value has for a number of years come to mean the cash you might expect to get for trading your asset into an active market.

Well that is easy enough when your asset is traded on an active market. But what if it is not? That is what the IASB are working on now and they have come up with a hierarchy for measurement. First if there is an active market, use the current price from that. If that does not work, look at sales of similar stuff around about the year end. Only if that does not work would you then be allowed to use your clever discounted cash flow.

March 2011 As I write this, today is Monday. So as usual I am aching from my early morning squash game with Anthony. Anthony is a derivatives trader in the City of London.

“So what?” You might ask. Well, unlike most derivative traders, Anthony does not speculate. He uses derivatives for hedging. Specifically he uses derivatives to mitigate the risks that his bank cannot avoid. Amazingly, even though he is a trader and economist, he reckons he spends about 90% of his time on the accounting for the hedging. He tells me that the actual hedging itself is really not all that complex, but making the hedge accounting work is a big deal. The result is that he probably knows more about hedge accounting than I do.

But of course he does not follow the International Accounting Standards Board as I do. The IASB started looking into hedge accounting in summer 2009, but did not really get into the matter until recently. When the IASB first looked into hedge accounting they fired off promises of simplification and clarity. But now the Exposure Draft is out, we can see that the rules are still fiendish. The proposal still



includes the ugly sisters, cash flow hedge accounting and fair value hedge accounting. It is still possible for one contract to be expressed using either method and much of the messiness remains. In fact, the standard is more onerous, as it requires greater disclosure. I did not have the heart to tell this to Anthony this morning; maybe next week, if I beat him.

April 2011 The current members of the International Accounting Standards Board (IASB) are coming to the end of their ten years in office. So over the last two years the IASB has been furiously developing new standards and a host of financial reporting issues are now coming to a head. So there is a lot to talk about. But just this month, I would like to step back from the individual projects and talk about the underlying philosophy of the IASB which has guided their thinking over the ten years.

The new standards issued by the IASB since incorporation ten years ago are highly prescriptive. They tell you exactly what to do and how to do it. So it may surprise you to discover that the IASB are a highly philosophical bunch just below the surface. They believe that over the last sixty years financial reporting has lost its way. They believe the obsession with profits has driven the quality of financial reporting down. They want to bring financial reporting back to its roots.

They argue that many of the current problems in financial reporting simply disappear upon reorientation of the mind. The IASB want to focus upon position. They want to create a statement of financial position that really is a statement of financial position and not simply a sheet that balances. They draw our attention to the five thousand year old position statements drafted on clay tablets in the museums of the world that heralded the birth of writing and tell us that looking at position is natural and deep in our soul.

Over the years they have used position focus to solve accounting problems. Their first project on share-based payment used position focus and the current proposals on revenue use position focus. But it is not an easy thing to change hearts and minds. Sixty years is not very long compared to five thousand, but sixty years is still a long time. So it has not been easy to draw market attention away from profit. If financial reporting is to return to its roots and refocus on position, then the new IASB members starting in July 2011 will have to have equal zeal for the mission.

May 2011 The leases project is coming to a head now, so it is probably worth a revisit. After all David Tweedie did memorably refer to this project as his proudest achievement as Chairman of the International Accounting Standards Board in this very magazine.

Well, let us say you rent “Satisfaction” from The Rolling Stones. I am not quite sure how that would work, but it is a whole lot more interesting than talking about a building or a car. The song “Satisfaction” has been around since 1965 and looks like continuing to get airtime forever. So say you rent the right to the song for the next three years at a figure of £1million per year.

How would that work under current financial reporting? Well, the current rules on leases would classify that deal as an operating lease. This is because the current rules would say that once the song is given back to The Rolling Stones after three years; it would still have years and years of life in it. So the current rules would



say the asset is not ours and require we ignore the whole story; except for the cash flow which we would throw into operating costs each year.

But that is utter nonsense. As soon as we sign the contract we have an obligation to pay £3million over three years. And as soon as we sign the contract we have the rights to one of the greatest pop songs ever written.

So how would the proposals deal with the contract? The proposals would tell us to measure the obligation by using a discounted cash flow and use this figure to represent the liability (obligation to the outflow) and the asset (right to the inflow from airtime revenues). Super cool heh? And as an added bonus, the proposals dispense with all that junk about classifying a lease as either operating or financing. All leases will be treated the same, as leases. Even cooler right?

June 2011 If you are an accounting train spotter like me then you are probably more excited about the issue of four more International Financial Reporting Standards then you are about the indiscretions of millionaire football stars. So for you the identity of these IFRS is as well known as the identity of that same footballer. However, IFRS are rarely the subject of trends on twitter. So you may have missed them and for that reason, I shall give you a heads up now.

All four standards were issued by the IASB on a very busy Thursday 12 May 2011. The first three relate to groups. The fourth relates to fair value.

IFRS10 first. No shocks here. The IFRS simply ratifies that punchiest of punchy definitions “control is the power to direct activities”. The IASB hope this will reduce the opportunity for pushing special purpose vehicles off group financial statements as masterfully illustrated by Enron.

IFRS11 next. No shocks here either. The IFRS bans proportional consolidation for Joint Ventures. This method had been widely discredited many years ago and this is the IASB catching up. The IFRS confirms that joint control is just another way of saying very significant influence and so requires associate accounting for Joint Ventures.

IFRS12 next. I like this one. This IFRS requires parents to tell their investors how they made their decisions about control, joint control and influence. Clever, do you not think? So no more hiding entities away in a back pocket.

IFRS13 finally. This is a cracker, but frankly the ideas have been around forever. This IFRS defines fair value as the transaction price between market participants and then uses the three tier hierarchy for measurement, as discussed in previous ivory tower articles.

The IASB are going nuts in there dying few weeks before handover at the end of June. So expect more IFRS next issue.



July 2011 As I write this it is 24 June 2011 and I have received today an email from the IASB confirming that Sir David Tweedie has attended his last IASB meeting. Yes, I do get regular update emails from the IASB; I am that dull. David retires officially in a few days’ time on 30 June 2011.

So the retirement of the immanent David Tweedie is imminent. That play on words was suggested by Debbie Crossman, my long time colleague. Debbie is a lawyer, as you may know, and gets her kicks from tangling and untangling words. You do know that “imminent” means about to happen. The glorious world wide web tells me that “immanent” means permanently pervading somewhat like “The Force” in Star Wars.

That word “immanent” works so well for David Tweedie. He has been a constant force in financial reporting since I started accounting in 1990. He signed up to chair the UK ASB at the same time I signed up to be an auditor. It will be a very strange world without his beneficent presence calming hot heads and kicking butt. Of course, I will go down to the IASB next month to watch the new guys in action and report back to you.

But, in the meantime, I can tell you that David did manage to usher in the new standards on control and joint control (IFRS10, 11&12) and the new standard on fair value (IFRS13). However, despite his best efforts it proved impossible to force through the standards on leasing and revenue. Even the standard on financial instruments that is so near completion must be finished by the new guys.

But forget about that. That is just detail. The big picture is the USA. David Tweedie is one of the two salient factors that lead to the most significant development in financial reporting. The most significant development is the imminent adoption of IFRS by the USA and the two factors are Enron and the immanent David Tweedie. Enron made the USA want to rip up their accounting standards and David Tweedie shone like a knight in shining armour when they looked up from the wreckage.

August 2011 “Accounting is now far too important to be left to accountants”. That is a quote from the eye of the storm in the financial crisis of 2009 and those words were ringing around and around my head as I cycled home today. They were said by Charlie McCreevy of the European Commission at the height of the mudslinging during the financial crisis and were intended to be every bit as offensive as your worst interpretation.

Those words could have meant “accounting is very important and we expect all members of the business community to get involved with the IASB in the process of developing standards”. The International Accounting Standards Board (IASB) have always felt that the development of International Financial Reporting Standards (IFRS) is a critically important process and have always put enormous effort into getting everyone involved. IFRS development projects are widely discussed with businesses, investors and government in a public process of road shows and web based discussion. So if McCreevy had meant “accounting is important and everyone should get involved” then the IASB would have been ecstatic.

But McCreevy did not mean that. He meant “the IASB are a bunch of clueless academics and should not be allowed near standards. I think politicians should write standards in Brussels”. His intentionally offensive language got a reaction.



David Tweedie threatened to resign if Europe started twiddling with standards and of all people, the Americans came out in force in support of the IASB. The United States Securities and Exchanges Commission described the IASB as the best forum for the development of standards going forward and the European Commission were forced to back down somewhat.

But the whole nasty business was never really tidied up and the European Commission still has the desire to tinker. All the above sounds like ancient history. What has all that got to do with 2011? Well look who is taking over the chair at the IASB. Hans Hoogervorst is not only in possession of a fantastically cool name he is also in possession of years of experience as a smooth European politician. What Hans is not in possession of is any form of accounting qualification. Perfect! I think so! As the Americans say “go figure…”

September 2011 It must be heart breaking to hand over your pet project to the new guys only for them to shove it into a cupboard. Such is the fate of the leases project. The old International Accounting Standards Board (IASB) was headed up by David Tweedie, who is record as saying the leases project is the one of which he is most proud. But he was never able to get the wider community to go for those ideas. So the new IASB headed up by Hans Hoogervorst took over and shelved the leases project because of the lack of support for the ideas.

I was chatting about this to my colleague, Natasha McDonald, and it got me thinking about how daft the whole thing is. The ideas are radical. Keeping it simple, the proposal is to treat all leases as finance leases which as the name suggests brings finance onto the balance sheet. This has a profound effect upon lessees who under the proposals would be required to treat all their operating leases as finance leases and thereby rocket up their gearing. But the odd thing is that the lessee accounting has been agreed in principle. The project got stuck in mud over the lessor accounting which appears to me to be no big deal, relatively speaking.

If I give you some numbers you may get a feel for my angle. Say you rent the beautifully stunning Gherkin building from me for £10million per annum for three years at an implied rate of 10%; then under current rules you would have an operating lease and would simply put the rent through operating costs. Under the proposal you would have to recognise an obligation of £10million for three years at 10% which from years of knocking out discounted cash flow you probably know is roughly £25million. So an asset and more significantly a liability of £25million would hit your balance sheet. Now that is radical, but oddly not the problem. It is widely agreed that this new lessee accounting is the way forward.

The lessor accounting is the problem. I am the lessor you remember and I have the Gherkin on my balance sheet for £100million. When I sign the contract with you, then the proposals propose that I simply derecognise a £25million chunk of my property and recognise a receivable of £25million. All I do is move £25million from property to debtors. How is that a big deal? Yet it is this element that has brought the whole project crashing down.



October 2011 I don’t know whether to jump for joy or groan with disappointment.

The new International Accounting Standards Board (IASB) has pretty much announced an extended period of quiet in financial reporting. The new IASB are suggesting there will be few International Financial Reporting Standards (IFRS) over the next five years or so and that each development project will be allowed to breathe in its own air before going live as a standard.

Let us look at the groan first. Just take the presentation project for example. Financial statements (fs) are rubbish and you know it. Well, that is a bit harsh, but you must admit that starting a cash flow statement with a profit figure rather than starting a cash flow statement with a cash flow is so daft that it borders on bizarre. The IASB propose the direct method to solve that but it appears that we must wait. The nonsense about splitting performance between income and other comprehensive income is painfully silly. The IASB have long championed a single simple performance statement but it appears we must wait. Plus you must admit that all the many different forms of balance sheet used around the world, all following the current presentation standard, but all different, make us accountants look inconsistent if not incompetent. The IASB have proposed a single net assets equals equity format but it appears we must wait.

So we must wait and continue to use these discredited formats for presentation. So of course I groan. Tidy logical fs would make my life so much easier. So I groan.

But also I jump for joy. I am a teacher, but also I am a writer and online presenter. If all these changes came through then my teaching would be so much easier. But if the presentation proposals became standards then I would have to go through everything and change the presentation of every answer. The word dull does not even come close. And then I would have to rerecord all my online lectures simply because the presentation of the fs had changed. It would be a killer.

So of course I jump for joy that the rate of development is set to slow.

November 2011 What does the word “corridor” mean to you? To those who live in the real world the word refers to the long room that connects other rooms. Not a particularly pleasant word really, as it conjures images of faceless bureaucracy. But to those trainspotters like myself, initiated in the arcane language of financial reporting, the word “corridor” means pain and misery. Maybe you too come out in a frozen cold sweat when you hear the word.

If that is the case then you are feeling the grip of the nonsense in IAS19, the one that covers pensions. This IAS represents one of the most bizarre standards ever to crawl out of the ivory tower of the International Accounting Standards Board (IASB). If you know what I am talking about, then you do not want reminding. If you do not know, then the following will suffice. IAS19 allows companies to capitalise their pension losses on the balance sheet as if they were assets. Yes, you read right. The standard permits you to take your losses from underperforming pension schemes and avoid reporting those losses by putting them onto the balance sheet as if they were assets. You think that is bizarre? You should read the rest of it.



Well no, you should not read the rest of it, because the fantastic news is that the IASB have finally got around to removing this bizarre loop hole in financial reporting. Now you must report your losses as losses on the performance report as only makes sense.

December 2011 Last month in this column I visited the weird and wacky world of pensions accounting. Unusually for this column I am going to revisit the same world. So pensions accounting in two consecutive columns. Last month I told you the headline grabbing news that at long last the IASB have excised the horrible corridor from pensions accounting. That really is huge news for us trainspotting beancounters living in the bubble of academic life. But out in the real world this is no big deal because nobody has been doing corridor for years. Well I say “nobody”, but of course there is British Airways. They have been using corridor and now they must align with the rest of us. But frankly their pensions accounting is so obtuse that they deserve all the trouble that they will have swapping from corridor to mainstream pensions accounting.

But it is in the small print that the really profound news is to be found. You see even in mainstream pensions accounting there is a nonsense that has been regularly used for legalised creative accounting. The loophole related to expected return on plan assets. You see until the new IAS19 was issued this June 2011, expected return on plan assets meant just that. In other words you could make up some ridiculous fake expectation for performance, say a growth in the asset of 12%, and put that through the income statement; when you knew that the actual return on plan assets was far worse, say a growth of 1%. Well under the reissued IAS19, you can no longer make up an expectation. You must use the discount rate on the liability for the expected return on the plan assets.

January 2012 You probably should know your joint venture from your joint operation. So here is the story. IFRS 11 Joint Arrangements looks at entities under joint control. Joint control exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. Joint control occurs when you and I together have control of another entity but individually have only influence. There are two arrangements, a joint operation (JO) and a joint venture (JV).

In a JO, you and I share control of the operation, but my assets are mine and your assets are yours. The accounting follows the substance. My assets go on my balance sheet and yours on yours. In a JV, you and I share control and everything else as well. Joint control is seen as very significant influence. So a JV is simply accounted for as an associate. The detail of associate accounting remains in old IAS 28. It is not always true, but usually incorporation gives away the underlying nature. JVs are incorporated and JOs are not.

An example may help make it clear. You and I are working together selling petrol. We go into Japan and we both put $100m each into a newly incorporated company that will build a refinery and buy oil to refine and sell to the Japanese. You will have half the shares and I will have the other half. We also go into Russia. We agree to share the revenue half and half. But you put your Russian refinery into the deal and I put my trans-Siberian pipeline in. We agree that your refinery remains yours and my pipeline remains mine, although to repeat, the revenue is to be shared half and half.



The Japanese joint arrangement is a JV. Everything is shared 50/50. Nothing is yours absolutely and nothing is mine absolutely. Everything belongs to the JV and the JV belongs to us half and half. Backing this conclusion up is the incorporation of the JV.

So the Japanese arrangement will be recorded as a 50% associate in my books and the same in yours. But the Russian deal is quite different. It is a JO. The pipeline is mine and not yours. The refinery is yours and not mine. We share the revenue and so operate jointly but we do not share everything. So the pipeline will stay on my b/s and the refinery will stay on yours.

February 2012 You know, of course, that the International Accounting Standards Board (IASB) are part way through their deliberations on financial instruments; assets and liabilities are done and so impairment and hedging is next. The hedging project is proving fiendishly difficult but at last the IASB think they are nearing the end. Most of the proposals are simply proposals to stay with the old mixed model of cash flow and fair value hedging rules which are far too complex to address in this column. But there is a new proposal and it is fairly straight forward and I think you will like it. Here goes.

Hedging is the process of betting against yourself to address risk. So if you are a chocolatier and fear a rise in the prices of cocoa at the next harvest you would bet on that very rise. Then if cocoa prices do rise you will lose on the more expensive raw stock but win on the bet. The result is that you no longer care if prices do rise and you are now hedged. In theory you should be able to build a perfect hedge; that is a hedge whereby for every £1 you win in one hand you lose £1 in the other. But if you know anything about hedging you will know that perfect hedging only exists in text books. In real life, you might lose £1 in one hand and gain only £0.80 in the other. The measure of £0.80 to £1.00 as a percentage of 80% is called the hedge “effectiveness” and currently 80% is the cut off. In other words if your hedge was 81% effective then you are allowed to use hedge accounting but if your hedge was 79% effective then you are not allowed to use hedge accounting. This 80% rule currently drives companies nuts; to the extent that I am aware of some companies abandoning hedge accounting altogether.

Well the good news is that the 80% rule has been pulled out of the proposals to be replaced by a simple rule that all hedging can use hedge accounting but any ineffectiveness must go to profit or loss.

March 2012 It is an unsightly experience to watch friends bicker. And the results are usually messy. We can see this at work in the otherwise brilliant IFRS3 on business combinations. Over the months leading up to the reissue of IFRS3 in 2008 the International Accounting Standards Board bickered bitterly about full and partial goodwill. It was all a load of nonsense really but it had a rather messy side effect. I will show you with some numbers. The numbers have been extracted from the ACCA P2 Corporate Reporting examination in December 2011. The examiner has faithfully transmitted the flavour of IFRS3 and the problem is not of his creating. It is the squabbling IASB we should blame. Here is the extract:

“On 1 December 2010, Traveler acquired 60% of the equity interests of Data, a public limited company. The purchase consideration comprised cash of $600 million. At acquisition, the fair value of the non-controlling interest in Data was $395



million. Traveler wishes to use the ‘full goodwill’ method. On 1 December 2010, the fair value of the identifiable net assets acquired was $935 million.”

Here is the goodwill that derives from the above:

$m

Fair value of consideration (60%) 600

Fair value of nci (40%) 395

Fair value of net assets (935)

___

Goodwill 60

___

“So what is wrong with that?” I hear you ask. Well, the examiner did nothing wrong; he faithfully transmitted the flavour of IFRS3, as I have said. But if you look carefully at the numbers then the mistake in IFRS3 will jump out. Can you see that the fair value of each percent of consideration is $10m ($600m/60%)? Can you see that the fair value of each percent of nci is slightly less at $9.875m? That is exactly how IFRS3 says it should be, but there have long been commentators who have challenged this. I am one but another critic is a little more famous – have you heard of PriceWaterhouseCoopers (PWC)? PWC have always maintained that if the consideration is worth $10m per percent then so are all the other shares.

Well here is the interesting twist. The IASB have recently changed their tune. Brand new IFRS13 on fair value measurement agrees with PWC. IFRS13 disagrees with IFRS3. IFRS13 says that the fair value of the nci should be taken from the fair value of the consideration. I wonder if examiners will notice this change of tune.

April 2012 I guess you know that the financial instruments project has been divided into four blocks; financial asset classification, financial liability classification, impairment and hedging. The International Accounting Standards Board (IASB) has cracked the first two nuts and there is now a standard in issue on classification of financial assets and financial liabilities. As you may imagine, the IASB expected to struggle with hedging and they have. But the IASB did not expect to struggle with impairment. But in truth impairment has proved more of a headache than hedging.

The reason is a little grim. Currently impairment losses on financial assets are only recognised if there is objective evidence of an impairment. That means that bad debts on receivables can only be recognised if they have happened; so the current accounting for impairment is called the “incurred loss model”. The logic goes something like this; sales can only be recognised if they have occurred; so bad debts should only be recognised if they have happened. The IASB introduced this criteria about ten years ago because fooling around with general provisions for bad debts in the 1990s had started to look like creative accounting. The objective evidence criteria had the effect of doing away with the general provision for bad debts and everybody was happy… for a while.

But then the 2009 financial crisis turned into the current recession and a grim consequence of the incurred loss model revealed itself. As the recession bit in to the economy, companies began to struggle and so banks started recognising bad debts. But that caused the banks themselves to struggle as they saw the bad debts



going through the income statements in banking financial statements and they began to lose faith in each other. This in turn drove the recession deeper.

Now no-one in 2012 is saying that accounting caused the recession, but even the IASB accept that this rather nasty twist in the incurred loss model did not help. So the IASB are trying to develop an “expected loss model”. The IASB are trying to develop some way of allowing banks in particular to provide for predictable losses when they are expected instead of waiting until they are incurred. But as everyone has pointed out, the banks were hopeless at predicting the troubles of 2009, so there is little reason to think that the banks will be any better at predicting losses in the future.

Hence the IASB are struggling.

May 2012 I think I will tell you a little more about the impairment project. Last month I explained the grim politics surrounding the development of a standard to accommodate expected losses in a portfolio of receivables. This month I think I will show you some numbers to give you a feel for the issues. But first I will give a quick reminder of the background.

Currently the impairment of receivables uses the incurred loss model. This perfectly logical model only recognises bad debts when they have happened. But the model tends to have the effect of making any recession worse by recognising losses as everyone is struggling. So the IASB are trying to develop an expected loss model that will build up predictable future losses in the good years, so that the bad years do not bite so deeply.

So let us play with some numbers. Say a bank has a portfolio of receivables with a face value of one billion pounds (£1000m) and that portfolio is earning interest at 5% but has predictable bad debts of 4% (£40m). So the bank wants a figure of £960m in receivables at the year end to reflect the expected future troubles. One way of accommodating the numbers is the old discredited general provision for bad debts. Here is the picture for year one:-

Opening Interest Instalment Closing Provision Closing

Year one 1000 50 (50) 1000 (40) 960

But the IASB do not like the above as they feel it is too clunky and easily manipulated. So the IASB are experimenting with attacking the interest earned. They are suggesting that the recognised interest earned should be less than the actual interest earned to accommodate the predictable losses. In this case an interest earned rate of 1% will do the trick:-

Opening Interest Instalment Closing

Year one 1000 10 (50) 960

Are you starting to get a little punch drunk? The above is outrageously oversimplified and yet is already looking outrageously complicated. Hence the IASB is really struggling with impairment.

June 2012 “Frigging”. Is that a word suitable for polite society? I knew the word was a little rude when I looked it up in Wikipedia, but was surprised to find that it is a “minced



oath”. In other words, it is used as a garbled substitute for a properly rude expression.

The expression was used by Scott Taub of IFRIC in a board meeting on 23 March this year. He was talking about goodwill. One of the other members of the board had just said something inane about goodwill and Scott was having none of it. Goodwill has long been a problem figure in financial reporting because it is so hard to pin down and Scott reinforced this by the following eloquent put down:

“It could be workforce. It could be customers. It could be you paid too frigging much.”

But who are IFRIC and what was I doing there? The International Financial Reporting Interpretation Committee (IFRIC) is a subsidiary board to the International Accounting Standards Board (IASB). As the two names suggest, the main purpose of the IASB is to issue accounting standards and the main purpose of IFRIC is to interpret those standards when following issue a standard is found to have contradictions. The IASB issue IFRS (International Financial Reporting Standards) and the IFRIC issue IFRICs (International Financial Reporting Interpretation Committee Interpretations).

Why was I there? Of course, I am a financial reporting train spotter and having frequently been to the IASB meetings but never having attended an IFRIC meeting I thought I would fill that hole in my life.

But why was goodwill being discussed? Well the IFRIC was debating the meaning of goodwill in the context of the incorporation of a joint venture between three parties when those parties bring apparently unequal assets to the pot. They are not for the faint hearted these IFRIC meetings.

July 2012 Attending the IFRIC (International Financial Reporting Interpretations Committee) earlier this year reminded me about something said by David Tweedie, former chairman of the IASB (International Accounting Standards Board). The IFRIC were going bonkers trying to decide what to do if there is a cost in your associate that does not make that associate shrink. The issue relates to share based payment in associates and frankly share based payment in your own group can be a killer. So share based payment in your associate is a killer with a headache.

The David Tweedie quote goes something like this: “yet more evidence of why equity accounting should be abandoned”. It was said a few years ago in relation to a quite different problem. But it popped into my head that day because it seemed so apt. Here is the connection.

Associates are accounted for by a method known as “equity accounting”. This means slapping the acquisition cost of the associate into the group balance sheet and then putting the growth in the associate over the year through the income statement and then on top of the acquisition cost. It sounds easy enough, but as the IFRIC discovered, it can get pretty messy in the detail.

Now equity accounting was invented back in the dark ages of financial reporting when shares were thrown onto the balance sheet at cost and left to rot. So equity accounting was a massive improvement at the time. But today we have modern investment accounting for financial instruments where shares are held at fair value and gains and losses go through the income statement. Is that not easy? Is that not meaningful?



The trouble is that shares that give influence are accounted for as associates by the meaningless equity method. What David Tweedie was saying was that all shares would be more usefully recognised at fair value and the idea of the associate should be abandoned. I think he was right and I think that it is still true today.

August 2012 I guess I really should talk to you about the process of standard setting. Goodness me, I can feel your eyes swivelling into the back of your head as you read this. “Process” is not the most inspiring of words, at the best of times, but couple “process” with “standard setting” and there you have a rival for watching paint dry. But I shall do my best to enliven the subject because it is a subject for which you should have a feel.

Of course, the standards are set by the International Accounting Standards Board (IASB) who sit around the round table in London like King Arthur and the knights. The table is not so round anymore as the number of members on the board has swelled to 15, but like the Knights of the Round Table, the board like to argue. The arguments are limited to a few subjects at any one time and at this moment the top subjects are revenue, leasing and financial instruments.

In common with many businesses these days, the IASB are a web based organisation, so if you want to know what the board are arguing about then you go to the webpage known as the “work plan”. There you will see the subjects going through the three phases of development; namely the discussion document (DP), the exposure draft (ED) and the International Financial Reporting Standard (IFRS). The names are intended to be literal. So the DP is a broad document laying out the problems and possible solutions, the ED is a draft standard awaiting board approval and the IFRS is the done deal. But the key issue is that the IASB actively encourage participation. So the big accounting firms, the big businesses and the scary government bodies all get in on the act by web based feedback. You can give your feedback to any of the subjects under development presently, if you like; just click onto the site!

Some projects chug along contentedly for a couple of years going through DP to ED to IFRS, like IFRS5 Discontinued, for example. But others die in the water, like the project on provisions which was so widely disliked that the IASB gave up.

The whole process is public. So you can go along. I do. But then I am a financial reporting train spotter.

September 2012 “Decoupling”. Now there is another word from the dictionary of the International Accounting Standards Board (IASB). I think I like this word. The IASB have a reputation for trawling up the most horrible words, “bifurcation” is one, but that is another story.

This story relates to hedge accounting. Hedging is the process of betting against any risk that you fear by way of a derivative. The effect is the reduction of the exposure to risk. So if you fear the price of the euro falling because you hold a euro asset, then you bet on the price of the euro falling by using a euro derivative. Then if the euro does fall, you lose on your euro asset but gain on your euro derivative. If you get it right then you come out neutral.

Hedging itself is technical but the real tricky stuff is the hedge accounting. There are some existing rules on general hedge accounting and although not perfect



these rules have been working ok for about ten years. So the IASB has tweaked the rules and issued an exposure draft that once approved will be incorporated into International Financial Reporting Standard 9 on financial instruments.

But the rules apply on a one to one basis. You can only use general hedge accounting if you have one derivative to address one risk. Most of the time this is fine because most hedging is done in this “back to back” style. But some hedging looks at whole portfolios assets and involves derivatives that combat risk in a portfolio. There is nothing in current financial reporting to address this “macro hedging”. So the IASB are developing mechanics for macro hedge accounting. But it is taking a long time to get these mechanics working and the general hedge accounting rules are done and ready to go. So the IASB are “decoupling” general hedge accounting and macro hedge accounting by putting general hedge accounting into IFRS9 and proposing a new standard for macro hedge accounting.

October 2012 Hedging is so hot at the moment that I think I shall revisit the subject. The International Accounting Standards Board (IASB) have issued an exposure draft on general hedge accounting that once approved shall be incorporated into existing International Financial Reporting Standard 9 (IFRS9) on financial instruments.

Essentially the IASB propose to retain the existing two models called “fair value” and “cash flow” hedge accounting because feedback has told the IASB that these two are working. What the feedback has roundly criticised is hedge effectiveness. The so called “80/125” test drives finance guys nuts. Let me explain.

Say you fear the price of oil rising because you predict oil price rises but you do not need or want your oil until three months from now. You might go into the market and buy an oil derivative that bets on the very oil price rise that you fear. Now say that, three months down the line, you buy your oil at $100m more than the old price, then you might be a little disappointed. But only a little disappointed because the derivative bet has won and yielded you $100m. This is what is called a “perfect hedge”. The $100m loss is covered by a $100m win. This is what finance guys are trying to achieve. But say you lose $100m on the oil but win only $79m on the derivative then you have a partially effective hedge. This happens all the time.

The problem is that the current rules say that hedge accounting is only allowed if the hedge effectiveness falls within the range 80% to 125%. The partially effective hedge has a ratio of 79% (79/100) [or 127% (100/79)]. So hedge accounting is not allowed. Imagine if that happened to you. You would be disappointed by the hedge but you would be raving mad with the accountants because your less than perfect hedge was still partially effective and yet hedge accounting is forbidden.

Well the IASB solution to the problem of the 80/125 rule is simple; get rid it and put the hedge ineffectiveness in the profit of loss.

Winter 2012 The ivory tower column is moving to quarterly reporting; after all if quarterly reporting is good enough for Tesco then it is good enough for me. So that means every quarter I shall bring you news from the rarefied atmosphere around the International Accounting Standards Board (IASB) in London. I think I shall use the extra space to solve practical problems to illustrate IASB developments.



I am going to start with Elton John. Imagine Elton John is thinking of coming back into football. He used to own Watford Football Club, you know. Well, he decides he is interested in buying back the club he sold many years ago. But he knows things have moved on since the days that John Barnes was a young man in a Watford strip. He knows that his multiple millions are really small fry compared to the likes of Roman Abramovich. So he buys just 2% of the equity shares of Watford Football Club with a view to buying more and maybe all the equity if things work out. He pays £10k for the shares. By the year end the shares have risen in value to £13k. In the new year he starts to question his investment and by the first month end in the new year has decided that he wants out of football. The shares are now worth £14k. But perversely, because of the rising value, a buyer is hard to find. Eventually a month later Elton sells for £16k. Let us have a look at how this should be accounted for and the current issue hidden in the numbers.

Firstly, I guess you know that the equity shares are financial instruments. FI are contracts that give rise to an asset in one entity and a liability or equity in another entity. Also I guess you can see that Elton has the asset (and Watford have the equity obligation). This means Elton must use the financial asset (FA) classification rules in International Financial Reporting Standard 9 (IFRS9) as follows:-

No

Yes No

Yes

Amortised cost Fair value

Of course, the equity investment is not a simple loan; it is not a loan asset at all. So the equity is carried at fair value. Now the default recognition for gains and losses on fair value changes is the income statement, which the IASB somewhat perversely call “profit or loss”, giving us the expression financial asset at fair value through profit or loss (FVPL). But hidden in IFRS9 is a special option to carry strategic equity at fair value through other comprehensive income (FVOCI). The OCI is an ugly wart like performance report growing off the bottom of the income statement that accommodates gains that are not allowed through the p/l. The classic example is revaluation gains on property plant and equipment. But now you know that strategic equity gains go there too. But there are two recognition criteria for strategic equity:-

(1) Strategic

The entity must be able to show a strategic intent to keep the asset.

Cash flow characteristics test (Is the FA a simple loan?)

Business model test (Is there intent to keep the FA?)



(2) Equity

The asset must be equity.

Clearly the shares in Watford fulfil both criteria and so will be carried FVOCI. But what does that mean in this case? It means the rise in value in the year of purchase of £3k (13-10) will go through the OCI. It also means that the first £1k (14-13) will go to the new year OCI. It is at that point Elton changes his mind about the investment and at that point that the equity no longer fulfils the “strategic” criteria given above. So now the asset is classed FVPL and the final £2k gain goes into the income statement.

Now comes the development issue. The gain of £2k that went through the income statement will end up in an equity bucket on the balance sheet called “retained earnings” (RE). But the two earlier gains of £1k from this year and £3k from last year went through the OCI. So they have been accumulated in an equity bucket called “other components of equity” (OCE). Now in old fashioned language this accumulated gain of £4k is described as “unrealised”. But now that the related asset has been sold the £4k is “realised” and must move to RE. In the old days of awful IAS39 this £4k was realised by the long route. It was taken off the balance sheet put into the income statement and thereby it would drop in RE. This was called “recycling”. But under the new IFRS9 the gain is simply moved from one equity reserve to the other directly on the balance sheet. So the £4k goes from OCE to RE.



CURRENT ISSUES EXAM QUESTIONS

Exam question: Value Relevance (December 2002)

The ‘value relevance’ of published financial statements is increasingly being put into question. Financial statements have been said to no longer have the same relevance to investors as they had in the past. Investment analysts are developing their own global investment performance standards which increasingly do not use historical cost as a basis for evaluating a company. The traditional accounting ratio analysis is outdated with a new range of performance measures now being used by analysts.

Companies themselves are under pressure to report information which is more transparent and which includes many non-financial disclosures. At the same time the move towards global accounting standards has become more important to companies wishing to raise capital in foreign markets. Corporate reporting is changing in order to meet the investors’ needs. However, earnings are still the critical ‘number’ in both the company and the analyst’s eyes.

In order to meet the increasing information needs of investors, standard setters are requiring the use of prospective information and current values more and more with the traditional historical cost accounts and related ratios seemingly becoming less and less important.

Required:

(a) Discuss the importance of published financial statements as a source of information for the investor, giving examples of the changing nature of the performance measures being utilised by investors.

(11 marks)

(b) Discuss how financial reporting is changing to meet the information requirements of investors and why the emphasis on the ‘earnings’ figure is potentially problematical. (8 marks)

(c) Discuss whether the intended use of fair values will reduce the importance of historical cost information. (6 marks)

(25 marks)



Exam question: World Energy (June 2004)

The directors of World Energy, a public limited company, feel that their financial statements do not address a broad enough range of users’ needs. The company’s main business is the generation and supply of electricity and gas. They have reviewed the published financial statements and have realised that there is very little information about their corporate environmental governance and their management of the workforce (sometimes called ‘Human Capital Management’).

The company disclose the following social and environmental information in the financial statements:

Corporate Environmental Governance

(i) The highest radiation dosage to a member of the public

(ii) Total acid gas emissions and global warming potential

(iii) Contribution to clean air through emission savings.

Human Capital Management

(i) Its full commitment to equal opportunities

(ii) Its investment in the training of the staff

(iii) The number of employees injured at work in the year.

The company wishes to enhance its disclosures in these areas but is unsure as to what the benefits would be for the company and what constitutes current practice in these areas. The problem that the directors envisage is how to measure and report the company’s performance in these areas. They are particularly concerned that their report on the management of the workforce (Human Capital Management) has no current value to the stakeholders in the company.

Required:

(a) Explain the factors which provide encouragement to companies to disclose social and environmental information in their financial statements, briefly discussing whether the content of such disclosure should be at the company’s discretion. (10 marks)

(b) Describe how the current disclosure by World Energy of its ‘Corporate Environmental Governance’ could be extended and improved. (7 marks)

(c) Discuss the general nature of the current information disclosed by companies concerning ‘Human Capital Management’ and how the link between the company performance and its employees could be made more visible. (8 marks)

(25 marks)



Exam question: Mineral (December 2001)

Mineral, a public limited company, has prepared its financial statements for the year ended 31 October 20X1. The following information relates to those financial statements.

20X1 20X0 $m $m

Group revenue 250 201 Gross profit 45 35 Profit from operations 10 9 Profit before taxation 12 8 Net profit for the period 5 4 ___ ___ Non-current assets 42 36 Current assets 55 43 Current liabilities 25 24 Non-current liabilities – long-term loans 13 9 Capital and reserves 59 46 ___ ___

The company expects to achieve growth in retained earnings of about 20% in the year to 31 October 20X2. Thereafter retained earnings are expected to accelerate to produce growth of between 20% and 25%. The growth will be generated by the introduction of new products and business efficiencies in manufacturing and in the company’s infrastructure.

Mineral manufactures products from aluminium and other metals and is one of the largest producers in the world. Production for 20X1 increased by 18% through the acquisition of a competitor company, increased production at three of its plants and through the regeneration of old plants. There has been a recent growth in the consumption of its products because of the substitution of aluminium for heavier metals in motor vehicle manufacture. Cost reductions continued as a business focus in 20X1 and Mineral has implemented a cost reduction programme to be achieved by 20X4. Targets for each operation have been set.

Mineral’s directors feel that its pricing strategy will help it compensate for increased competition in the sector. The company recently reduced the price of its products to the motor vehicle industry. This strategy is expected to increase demand and the usage of aluminium in the industry. However, in spite of the environmental benefits, certain car manufacturers have formed a cartel to prevent the increased usage of aluminium in car production.

In the period 20X1 to 20X3, Mineral expects to spend around $40 million on research and development and investment in non-current assets. The focus of the investments will be on enlarging the production capabilities. An important research and development project will be the joint project with a global car manufacturer to develop a new aluminium alloy car body.

In January 20X1, Mineral commenced a programme of acquisition of its own ordinary shares for cancellation. At 31 October 20X1, Mineral had purchased and cancelled five million ordinary shares of $1. In addition, a subsidiary of Mineral had $4 million of convertible redeemable loan notes outstanding. The loan notes mature on 15 June 20X4 and are convertible into ordinary shares at the option of the holder. The competitive environment requires Mineral to provide medium and long-term financing to its customers in connection with the sale of its products. Generally the financing is placed with third party lenders but due to the higher risks



associated with such financing, the amount of the financing expected to be provided by Mineral itself is likely to increase.

The directors of Mineral have attempted to minimise the financial risk to which the group is exposed. The company operates in the global market place with the inherent financial risk that this entails. The management have performed a sensitivity analysis assuming a 10% adverse movement in foreign exchange rates and interest rates applied to hedging contracts and other exposures. The analysis indicated that such market movement would not have a material effect on the company’s financial position.

Mineral has a reputation for responsible corporate behaviour and sees the work force as the key factor in the profitable growth of the business. During the year the company made progress towards the aim of linking environmental performance with financial performance by reporting the relationship between the eco-productivity index for basic production, and water and energy costs used in basic production. A feature of this index is that it can be segregated at site and divisional level and can be used in the internal management decision-making process.

The directors of Mineral are increasingly seeing their shareholder base widen with the result that investors are more demanding and sophisticated. As a result, the directors are uncertain as to the nature of the information which would provide clear and credible explanations of corporate activity. They wish their annual report to meet market expectations and not just the basic requirements of company law. They have heard that many companies deal with three key elements of corporate activity, namely reporting business performance, the analysis of the financial position, and the nature of corporate citizenship, and have asked your firm’s advice in drawing up the annual report.

Required:

Draft a report to the directors of Mineral setting out the nature of information which could be disclosed in annual reports in order that there might be better assessment of the performance of the company.

Candidates should use the information in the question and produce their report under the headings:

(i) Reporting business performance (10 marks)

(ii) Analysis of financial position (6 marks)

(iii) The nature of corporate citizenship (5 marks)

Marks will be awarded for the presentation and style of the report.(4 marks)

(25 marks)



IFRS FOR SMES

Here is another article by Graham Holt from the same source.

Studying this technical article and answering the related questions can count towards your verifiable CPD if you are following the unit route to CPD and the content is relevant to your learning and development needs. One hour of learning equates to one hour of CPD. We'd suggest that you use this as a guide when allocating yourself CPD units.

The principal aim when developing accounting standards for small- to medium-sized enterprises (SMEs) is to provide a framework that generates relevant, reliable and useful information, which should provide a high-quality and understandable set of accounting standards suitable for SMEs. In July, the International Accounting Standards Board (IASB) issued IFRS for Small and Medium-Sized Entities (IFRS for SMEs). This standard provides an alternative framework that can be applied by eligible entities in place of the full set of International Financial Reporting Standards (IFRS).

IFRS for SMEs is a self-contained standard, incorporating accounting principles based on existing IFRS, which have been simplified to suit the entities that fall within its scope. There are a number of accounting practices and disclosures that may not provide useful information for the users of SME financial statements. As a result, the standard does not address the following topics:

1. Earnings per share 2. Interim financial reporting 3. Segment reporting 4. Insurance (because entities that issue insurance contracts are not eligible to

use the standard) 5. Assets held for sale.

In addition, there are certain accounting treatments that are not allowable under the standard. Examples are the revaluation model for property, plant and equipment and intangible assets, and proportionate consolidation for investments in jointly controlled entities. Generally, there are simpler methods of accounting available to SMEs than the disallowed accounting practices. The standard also eliminates the 'available-for-sale' and 'held-to maturity' classifications of IAS 39, Financial Instruments: Recognition and Measurement.

All financial instruments are measured at amortised cost using the effective interest method, except that investments in non-convertible and non-puttable ordinary and preference shares that are publicly traded, or whose fair value can otherwise be measured reliably, are measured at fair value through profit or loss. All amortised cost instruments must be tested for impairment. At the same time, the standard simplifies the hedge accounting and derecognition requirements. However, SMEs can also choose to apply IAS 39 in full.

The standard also contains a section on transition, which allows all of the exemptions in IFRS 1, First-Time Adoption of International Financial Reporting Standards. It also contains 'impracticability' exemptions for comparative information and the restatement of the opening statement of financial position. As a result of the above, IFRS require SMEs to comply with less than 10% of the volume of accounting requirements applicable to listed companies.



What is an SME?

There is no universally agreed definition of an SME. No single definition can capture all the dimensions of a small- or medium-sized enterprise, nor can it be expected to reflect the differences between firms, sectors, or countries at different levels of development. Most definitions based on size use measures such as number of employees, balance sheet total, or annual turnover. However, none of these measures apply well across national borders. IFRS for SMEs is intended for use by entities that have no public accountability (ie, their debt or equity instruments are not publicly traded).

Ultimately, the decision regarding which entities should use IFRS for SMEs stays with national regulatory authorities and standard-setters. These bodies will often specify more detailed eligibility criteria. If an entity opts to use IFRS for SMEs, it must follow the standard in its entirety – it cannot cherry pick between the requirements of IFRS for SMEs and the full set.

The IASB makes it clear that the prime users of IFRS are the capital markets. This means that IFRS are primarily designed for quoted companies and not SMEs. The vast majority of the world's companies are small and privately owned, and it could be argued that full International Financial Reporting Standards are not relevant to their needs or to their users. It is often thought that small business managers perceive the cost of compliance with accounting standards to be greater than their benefit. Because of this, the IFRS for SMEs makes numerous simplifications to the recognition, measurement and disclosure requirements in full IFRS. Examples of these simplifications are:

1. Goodwill and other indefinite-life intangibles are amortised over their useful lives, but if useful life cannot be reliably estimated, then 10 years.

2. A simplified calculation is allowed if measurement of defined benefit pension plan obligations (under the projected unit credit method) involve undue cost or effort.

3. The cost model is permitted for investments in associates and joint ventures.

The main argument for separate SME accounting standards is the undue cost burden of reporting, which is proportionately heavier for smaller firms. The cost of applying the full set of IFRS may simply not be justified on the basis of user needs. Further, much of the current reporting framework is based on the needs of large business, so SMEs perceive that the full statutory financial statements are less relevant to the users of SME accounts. SMEs also use financial statements for a narrower range of decisions, as they have less complex transactions and therefore less need for a sophisticated analysis of financial statements. Therefore, the disclosure requirements in the IFRS for SMEs are also substantially reduced.

Differing approaches

Those who argue against different reporting requirements for SMEs say the system could lead to a two-tier system of reporting. Entities should not be subject to different rules, which could give rise to different 'true and fair views'.

There were a number of approaches that could have been taken to developing standards for SMEs. An alternative could have been for generally accepted accounting principles for SMEs to have been developed on a national basis, with IFRS focusing on accounting for listed company activities. However, the main issue here would be that the practices developed for SMEs may not have been consistent



and may have lacked comparability across national boundaries. Also, if an SME wished to later list its shares on a capital market, the transition to IFRS could be harder.

Under another approach, the exemptions given to smaller entities would have been prescribed in the mainstream accounting standard. For example, an appendix could have been included within the standard, detailing those exemptions given to smaller enterprises. Yet another approach would have been to introduce a separate standard comprising all the issues addressed in IFRS that were relevant to SMEs.

As it stands

IFRS for SMEs is a self-contained set of accounting principles, based on full IFRS, but simplified so that they are suitable for SMEs. The standard has been organised by topic with the intention that the standard is user-friendlier for preparers and users of SME financial statements. IFRS for SMEs and full IFRS are separate and distinct frameworks.

Therefore, the standard for SMEs is by nature not an independently developed set of standards. It is based on recognised concepts and pervasive principles and it allows easier transition to full IFRS if the SME later becomes a public listed entity. In deciding on the modifications to make to IFRS, the needs of the users have been taken into account, as well as the costs and other burdens imposed upon SMEs by the IFRS.

Relaxation of some of the measurement and recognition criteria in IFRS had to be made in order to achieve the reduction in these costs and burdens. Some disclosure requirements are intended to meet the needs of listed entities, or to assist users in making forecasts of the future. Users of financial statements of SMEs often do not make these kinds of forecasts.

Small companies pursue different strategies, and their goals are more likely to be survival and stability rather than growth and profit maximisation. The stewardship function is often absent in small companies, with the accounts playing an agency role between the owner-manager and the bank.

Where financial statements are prepared using the standard, the basis of presentation note and the auditor's report will refer to compliance with IFRS for SMEs. This reference may improve SME's access to capital. The standard also contains simplified language and explanations of the standards.

The IASB has not set an effective date for the standard because the decision as to whether to adopt IFRS for SMEs is a matter for each jurisdiction.

In the absence of specific guidance on a particular subject, an SME may, but is not required to, consider the requirements and guidance in full IFRS dealing with similar issues. The IASB has produced full implementation guidance for SMEs.

IFRS for SMEs is a response to international demand from developed and emerging economies for a rigorous and common set of accounting standards for smaller and medium-sized enterprises that is much easier to use than the full set of IFRS.

It should provide improved comparability for users of accounts while enhancing the overall confidence in the accounts of SMEs, and reduce the significant costs involved in maintaining standards on a national basis.

Graham Holt, ACCA examiner and principal lecturer in accounting and finance, Manchester Metropolitan University Business School.


Chapter 6

Performance reporting

CHAPTER 6 – PERFORMANCE REPORTING


CHAPTER CONTENTS

PERFORMANCE REPORTS (IAS 1) ------------------------------------- 125

INCOME STATEMENT OR PROFIT AND LOSS REPORT 125

OCI OR SORIE OR STRGL 125

PRIOR PERIOD ADJUSTMENTS (IAS 8) ------------------------------ 126

REVENUE (IAS 18) ------------------------------------------------------ 126

HELD FOR SALE AND DISCONTINUED (IFRS5) ---------------------- 127

HELD FOR SALE 127

DISCONTINUED OPERATIONS 127

SEGMENTS (IFRS8) ----------------------------------------------------- 128

IFRS8 PHILOSOPHY 129

IFRS8 DISCLOSURE 130



PERFORMANCE REPORTS

This is study guide entry C1a, c

There are two performance reports, the income statement and the OCI.

Income statement or profit and loss report This primary statement records realised transactions and divides into four sections:-

Operating x Superexceptionals x Financing x Tax x

Superexceptionals are large unusual transactions, that are so significant they are worthy of disclosure to the shareholders on the face of the income statement. The classic superexceptional at P2 is the profit on the disposal of a subsidiary.

OCI or SORIE or STRGL The Other Comprehensive Income Statement (OCI) is also a primary statement and dangles just below the Income Statement on the performance page of the financial statements. It records unrealised transactions. The classic gain that appears here is the revaluation gain. It also goes by the name SORIE (Statement of Recognised Income and Expense) and the name STRGL (Statement of Total Recognised Gains and Losses).

The income statement and OCI are always presented on one page in real financial statements because they present the two sides of performance. When combined together on one page they are often called the Comprehensive Income Statement.

Supposedly, realised gains go to P&L and unrealised gains go to OCI. However, the distinction between realised and unrealised is nowhere defined and entirely arbitrary anyway. So it is proposed that there be one performance statement going forward. However, this proposal has been under development for many years and a format for this single performance statement has never been finalised.



PRIOR PERIOD ADJUSTMENTS (IAS 8)

These result from a fundamental change in accounting policy (or a fundamental error). The classic example is a change in the way we do things resultant from a new IFRS. A prior period adjustment requires that the comparatives are adjusted to make them comparable, but also require an adjustment to the opening statement of financial position. This last adjustment is the PPA and is disclosed in the OCI (STRGL).

REVENUE (IAS 18)

This is study guide entry C1b

There are two forms of revenue recognition:

Sale of goods: ‘At’ revenue (critical event method)

Revenue on sale of goods is recognised at the point that risks and rewards are transferred from one part to the other.

Sale of services: ‘Over’ revenue (accretion method)

Revenue on services is recognised over the period the revenue is earned.

Unbundling

This is the process of splitting a bundled transaction, sometimes known as a “multi-element arrangement”, into its component parts.

Question: Furniture

A furniture company sells a table for $1,000 on two year interest free credit, on first day of the year. The table is delivered two weeks after the contract is signed. The liability is paid off by two payments of $500 at the end of year 1 and year 2. Interest on other similar deals is normally 16%.

Further investigation reveals that similar transactions were common last year. Last year the revenue was simply recorded at the stated sale price and all finance implications were ignored.

Required:

Discuss the implications of the above transactions on the current financial statements.

(7 marks)

(Classic component of an exam mix question.)



HELD FOR SALE AND DISCONTINUED OPERATIONS (IFRS5)

This is study guide entry C2a, b + D2a, b.

This FRS has two distinct sections connected by a consistent criteria applied to both.

Held for sale A non current asset is moved to current assets and classified as held for sale if it fulfils certain criteria.

Exam question: Rockby (held for sale)

Plant with a carrying value of $5million at the year end had ceased to be used because of a downturn in the economy. The company had decided at that time to maintain the plant in a workable condition in case of a change in economic conditions. Rockby subsequently sold the plant by auction six weeks later for $3million.

Required:

Discuss the effect of the above on the current financial statements.

(7 marks)

(“Rockby” part(b) June 2004)

Discontinued operations An operation is discontinued if it is closed or sold during the year or held for sale at the year end.

Question: Rockby (discontinued)

Rockby has committed itself before its year end to a plan to sell a subsidiary, Bye. The sale is expected to be completed four months after the year end. The subsidiary Bye has net assets of $5million and goodwill of $1million. Bye is expected to make losses of $600,000 up to disposal. Rockby had entered negotiations to sell Bye at the year end and prepared the subsidiary for disposal at that time. Rockby expected to receive $4.4million for the company after selling costs. The value in use of Bye was estimated at $3.9million.

Required:

Discuss the effect of the planned sale of Bye upon the current financial statements.

(9 marks)

(“Rockby” part(a) June 2004)



SEGMENTS (IFRS8)

This is study guide entry C5a, b.

Segments are business divisions within a group that are sufficiently big and sufficiently different from the core business to worthy of disclosure within a segmental note. The standards do not define sufficiently big, but do suggest a 10% threshold. As for sufficiently different to the core, that is entirely up to directors.

A multinational conglomerate (MNC) discloses both business and geographical results.

Question: Kiplin

Kiplin is an education provider, in the UK and the US. The figures split out as follows:-

$m Revenue 700 Operating profit 200 Net assets 500 Professional Higher Education education

Rev 50% 50% OP 30% 70% NA 30% 70% US UK

Rev 80% 20% OP 50% 50% NA 70% 30%

Required:

Show the Segmental note for the current year.

(2 marks)



IFRS8 philosophy There is a new(ish) IFRS on segmental reporting. It brings in one contentious issue:

Risks and rewards philosophy

The old philosophy automatically required both business and geographic notes where businesses straddled borders. So previously all MNCs automatically produced two segmental notes. The old rules did not care whether the group CEO focused on one or the other. It was called the “risks and rewards philosophy” for rather obscure reasons.

Managerial philosophy

The new philosophy asks only that the figures required by directors are disclosed. Whatever, information the group directors use to direct the group, should be condensed and disclosed to the shareholders. This is labelled the “managerial philosophy” and is used by IFRS8.

Problem and reflection

Some commentators thought that this would reduce information given to shareholders. However, refection on the subject has led those commentators to suggest that if both geography and business are important then directors will look at both and therefore disclose both.



IFRS8 disclosure So IFRS8 requires directors to communicate to the shareholders using the same segmental divisions that they use when communicating amongst themselves. The IFRS requires that the same segmental divisions are used in the fs as are used in the board meetings. However, to avoid being Anglo centric, the IFRS refers to the board of directors as the Chief Operating Decision Maker (COD maker!). But IFRS8 also encourages directors to be succinct in their disclosure and avoid overwhelming shareholders with information. So IFRS8 also addresses the idea of aggregation.

Aggregation

Aggregation is the idea that smaller segments can be aggregated into one for the purpose of segmental disclosure. The overriding requirement of IFRS8 is that directors use their common sense so as to produce a meaningful segmental report that helps shareholders understand the business issues without unnecessary detail. This simple idea is more than enough for the P2 exam.

Example

So a group with four operating segments would report all four. But a group with 25 operating segments would be required to aggregate the smaller ones in order to reduce the detail whilst still telling the important stories. The process of aggregation would be down to judgement and depend on the issues the board felt required communication.

Guidance

To help with this process, IFR8 gives some guidance. This is enormously complex, but boils down to two main ideas. Any segment that has a figure (sales, profit, assets) that is greater than 10% of the total must be reported separately. Also “other segments” should be kept to a minimum and certainly less than a maximum of 25% of the whole group, so that a minimum of 75% of the group is clearly labelled.


Chapter 7

Provsions and other issues

CHAPTER 7 – PROVISIONS


CHAPTER CONTENTS

PROVISIONS (IAS37) -------------------------------------------------- 133

CONTINGENCIES (IAS 37) --------------------------------------------- 134

EVENTS AFTER THE REPORTING PERIOD (IAS 10) ----------------- 135

RELATED PARTY DISCLOSURE (IAS24) ------------------------------ 136

PROVISIONS ARTICLE ------------------------------------------------- 137



PROVISIONS (IAS37)


Three criteria:

(R) Reasonably reliable estimate

There must be a reasonably reliable estimate available for the future costs. Frankly, there always is.

(O) Obligation

There must be a present legal or constructive obligation at the year end.

(T) Transfer

Cash must be expected to transfer out in the future. Frankly, it always is.

Question: Russian Chemical Spill

A company spills chemicals onto Russian land, causing damage that will cost $7m to clean. There is no environmental legislation but the company has clear green policies on its websites.

Required:

Discuss Financial Statement effects for the current year.

(3 marks)

Question: Oil Rig

A company starts using an oil rig at a cost as follows:

$m

Construction 200

Installation 100

The oil starts pumping at the year start. At this point the company sign a licence with the government agreeing to dismantle the rig when the oil runs out which is estimated to be 20 years. The cost of dismantling the rig is estimated at $120m and the discount rate is 10%.

Required:

Discuss Financial Statement effects for the current year.

(7 marks)



CONTINGENCIES (IAS 37)

This is study guide entry C8a.

Contingencies are cash flows that may or may not occur. They are accounted for as follows:

Liability (outflow) Asset (inflow)

Probable Provide Disclose

Possible Disclose Ignore

Remote Ignore Ignore

Question: Outrageous

A newspaper accuses a public figure of being mafia, even though they know this is not true. The public figure sues and both sets of lawyers agree that it is likely that the public figure will win the case and receive damages in the order of $1million. There is no possibility of the case being resolved before the financial statements must be finalised.

Required:

Discuss how the above litigation will be represented in the financial statements of both entities; the newspaper and the public figure.

(2 marks)



EVENTS AFTER THE REPORTING PERIOD (IAS 10)

This is study guide entry C8c, d.

These are usually referred to as PBSE (post balance sheet events) and are accounted for as follows:

Relationship of PBSE to year end PBSE

PBSE gives evidence of condition existing at the year end

Adjusting

PBSE does not give evidence of condition existing at the year end

Non-adjusting

In the unlikely event that something happens after the year end that undermines the going concern basis then it is very unlikely the entity would issue any fs. If it did then a break up basis would be necessary.

Question: Fraud

Three weeks after the year end, internal auditors discover a fraud. The finance director has stolen $30million from a bank account, $10million before the year end and $20million after. The theft is, of course, unreflected in the draft fs.

Required:

Discuss the effect of the fraud upon the current financial statements.

(2 marks)



RELATED PARTY DISCLOSURE (IAS24)


Transactions between parties related by control or influence are disclosed.

Disclosure

● Transaction

● Parties

● Relationship

● Value

● Date.

Question: Cheated

Cheated private limited company is a 70% owned by its chief executive director, Mr Cute. Mr Cute is married to Mrs Cute who owns 100% of Cheeky, a private limited company. Cheated is a garage business and services Cheeky company cars for free.

Required:

Discuss the effect of the above transaction on the individual financial statements of Cheated.

(2 marks)



PROVISIONS ARTICLE

I (Martin Jones) write extensively for the AACA magazine “Student Accountant”. If by some miracle you are ahead of the teaching and have completed all the homework that you can find, then head for the ACCA website. There under P2 is a section called “relevant articles”. You will find many have been written by me and of course I recommend all my articles to you. Here is an extract from one article, with the answer in the back.

The examiner at P2, Graham Holt, is fond of focussing on one IFRS in one of his questions in each of his exams. In the December 2010 exam Graham had a look at share based payment in a question called Margie. Going further back, in December 2009, it was impairment and in June 2009, it was financial instruments. The clever thing about these questions is that they are never dead straight. So in the last exam, question Margie was not just share based payment. It had financial instruments, it had fair value and simple share issue. Also the question was highly analytical. There were few marks for regurgitation of knowledge. The bulk of the mark were for analysis.

So to give you an idea of how these questions work and to revisit a subject that has not been the subject of focus for a while, I am going to resurrect an ancient Graham Holt question called Satellite. It is a focus question that focuses upon provisions, but also has plenty of other accounting issues to consider. Of course I have had to change the question slightly to bring it up to date.

I hope the question and especially the answer gives you a feel as to how to tackle these questions. Here it is:-

Satellite

Satellite, a public limited company, has produced draft consolidated financial statements as at 30 November. The group accountant has asked your advice on several matters. These issues are set out below and have not been dealt with in the draft group financial statements:

1 Satellite has buildings under an operating lease. A requirement of the operating lease for the corporate offices is that the asset is returned in good condition. The operating lease was signed in the current year and lasts for six years. Satellite intends to refurbish the building in six years’ time at a cost of $6 million in order to meet the requirements of the lease. This amount includes the cost of renovating the exterior of the building and is based on current price levels. Currently there is evidence that due to severe and exceptional weather damage the company will have to spend $1.2 million in the next year on having the exterior of the building renovated. The company feels that this expenditure will reduce the refurbishment cost at the end of the lease by an equivalent amount. There is no provision for the above expenditure in the financial statements.

(3 marks)



2 An 80% owned subsidiary company, Universe, has a leasehold property (historical cost $8 million, acquired at the year start). It has been modified to include a sports facility for the employees. Under the terms of the lease, the warehouse must be restored to its original state when the lease expires in ten years’ time or earlier termination. The present value of the costs of reinstatement are likely to be $2 million measured at the year start and the directors wish to provide for $200,000 per annum for ten years. The lease was signed and operated from the current year start and the modifications occurred immediately after. The directors estimate that the lease has a recoverable value of $9.5 million at 30 November year end and have not provided for any of the above amounts.

(9 marks)

3 Additionally Satellite owns buildings at a carrying value of $20 million, which will require repair expenditure of approximately $6 million over the next five years. No provision has been made for this amount in the financial statements and depreciation is charged on leasehold buildings at 10% per annum and on owned buildings at 5% per annum, on the straight line basis.

(3 marks)

4 Universe has developed a database during the year to 30 November and it is included in intangible non-current assets at a cost of $3 million. The asset comprises the internal and external costs of developing the database. The cost of such intangible assets is amortised over five years and one year’s amortisation has been charged. The database is used to produce a technical accounting manual, which is used by the whole group and sold to other parties. Net revenue of $2 million is expected from sales of the manual over its four year life. It has quickly become a market leader in this field. Any costs of maintaining the database and the technical manual are written off as incurred. The technical manual requires substantial revision every four years. Therefore universe are considering providing for the cost of revision.

(2 marks)

5 Satellite purchased a wholly owned subsidiary company, Globe, on 1 December, at the prior year start. The vendors commenced a legal action on 31 March during the current year over the amount of the purchase consideration which was based on the performance of the subsidiary. An amount had been paid to the vendors and included in the calculation of goodwill but the vendors disputed the amount of this payment. The court made a decision on 30 November at the current year end which requires Satellite to pay an additional $8 million to the vendors within three months. The directors do not know how to treat the additional purchase consideration and have not accounted for the item.

(3 marks)

Required:

(a) Discuss the recognition criteria for the recognition of a provision (IAS37). (5 marks)

(b) Discuss how the above five issues should be dealt with in the group financial statements of Satellite. (20 marks)

(25 marks)


Chapter 8

Non current assets

CHAPTER 8 – NON CURRENT ASSETS


CHAPTER CONTENTS

INTRODUCTION TO NON CURRENT ASSETS ------------------------- 141

COST (IAS 16) ---------------------------------------------------------- 141

FINANCE COSTS (IAS 23) ---------------------------------------------- 141

DEPRECIATION (IAS 16) ---------------------------------------------- 142

REVALUATION (IAS 16)------------------------------------------------ 142

IMPAIRMENT (IAS 36) ------------------------------------------------- 143

CASH GENERATING UNIT OR INCOME GENERATING UNIT 143

ALLOCATION 143

REVERSAL 144

GOODWILL 145

GOVERNMENT GRANTS (IAS 20) -------------------------------------- 145

INVESTMENT PROPERTIES (IAS40) ---------------------------------- 146

INTANGIBLES (IAS38) ------------------------------------------------- 147



INTRODUCTION TO NON CURRENT ASSETS

This chapter covers study guide entry C2a, c, d.

This large chapter involves a revision of the accounting for non current assets. There are particular areas that the examiner focuses upon:-

Cost

Finance costs

Depreciation

Revaluation

Impairment

Reversal

Government grants

Investment properties

Intangibles

COST (IAS 16)

The initial cost of a tangible fixed asset is all the expenditure in bringing the asset to its present location and condition.

FINANCE COSTS (IAS 23)

Under existing rules, finance related to the period of building a fixed asset is capitalised.

Question: Supermarket

A supermarket chain build their own supermarket. Costs are as follows:

$M Materials 30 Labour 20 Legal costs related to planning permission 2 General legal costs 3 Apportioned management time 5

Also a 10% loan of $40million was taken out for the full year, but the building took only nine of those twelve months to complete.

Requirement:

Calculate and explain Initial cost.

(3 marks)



DEPRECIATION (IAS 16)

This simply involves taking the remaining carrying value and dividing by the remaining life.

Question: Oops

Oops purchase a machine at the year start for $100,000 believing its life to be 10 years. At the first year end the expected life is unchanged. However, during the second year it is recognised that the original estimate of life was grossly overstated and that there are only three further years of use including the current year. So with hindsight it appears the likely total life is four years.

Requirement:

Financial statement effects for both the first and second years.

(2 marks)

REVALUATION (IAS 16)

The increase in the carrying value of property plant or equipment is called a revaluation.



IMPAIRMENT (IAS 36)

This occurs when the recoverable value falls below the carrying value.

Recoverable value

This is the higher of value in use (VIU) and net realisable value (NRV).

Question: Blob

Blob have three machines that are suspected of impairment. The figures are as follows:

$‘000 $‘000 $‘000 Basher Smasher Crasher Carrying value 300 400 500 Value in use (VIU) 290 170 540 Net realisable value (NRV) 110 230 20

Required:

Calculate Financial statement effects at the point of the impairment test.

(3 marks)

Cash generating unit or income generating unit This is a unit that could independently generate an income.

Allocation

IAS allocation (IAS 36) Losses are allocated in a CGU as follows:

(1) Specific obvious impairment

(2) Goodwill

(3) Remainder (weighted average)

But never impair below NRV.



Exam question: AB

AB acquired a car taxi business on 1 January for $230,000. The values of the assets of the business at that date based on book values were as follows:

$000 Garage 20 Computers 10 Vehicles (9 vehicles) 90 Intangible assets (taxi licence) 30 Trade receivables (recoverable value) 10 Cash 50 Trade payables (20) 190

On 1 February, the taxi company had three of its vehicles stolen. The net selling value and net book value of each vehicle was $10,000. Because of non-disclosure of certain risks to the insurance company, the vehicles were uninsured. Also on 1 February a rival taxi company commenced business in the same area. It is anticipated that the business revenue of AB will be reduced leading to a decline in the present value in use of the business, which is calculated at $140,000. It is unlikely the business could be sold as a going concern. The net selling value of the taxi licence has fallen to $25,000 as a result of the rival taxi operator.

Required:

Describe how AB should treat the above in its financial statements.

(4 marks)

Reversal A reversal is recognised in the same performance statement as the original movement.

Question: Revert

A company purchased some land on the first day of last year. It has the policy of revaluation of land.

$m Cost 400 Opening value 410 Closing value 397

Required:

Discuss the effect of the above in the current financial statements.

(3 marks)



Question: Rethink

A company purchased a warehouse on the first day of last year. The warehouse had a life of 10 years from purchase and this estimate is unchanged throughout. The company has the policy of revaluation of property.

$m Cost 8 Opening value 10 Closing value 4

Required:

Discuss the effect of the above in the current financial statements.

(4 marks)

Note that the above question is based upon the warehouse going up in value last year and down in value this year. But the principles used for the above work equally for down then up. So the answer in the back works the question both ways so that you can see that the two movement sequences use the same ideas.

Goodwill Goodwill can never be pushed up in value so one can never record a revaluation or reversal for goodwill.

GOVERNMENT GRANTS (IAS 20)

Non current assets are grossed for government grants.

Question: Grant Mitchell

A building costs a net $100m at the year start and the government pay the supplier an extra $20m. The estimated life of the building is 20 years.

Required:

Discuss financial statement effects for the first year.

(3 marks)



INVESTMENT PROPERTIES (IAS40)

Properties are only recognised as investment properties if three criteria are fulfilled:

● The property is held for investment purposes

● The property is substantially complete (so it’s not work in progress).

● The property is unoccupied by the group.

Once a property fulfils the investment property criteria, then two simple rules are applied:

Do: Revalue Do not: Depreciate

Question: Decided

Decided have a factory carried at an opening net book value of $40million. At the year start they decided to sell the property, but continue to use the factory for manufacture during the year. As they have made no positive moves towards disposal, they are well aware that the property is not held for sale. But they do wish to classify the building as an investment property and recognise a gain of $32million in the income statement based on a closing market value of $72million. It is estimated the factory has a remaining life of 20 years. Decided apply the cost model to their other factories.

Required:

Discuss the financial statement effects of the above in the current year.

(3 marks)



INTANGIBLES (IAS38)

Intangibles (excluding development) are recognised if they are purchased, either directly or as part of a sub acquisition.

Development costs are deferred if they fulfil criteria designed to test the probability of project success. The examiner rarely examines development and has never examined the criteria. His focus is on the other intangibles above.

Question: Game

Game is a diversified business. Game purchases an incorporated football club towards the end of their accounting year. In the football club are twenty football players all trained by the club from school boys. Therefore, the subsidiary attaches no carrying value to the players. However, the twenty players are worth a combined $23million at acquisition.

Immediately after the subsidiary acquisition the football club purchases a star striker for $17million and starts to use the slogan “We are the Future”. Game argues that because of the belief in their new venture, the slogan has a genuine value of $7million at the year end.

Required:

Calculate and explain Group Intangibles at purchase.

(2 marks)

Exam question: Tyre

The property of the former administrative centre of Tyre is owned by the company. Tyre had decided in the year that the property was surplus to requirements and demolished the building on 10 June 2006. After demolition, the company will have to carry out remedial environmental work, which is a legal requirement resulting from the demolition. It was intended that the land would be sold after the remedial work had been carried out. However, land prices are currently increasing in value and, therefore, the company has decided that it will not sell the land immediately. Tyre uses the ‘cost model’ in IAS16 ‘Property, plant and equipment’ and has owned the property for many years.

Required:

Advise the directors how to treat the above in the financial statements for the year ended 31 May 2006.

(7 marks)

Note that the above is taken from a classic past mix question. For the full question Tyre check out your revision kit. Also note the style of answer required here. This is scenario analysis. There is no brutal number crunching in the above. A narrative answer is required. It is typical of P2 and explains why P2 is such a challenge. I have provided both the examiner’s answer and my own in the back.


Chapter 9

Leases

CHAPTER 9 - LEASES


CHAPTER CONTENTS

LEASE ACCOUNTING (IAS 17) ----------------------------------------- 151

OPERATING AND FINANCE LEASES 151

CREATIVE ACCOUNTING 152

DISCUSSION PAPER ON LEASES 152

SALE AND LEASEBACK ------------------------------------------------- 153

CHAPTER 9 - LEASES


LEASE ACCOUNTING (IAS 17)

This chapter covers study guide entry C4a, b.

Two forms:

Operating lease

Accounting: the cost goes into operating costs.

Finance lease

Accounting: Recognise two things in the statement of financial position, therefore two in profit and loss.

Statement of financial position Income Statement Profit and loss Fixed asset Depreciation Loan Interest

Operating and finance leases The test distinguishing between the above is as follows:

Risks and rewards Lease of ownership with accounting

User (lessee) Finance Owner (lessor) Operating

Question: ABMN

Part 0ne (in advance)

ABMN has the following lease contracts where instalments are paid in advance:

A B

Machine $800k $700k Life of contract and machine 4 years 7 years Instalments in advance $220k $112K Interest 10% 10%

Required:

Calculate FS effects for year one.

(4 marks)

CHAPTER 9 - LEASES


Part Two (in arrears)

Also ABMN have two contracts in which the payments are made at the end of each year:

M N

Machine cost $500k $650k Life of contract and machine 5 years 13 years Instalments in arrears $130k $70k Interest 10% 10%

Required:

Calculate FS effects for year one.

(4 marks)

Part Three (operating lease accounting)

Further investigation of contract N reveals that the machine life is more in the region of 50 years. Of course, this does not change the contract life of 13 years.

Required:

Explain FS effects of the change in life.

(2 marks)

Creative accounting The trouble is that it is relatively easy to lie and say the life of the machine is 50 years when it isn’t. This results in untrue operating lease accounting and is the classic form of off statement of financial position finance.

Discussion paper on leases The IASB propose that only finance lease accounting be available. This would prevent the above creative accounting.

CHAPTER 9 - LEASES


SALE AND LEASEBACK

Two forms:

(A) Sale and finance leaseback

The risks and rewards transfer out during the sale and then come straight back in again during the finance leaseback. So the sale is not a sale and the sale proceeds are not sale proceeds. They are loan proceeds.

(B) Sale and operating leaseback

The risks and rewards transfer out during the sale and stay out during the leaseback. So the sale is a sale.

Question: Tabular

The above company has had four sale and lease back transactions during the year. They all relate to property. The first involves a leaseback contract for 20 years on a warehouse believed to have a life of roughly the same duration. The other three involve short contracts of only 5 years on properties known to have a life of much longer.

Description Sale proceeds Fair value Book value

$m $m $m (i) Sale and finance lease

back 30 30 23

(ii) Sale at fair value and

operating leaseback 50 50 42

(iii) Sale at overvalue and

operating lease back 70 65 68

(iv) Sale at undervalue and operating lease back

20 23 17

Required:

Discuss how the above transactions might be accounted for in the current financial statements.

CHAPTER 9 - LEASES



Chapter 10

Employee benefits

CHAPTER 10 – EMPLOYEE BENEFITS


CHAPTER CONTENTS

EMPLOYEE BENEFITS (IAS 19) ---------------------------------------- 157

PENSION ACCOUNTING 157

PENSION EXERCISES 158

SHORT TERM BENEFITS 160

CURTAILMENT 160

ASSET CEILING 160



EMPLOYEE BENEFITS (IAS 19)

Essentially, this means pension accounting.

This chapter covers study guide C6a, b, c, d.

Pension accounting There are two types of pensions:

1. Defined contribution pension scheme

These are very simple. The company simply agrees to pay an amount into the pension of an employee each year and then does it.

Accounting

The cash simply goes into operating costs and that’s it.

2. Defined benefit pension scheme

This much more complicated deal is much less common. It involves making an employee a promise to give the employee a certain amount of money when they retire. This then generates an obligation and hence a liability. A portfolio of investments that is built up over the years to pay them and hence the scheme also generates an asset.

Accounting

So, we end up accounting for an asset and a liability. By the way, a change to IAS19 in June 2011 resulted in the use of the discount rate for both unwinding the liability and the expected return on the plan assets. Further, this change in IAS19 resulted in the removal of the corridor method



Pension exercises

Question: Contact Details PLC

The following information is given about a funded defined benefit plan given to employees by the above company who operate in the dating agency industry. To keep the computations simple, all transactions are assumed to occur at the year-end. The present value of the obligation was $990 million and the market value of the plan assets was $1,000 million at 1 January year one. Actuarial gains and losses are to be recognised as they occur outside the profit and loss in other comprehensive income.

Year One Two Three

$m $m $m

Current service cost 130 140 150

Benefits paid 150 180 190

Contributions paid 90 100 110

Present value of obligations at 31 December

1,100 1,380 1,408

Market value of plan assets at 31 December

1,190 1,372 1,188

Discount rate at start of year 10% 9% 8%

Expected rate of return on plan assets at start of year (ignore this!!)

12% 11% 10%

Required:

Financial statement effects for all three years.



Supplementary Question: Glossary

The following information is given about a funded defined benefit plan. To keep the computations simple, all transactions are assumed to occur at the year-end.

Present value of obligations at year start $400m

Market value of plan assets at year start $390m

Discount rate at start of year 10%

Current service cost $14m

Benefits paid $26m

Contributions paid $34m

Present value of obligations at year end $530m

Market value of plan assets at year end $370m

There was a variation in the benefit terms during the year, which resulted in a past service cost of $100m.

Required

(a) Financial statement effects for the year.

(b) Explain the policies available to Glossary for the recognition of the actuarial loss and briefly explain the meaning of “corridor” in this context.

Following the above, the pension is wound up at the year end. The market value of the plan assets is unchanged by the curtailment. But the liability is affected. The employees departing the scheme agree to receive the plan assets in full plus a further payment of $167m. The cash was paid just before the year end.

Required

(c) Explain the effect of the above curtailment on the current financial statements.

A few years later, Glossary has a new defined benefit pension scheme with new employees. This scheme is in surplus with an asset value of $100m and a liability value of $82m. Of course, because the asset exceeds the liability, it is expected that in the future it will be possible to reduce contributions into the scheme. However, the present value of the reductions in future contributions is only $16m.

Required

(d) Explain the effect of the above asset ceiling on the current financial statements.



Short term benefits There are three tiny minor subjects under employee benefits. The first is short term benefits and is covered here. The other two are curtailment and asset ceiling and these are covered below.

Short term benefits to employees are recognised on a straight line basis to match the benefit the employee provides. Normally this means that the cost of the benefit is recognised by the entity as the cash flows. But if the entity pays up front there may be an accrual. For example, if an entity pays health insurance for an employee now for a year that straddles the accounting year end, then an accrual would be needed.

Curtailment This occurs if a pension is wound up. Essentially, the asset and liability is measured at the point of curtailment. The asset is unlikely to be changed by the curtailment. But the curtailment is likely to change the liability. This will give a profit or more usually a loss. The mechanics are illustrated in the question Glossary.

Asset ceiling If the pension asset exceeds the pension liability then a net pension asset is recorded. However, an asset must be a right to a source of economic benefit. So for this net pension asset to be recorded in full, the net pension asset must be a genuine asset. That is the asset must represent reduced future contributions to the pension scheme. This reduction to the future contributions is called the “asset ceiling” and sets a limit on the net pension asset.

In real in almost all circumstances, the net pension asset will be recoverable in full and the asset ceiling test will be irrelevant. The pension asset is a real asset represented by stocks and shares and other investments. So of course if the asset grows bigger than expected, outgrowing the liability, then the entity will benefit by having to make smaller contributions in the future. In theory, it is possible if a number of freak variables line up in an unusual way, then the amount the entity expects to get back (the asset ceiling) might be less than the market value of the excess (the net pension asset). This is just possible in real life, but very unlikely. However, it may happen in the exam and the mechanics are illustrated in the question Glossary.


Chapter 11

Share based payments

CHAPTER 11 – SHARE BASED PAYMENTS


CHAPTER CONTENTS

SHARE BASED PAYMENT ACCOUNTING (IFRS 2) -------------------- 163

SHARE BASED PAYMENT OBLIGATION 163

SHARE BASED PAYMENT EXERCISES 164



SHARE BASED PAYMENT ACCOUNTING (IFRS 2)


Share based payment obligation This is based on an equation:

Obligation = number of rights expected to vest

x fair value x timing ratio

Timing Ratio

This is simply the position of the year end within the contract.

Timing ratio = Year end Vesting period

Fair Value

This is the fair value of the rights given to the employees. It’s not the intrinsic value of the options, nor is it the fair value of the shares.

However, the recognition depends on the type of share based payment. There are two types, options and share appreciation rights. They are almost identical. The fair value is recognised as follows:

Settlement Name Fair Value Settled in Equity Options Grant Fair Value Settled in Cash Share Appreciation

Rights (SAR) Current Fair Value

Number of rights expected to vest

This is simply a guess at the current year end of the number of rights expected to vest on the vesting date.



Share based payment exercises

Question: Benign

Benign offered directors an option scheme based on a three year period of service. The number of rights taken up by directors at the inception of the scheme was 100 million. The options were exercisable shortly after the end of the third year. The fair value of the options and the number of rights expected to vest were at each relevant point:-

Year Rights expected to vest Fair value of the option

0 97m 40c

1 90m 45c

2 93m 37c

3 94m 56c

Required:

Financial statement effects.

Question: Bilberry

Bilberry offered a three year share based payment scheme to its directors. The volume granted was 20m.

Year Rights expected to vest Fair value of the option

0 17m 20c

1 18m 27c

2 15m 33c

3 16m 29c

Required:

FS effects over 3 yrs, assuming that the share based payment used:

(i) Options.

(ii) Share appreciation rights.



Exam question: Beth

Beth granted 200 share options to each of its 10,000 employees on 1 December 2006. The shares vest if the employees work for the Group for the next two years. On 1 December 2006, Beth estimated that there would be 1,000 eligible employees leaving in each year up to the vesting date. At 30 November 2007, 600 eligible employees had left the company. The estimate of the number of employees leaving in the year to 30 November 2008 was 500 at 30 November 2007. The fair value of each share option at the grant date (1 December 2006) was $10. The share options have not been accounted for in the financial statements.

Required:

Financial statements effects for the year ended 30 November 2007.

(4 marks)

Examiner’s article question: Easy Peasy

A company grants 750 share options to each of its six directors on 1 May 20X7. The options vest on 30 April 20X9. The fair value of each option on 1 May 20X7 is $15 and their intrinsic value is $10 per share. It is anticipated that all of the share options will vest on 30 April 20X9.

Required:

Show how this transaction will be dealt with in the financial statements for year ended 30 April 20X8.

Examiner’s article question: Sneaky

A company grants 2,000 share options to each of its three directors on 1 January 20X6, subject to the directors being employed on 31 December 20X8. The options vest on 31 December 20X8. The fair value of each option on 1 January 20X6 is $10, and it is anticipated that on 1 January 20X6 all of the share options will vest on 30 December 20X8. The options will only vest if the company’s share price reaches $14 per share. The share price at 31 December 20X6 is $8 and it is not anticipated that it will rise over the next two years. It is anticipated that on 31 December 20X6 only two directors will be employed on 31 December 20X8.

Required:

Show how the share options will be treated in the financial statements for the year ended 31 December 20X6.



Examiner’s article question: Jay

Jay, a public limited company, has granted 300 share appreciation rights to each of its 500 employees on 1 August 20X5. The management feels that as at 31 July 20X6, the year end of Jay, 80% of the awards will vest on 31 July 20X7. The fair value of each share appreciation right on 31 July 20X6 is $15.

Required:

Show how this transaction will be dealt with in the financial statements for the year ended 31 July 20X6.

Examiner’s article question: Crow

Crow, a public limited company has granted 700 share appreciation rights (SARs) to each of its 400 employees on 1 January 20X6. The rights are due to vest on 31 December 20X8 with payment being made on 31 December 20X9. During 20X6, 50 employees leave, and it is anticipated that a further 50 employees will leave during the vesting period. Fair values of the SARs are as follows:

$ 1 January 20X6 15 31 December 20X6 18 31 December 20X7 20

Required:

Show how this transaction will be dealt with in the financial statements for the year ended 31 December 20X7.

Examiner’s article question: Normally

A company issues fully paid shares to 500 employees on 31 July 20X8. Shares issued to employees normally have vesting conditions attached to them and vest over a three-year period, at the end of which the employees have to be in the company’s employment. These shares have been given to the employees because of the performance of the company during the year. The shares have a market value of $2m on 31 July 20X8 and an average fair value for the year of $3m. It is anticipated that in three years’ time there will be 400 employees at the company.

Required:

Show how this transaction will be dealt with in the financial statements.

Examiner’s article question: Inventory

A company issued share options on 1 June 20X6 to pay for the purchase of inventory. The value of the inventory on 1 June 20X6 was $6m and this value was unchanged up to the date of sale. The shares issued have a market value of $6.3m.

Required:

Show how this transaction will be dealt with in the financial statements.


Chapter 12

Financial instruments

CHAPTER 12 – FINANCIAL INSTRUMENTS


CHAPTER CONTENTS

FINANCIAL INSTRUMENT CLASSIFICATION (IFRS9) --------------- 169

FI CLASSIFICATION SUMMARY 169

FA CLASSIFICATION SUMMARY 170

FL CLASSIFICATION SUMMARY 172

FA CARRIED AT AMORTISED COST 173

FA CARRIED AT FAIR VALUE 174

FAIR VALUE MEASUREMENT (IFRS13) ------------------------------- 176

IMPAIRMENT IN FINANCIAL ASSETS (IAS39) ---------------------- 178

HEDGING ---------------------------------------------------------------- 179

CASH FLOW HEDGING 179

FAIR VALUE HEDGING 179

CASH FLOW HEDGE ACCOUNTING 179

FAIR VALUE HEDGE ACCOUNTING 179

PERFECT HEDGING 179

ZERO COST 179



FINANCIAL INSTRUMENT CLASSIFICATION (IFRS9)

This chapter covers study guide entry C3a, b, c, d, e, f.

Financial instruments (FI) are classified in accordance with IFRS9, but the accounting for FI impairment and hedging is in old IAS39. This is a little messy, but is simply because the 2011 ACCA syllabus catches the FI development project mid point. The IFRS numbers are not examinable, so this detail should make no difference to you. But an awareness of this mixed reference to old and new standards might prevent you being confused if you do see the two IFRS numbers in use.

FI classification summary Keeping it simple, essentially all FI are carried at fair value, except if they are uncomplicated loans. Uncomplicated loans are carried at amortised cost (unwound value). This applies to both financial assets and financial liabilities.



FA classification summary But the classification of FI (financial instruments) is not quite so simple. Firstly, it breaks down into two components, the classification of FA (financial assets) and the classification of FL (financial liabilities).

FA are carried at fair value (FV), unless FA fulfil two tests, in which case they are carried at amortised cost. The two tests are the cash flow characteristics test and the business model test.

Gains on FA carried at FV default to the profit or loss (FA at FVTPL) unless the entity can show that there is a strategic intent to keep an equity investment, in which case the gains go to the other comprehensive income (FA at FVTOCI).

Also to add to the complexity it is possible to elect to carry FA at amortised cost at fair value instead, if an accounting mismatch can be shown (the FVO).

These ideas are best understood by working steadily through the examples that follow.

Financial asset classification in more detail This is based upon asking two questions:

No No

Amortised cost Fair value

Cash flow characteristics test

This test is asking ‘Does the debt asset have interest and principal repayment and no other features?’

In other words the IFRS is asking ‘Do you have a simple loan?’

Business model test

This test is asking ‘Is the debt asset managed for collection purposes?’

In other words the IFRS is asking ‘Do you intend to keep the asset until maturity?’

Cash flow characteristics test (Is the FA a simple loan?)

Business model test (Is there intent to keep the FA?)



Two other FA issues

(1) Strategic equity

(2) FVO

Firstly, (1) Strategic equity:

Fair value accounting

The default position for the gains (and losses) on financial assets at fair value is the income statement.

FVTPL

These assets are often referred to as financial assets at fair value through profit or loss (FVTPL).

Strategic equity

However, if you have an equity investment and can show a strategic intent to keep the asset, then gains (and losses) can be pushed through other comprehensive income.

FVTOCI

This strategic equity is more commonly known as a financial asset at fair value through other comprehensive income (FVTOCI).

Now, (2) FVO:

Mismatch

If an entity identifies an accounting mismatch then the entity may use the fair value option. An accounting mismatch occurs when there is a FA carried at amortised cost on the top of the position statement and a very similar FL carried at FV on the bottom of the position statement.

Fair value option (FVO)

When this occurs the entity can elect to carry the FA at fair value.



FL classification summary FL classification is reasonably simple. All FL are carried at amortised cost unless an intent to trade the liability can be shown in which case fair value applies. An intent to trade an FL means an intent to go into the market and find someone to take the loan off you. It means taking a bag full of money into the market and trying to find someone who will take your money and the liability. This does happen, but it is incredibly rare. So almost without exception FL are carried at amortised cost.

There is absolutely no difference between accounting for an FA at amortised cost and accounting for an FL at amortised cost, apart from one gives an asset and the other gives a liability, obviously.

The FL classification based on intent can be shown by the following decision tree:

Intent Keep Trade Amortised Fair Cost value



FA carried at amortised cost The following two examples both look at the story from the point of view of the lender. So both address the FA. But the numbers and the accounting would be identical in the books of the borrower. So both also address the FL.

Question: John

The above buy a debenture off the market with a nominal value of $8,000. The coupon rate is 1%, but the market demands a return of 8%. The loan has four years to run. The intent is to hold the investment to maturity.

Required:

Calculate the amount that the company would be prepared to pay for the asset and show how it would be accounted for over the four years.

(4 marks)

(P2 exam equivalent June 2003 Q Glove extracted)

Question: Travolta

The above buy a debenture off the market with a nominal value of $1,000. The coupon rate is 2%, but the market demands a return of 7%. The loan has three years to run.

Required:

Calculate the amount that Travolta would be prepared to pay for the asset and show how it would be accounted for over the three years.

(4 marks)

(P2 exam equivalent June 2003 Q Glove extracted)



FA carried at fair value The following examples look at the easy accounting for FVTPL (financial assets carried at fair value through the profit or loss). But then the examples move to FVTOCI (financial assets at fair value through the other comprehensive income) and on to the FVO (fair value option).

Question: Blip

Blip bought shares on the stock exchange for the purpose of speculating for $400 shortly before the year end. The value at the year end is $330 and the value rises to $370 a few weeks later when the shares are sold.

Required:


Question: Bliny

Bliny bought some debenture loans on the stock exchange for a short term investment shortly before the year end. The cost was $900 and the year end value was $800. Shortly after the new year start the debentures were sold for $850.

Required:


Question: Bling

Bling bought derivatives for $100 just before the year end. The value at the year end was $110.

Required:


(2 marks)



Question: Footy

Footy buy a small percentage of the share capital of a football club for $780. The company intends to keep the investment indefinitely. At the year end the investment is valued at $710.

Required:


(2 marks)

Question: Special

Special purchase equity representing a company that owns music rights that they wish to keep forever. The cost was $500 shortly before the year end and by the year end the value had risen to $540. Then shortly after the year end the plans as regards the music changed completely and the company sold the equity for the year end value of $540.

Required:


(4 marks)

(P2 exam June 2009 Q Aron rewritten)

Question: FVO

FVO is bank. FVO has a financial asset carried at amortised cost on the draft financial statements for the current year ended 31 March. The asset is correctly carried at amortised cost because it fulfils both the cash flow characteristics test and the business model test. However, it has been noticed that a very similar liability is being carried at fair value. This means that on the draft fs there is an asset on the top of the position statement that is being carried at amortised cost that is very similar to a liability on the bottom of the position statement being carried at fair value.

Required:

Discuss if there is a solution to this problem in IFRS9 Financial Instruments.

(2 marks)



FAIR VALUE MEASUREMENT (IFRS13)

The measurement of fair value in the context of financial instruments and other areas can involve some educated guess work. So the IFRS on fair value measurement gives some guidance on how to measure fair value.

The IFRS first defines fair value quite simply as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Then the IFRS goes on to dictate a market psychology when measuring fair value. You must always, always use the best information available to give a market price.

The IFRS uses a hierarchy to help with measuring the market price and the IFRS uses some other fancy words. So it may sound a little daunting. But it is in fact quite straight forward, as the question below illustrates.

Hierarchy The rule when applying the above is that if level one works you must use it, if not then level two; only if both fail can level three be used:

Level one inputs: Quoted prices

If there is an active market then the market price from that market on the measurement date must be used.

Level two inputs: Similar quoted prices

If level one fails to give a figure then level two requires that similar market data must be used to approximate the market price.

Level three: Unobservable inputs

If both level one and level two fail to give a number then you are required to use financial models to estimate the unavailable market price.

Article The examiner has written an article on the subject of fair value which is included at the back of this chapter.



Question: Gambit

The above company is trying to obtain fair value measurements for the following four assets:

(1) Pawn

Gambit holds a number of shares in Pawn incorporated which is listed on an active world share exchange.

(2) Knight

Gambit holds a number of shares in Knight. Knight is a private company and the shares are rarely traded. But Knight is a direct competitor of Pawn and the two entities are very similar.

(3) Bishop

Bishop is a building. There has been no trading in other buildings in the area for the last year, but Gambit purchased Bishop only six months ago.

(4) Queen

Gambit also holds a half share of a development company called Queen limited. The development company is developing a new drug. There is nothing like this new drug in the market and no competitors are developing anything similar. However, technical development has been very positive and market research has plenty of data on projected cash flows.

Required:

Discuss the methods most appropriate for the measurement of fair value in reference to each of the above assets.

(4 Marks)



IMPAIRMENT IN FINANCIAL ASSETS (IAS39)

All that the IFRS does in this area is formalize the process of writing off bad debts. Now there are two specific requirements before a bad debt can be recognised.

Objective evidence

There has to be real evidence of a bad debt. You cannot now simply write off a receivable because you feel like it.

Recoverable amount

Also you must be able to generate a reasonably reliable estimate of recoverable amount. In practice, any guess will suffice.

Question: Bad

The above buy a debenture off the market with a nominal value of $12,000 due from a large public limited company called Luck. The coupon rate is 3%, but the market demands a return of 6% at purchase. The loan has four years to run. The intent is to keep the asset to maturity.

The loan runs as expected for the first two years, but at the end of the second year just as the second interest payment is received, Bad read a report in the newspaper saying that Luck are going through a financial reorganisation. Further investigation reveals that Luck is unlikely to pay any further interest instalments and Luck is estimated to pay only $5,000 of the nominal value of the loan at the end. The market rate for equivalent bonds has now moved to 7%.

In the event, the remaining two years do unfold as predicted. No further interest is received and only $5,000 of the $12,000 is repaid on the debenture at the end of the fourth year.

Required:

(a) Describe the impairment recognition criteria applicable to the impairment of financial asset and apply the criteria to the Luck receivable at the end of year two.

(4 marks)

(b) Calculate the amount that the company would be prepared to pay for the asset at purchase, identify the impairment and then show how the financial asset would be accounted for over the four years.

(6 marks)

(c) Explain the issues regarding impairment of financial assets that have resulted in the development of alternative methods of recognising impairment.

(P2 exam equivalent December 2005 Q Ambush rewritten)



HEDGING

This is the process of betting against yourself; whatever you fear, that is what you bet on.

Hedging styles

There are two:

(1) Cash flow hedging

(2) Fair value hedging.

Cash flow hedging This addresses the fear that the asset may rise in value before you can buy it. So the company bets on a price rise.

Fair value hedging This addresses the fear that the fair value of an asset might fall whilst you’re holding it. So you bet on a price fall.

Question: Spot

Spot the hedging style.

(1) Gold – The company hold gold for input into electronic inventory. They fear a price fall so bet on gold prices dropping.

(2) Coffee – Weather reports make a coffee company fearful of coffee prices rising before the coffee ripens. So they bet on a price rise.

Cash flow hedge accounting The derivative bet is carried at fair value with gains and losses to hedge reserve.

Fair value hedge accounting The primary asset is carried at fair value with gains and losses to P&L.

Perfect hedging When hedging, companies always try to make their hedges perfect. This means that they try to set up the deal such that if they lose a $1, they win $1. In practice, a hedge rarely works out as perfect. In an exam, hedges are always perfect.

Zero cost In real life, companies almost always have to pay for the derivative bet. In an exam, the derivative bet is zero cost.



Question: Bescafe

The above company plans to buy a massive consignment of coffee shortly after the current year end when the coffee ripens and comes to the market. The bulk purchase has an expected cost of $500m based on current market prices. However, freak weather conditions and reports of global warming have caused the management to fear that coffee prices will rise and that the price of the bulk purchase will be higher when the crop of coffee beans comes to the market.

So the company enters into a perfect hedge instrument derivative based on the price of coffee. The instrument is a bet on the price of coffee rising and pays $1m for every $1m that the cost of the consignment rises above $500m. The cost of the derivative is zero because the other party to the bet believes that the price of the coffee will fall. The other party is looking at the same information but believes that global warming will increase the volume of coffee being produced at the next harvest.

By the year end, the market value of the consignment of coffee has risen to $530m and this is the price at which the coffee is purchased shortly after the new year start. So the derivative is closed out by the other party by paying $30m to clear their liability. Clearly, Bescafe were right about coffee prices and so won the bet.

Required:

Explain the financial statement effects of the above using journals to show the changes for both the years. (5 marks)

(P2 exam equivalent December 2004 Q Artright rewritten)

Question: Kent

The above company plan to buy a specialist piece of machinery from a French specialist manufacturer. The order will take six months to make and so Kent will take delivery and make payment in full shortly after the current year end. The French supplier demands that the invoice be agreed in their local currency and a contract is signed to the effect that Kent becomes liable for 200m Euros upon delivery of the machine to the Kent factory in the new year and will make payment the following day.

The result is that Kent finds itself being exposed to changes in the value of currencies. So being risk averse, Kent enters a future contract to buy 200m Euros at the current market price of $150m. The derivative is a perfect hedge and is purchased at zero cost.

By the year end the value of the 200m Euros has fallen to $140m and it at this price that Kent buy the machine upon delivery in the new year. They make payment by sending $140m to their bank, asking the bank to turn it into 200m Euros and forwarding that to the French supplier.

Of course, at that time they also close out the derivative bet by paying the other party the difference of $10m.

Required:

Financial statement effects for both years. (5 marks)



Question: Jewellery

The above manufacture jewellery and have purchased $100m in gold for input into their production of inventory. They made the bulk purchase because they believed the price to be low. However, immediately after the purchase they fear that the price may fall further and so obtain a zero cost perfect hedge by contracting into a gold derivative.

The value of the gold actually rises and at the year end is valued at $109m.

The value of the gold continues to rise after the new year start. The value of the gold is $112m when Jewellery transfer the gold into their work in progress, at which point the hedge is deemed no longer necessary and the derivative contract is closed out with the derivative trader.

Required:

Explain the effect of the above on the financial statements.



HOW TO MEASURE FAIR VALUE

By Graham Holt

The International Accounting Standards Board (IASB) has recently completed a joint project with the Financial Accounting Standards Board (FASB) on fair value measurement. The result is IFRS 13, Fair Value Measurement. The standard defines fair value, establishes a framework for measuring it, and requires significant disclosures relating to it. The IASB wanted to enhance disclosures for fair value so that users could better assess the valuation techniques and inputs used to measure it. There are no new requirements in IFRS 13 about when fair value accounting is required - the IASB is relying on guidance on fair value measurements in existing standards. Although IFRS 13 moves International Financial Reporting Standards (IFRS) and US GAAP closer on how to measure fair value, differences remain about when fair value measurements are required and the recognition of gains or losses on initial recognition. The guidance in IFRS 13 does not apply to transactions dealt with by certain standards (such as share-based payment transactions in IFRS 2, Share-based Payment, and leasing transactions in IAS 17, Leases) nor to measurements that are similar to fair value but are not fair value (such as net realisable value calculations in IAS 2, Inventories, or value in use calculations in IAS 36, Impairment of Assets). IFRS 13 applies therefore to fair value measurements that are required or permitted by those standards not scoped out by IFRS 13. It replaces the inconsistent guidance found in various IFRSs with a single source of guidance on measurement of fair value, and has an effective date of 1 January 2013. The standard is applied prospectively and can be adopted early. The exit price Fair value has a different meaning depending on the context and usage. The IASB's definition of fair value is: the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In other words, it is an exit price. Fair value is focused on the assumptions of the marketplace and is not entity-specific. It therefore takes into account any assumptions about risk. It is measured using the same assumptions and taking into account the same characteristics of the asset or liability as market participants would. Such characteristics include the condition and location of the asset and any restrictions on its sale or use. The basic principles thus remain similar to current IFRS, but if an entity did not use these principles before IFRS 13, it could result in significant change. For example, if an entity's view of fair value did not take into account the highest and best use of the asset when revaluing its property, plant and equipment, then IFRS 13 could result in a higher fair value. It is not a relevant argument in the valuation process for the entity to insist that prices are too low relative to its own valuation of the asset and that it would be unwilling to sell at such low prices. The prices to be used are those in 'an orderly transaction' - one that assumes exposure to the market for a period before the date of measurement to allow for normal marketing activities and to ensure that it is not a forced transaction.



If the transaction is not 'orderly' there will not have been enough time to create competition, and potential buyers may reduce the price that they are willing to pay. Similarly, if a seller is forced to accept a price in a short period of time, then the price may not be representative. However, it does not follow that a market with few transactions is not an orderly one. If there has been competitive price tension, and sufficient time and information about the asset, then the market may return a fair value for the asset. Unit of account The unit of account to be employed for measuring fair value is not specified by IFRS 13, but is determined by the individual standard. A 'unit of account' is the single asset or liability or a group of assets or liabilities. The characteristic of an asset or liability must be distinguished from a characteristic arising from the holding of an asset or liability by an entity. An example is where an entity has to sell a large block of shares at a discount to the market price. This discount is a characteristic of holding the asset rather than of the asset itself and should not be taken into account when fair-valuing the asset. Which market? Fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place in the principal market for the asset or liability or, in the absence of a principal market, in the most advantageous market for the asset or liability. The principal market is the one with the greatest volume and level of activity for the asset or liability that can be accessed by the entity. The most advantageous market is the one that maximises the amount that would be received for the asset or paid to extinguish the liability after transport and transaction costs. Often these markets would be the same. Sensibly, an entity does not have to carry out an exhaustive search to identify either market but should take into account all available information. Although transaction costs are taken into account when identifying the most advantageous market, the fair value is not after adjustment for transaction costs because these costs are a characteristic of the transaction, not the asset or liability. If location is a factor, then the market price is adjusted for the costs incurred to transport the asset to that market. Market participants must be independent of each other and knowledgeable, and able and willing to enter into transactions. IFRS 13 sets out a valuation approach that refers to a broad range of techniques. These techniques are threefold: the market, income and cost approaches. When measuring fair value, the entity is required to maximise the use of observable inputs and minimise the use of unobservable inputs. To this end, the standard introduces a fair value hierarchy, which prioritises the inputs into the fair value measurement process. Fair value measurements are categorised into a three-level hierarchy, based on the type of inputs to the valuation techniques used, as follows. Input hierarchy Level 1 inputs are unadjusted quoted prices in active markets for items identical to the asset or liability being measured. As with current IFRS, if there is a quoted price in an active market, an entity uses that price without adjustment when measuring fair value. An example of this would be prices quoted on a stock exchange. The



entity needs to be able to access the market at the measurement date. Active markets are ones where transactions take place with sufficient frequency and volume for pricing information to be provided. An alternative method may be used where it is expedient, and the standard sets out criteria where this may be applicable. For example, it may be that the price quoted in an active market does not represent fair value at the measurement date, a situation which may occur when a significant event such as a business reorganisation or combination takes place after the close of the market. Determining whether a fair value measurement is a level 2 or level 3 input depends on whether the inputs are observable or unobservable, and on their significance. Level 2 inputs are inputs other than quoted prices in level 1 that are observable for that asset or liability. They are quoted assets or liabilities for similar items in active markets or supported by market data – for example, interest rates, credit spreads or yield curves. Adjustments may be needed to level 2 inputs, and if these are significant, the fair value may need to be classified as level 3. Level 3 inputs are unobservable inputs, which should be used as a minimum. Where situations occur when relevant inputs are not observable, they must be developed to reflect the assumptions that market participants would use when determining an appropriate price for the asset or liability. The entity should maximise the use of relevant observable inputs and minimise the use of unobservable ones. The general principle of using an exit price remains and IFRS 13 does not preclude an entity from using its own data. For example, cashflow forecasts may be used to value an entity that is not listed. Each fair value measurement is categorised on the basis of the lowest level input that is significant to it. Valuation concepts IFRS 13 also sets out certain valuation concepts to assist in the determination of fair value. For non-financial assets only, fair value is decided based on the highest and best use of the asset as determined by a market participant. The fair value of a liability or the entity's own equity assumes it is transferred to a market participant on the measurement date. Often there is no observable market to provide pricing information and the highest and best use is not applicable. The fair value is then based on the perspective of a market participant who holds the identical instrument as an asset. If there is no corresponding asset, a valuation technique is used, as is the case with a decommissioning activity. The fair value of a liability reflects the non-performance risk based on the entity's own credit standing plus any compensation for risk and profit margin a market participant might require to undertake the activity. Transaction price is not always the best indicator of fair value at recognition because entry and exit prices are conceptually different. Disclosure The guidance includes enhanced disclosure requirements that could result in more work for reporting entities. Required disclosures include:

• information about the hierarchy level into which fair value measurements fall;

• transfers between levels 1 and 2;



• methods and inputs to the fair value measurements and changes in valuation techniques; and

• additional disclosures for level 3 measurements that include a reconciliation of opening and closing balances, and quantitative information about unobservable inputs and assumptions used.

This article is merely a snapshot of a standard that will require a significant amount of work by entities simply to understand the nature of the principles and concepts involved. Graham Holt is an examiner for ACCA and executive head of the accounting and finance division at Manchester Metropolitan University Business School.


Chapter 13

Tax

CHAPTER 13 – TAX


CHAPTER CONTENTS

DEFERED TAX FORMULA ----------------------------------------------- 189

TEMPORARY DIFFERENCE (IAS12) 189

ACCELERATED CAPITAL ALLOWANCES (ACA) 190

CONCEPTUAL BASIS OF DEFERRED TAX ------------------------------ 191

SPECIFIC TEMPORARY DIFFERENCES -------------------------------- 192

ACA 192

REVALUATIONS 192

DEVELOPMENT 192

PROVISIONS 193

GROUP TEMPORARY DIFFERENCES ----------------------------------- 194

FAIR VALUE ADJUSTMENTS 194

UNREMITTED FOREIGN DIVIDENDS 194

GOODWILL 194

SBP TEMPORARY DIFFERENCES --------------------------------------- 195

SHARE BASED PAYMENT 195

REAL DEFERRED TAX --------------------------------------------------- 196

TAX LOSSES 196

CHAPTER 13 – TAX


DEFERED TAX FORMULA


Tax for our purposes means deferred tax.

Deferred tax has degenerated into a mathematical exercise. As you will see later, the conceptual basis of deferred tax is weak. This just leaves the numbers. So DT is about crunching numbers.

Deferred tax is given by formula:

DT TD Rate

Deferred = Temporary x CT Tax difference rate

Question: Formula One

Opening deferred tax (DT) 60

Closing temporary difference (TD) 200

CT rate 40%

Required:

Deferred tax movement.

Temporary difference (IAS12) This is the difference between two assets, one in the statement of financial position (carrying value) and one in the tax books (tax base).

Question: Formula Two Opening DT 25 Closing NBV (net book value) 1,000 Closing TWDV (tax written down value) 600 CT rate 30%

Required:

DT movement.

CHAPTER 13 – TAX


Accelerated capital allowances (ACA) ACA are by far the most common TD. They occur when capital allowances accelerate ahead of depreciation.

Question: Newly Incorporated

A newly incorporated business buys a machine for $8,000 that attracts capital allowances at 25% but has life of 10 years.

CT = 30%

Required:

Show DT movement.

CHAPTER 13 – TAX


CONCEPTUAL BASIS OF DEFERRED TAX

Deferred tax was developed in the 1970s when the focus of financial reporting was on the income statement and the concept of matching. This form of accounting can be referred to as “performance focus”. Even back then deferred tax had its critics. Now financial reporting has moved to focus on the position statement and the concept of the asset/liability. This form of accounting can be referred to as “position focus”. This seriously undermines the conceptual basis of deferred tax.

Conceptual question: Hold

Hold purchased a small percentage of the share capital of a listed company. Hold made this equity investment with the intent to speculate and therefore classified the asset as fair value with gains being reported in the income statement. The purchase occurred three weeks before the year end at a cost of $70,000. At the year end three weeks later, the market value had risen to $110,000. So Hold recognised a gain of $40,000 in the income statement and recognised a current asset investment at $110,000 in the position statement.

Subsequent to this the auditors pointed out that the financial accounting asset value of the investment differed from the tax accounting asset value of the investment. They therefore requested that Hold recognise an appropriate deferred tax liability. The finance director of Hold agreed to this, but pointed out that in truth there was no liability to the tax authorities in respect of this asset at the year end and therefore challenged the validity of deferred tax. The current year corporation tax rate is 30%.

Required:

Briefly discuss the conceptual basis of deferred tax, using the information above to illustrate your answer.

CHAPTER 13 – TAX


SPECIFIC TEMPORARY DIFFERENCES

Temporary differences occur when there are differences between the tax accounting and the financial accounting. So a timing difference can occur anywhere. However, there are certain specific temporary differences the examiner likes to examine.

ACA As we know from the above, accelerated capital allowances are the most common form of temporary difference.

Question: Accentuate

A company purchased a building at the year start for $200k. The life of the building is 20 years and there is no residual value. Capital allowances are allowed at 40% for the year. CT rate is 30%.

Required:

DT effects.

Revaluations Of course, the tax man completely ignores revaluations, inevitably resulting in a difference between what the tax man carries on his statement of financial position and what we accountants carry on ours.

Question: Relative

A company purchased a building at the year start for $900k. The life of the building is 10 years and there is no residual value. Capital allowances are allowed at 40% for the year. At the year end the building is revalued to $950k. CT rate is 30%.

Required:

DT effects.

Development In most countries the tax man allows development in full as the cash is spent.

Question: Deviation

A company spends $15million on a development project that will lead to five years of sales including the current year. The tax man allows this cost in full as incurred. CT rate is 30%.

Required:

DT.

CHAPTER 13 – TAX


Provisions Most provisions are ignored by the tax man.

Question: Proviso

Environmental provision $60million CT rate 30%

Tax man recognises environmental costs as the cash flow.

Required:

DT.

CHAPTER 13 – TAX


GROUP TEMPORARY DIFFERENCES

Corporation tax applies to corporations. Each individual entity has its own CT. Taxmen worldwide are blind to groups and so do not see group financial statements. So if a figure is different in our group fs to the equivalent figure in the entity fs then a temporary difference will arise.

Fair value adjustments Of course, the tax man does not recognise FVA either.

Question: Inventory

A parent buys a sub just before year end. The sub has inventory as at cost of $50k but fair value of $55k. All the inventory is still in inventory a few days later at the year end. CT rate is 30%.

Required:

DT effects.

Unremitted foreign dividends This one is much more difficult to understand, but fortunately is rarely examined.

Question: Thailand

A parent bought a foreign sub for $300k, measured in the parental home currency. The sub has grown to $370k because of net profits of $70k that the sub has retained. The withholding tax rate is 60%.

Required:

DT effect.

Goodwill The tax man always ignores goodwill. We accountants always calculate goodwill during any acquisition. Inevitably this does lead to a difference. However, this difference is always ignored.

Question: Acky

A parent acquires a sub incurring $1million in goodwill.

Required:

DT effects.

CHAPTER 13 – TAX


SBP TEMPORARY DIFFERENCES

The IFRS for share based payment was developed by the IASB. They took a lot of care in the measurement of the obligation itself. However, little care was taken in the related dt. The effect is an utterly bizarre accounting outcome.

Share based payment The deferred tax accounting for share based payment is completely illogical. Instead of recognising the carrying value at the actual carrying value, we use a made up carrying value based on intrinsic value. Don’t try and look for some underlying logic because there isn’t any and it will only make your head hurt.

Question: SBP

SBP are at the end of year one of a four year motivational option scheme. There are 20million options in the scheme and they are all expected to vest at the end. The fair value of the options at the grant date was $10 and the current intrinsic value of each is $8. CT rate is 30%.

Required:

Calculate the actual carrying value, the carrying value for DT purposes and the DT for the above.

CHAPTER 13 – TAX


REAL DEFERRED TAX

Here is a shock. The deferred tax that derives from the following is real. The taxman will acknowledge that there is a present right to a future economic inflow in the context of the following.

Tax losses Rather oddly the tax man carries losses forwards as if they were assets. However, we are only permitted to recognise the dt asset if the asset appears likely to be recoverable. In the context of a dt asset for losses carried forward, recoverability refers to the prospect of the entity returning to profitability. If the entity is not going to return to profits then we are not going to get the benefit from losses carried forward.

Question: Lost

The tax man is carrying forward losses of $100million. CT rate is 30%.

Required:

DT effect.

CHAPTER 13 – TAX


Full Exam Question: Panellette

The directors of Panellette, a public limited company, are reviewing the procedures for the calculation of the deferred tax provision for their company. They have always struggled to understand why deferred tax is recognised as a liability when there appears to be no present obligation, as required by the framework. The directors wish to know how the provision for deferred taxation would be calculated in the following situations:

(i) On 1 November 2003, the first day of the previous year, the company had granted ten million share options with an initial fair value of $4 each, subject to a two year vesting period. Local tax law allows a tax deduction at the exercise date of the intrinsic value of the options. The intrinsic value of the ten million share options at 31 October 2004 was $1.60 each and at 31 October 2005 was $4.60 each. The increase in the share price in the year to 31 October 2005 could not be foreseen at 31 October 2004. The options were exercised on the first day of the following year, 1 November 2005.

(ii) Panellette is leasing plant under a finance lease over a five year period. The asset was recorded at the present value of the minimum lease payments of $12 million at the inception of the lease which was 1 November 2004. The asset is depreciated on a straight line basis over the five years and has no residual value. The annual lease payments are $3 million payable in arrears on 31 October and the effective interest rate is 8% per annum. The directors have not leased an asset under a finance lease before and are unsure as to its treatment for deferred taxation. The company can claim a tax deduction for the annual rental payment as the finance lease does not qualify for tax relief.

(iii) A wholly owned overseas subsidiary, Pins, a limited liability company, sold goods costing $7 million to Panellette on 1 September 2005, and these goods had not been sold by Panellette before the year end. Panellette had paid $9 million for these goods. The directors do not understand how this transaction should be dealt with in the financial statements of the subsidiary and the group for taxation purposes. Pins pay tax locally at 30%.

(iv) Nails, a limited liability company, is a wholly owned subsidiary of Panellette, and is a cash generating unit in its own right. The value of the property, plant and equipment of Nails at 31 October 2005 was $6 million and purchased goodwill was $1 million before any impairment loss. The company had no other assets or liabilities. An impairment loss of $1.8 million had occurred at 31 October 2005. The tax base of the property, plant and equipment of Nails was $4 million as at 31 October 2005. The directors wish to know how the impairment loss will affect the deferred tax provision for the year.

Assume a tax rate of 30%.

CHAPTER 13 – TAX


Required:

(a) Discuss the conceptual basis of deferred tax, making particular reference to the relationship between deferred tax and the framework for financial reporting. (9 marks)

(b) Discuss, with suitable computations, how the situations (i) to (iv) above will impact on the accounting for deferred tax in the group financial statements of Panellette for the year ended 31 October 2005. For (i) above show the movement in the deferred tax over the two year period to the year ended 31 October 2005. For (ii), (iii) and (iv) show only the deferred tax at the year end. (16 marks)

(25 marks)

(The situations in (i) to (iv) above carry equal marks)

(P2 exam equivalent December 2005 Q Panel adjusted)

Note: you may recognise this as derived from the original question Panel. But be warned, the question is not exactly the same as the original.

CHAPTER 13 – TAX


Exam question: Nette

Nette, a public limited company, manufactures mining equipment and extracts natural gas. The directors are uncertain about the role of the IASB’s ‘Framework for the Preparation and Presentation of Financial Statements’ (the Framework) in corporate reporting and the equivalent Statement of Principles, applicable in the United Kingdom. Their view is that accounting is based on the transactions carried out by the company and these transactions are allocated to the company’s accounting period by using the matching and prudence concepts.

The argument put forward by the directors is that the Framework does not take into account the business constraints within which companies operate. Further they have given one situation which has arisen in the current financial statements where they feel that the current accounting practice is inconsistent with the Framework.

Situation

Nette purchased a building on 1 June 2003 for $10 million. The building qualified for a grant of $2 million which has been treated as a deferred credit in the financial statements. The tax allowances are reduced by the amount of the grant. Assume that the depreciation of the building is straight line over ten years, and tax allowances of 25% on the reducing balance basis can be claimed on the building.

Also the company has sold extraction equipment which carries a five year warranty. The directors have made a provision for the warranty of $4 million at 31 May 2004 which is deductible for tax when costs are incurred under the warranty. In addition to the warranty provision the company has unused tax losses of $70 million.

There are further additional temporary differences of $40 million in respect of other deferred tax liabilities at the year end. Tax is payable at 30%. The directors of the company are unsure as to whether a provision for deferred taxation is required.

Required:

(a) Explain the importance of the ‘Framework’ to the reporting of corporate performance and whether it takes into account the business constraints placed upon companies. (2 marks)

(b) Calculate the deferred tax in the financial statements for the year ended 31 May 2004, including a brief explanation. (7 marks)

(c) Discuss whether the treatment of the items appears consistent with the ‘Framework’. (2 marks)

(11 marks)

(June 2004 rewritten)

CHAPTER 13 – TAX



Chapter 14

UK Corporate Reporting

CHAPTER 14 – UK CORPORATE REPORTING


CHAPTER CONTENTS

UK CORPORATE REPORTING ------------------------------------------ 203

REASONS FOR TAKING UK 203

STREAM DIFFERENCES 204

UK LEGISLATION FOR FINANCIAL REPORTING --------------------- 205

ENTITY FINANCIAL STATEMENTS 205

GROUP FINANCIAL STATEMENTS 205

UK FINANCIAL REPORTING DIVERGENCE --------------------------- 206

NCA DIVERGENCE 206

LEASES DIVERGENCE 207

SEGMENT DIVERGENCE 207

EMPLOYEE BENEFIT DIVERGENCE 207

DEFERRED TAX DIVERGENCE 208

RELATED PARTY DIVERGENCE 208

SME DIVERGENCE 208

GOODWILL DIVERGENCE 208



UK CORPORATE REPORTING

The ACCA have various streams available for students studying P2 Corporate Reporting. The dominant stream is the international stream based upon International Financial Reporting Standards (IFRS). The examiner writes this exam first and then tweaks the international exam to create the others.

The UK stream is also based upon IFRS. So often the examiner will make no adjustments to his international exam before rebranding the exam as the UK stream exam. But there could be up to 20 marks in a P2 UK exam that has been derived specifically from the UK side of the UK syllabus.

The UK syllabus is based upon the international syllabus but includes extra details currently deemed of use to a UK practicing auditor. This means that the UK syllabus is bigger than the international syllabus. The difference is not huge, but it is certainly not easy either. Looking at financial reporting from the point of view of two different systems can be mind bending. It will add an extra burden on any student wishing to take the UK exam.

Reasons for taking UK Unless you have a very good reason for taking the UK stream, then my advice would be take the international stream. Soon there will only be one form of accounting worldwide based on IFRS and any learning of local standards will quickly become redundant.

However, the ACCA advise that if you wish to be a signatory audit partner in an ACCA practice you must have P2 UK. The following are extracts from ACCA’s website in December 2012 (originally posted by ACCA in April 2011):

“Should you wish to practise as a registered auditor within the UK (obtain the audit qualification/audit practising certificate), you must attempt the P2 UK and P7 UK papers from June 2011 onwards. This is not a retrospective ruling, so any International papers you have already passed will be unaffected by this ruling.”

“All UK professional accountancy bodies are governed by the requirements of the Statutory Audit Directive (SAD). In order to comply with the requirements of SAD – and to practise as an auditor – certain elements of UK legislation and regulation should be examined. The revised Papers P2 (UK) and P7 (UK) fully meet regulatory and business environment requirements for those wishing to obtain the UK audit qualification and hence practise as a registered auditor in the UK.”

Of course, you should also bear in mind that even if you do wish to become an audit partner and sign audit reports, by the time you actually get there it is possible there will be no UK FRS and the criteria for a registered auditor may have changed.



Stream differences As discussed above, both the international stream and the UK stream are based upon IFRS. The UK syllabus simply adds extra requirements on to the international syllabus. So the UK syllabus is the international syllabus with extras bolted on. The extras are essentially of two forms:

UK legislation for financial reporting

UK financial reporting divergence

The ACCA P2 study guide gives detailed advice on the syllabus. All the extras are clearly labelled and fairly obvious. All the extras are also all covered briefly here in this chapter.



UK LEGISLATION FOR FINANCIAL REPORTING

This is reference B3a in the P2 UK study guide.

Entity financial statements All UK companies must produce financial statements. The most significant element of the legislation on financial reporting in the UK applies to small companies. Small companies are defined by size criteria that are highly unlikely to be examined, but for completeness an extract of the UK Companies House website is given below.

“A small company must meet at least two of the following conditions:

● annual turnover must be not more than £6.5 million;

● the balance sheet total must be not more than £3.26 million;

● the average number of employees must be not more than 50.”

The main advantage of qualifying as small in the UK is that a small company is exempt from filing a cash flow statement.

Group financial statements A small group is exempt from producing group fs altogether. Of course, the individual entities must produce entity fs, but consolidation is not required by law. Again it is highly unlikely that the small group criteria would be examined but here is an extract from the UK Companies House website:-

“To qualify as small, a group of companies must meet at least two of the following conditions:

● aggregate turnover must be not more than £6.5 million net (or £7.8 million gross);

● the aggregate balance sheet total must be not more than £3.26 million net (or £3.9 million gross); and

● the aggregate average number of employees must be not more than 50.”

Also sub parents are not required to produce group fs. Only ultimate parents are required to produce group fs. So for one group, only one group fs is required.



UK FINANCIAL REPORTING DIVERGENCE

The UK started the process of convergence with IFRS in 1990. In the period 1997 to 2003 the process became the primary aim of the UK Accounting Standards Board (UK ASB). During that period it was assumed that IFRS would be applicable to all companies by 2005. So in order to make the cross over as painless as possible, the UK ASB put in all their efforts to making the UK system as close as possible to the IFRS system.

Then in 2005 listed companies adopted IFRS and nothing of any significance has happened in UK financial reporting since then. The UK standards, which in 2005 were right up to date, simply froze at that time. With each year, the IFRS are developed, improved and changed and the UK standards stay frozen in time. As the UK standards get older they get less in tune with IFRS. This is the process of UK divergence.

Also the adoption of IFRS for all companies in the UK never happened. Of course, the quoted companies all adopted IFRS because they had to. Also the forward thinking unquoted companies adopted IFRS as well. But many UK small and medium companies are stuck in the time warped world of UK Financial Reporting Standards (UK FRS).

It is the differences between UK FRS and IFRS that forms the bulk of the extras in the UK P2 syllabus. It is this UK divergence that is most likely to feature in a UK P2 exam as a variation from the otherwise identical international exam.

NCA divergence The accounting for non–current assets in the UK FRS and the IFRS is essentially the same. The only substantial difference of note relates to investment properties.

Investment properties

Under IFRS the gain on an investment property goes to the income statement. Under UK FRS the gain goes to the UK Other Comprehensive Income (OCI) which itself is relabelled the Statement of Total Recognised Gains and Losses (STRGL).

Also as a minor point the value to which you revalue an investment property under IFRS is of course the fair value. This simply means the market value. Under UK FRS the value to which you revalue is the Existing Use Value. This means the UK value could be lower if the asset is land and is being used inefficiently as a farm or a football pitch, say.

This is reference C2f in the P2 UK study guide



Leases divergence The accounting for leases under UK FRS and IFRS is almost identical. But there are two tiny differences.

The primary test for a finance lease in the UK FRS is risks and rewards, as it is in the IFRS. However, in the UK FRS there is a secondary test that is not in the IFRS. This secondary test is mathematical and states that a lease is likely to be a finance lease if the present value of minimum lease payments exceeds 90% of the fair value of the asset.

The other difference is a bit silly really, it more cultural interpretation than substance. But the IFRS on leases requires that property leases are split into land and buildings components; whereas the UK FRS implies that property leases are just leases for property and so no split is required.

This is reference C4c in the P2 UK study guide

Segment divergence Segment reporting in the UK is essentially the same whether using IFRS or UK FRS. But there is a difference in philosophy. The IFRS uses the managerial philosophy. This argues that segmental divisions should be based on management analysis of conglomerates. The UK FRS is of course older and so uses the older risks and rewards philosophy. This means segmental divisions must be based on underlying differences in the businesses.

In practice this makes absolutely no difference, as obviously management are going to focus on underlying differences in businesses.

This is reference C5c in the P2 UK study guide

Employee benefit divergence The accounting for pensions under both streams is identical. The exception relates to the “corridor”. Of course, the corridor is soon to be removed from IFRS. UK FRS never had a corridor.

This is reference C6e in the P2 UK study guide.



Deferred tax divergence Both the IFRS and the UK FRS suffer from the same lack of underlying logic. Both contradict the Framework for Financial Reporting. Both are essentially number crunching exercises and applying either will give the same answer in almost all circumstances.

However, there is a difference in language. The IFRS on DT refers to temporary differences. This idea, as you might remember, refers to the difference in carrying values carried by the financial accountant and the tax accountant.

The UK FRS refers to timing differences. This idea refers to the difference between accumulated costs recognised by the financial accountant and the tax accountant.

Both look at the differences that arise because financial accountants use accounting standards and tax accountants use tax legislation.

This is reference C7e in the P2 UK study guide.

Related party divergence The UK ASB and the IASB developed their related party reporting standards together. So hardly surprisingly there are almost no differences between the standards. Both are horrifically detailed standards with reams of painful details. It is in the detail where tiny differences may be found. However, there are no differences in the principles and it is these principles that have been the subject of examination since the standards were issued.

This is reference C9c in the P2 UK study guide.

SME divergence As you know, the relatively new IFRS for SMEs allows unquoted companies to produce financial statements using the less bulky IFRS for SMEs rather than the more bulky full IFRS.

The UK has had an equivalent standard for a number of years. It is called the Financial Reporting Standard for Small Entities (FRSSE). The FRSSE is based on the same economic idea as the IFRS for SMEs. This is the idea that reduced financial reporting for SMEs is good for the economy as a whole as it encourages entrepreneurs.

The two standards are similar, but it is probably fair to say the UK FRSSE is even less burdensome than the IFRS for SMEs. One notable difference is that the FRSSE does not require a cash flow statement!

The FRSSE is available for small companies as defined earlier in the chapter.

This is reference C11f in the P2 UK study guide.

Goodwill divergence As discussed above, UK financial reporting is stuck in a time warp. So the calculation of goodwill is on the partial basis only. Further under the UK FRS the partial goodwill is depreciated.

This is reference D1j in the P2 UK study guide.


Appendix

Suggested solutions to questions and

examples

SUGGESTED SOLUTIONS TO QUESTIONS AND EXAMPLES


CHAPTER 1

Answer: Peddle

Net assets

S A Acq B/S Acq B/S

Share capital 50 50 30 30 Reserves 200 310 300 440 __ ___ __ __

250 360 330 470 __ ___ __ __

Goodwill

Fair value of cost 260 120 Fair value of nci 60 Fair value of net assets (250) (330) (30%) (99) ___ ____

Goodwill 70 21 ___ ____

The split of ownership of goodwill is not required unless specifically requested. But here it is for completeness:-

CI (260-80%(250)) 60 NCI (60-20%(250)) 10 to nci below ___

Goodwill 70 ___

Group statement of financial position (balance sheet)

Non-current assets Goodwill 70 Investment in associate [Roll forward: 120+30%(470-330) or At: 30%(470)+21] 162 Net assets (390 + 360) 750 ___

982 ___ Share capital 100 Reserves 800 Non-controlling interest [Roll forward: 60+20%(360-250) or At: 20%(360)+10gw)] 82 ___

982 ___ Reserves Parent 670 S (360 - 250) (80%) 88 A (470 – 330) (30%) 42 ___

800 ___



Roll forward and traditional at methods

Note that in theory one could generate the nci and the associate by either roll forward or traditional at. Both methods are presented above. However, in practice the roll forward method should be used in the exam, as discussed in more detail below.

Nci roll forward

Traditional at uses the more apparently logical approach for calculating nci. The traditional at method argues that the nci has ownership of both net assets and goodwill at the year end and the nci is simply the sum of the nci ownership in those two things. However, in practice the roll forward method works much quicker as it avoids the necessity to split the goodwill. The nci roll forward uses the rather cock-eyed logic that the nci now is what it was at acquisition plus the growth since then. In spite of its cock-eyed logic and because of its quickness the roll forward is used by the examiner and should be used in the exam.

Associate roll forward

Similar logic is used by the examiner to justify the use of roll forward for calculating the associate balance at the year end. Roll forward for associate is particularly effective as it avoids the need to calculate associate goodwill altogether. So roll forward should be used for both nci and associate in the exam.

Group income statement (profit and loss account)

Parent Sub Adj Group

Revenue 500 400 900 Operating costs (200) (210) (410) _____

Operating profit 490 Associate140(30%) 42 42 Interest expense (50) (20) (70) _____

Profit before tax 462 Tax (80) (60) (140) ___ _____

Profit after tax 110 322 ___ Non-controlling interest 20% (22) _____

Profit attributable to members 300 _____

Group Reserve movement (not required)

Opening 500 Profit attributable to members 300 _____

Closing 800 _____



Answer: Fakenstock At acq At B/S Net assets SC 100 100 Reserves 400 600 ___ ___

500 700 ___ ___ Goodwill FV of consideration 900 NA (500) ___

Goodwill at acquisition 400 Impairment (320)* ___

Goodwill at statement of financial position 80 ___ Impairment Carry value (NA 700 + GW 400) 1,100 Impairment (balancing) (320)* ___

Recoverable value (higher of VIU and NRV) 780 ___

*Impairment of sub is the impairment of goodwill.

Answer: Terra Net assets At acq At B/S SC 50 50 Reserves 350 400 FVA (machines) 100 80 PUP (12 x 0.25 x 1/3) (1) ___ ___

500 529 ___ ___ Full Goodwill FV of consideration 800 FV of nci 317 FV of NA (500) ___

Goodwill at acquisition 617 ___ CI 450 NCI 167 ___ Goodwill at acquisition 617 Impairment (from below) (480) ___

Goodwill at statement of financial position 137 ___ Impairment Carry value (GW 617 +NA 529) 1,146 Impairment (balancing figure) β (480) ___

Recoverable value 666 ___



Note that the full goodwill dominates the goodwill impairment. So we use full net assets and full recoverable value.

NCI (317 + 30%(529-500) – (30%)(480)) 182 ___ NCI (30%)(529) + 167 – (30%)(480) 182 ___

Note how the nci is made up of ownership of net assets and ownership of goodwill. But note also that the impairment of goodwill is based on share ownership (30%) and not on the actual ownership of goodwill. There is no logic to this whatsoever, but it is all laid down in the IFRSs.

Note also that you can get the same answer for nci by either method above. The first method is called “roll forward” because it starts with nci at acquisition and rolls forward through the growth and the impairment. It is the one currently preferred by the examiner. The other is the traditional “at” calculation and recognises that the nci have ownership of net assets and goodwill at the year end. This is the method the examiner used until IFRS3 (2008 revised) came along.

Partial Goodwill

This is not required by the question. The examiner said at the conference in February 2009 that the focus of P2 would be on full goodwill. However, he did not say that partial goodwill would cease to be examined. So the following is given for completeness.

Partial Goodwill

FV of consideration 800 FV of nci (30%)(500) 150 FV of NA (500) ___

Goodwill at acquisition 450 ___ CI 450 NCI 0 ___ Goodwill at acquisition 450 Impairment (from below) (354) ___

Goodwill at statement of financial position 96 ___

Impairment

Carry value (GW 450 +NA 529(70%)) 820 Impairment (balancing figure) β (354) ___

Recoverable value (666(70%)) 466 ___

Note that the partial goodwill dominates the goodwill impairment. So we use partial (70%) net assets and partial (70%) recoverable value.

NCI (30%)(529) 159 ___

Note that the above nci has no interest in the goodwill. So it is completely unaffected by the goodwill impairment.



Answer: Top

Full Goodwill

FV of consideration 60 FV of previous 21 FV of nci 58.5 FV of NA (100) ___

Goodwill at acquisition 39.5 ___

Remember, goodwill ownership split is not required. Here it is purely for completeness:

CI (60+21-55%(100)) 26 NCI (58.5-45%(100)) 13.5 ___ Goodwill at acquisition 39.5 ___

By the way, there is also a gain on the previous of $6m (21-15) that would be recorded in the P/L (or OCI depending in interpretation).

Answer: Toy

Full Goodwill

FV of consideration 300 FV of nci 80 FV of NA (180) ___

Goodwill at acquisition 200 ___ CI (300-75%(180)) 165 NCI (80-25%(180)) 35 ___ Goodwill at acquisition 200 ___

Transfer

Nci before (80+25%(200-180)) or (25%(200)+35) 85 Transfer (5%/25%) (17) ___ Nci after 68 ___

Reduction in ci

Transfer in 17 Consideration out (24) ___ (7) ___



Answer: Love

Strictly, the two transfer examples, Toy and Love, should account for the changes in ownership consistently. The Toy example above involves the nci transferring one fifth (5%/25%) of their ownership to the ci. It does not involve the nci transferring 5% of the whole sub.

On this basis, the Love example should involve the ci transferring one ninth (10%/90%) of their ownership to the nci. It should not involve the ci transferring 10% of the whole sub.

However, this second method is the one that the examiner used in his article in February 2009. He has since stated that he would accept either method, but just taking the transfer to be 10% of the whole sub is so easy and so acceptable to the examiner, that I suggest we do not worry whether it is right or wrong. I suggest we use that method.

Full Goodwill



Transfer (strictly consistent method)

ci before (90%(400)+108) 468 Transfer (10%/90%) (52) ___ ci after 68 ___

Increase in ci

Transfer out (52) Consideration in 55 ___ 3 ___

Transfer (preferred easy alternative)

Sub (400na+115gw) 515 ___ Transfer (10%) 51.5 ___

Increase in ci

Transfer out (51.5) Consideration in 55 ___ 3.5 ___

Note that the easy method is particularly attractive because it does not even require that we do the goodwill ownership split!



Answer: Rock

Full Goodwill



Disposal

Actual sale proceeds 150 Deemed sale proceeds 420 Nci (200+40%(430-400)) or (430(40%)+40) 212 Net assets (430) Goodwill (160) ___ Profit 192 ___

Answer: Lady Gaga

Remember, if you have not completed the four exercises above, then they provide useful practice and more detailed answers.

Full Goodwill

FV of consideration 120 FV of previous 27 FV of nci 110 FV of NA (150) ___

Goodwill at acquisition 107 ___

By the way, there is also a gain on the previous equity of $2m (27-25). That would be recorded in the P/L (or the OCI depending on interpretation).



Answer: Adam Ant

Full Goodwill



Disposal

Actual sale proceeds 250 Deemed sale proceeds 410 Nci (200+30%(30)) 209 Net assets (330) Goodwill (360) ___ Profit 179 ___

Answer: Iggy Pop

Full Goodwill



Transfer (use proportion of one third)

Nci before (138+30%(20)) 144 {Usual roll forward: acq plus growth} Transfer (10%/30%)(144) (48) {one third of nci} ___ Nci after 96 ___

Reduction in ci

Transfer in 50 Consideration out (55) ___ (5) ___



Answer: Busta Rhymes

As you remember from the two examples above (Q Toy and Q Love), there is inconsistency between the methods used by the examiner in this area. For no obvious reason, the examiner uses a proportion when the nci transfers to the ci (see Q Iggy Pop). But the examiner uses a percentage when the ci transfer to nci (see this Q Busta Rhymes).

If you are uncertain about this conundrum, then you need to go back to the primary examples above (Q Toy and Q Love).

Full Goodwill



Transfer (use percentage of 15%)

Sub (220na+300gw) 520 {Whole sub carrying value} Percentage 15% {Forget about proportion when ci transfers to nci} ___ Transfer 78 ___

Increase in ci

Transfer out (78) Consideration in 90 ___ 12 ___

Answer: Freddie

Note: the examiner has said that full goodwill becomes the dominant method for goodwill from June 2009. But he has not said that partial goodwill would never be examined. So this question uses the partial goodwill assumption.

Net assets At acq At disposal

Share capital 100 100 Reserves (340 + (6/12)(100) - 20 div) 200 370 FVA (balancing figure) 20 - _______ _______

320 470 _______ _______



Goodwill FV of consideration 500 FV of nci (320x20%) 64 FV of na (320) _____

Partial Goodwill 244 _____

Disposal Actual sale proceeds 430 Deemed sale proceeds 420 Nci (roll forward=64(at acq from above)+20%(470-320)) or (at=(20%)(470)) 94 Net assets (470) Goodwill (244) _______

Profit on disposal 230 _______

Before you move on to the income statement, make sure you know what an income statement does. An income statement reports the performance of the entity over the period. So because we have control of Mercury for the first six months of the year and then have influence after, Mercury is treated as a sub for the first half year and then as an associate for the second half year. Note that at the year end Mercury is an associate and will appear as such on the balance sheet. But you have not been asked for the position statement.

Group income statement (INT) Parent Sub 6/12 Ass 6/12 Adj Group

Sales 900 120 - - 1,020 Operating costs (500) (50) - - (550) _______

Operating profits 470 Associate (6/12)100(40%) 20 Disposal 230 Investment income 80 from sub (16) 64 Finance cost (20) (5) (25) _____

PBT 759 Tax (110) (15) (125) ______ ______

PAT 50 634 ______ @ 20% Non-controlling interest (10) ______

PAM 624 ______

The dividend from the sub is paid to the parent when the ownership is 80%. So the inter company dividend income to be stripped from investment income is 16 ($20mX80%).



Answer: Hebrides

Net assets

S A Acq B/S Acq B/S

Share capital 200 200 160 160 Share Premium 100 100 40 40 Reserves(Opening 600 + 6/12(200 PAT) = 700) 700 760 450 500 FVA (land) 400 400 FVA (plant) (half year depreciation to y/e) 300 270 PUP (120) (20%) (5/6) (20) _____ _____ ___ ___

1,700 1,710 650 700 _____ _____ ___ ___

Note that the acquisition reserves are required for the mid point of the year, whereas the dividend is after that and so is ignored when rolling forward from the year start to the year middle.

Associate

Note also that under the examiner new ‘roll forward’ method applied to the associate, you do not need to calculate the associate goodwill. So you can now calculate the associate carrying value as follows:

Associate Acquisition 500 Growth (700-650)30% 15 ___ Closing before impairment 515 Impairment (balancing figure) (278) ___ Closing after impairment for b/s (790)30% 237 ___

Goodwill

Just to remind you, the following applies partial goodwill (proportional goodwill) to the sub because that was required by this question.

S Fair value of cost (200)(80%)(5/2)$5 2,000 (shares) Fair value of nci (20%)(1700) 340 Fair value of net assets (1,700) _____

Goodwill at statement of financial position 640 ___ Note the associate suffers the impairment and not the sub.



Group I/S

Parent Sub Ass Adj Group

Revenue 11,000 1,800 (120) 12,680 Cost of sales (6,000) (1,300) 120 (7,230) PUP(20) FVA(30) ______

Gross profit 5,450 Operating expenses (2,500) (210) (2,710) _____

Operating profit 2,740 Associate 6/12(100)(30%) 15 Goodwill impairment (278) _____

Profit before interest and tax 2,477 Interest (700) (140) (840) _____

Profit before tax 1,637 Tax (832) (50) (882) _____ _____

Profit after tax 50 755 Non-controlling interest 20% (10) ___

Profit attributable to members 745 ___

Group reserve movement

Opening reserves 9,000 PAM 745 Dividends (400) _____

Closing reserves 9,345 _____



Group statement of financial position

Non-current assets

Goodwill 640 Associate [790(30%) see above] 237 Land and buildings (9,000 + 2,000 + 400 FVA) 11,400 Plant and machinery (4,000 + 1,500 + 270 FVA) 5,770 Investment in other shares (600 + 300) 900

Current assets

Inventory (1,100 + 300 – 20(pup)) 1,380 Receivables (1,500 + 150 – 25(inter-company)) 1,625 Bank (300 + 70 + 4(cash in transit)) 374 ______

22,326 ______

Equity

Share capital (1,000 + 400(parent share issue nominal)) 1,400 Share premium (2,000 + 1,600(parent share issue premium)) 3,600 Reserves 9,345 Non-controlling interest [340+(1710-1700)(20%) or (1,710)(20%)] 342

Non-current liabilities

Loan (2,800 + 3,020) 5,820

Current liabilities

Trade (900 + 140 – 21(inter-company)) 1,019 Tax (700 + 100) 800 ______

22,326 ______

Note: Parent share issue was consideration for the sub acquisition described in the opening paragraph.

Note: We strip $21k out of trade payables because that’s the balance in there. The sub records a liability of $21k because after sending a cheque of $4k on a liability of $25k it still owes $21k.

Reserves

Parent 9,600 Sub (1,710 – 1,700) (80%) 8 Ass (700 – 650) (30%) 15 Impairment (278) _____

9,345 _____



Alternative method for the associate

There is an older alternative method of accounting for the associate that splits the associate between goodwill and net assets. The method is not required and is a little slower than roll forward used above. However, seeing the method may help you to understand the composition of the associate figure. Just to remind you, the following applies partial goodwill (proportional goodwill) to the sub because that was required by this question. The following includes associate goodwill merely for completeness.

Goodwill

S A Fair value of cost (200)(80%)(5/2)$5 2,000 (shares) 500 (cash) Fair value of nci (20%)(1700) 340 not applicable Fair value of net assets (1,700) (30%) (650) (195) _____ ___

Goodwill at acquisition 640 305 Impairment (see below) (278) ___ ___

Goodwill at statement of financial position 640 27 ___ ___

Impairment

Carrying value [700 (30%) + 305] 515 Impairment (balance) (278) ___

Recoverable value [790(30%)] 237 ___

Associate

Therefore the associate carrying value can be verified by summing associate goodwill remaining after impairment and our share of associate net assets:-

Associate [27 + (30%)(700)] 237 ___



CHAPTER 2

Answer: Hendrix H 70% S 60% (42%) SS Net assets Acq B/S Acq B/S

Share capital 20 20 10 10 Reserves 60 230 30 90 __ ___ __ ___

80 250 40 100 __ ___ __ ___ Goodwill Fair value of consideration 60 (70%) (50) 35.0 Fair value of nci (80) (30%) 24 (40) (58%) 23.2 Fair value of net assets (80) (40) __ ____

Goodwill 4 18.2 __ ____ Goodwill (alternative) Fair value of cost 60 (70%) (50%) 35.0 Fair value of net assets (80) (70%) (56) (40) (42%) (16.8) __ ____

Goodwill 4 18.2 __ ____

This alternative looks okay. But the examiner has prefers to follow the IFRS more strictly. So I would recommend the first method, even though it is a little longer.


Goodwill (4 + 18.2) 22.2 Other NA (300 + 200 + 100) 600.0 _____

622.2 _____

Share capital 30.0 Reserves 474.2 NCI 118.0 _____

622.2 _____



NCI (new ‘roll forward’))

S 24-30%(50inv)+30%(250-80) 60 SS 23.2 +58%(100-40) 58 ___

118 ___ NCI (traditional ‘at’)

S (30%) (250 – 50) 60 SS (58%) (100) 58 ___

118 ___ Reserves

Parent 330.0 S (70%) (250 – 80) 119.0 SS (42%) (100 – 40) 25.2 _____

474.2 _____

Answer: Dee

Net assets

Acq B/S Acq B/S $m $m $m $m

Share capital 20 20 10 10 Reserves 100 172 150 170 ___ ___ ___ ___

120 192 160 180 ___ ___ ___ ___

Goodwill

Fair value of consideration 200 70 (direct) (75%) (80) 60 (indirect) ___

130 Fair value of nci 62 83 Fair value of net assets (120) (160) ___ ___

Goodwill 142 53 ___ ___


Goodwill (142+53) 195 Other net assets (600 + 112 + 180) 892 _____

1,087 _____ Share capital 100 Reserves 835 Non-controlling interest 152 _____

1,087 _____



Reserves

Parent 770 M (75%)(192 – 120) 54 I (55%)(180 – 160) 11 ___

835 ___

Non-controlling interest (roll forward)

M 62 -25%(80inv) +25%(192-120) 60 I 83 +45%(180-160) 92 ___

152 ___

Sub-Sub Strip

The removal of the 25% of $80k above is often referred to as the sub sub strip or just the “strip” for short. The strip is frankly the hardest part of all P2. It is one of the hardest ideas in all financial reporting. It is unbelievably difficult and you will have to be unbelievably good at financial reporting to understand this explanation in full. You would also have to be unbelievably bad at exam technique to worry about it, as it is only worth one mark. But here goes anyway.

Indirect ownership adjustment

Firstly, this adjustment is also called the “indirect ownership adjustment” which strikes me as a very good name, if a little long. In this context, it is often noted that when we calculate the indirect consideration for I as $60m by calculating 75% of $80m, we are effectively stripping 25% of $80m out of the top of the b/s. When we strip 25% of $80m from nci, we are simply repeating on the bottom of the b/s what we did on the top of the b/s. this is why the b/s balances.

This answer is just juggling with numbers and is really a little superficial, but given that you have a maximum of 1 mark for the strip, this brief accounting explanation should really be enough.

Pure sub

Are you still reading this? Why? If you really do want to know more, then here is more… a lot more.

The place to start is with I. I is a pure sub. The only thing I has to account for is itself. All very easy for the accountants in I.

Impure sub

Contrast that with M. M is both a sub and a parent to I. M is a sub parent. So the accountants in M are required to account for the assets in M as well as accounting for the shares in I. Just look at the current balance sheet and you can see that. The current balance sheet balance of $192k is made up of $80k of investment in I as well as the $112k net assets of M. So M is partly itself and partly the lower entity. So M is impure. Unless we pick up on this, we are going to end up accounting for I twice, once when we account for I and again when we account for M. That is just the start of the story.



NCI

But actually the removal of the 25% of $80k above is the NCI implication of this. 25% of $80k is $20k. By convention the acquisition nci of $62k is quoted including this $20k. So the $62k above is made up of $42k of value in M and $20k of value in the shares in I. But that is the point. When looking at M we do not want to be looking at I. We want to be looking at only M. So if the $62k is quoted by convention including a bit of I then we have to take that bit of I out. If the $62k includes $20k that represents I then we must strip that out of the M line above to prevent double counting for I.

Convention

But why is it the convention to quote the nci in M inclusive of the nci in the investment in I? Why not quote the nci in M like this “the nci in M underlying assets excluding the interest in the sub-sub is $42k”? Why not do that, then we would not need the sub-sub strip above? Well like everything in this area the answer is subtle. We could quote nci as described above, but that would make the goodwill calculation a nightmare. You see the goodwill starts with the fair value of consideration being $200k. That is the cash that the parent paid. But that $200k includes what D paid to get hold of a 75% ownership of the 40% investment that M has in I. In other words, D paid $60k for 75% of the $80k investment in I and the other $140k was paid for the ownership in M itself. Of course, if D paid $200k then D is bound to quote its consideration as $200k. D is hardly likely to say “I paid $200k for the M shares of which $60k was to get at I and the other $140k was to get at M itself”. That is not going to happen. D is going to say “I paid $200k” and that is it. So if the consideration is inclusive of the element related to the sub-sub, then the nci has to be quoted inclusive of the part related to the sub-sub. That is how the convention came about.

Goodwill

So is there a problem with goodwill? The $200k consideration includes $60k related to I and the $62k nci includes $20k related to I. Does that mean that I ends up in the M goodwill? The answer is no. Without realising it, you have included the $80k shares in I in the combined consideration and nci then included the same $80k in the net assets of $120k. The net assets at acquisition were $120k as you can see from the net assets schedule. This $120k includes the shares in I at cost of $80k. In fact at acquisition the underlying assets of M alone were only $40k. The effect of including the $80k in the consideration and nci and in the net assets is that the $80k is cancelled out. If your good with numbers you will be able to see that you could derive the M goodwill by looking at pure M. Pure M value is $182k ($200k and $62k less $80k of I) and pure M net assets is $40k ($120k less $80k). If you deduct one form the other you get $142k, as we had above.

Mad

Frankly if you are still reading this I think you are mad. Is there nothing on the telly?

Assumption

But if you have to go to the bitter end, you need to pick up an assumption that the examiner makes here. Actually the $80k we keep talking about that appears on the M balance sheet was acquired at the year start by M. D does not get involved until the mid point in the year. The examiner has therefore assumed that the fair



value of the shares in I have not changed over the six months since the year start. This is of course highly unrealistic, but that is the assumption being used here. If you allow the fair value of the I shares to float, then the difficulty of this nonsense steps up a notch.

Examiner

I think that the fact that the examiner assumes that the fair value of the I shares is constant over the six months shows that the examiner has no interest in this nonsense. There is more evidence of this. The sub-sub strip of 25% of $80k ($20k) is stripping out the fair value of the nci in I from the fair value of the nci in the combined M and I ($62k) to leave you with the acquisition nci in pure M ($42k). So the $20k simply represents the fair value of the nci in the I shares at acquisition. But the $83k represents the fair of the nci in the I business at acquisition. But each share gives you a share of the business. Holding a share certificate is simply holding a bit of paper that tells you that you own a share in the business. The fair value of any business is equal to the fair value of its combined share capital. So the fair value of the nci in the I shares ($20k) and the fair value of the nci in the I business ($83k) are exactly the same thing and so should of course have the same value. The $20k and the $83k should be the same number. But they are not. They do not have the same value because the examiner has no interest whatsoever in this nonsense. The examiner has not spent hours thinking about this and nor should you. In some ways it is a shame. If the examiner had written that the fair value of the nci in I at acquisition was $20k and included that $20k in his table on the question instead of using the $83k that we see, then it would be much easier to see the double count that the sub-sub strip removes.

Double entry

There is a cute double entry feature of this and this double entry trick tickles some students who like their debits and credits. You notice that the sub-sub strip of $20k is coming out of nci. There is a corresponding $20k coming out goodwill as well. Do you see it? It happens when we take 75% of $80k when looking at the indirect consideration. So we take $20k out of the goodwill and $20k out of the nci and the balance sheet continues to balance. Cute hey?

One mark

Understanding the above takes a fiendishly good brain for twiddling with numbers and seeing the tricks. No-one is ever going to be impressed if you do understand this. No-one will ever care if you do not. There is one mark for stripping the 25% of $80k from the $62k and that is just for the mechanics. You would never ever be asked to explain it. Focus on the marks and the pay rise that comes with qualification.

Goodwill split

By the way, if you are into splitting your goodwill and doing your nci at the balance sheet date by the traditional method, then here is another way to get nci. Note how you strip the whole of the $80k of I from the impure $192k of M in this method. This method is not used by the examiner and should not be used in the exam.



Goodwill

Fair value of consideration 200 70 (direct) (75%) (80) 60 (indirect) ___

130 Fair value of nci 62 83 Fair value of net assets (120) (160) ___ ___

Goodwill 142 53 ___ ___ Ci 110 42 Nci 32 11 ___ ___

Goodwill 142 53 ___ ___

Non-controlling interest (traditional at)

M (25%)(192 – 80) + 32 60 I (45%)(180) + 11 92 ___

152 ___



Answer: Rodney

Rod 80%

Del 40% 25%

Trigger

Trigger ownership

Direct 40% Indirect (80%)(25%) 20% ___

60% ___

Trigger NCI

Therefore 40% ___

Net assets

Del Trigger Acq B/S Acq B/S

Share capital 500 500 200 200 Share premium 100 100 50 50 Profits reserve 100 200 50 60 FVA (inventory) (balance) 10 0 Inventory error (iii) (20) Discount error (iv) (5/6)(6) (5) Transfer (v) (70/5) 14 ___ ___ ___ ___

710 775 300 324 ___ ___ ___ ___



Net assets notes

The following explanatory notes are just that and are certainly not required in the exam.

Inventory error (iii)

Reinstatement of dead costs is never permissible. Once costs are written off, they must stay dead. The correcting double entry is:-

Dr retained earnings 20 Cr inventory 20

Discount error (iv)

The erroneous recognition of the discount in the income statement has caused a corresponding overstatement of nca of $6m at the year start. But nca is depreciating, so the error is itself depreciating. Over the year $1m of error has dropped off the b/s into the i/s as depreciation. So only $5m is still left on the b/s in net assets at the year end. The correcting double entry is:-

Dr discount (i/s) 6 (to remove the erroneous discount) Cr tangibles (b/s) 5 (to get the nca back to where they should be) Cr depreciation charge (i/s) 1 (to strip out the overdepreciation)

Transfer (v)

Of course, the sub policy for property plant and equipment (ppe) must be consistent with the parent. So the revaluation reserve must go. But to remove it correctly there must be two corrections. This is because Trigger has made two mistakes. Firstly, we must recognise the realisation of the reserve and put through the transfer that Trigger has ignored. Then we must sweep away the remainder of the revaluation reserve and slap it against the ppe to reduce the tangibles back to historical net book value. Revaluation reserves should be realised over their lives. The life of the Trigger tangibles was six years at the point of purchase. But the revaluation is one year after purchase and so the revaluation reserve has a life of only five years from revaluation. The first of those five years is this year. So one fifth of the $70m must be realised. That means $14m is transferred to retained earnings, leaving $56m still in the revaluation reserve. Now that is swept out of the revaluation reserve and set against the $256m in tangibles. This magically shrinks to $200m, which is where it would have been had Trigger not put through the revaluation. After all, the tangibles are two years through a six year life and had originally cost $300m. Do not, even in your wildest and most fanciful dreams, think there is any chance whatsoever of you sorting that out in the exam. Forget it. Ignore it. If you try to solve a paragraph like this one in your exam you will fail the exam and you will have to listen to me next term telling you again not to get bogged down in impossible nonsense. The correcting double entry is:

Dr revaluation reserve 70 (to remove the offending reserve) Cr retained earnings 14 (to transfer a fifth of the reserve) Cr tangibles 56 (to remove the remainder of the reserve)



Goodwill Del Trigger

Fair value of consideration 640 Trigger direct 160 Trigger indirect (80%)(100) 80 Fair value of nci 154 149 Fair value of net assets (710) (300) ___ ___

Goodwill at acq 84 89 ___ ___ Impairment (below) (50) ___ ___ Goodwill at ye 34 89 ___ ___ Carrying value (84+775) 859 Impairment (balance) (50) ___ Recoverable value 809 ___

Goodwill ownership split

Remember, the goodwill ownership split is not required! But here it is for completeness:-

Ci (640-80%(710)) 72 (240-60%(300)) 60 Nci (154-20%(710)) 12 (149-40%(300)) 29 ___ ___

Goodwill at acq 84 89 ___ ___

Goodwill impairment

The goodwill impairment is split between the parent and the nci based on the ownership of shares, regardless of the ownership of goodwill. So this impairment is split 80%/20%.



Group statement of financial position Non-current assets Goodwill (34+89) 123 Tangible (1,230 + 505 – 5 discount + 256 – 56 revaluation) 1,930 Current assets Inventory (300 + 135 + 65 – 20 development) 480 Receivables (240 + 105 + 49) 394 Bank (90 + 50 + 80) 220 _____

3,147 _____ Equity Share capital 1,500.0 Share premium 300.0 Reserves 651.4 Non-controlling interest 295.6 Non-current liabilities (135 + 25 + 20) 180.0 Current liabilities (100+ 70 + 50) 220.0 ______

3,147.0 ______

Reserves Parent (625 – 80%(50 impairment)) 585.0 Del (775 – 710)(80%) 52.0 Trigger (324 – 300)(60%) 14.4 _____

651.4 _____

NCI (roll forward) Del (154 -20%(100inv) + 20%(775-710) – 20%(50imp)) 137.0 Trigger (149 +40%(324-300)) 158.6 _____

295.6 _____

NCI (traditional at) Del (20%)(775 – 100)=135na + 12gw – 20%(50imp) 137.0 Trigger (40%)(324)=129.6na + 29gw 158.6 _____

295.6 _____



Ronnette

Note that this question is of course based upon the classic complex groups question Rodney. If you struggle with the issues raised here make sure you go back to that question.

Ronnette (a) 70%

Tommy 20% 40%

Jimmy

Jimmy ownership

Direct 20% Indirect (70%)(40%) 28% ___

48% ___

Jimmy NCI

Therefore 52% ___

But note that Jimmy is a sub because Ronnette has control. At any general meeting of Jimmy shareholders both Ronnette and Tommy will attend and together they represent 60% of the votes.

Control

Here is a question and answer analysis of Ronnette control of Jimmy that gives a stronger feel for the voting. Remember voting is not the same thing as ownership.

It is actually really easy. Here is a question: "who would go to the shareholders meetings?” Answer: "shareholders". Question: "who are the major shareholders?” answer "R and T". Question “how many votes do they have?". Answer "60%". Question "who decides how those two would vote?”. Answer "R decides how R votes and R decides how T votes". Response "oh okay, that is obviously control".



Net assets

The marks for the na working form part of the marks

Tommy Jimmy Acq B/S Acq B/S

Share capital 300 300 100 100 Share premium 100 100 50 50 Profits reserve (i)200 676 (ii)400 525 FVA (PPE) (balance) 100 70 - - Inventory (iii) - (20) - - ___ ___ ___ ___

(i)700 1,126 550 675 ___ ___ ___ ___

(7 marks)

The following explanatory notes are just that and are certainly not required in the exam.

Note that the FVA is calculated as a balancing figure. Note also that the FVA is depreciating over 10 years, 3 of which have gone, leaving 7 remaining.

Inventory (iii)

The actual sale proceeds are used because the sale is an adjusting post b/s event. The correcting double entry is:-

Dr retained earnings 20 Cr inventory 20



Goodwill Tommy Jimmy

Fair value of consideration 900 Jimmy direct 220 Jimmy indirect (70%)(400) 280 Fair value of nci 354 449 Fair value of net assets (700) (550) ___ ___

Goodwill at acq 554 399 Impairment (below) (306) - ___ ___ Goodwill at ye 248 399 ___ ___ Carrying value (554+1126) 1,680 (4 marks) Impairment (balance) (306) ___ Recoverable value 1,374 ___ (4 marks)

Goodwill impairment

The goodwill impairment is split between the parent and the nci based on the ownership of shares, regardless of the ownership of goodwill. So this impairment is split 70%/30%.


Non-current assets Goodwill (248+399) 647 Tangible (1,800 + 406 + 250 + 70 FVA – 6 (v)discount) 2,520 Current assets Inventory (540+160+165-20(iv)) 845 Receivables (140+150+140) 430 Bank (190+50+180) 420 _____

4,862 _____

(2 marks excluding the 7 marks for na and the 8 marks already given to goodwill) Equity Share capital 500 Share premium 300 Reserves 2,764 Non-controlling interest 784 Non-current liabilities (230+20+10-10(vi) 250 Current liabilities (130+70+50+11(vi)+3(vii) 264 ______

4,862 ______

(7 marks excluding RE and NCI)

Reserves

Parent (2,630 – 70%(306) impairment – 6 (v) - 1(vi) – 3(vii)) 2,406 Tommy (1,126-700)(70%) 298 Jimmy (675-550)(48%) 60 _____

2,764 _____

(6 marks)



NCI (roll forward)

Tommy (354 -30%(400inv) + 30%(1,126-700) – 30%(306imp)) 270 Jimmy (449 +52%(675-550)) 514 _____

784 _____

(5 marks)

Exam advice

Note that you can score very high marks even completely ignoring paragraphs (v) (vi) and (vii). Truthfully, paragraphs (vi) and (vii) are fairly easy and really you should put those adjustments through. But paragraph (v) is very tricky, so given the time pressure of an exam I would recommend you ignore that paragraph. You will still score 32/35.

Explanatory notes

Again these notes are purely for your learning benefit and are not required in the exam.

Discount error (v)

Discount error = (3/4)(8) = (6)

The erroneous recognition of the discount in the income statement has caused a corresponding overstatement of nca of $8m at the year start. But nca is depreciating, so the error is itself depreciating. Over the year $2m of error has dropped off the b/s into the i/s as depreciation. So only $6m is still left on the b/s in net assets at the year end. The correcting double entry is:-

Dr discount (i/s) 8 (to remove the erroneous discount) Cr tangibles (b/s) 6 (to get the nca back to where they should be) Cr depreciation charge (i/s) 2 (to strip out the overdepreciation)

Repayment fee (vi)

The repayment fee is a cost.

Environmental (vii)

The announcement creates a constructive obligation to pay out the $3m. No such obligation applies to the $1m.



Desperate

When examined in December 2011, the original version of this question was a focus question based upon focus on group reorganisation with a hint of entity reconstruction. The question is essentially a list of instructions to be turned into double entry and put through the books of the individual entities. The instructions are very silly but not particularly difficult. In fact, if you can think double entry in your head, then you will be able to adjust the balance sheets without writing out the journals in full. This is the approach the examiner took.

But regardless of the approach to this question, you would have to be brilliant at double entry and spectacularly quick thinking to get anywhere with this question in the exam.

(a) (i) Comment

This requirement is technical beyond belief. Very few students even had a clue what they were being asked. Even the length of the answer is ridiculous for 5 marks. If you get into this subject and start to understand what IAS 27 is saying about group reorganisation then go back to the examiner’s answer you will find that it appears even his interpretation is deeply suspicious.

Marking guide

Theoretically 1 mark per point.

IAS 27 regarding dividends

IAS 27 makes it crystal clear that post acquisition dividends from any sub are recorded by the parent in the income statement as dividend income.

Pre and Post acquisition dividends

The above may seem completely obvious, but it was written into the IAS to prevent a nonsense that used to be recorded in the 1990s. The nonsense involved pretending that part of the post acquisition dividend was pre acquisition and then using this pre acquisition element to reduce the cost of the investment.

Application to Desperate

The $30m dividend from Meaty to Desperate must be recorded by Desperate in the i/s in full. It is not necessary or even permitted to start thinking about pre acquisition elements and then reducing the cost of investment of $100m.

IAS 27 regarding group reorganisation

Specified accounting applies in separate financial statements when a parent reorganises the structure of its group by establishing a new entity as its parent in a manner satisfying the following criteria:

(1) Equity swap

The new parent obtains control of the original parent by issuing equity instruments in exchange for existing equity instruments of the original parent



(2) Unchanged group

The assets and liabilities of the new group and the original group are the same immediately before and after the reorganisation, and

(3) Unchanged owners

The owners of the original parent before the reorganisation have the same absolute and relative interests in the net assets of the original group and the new group immediately before and after the reorganisation.

Where these criteria are met, and the new parent accounts for its investment in the original parent at cost, the new parent measures the carrying amount of its share of the equity items shown in the separate financial statements of the original parent at the date of the reorganisation.

Application of original cost rule

The above requirements:

(x) Intermediate parent

Apply to the establishment of an intermediate parent within a group, as well as establishment of a new ultimate parent of a group.

(y) New parent

Apply to an entity that is not a parent entity and establishes a parent in a manner that satisfies the above criteria.

(z) Common control transactions

Apply only where the criteria above are satisfied and do not apply to other types of reorganisations or for common control transactions more broadly.

Application to Desperate Group

At first it appears the original cost rule applies to the transaction in point 1. Meaty becomes an intermediate parent as given in (x). Also the original owner (Desperate) of Needy owns Needy absolutely before and after the transaction. So condition (3) unchanged owners is fulfilled. Also the group has the same assets and liabilities before and after. So condition (2) unchanged group is fulfilled. But the transaction is not an equity swap. Meaty pays cash. So the original cost rule does not apply and Meaty recognises the new cost of $160m rather than the original cost of $150m.



(a) (i) Journals

As mentioned above, the journals are not strictly necessary to the answer to this question. But they do help keep a track of the plan.

Point 1

Meaty purchase

Dr Investment in Needy 160 Cr Bank 160

Desperate sale

Dr Bank 160 Cr Investment in Needy 160 Cr Profit on sale (I/S & RE) 10

Desperate loan

Dr Needy receivable (nca) 160 Cr Bank 160

Needy cash injection

Dr Bank 160 Cr Desperate payable (ncl) 160

Point 2

Meaty purchase

Dr Land 20 Cr Mortgage 7 Cr Share capital (nominal) 5 Cr Share capital (premium){balance} 8

Needy sale

Dr Investment in Meaty 13 Dr Mortgage 7 Cr Land 12 Cr Profit on disposal (RE) 8

Point 3

Meaty payment

Dr Dividend paid (SOCIE & RE) 30 Cr Bank 30

Desperate receipt

Dr Bank 30 Cr Dividend Received (I/S & RE) 30



Redundancy

Year CF DF PV 1 11 0.909 10 2 24.2 0.826 20

Meaty provision

Dr Cost (I/S & RE) 30 Cr Provision (CL) 10 Cr Provision (NCL) 20

Restructure

Desperate cost

Dr Cost (I/S & RE) 1 Cr Provision 1

Comment

Like any question on double entry, there are other ways to interpret the journals, which would be acceptable. For example, you may have interpreted the restructure cost as paid “after the proposed restructuring plan” to quote the requirement.



Desperate

before 1 2 3 4 after

NCA 400 +160 560

Inv(Meaty) 100 100

Inv(Needy) 150 -150 0

CA 300 +160-160 +33 333

____ ____

950 993

____ ____

SC 100 100

RE 400 +10 +33 -1 442

NCL 200 200

CL 250 +1 251

____ ____

950 993

____ ____

Meaty

before 1 2 3 4 after

NCA 200 +20 220

Inv(Meaty)

Inv(Needy) +160 160

CA 400 -160 -33 207

____ ____

600 587

____ ____

SC 20 +5+8 33

RE 240 -33 -30 177

NCL 120 +7 +20 147

CL 220 +10 230

____ ____

600 587

____ ____



Needy

before 1 2 3 after

NCA 100 -12 88

Inv(Meaty) 0 +13 13

Inv(Needy)

CA 30 +160 190

____ ____

130 291

____ ____

SC 5 5

RE 5 +8 13

NCL 90 +160 -7 243

CL 30 30

____ ____

130 291

____ ____

(b) Marking guide

Usual 1 mark per valid point

Group reorganisation

The plan represents a classic group reorganisation. The reorganisation described in point 1 is the purchase of Needy by Meaty. This is a classic group reorganisation called “simple group to vertical group”.

Group implications

The implications of all group reorganisations are the same. Group reorganisations have no effect on group fs. The group has the same assets and liabilities before and after point 1 is transacted.

Entity reconstruction

There is a flavour of entity reconstruction in this question as well. After all, the plan was motivated by a desire to get Needy out of trouble.

Complex

The plan is breathtakingly complex. Money and shares and other assets are flying through the entities with no apparent logic. Transaction 2 is daft beyond belief. The group takes useful land off a struggling sub and gives useless shares in a fellow sub in exchange. Truly bizarre.

Recommendation

I recommend that the group do not execute their plan. I recommend that Desperate simply lends cash to Needy and helps Needy through its troubles.



CHAPTER 3

Answer: Furtive € Rate

Delivery 50,000 1.25 40,000 Y/e 50,000 1.30 38,462 ______

Forex gain 1,538 ______

Delivery journal

Dr Fixed asset (cost) 40,000 Cr Creditors 40,000

Year end journal

Dr Creditor 1,538 Cr (P&L) Forex gain (financing) 1,538

Answer: Feature Roubles Rate $

Delivery 90,000 10 9,000 Y/e 90,000 9 10,000 ______

Forex loss 1,000 ______ Journals At delivery Dr Fixed asset (cost) 9,000 Cr Creditors 9,000 At year end Dr Financing (Forex loss) (P&L) 1,000 Cr Creditor 1,000



Answer: Feature (continued)

Roubles Rate $

Year start 90,000 9 10,000 Payment 90,000 9.2 9,783 ______

Forex gain 217 ______

Journals (closure)

Dr Creditor 217 Cr Financing (Forex gain) (P&L) 217 Dr Creditor 9,783 Cr Bank 9,783

Answer: Kenya (full goodwill)

Net assets

At acq At B/S Share capital 50 50 Reserves 700 1050 FVA land 250 250 ______ ______

1,000 1,350 ______ ______

Goodwill

FV of consideration 1,200 FV of nci (given) 133 FV of NA acquired (1,000) ______

Goodwill at acquisition and statement of financial position 333 ______




Non current assets Intangible (333/2.1)) 159 Other Net Assets (17,500 + (1,100 + 250)/2.1) 18,143 ______

18,302 ______ Share capital 70 Reserves 18,152 Non-controlling interest [133 +10%(1,350-1,000)]/2.1 80 ______

18,302 ______

Reserves

Parent 17,930 Parent gain on cost of investment (below) 71 Sub (1,350-1,000) (90%)/2.1 151 _____

18,152 _____ Parent gain on cost of investment At year start (given) 500 At year end (1,200/2.1)) 571 _____ Parents gain on Forex 71 _____

Group profit and loss

Parent Sub Rate Sub Adj Group

Sales 28,000 1,700 2.2 773 28,773 Costs (22,500) (1,160) 2.2 (527) (23,027) _____

PBT Tax (1,900) (190) 2.2 (86) (1,986) _____ _____ _____

PAT 350 160 @ 10% Non-controlling interest (16) _____

PAM 3,744 _____



Group movement on reserves

Opening (closing 17,930 – PAT 3,600) 14,330 Profit retained for group (PAM) 3,744 Retranslation of the sub PAT to closing rate from average rate 350/2.1 = 167 350/2.2 = 159 ___

Forex gain 8 @ 90% 7 ___ Retranslation of opening NA to closing rate from opening rate 1,000/2.1 = 476 1,000/2.4 = 417 _____

Forex gain 59 @ 90% 53 _____ Retranslation of goodwill to closing rate from opening rate 333/2.1 = 159 333/2.4 = 139 _____

Forex gain 20 @ 90% 18 _____ _____

18,152 To b/s _____



Answer: Kenya (partial goodwill)

Net assets

At acq At B/S Share capital 50 50 Reserves 700 1050 FVA land 250 250 ______ ______

1,000 1,350 ______ ______

Goodwill

FV of consideration 1,200 FV of NA acquired (90% x 1,000) (900) ______


Goodwill (alternative)

FV of consideration 1,200 FV of nci (10% x 1,000) 100 FV of NA acquired (1,000) ______





Non current assets Intangible (300/2.1)) 143 Other Net Assets (17,500 + (1,100 + 250)/2.1) 18,143 ______

18,286 ______ Share capital 70 Reserves 18,152 Minority interest (1,350)(10%)/2.1 64 ______

18,286 ______

Reserves

Parent 17,930 Parent gain on cost of investment (below) 71 Sub (1,350-1,0000(90%)/2.1 151 _____

18,152 _____

Parent gain on cost of investment

At year start (given) 500 At year end (1,200/2.1)) 571 _____ Parents gain on Forex 71 _____

Group profit and loss


Sales 28,000 1,700 2.2 773 28,773 Costs (22,500) (1,160) 2.2 (527) (23,027) _____

PBT Tax (1,900) (190) 2.2 (86) (1,986) _____ _____ _____

PAT 350 160 @ 10% Non-controlling interest (16) _____

PAM 3,744 _____



Group movement on reserves

Opening (closing 17,930 – PAT 3,600) 14,330 Profit retained for group (PAM) 3,744 Retranslation of the sub PAT to closing rate from average rate 350/2.1 = 167 350/2.2 = 159 ___

Forex gain 8 @ 90% 7 ___ Retranslation of opening NA to closing rate from opening rate 1,000/2.1 = 476 1,000/2.4 = 417 _____

Forex gain 59 @ 90% 53 _____ Retranslation of goodwill to closing rate from opening rate 300/2.1 = 143 300/2.4 = 125 _____

Forex gain 18 18 _____ _____

18,152 To b/s _____

Answer: Xenon (full goodwill)

Net assets

Acq B/S

SC 100 100 SP 200 200 RE 1,200 2,000 PPA (2) (100) FVA (3) 600 480 Forex (4) (180 – 195) (15) Forex (5) (250 – 400) (150) _____ _____

2,000 2,615 _____ _____

Goodwill

FV of cost (440)(5) 2,200 FV of nci (given) 1,466 FV of NA (2,000) _____

1,666 _____



Group B/S NCA Goodwill (1,666/8) 208 Tangible (3,000 + (1,800 + 480)/8) 3,285 CA (2,000 + 2,200/8 – 3 PUP – 50 CA) 2,222 CL (1,000 + (1,000 + 15 Forex)/8) (1,127) NCL (1,200 + (700 – 250 Loan)/8) (1,256) _____

3,332 _____

SC 1,000 SP 500 RE (below) 1,618 NCI [1,466 +40%(2,615-2,000)]/8 214 _____

3,332 _____

Group reserves direct

Parent (1,740 – 3 PUP) 1,737 Sub (2,615 – 2,000)(60%)/8 46 Forex on invest 2,200/8 = 275 2,200/5 = (440) ___

(165) (165) ___ _____

RE 1,618 _____

Group I/S


Revenue 4,000 8,000 7 1,143 (30) 5,113 Cost of sales (2,500) (4,000) 7 (571) 30 (3,061) PUP (3) FVA (120) 7 (17) _____

Gross profit 2,052 Operating expenses (500) (1,000) 7 (157) (657) IMP (100) _____

Operating profit 1,395 Interest expense (100) (300) 7 (43) (143) Interest income 40 100 7 14 54 Forex (150) 7 (24) (24) (15) 7 _____

Profit before tax 1,282 Tax (300) (1,000) 7 (143) (443) _____ _____ _____

Profit after tax 1,415 202 839 _____ _____ MI 40% (81) ___

PAM 758 ___




Opening 1,140 PAM 758 Dividends (100) Forex 1,415/8 = 177 1,415/7 = (202) ___

(25) (60%) (15) ___ Forex 2,000/8 = 250 2,000/5 = (400) ___

(150) (60%) (90) ___ Forex 1,666/8 = 208 1,666/5 = (333) ___

(125) (60%) (75) ___ _____

Closing 1,618 _____

Answer: Xenon (partial goodwill)

Net assets

Acq B/S

SC 100 100 SP 200 200 RE 1,200 2,000 PPA (2) (100) FVA (3) 600 480 Forex (4) (180 – 195) (15) Forex (5) (250 – 400) (150) _____ _____

2,000 2,615 _____ _____

Goodwill

FV of cost (440)(5) 2,200 FV of NA (2,000)(60%) (1,200) _____

1,000 _____

Goodwill (alternative)

FV of cost (440)(5) 2,200 FV of nci (2,000)(40%) 800 FV of NA (2,000) _____

1,000 _____



Group B/S

NCA Goodwill (1,000/8) 125 Tangible (3,000 + (1,800 + 480)/8) 3,285 CA (2,000 + 2,200/8 – 3 PUP – 50 CA) 2,222 CL (1,000 + (1,000 + 15 Forex)/8) (1,127) NCL (1,200 + (700 – 250 Loan)/8) (1,256) _____

3,249 _____

SC 1,000 SP 500 RE (below) 1,618 MI (40%)(2,615/8) 131 _____

3,249 _____


Parent (1,740 – 3 PUP) 1,737 Sub (2,615 – 2,000)(60%)/8 46 Forex on invest 2,200/8 = 275 2,200/5 = (440) ___

(165) (165) ___ _____

RE 1,618 _____

Group I/S


Revenue 4,000 8,000 7 1,143 (30) 5,113 Cost of sales (2,500) (4,000) 7 (571) 30 (3,061) PUP (3) FVA (120) 7 (17) _____

Gross profit 2,052 Operating expenses (500) (1,000) 7 (157) (657) IMP (100) _____

Operating profit 1,395 Interest expense (100) (300) 7 (43) (143) Interest income 40 100 7 14 54 Forex (150) 7 (24) (24) (15) 7 _____

Profit before tax 1,282 Tax (300) (1,000) 7 (143) (443) _____ _____ _____

Profit after tax 1,415 202 839 _____ _____ MI 40% (81) ___

PAM 758 ___




Opening 1,140 PAM 758 Dividends (100) Forex 1,415/8 = 177 1,415/7 = (202) ___

(25) (60%) (15) ___ Forex 2,000/8 = 250 2,000/5 = (400) ___

(150) (60%) (90) ___ Forex 1,000/8 = 125 1,000/5 = (200) ___

(75) (75) ___ _____

Closing 1,618 _____

Answer: Xtreme (full goodwill)

Net assets

Acq B/S

SC 100 100 RE 2,000 2,100 FVA (ii) (40 depreciation for the current year) 400 360 Forex (iv) [($4m)4-($4m)6] {loss on the loan in the current account CA} (8) _____ _____

(given)2,500 2,552 _____ _____

Goodwill

FV of cost (1,100)(4) 4,400 FV of nci (given) 1,888 FV of NA (2,500) _____

3,788 _____



Group B/S NCA Goodwill (3,788/6) 631 Investments (v) 15 Tangible (3,000 – 10 (v) + [1,700 + FVA 360]/6) 3,333 CA (2,300 + 2,200/6 – 2 PUP – 4 CA) {PUP from (iii) & CA from (iv)} 2,661 CL (1,100 + (1,000 – 16 CA)/6) (1,264) NCL (1,200 + (700)/6) (1,317) _____

4,059 _____

SC 1,000 RE (below) 2,737 NCI [1,888 +30%(2,552-2,500)]/6 317 _____

4,059 _____


Parent (3,100 – 2 PUP (iii) + 5 (v) ) 3,103 Sub (2,552 – 2,500)(70%)/6 6 Forex on investment 4,400/6 = 733 4,400/4 = (1,100) ___

(367) (367) ___ _____

RE 2,742 _____

Group I/S


Revenue 500 800 5 160 (20) 640 Cost of sales (200) (400) 5 (80) 20 (270) PUP (2) FVA (40) 5 (8) _____

Gross profit 370 Operating expenses (100) (100) 5 (20) (120) _____

Operating profit 250 Impairment (70) 5 (14) (14) Interest expense (10) (30) 5 (6) (16) Forex (8) 5 (1.6) (2) Property gain (v) 5 5 _____

Profit before tax 223 Tax (90) (100) 5 (20) (110) _____ _____ _____

Profit after tax add down for both PAT 52 5 10.4 113 _____ _____ NCI 30% (3) ___

PAM {Profit Attributable to Members) 110 ___



Group reserve movement (not required of course!)

Opening 3,000 PAM 110 Forex 52/6 = 8.7 52/5 = (10.4) ___

(1.7) (70%) (1) ___ Forex 2,500/6 = 417 2,500/4 = (625) ___

(208) (70%) (146) ___ Forex 3,788/6 = 631 3,788/4 = (947) ___

(316) (70%) (221) ___ _____

Closing {see b/s} 2,742 _____

Working (v) Investment property

The land is for speculating so should be classified as an investment property. This means the asset must come out of tangibles (at cost) and go into investments (at year end fair value). The IAS on investment properties requires a gain in the i/s. It is not usual to split the gain between the forex and the land rise components. This is because both are speculating gains.

$m Cost {to come out of tangible} (D110/11) 10 Gain {to i/s} (balance) 5 ___ Closing {to go into investment} (D180/12) 15 ___



CHAPTER 4

Answer: Example 1

Cash flow additions (700-900+70-30-60-40+10) = 250.

Answer: Example 2

Tax paid (350-400+120-110+410-20) = 350.

Answer: Example 3

Associate dividend received (670-900+430+40) = 240.



Answer: Squire

Cash flow statement (IAS7)

Profit before tax 415 Interest 84 Associate (65) ___

Operating profit 434 Inventory (1,160 – 1,300 + 70) (70) Receivables (1,060 – 1,220 + 100) (60) Payables (2,105 – 2,355 + 90) 160 Depreciation 129 Disposal - Compensation payment (30) Goodwill impairment 25 Pension charge 20 ___

Cash generated from operations 608 Interest paid (45 – 65 + 84) (64) Tax paid (140) ___

Operating cash flow 404 Investing Sub acquisition (200) Pension payment (26) Tangible non current assets (338) Associate 50 _____ (514) Financing Share issue (30 + 30) 60 Dividend paid (85) Loan repayment (50) NCI dividend paid (5) ___ (80) _____

Cash flow (190) Opening 280 ___

Closing 90 ___

Workings

Intangible

Opening 65 Acq (250+30%(300)-300) 40 Closing (80) __

Impairment 25 __



Tangible

Opening 2,010 Closing (2,630) Reversal (194) Acquisition 250 Finance addition 355 Depreciation (129) _____

Purchase payment (338) _____

Associate

Opening 550 Closing (535) I/S 65 I/S (20) Forex (10) ___

Dividend received 50 ___

Retirement

Opening 16 Closing (22) Pension charge (20) ___

Cash flow (26) ___

NCI

Opening 345 Closing (522) I/S 92 Acquisition (30%)(300) 90 ___ Dividend 5 ___

Tax

Opening CT 160 Closing CT (200) Opening DT 175 Closing DT (200) I/S 205 ___

Tax paid 140 ___



Answer: Ducky


Profit before tax 866 Interest payable 45 Interest receivable (23) Associate (98) ___

Operating profit 790 Inventory (622 – 734 + 33) (79) Receivables (601 – 689 + 27) (61) Payables (913 – 1,003 + 22) 68 Depreciation 51 Disposal (7) Impairment of goodwill 40 Raw materials acquired on finance 70 ___

Cash generated from operations 872 Interest paid (9 – 6 + 45) (48) Tax paid (233) ___

Operating cash flow 591 Investing Interest received 23 Sub acquisition (204 – 80) (124) Cash in hand 3 Sale of tangible (40 + 7) 47 Associate 90 Purchase of tangibles (1,064) ___ (1,025) Financing Share issue (100 – 60 + 185 - 75 - 80) 70 Preference shares redemption (30) Borrowings issue (570 – 1,005 + 70) 365 Dividend paid (78) NCI dividend paid (41) ___ 286 ___


Closing 57 ___

Workings

Goodwill

Opening 92 Closing (78) GW [204 + 22 -200] 26 __

Impairment 40 __



Tangible

Opening 1,248 Closing (2,473) Revaluation 80 Acquisition 172 Disposal (40) Depreciation (51) _____

Cash flow purchases (1,064) _____

Associate

Opening 550 Closing (545) I/S 98 Forex (13) ___

Cash dividend 90 ___

NCI

Opening 107 Closing (157) I/S 69 Acquisition (given para (i)) 22 ___

Dividend paid 41 ___

Tax

Opening CT 202 Closing CT (222) Opening DT 417 Closing DT (390) I/S 213 Acquisition 13 ___

Tax paid 233 ___



Answer: Duke


Profit before tax 728 Interest payable 37 Interest receivable (34) Associate (98) ___

Operating profit 633 Inventory (588 – 750 + 30) (132) Receivables (530 – 660 + 25) (105) Payables (913 – 1,193 + 20) 260 Depreciation 39 Disposal (15) Impairment of goodwill 10 ___

Cash generated from operations 690 Interest paid (37) Tax paid (250) ___

Operating cash flow 403 Investing Interest received 34 Sub acquisition (17) Cash in hand 35 Sale of tangible 45 Associate (622) Purchase of tangibles (118) ___ (643) Financing Share issue (30 + 70 - 80) 20 Preference shares redemption (30) Borrowings issue (700 – 1,098 + 100) 298 Dividend paid (126) NCI dividend paid (17) ___ 145 ___


Closing 45 ___

Workings

Goodwill

Opening 83 Closing (90) GW [97 – (80%)(100)] 17 __

Impairment 10 __



Tangible

Opening 1,010 Closing (1,239) Revaluation 20 Acquisition 60 Disposal (30) Depreciation (39) Finance addition 100 _____

Cash flow purchases (118) _____

Associate

Opening 270 Closing (780) I/S 98 I/S (15) Forex (195) ___

Cash injection (622) ___

NCI

Opening 150 Closing (250) I/S 97 Acquisition (100)(20%) 20 ___

Dividend paid 17 ___

Tax

Opening CT 300 Closing CT (308) Opening DT 230 Closing DT (200) I/S 198 Acquisition 30 ___

Tax paid 250 ___



CHAPTER 5

Examiner’s answer: Value Relevance (a) External financial reporting will always be required for compliance purposes.

Governments will require accurate financial reporting as a basis for levying taxation and evaluation of the stewardship of management. However, financial statements are just one source of information for the investor. Investor information has grown to become a commodity in itself. Online news and market-information companies, databases and financial statements and other sources of product and market data have supplemented the information given in financial statements. Investors are becoming more demanding in terms of the quantity and quality of information that they receive and investor relations and its management has become a critical corporate function.

Historical financial reporting is just one element of a set of factors which investors use to determine the strength of a company. The use of new technology, new products, long-term strategic planning and the business and political environment are also judged by the market. Global investment performance standards have been developed by the Association for Investment Management and Research (AIMR) in order to standardise the calculation and presentation of investment performance. For example, these standards use calculations which involve ‘total return’ which includes realised and unrealised gains and income, and time weighted rates of return which adjust for daily-weighted cash flows. Thus it can be seen that the traditional ratio analysis based on historical cost financial statements is becoming somewhat outdated.

A key performance measure is the cash flow of the company. When financial markets value a company, they pay attention to the free cash flow which consists of cash revenues less cash expenses, taxes paid, cash needed for working capital and cash required for routine capital expenditure. These factors are projected into the future and discounted in order to provide an approximation of the company’s market value. Similarly, by taking certain free cash flow items and comparing them with the cost of capital employed, financial markets can determine whether shareholder value has increased or decreased. If the market concludes that the cash flow generated by the company will not be sustained to the long term benefit of investors, then the likelihood is that investors will abandon the shares.

The nature of the ratios being calculated from the financial statements has changed. Whilst Earnings per share and the P/E ratio are still a significant measure, analysts are calculating such measures as ‘Consensus EPS’ which estimates the EPS for the next two or more years, cash flow per share, price compared to cash flow which calculates how many times the current cash flow per share needs to be paid to purchase a share, and market value or book value per share. Additionally analysts are giving investment opinions on the potential price volatility of the share, the potential for appreciation and the income rating of a company. The use of present value analysis, the importance of quarterly earnings announcements, a belief in efficient markets and the importance of international diversification for risk reduction are other analytical techniques used by financial analysts to evaluate a company.

Of course, all of these techniques used to analyse a company cannot predict irrational behaviour by company directors.

(b) Financial reporting is evolving. The creation of the International Accounting Standards Board to work with standard setters throughout the world is helping to achieve a greater consensus on accounting standards which will reduce the risk for global investors. There is a move towards greater transparency in financial statements. Management feel that it is in their interest to make their performance more visible. Companies are seizing the initiative to explain their strategy and activities to the market focusing on the creating of long-term value. They are also explaining how they are managing the impact that the external environment has on the business.



There is increasing disclosure of non-financial measures as this is seen as a good way to communicate with shareholders about the progress of the company. Product development, brand awareness statistics, customer satisfaction surveys, employee turnover and environmental pollution records are just part of the information being disclosed as corporate reporting takes a step forward. The information disclosed can be forward looking in terms of goals, strategy, etc, or historical in terms of current resources and historical trends. In either case, the information builds on the strengths of the existing reporting systems but looks forward to the needs of the future market place.

However, too many users of financial statements still rely upon earnings as the single most important measure of corporate performance. This dependence has led to the development of the Earnings before interest, tax, depreciation and amortisation (EBITDA) being quoted as the best measure of performance. The maximisation of EBITDA is seemingly a corporate goal in itself with dubious revenue recognition and classification policies being utilised in order to achieve this goal. Analysts focus on quarterly and annual earnings figures and as a result small movements in a company’s profitability can have dramatic impact on a company’s share price. With the growth of communication via the internet, rumour and conjecture about corporate performance can have a significant effect on the value of a company even though the company is performing well.

(c) If it is assumed that one of the purposes of financial reporting is to help users predict future cash flows, then fair value accounting will assist in this prediction as fair value measurement represents the present value of future cash flows. It can, therefore, show directly the potential contribution of an asset to future cash flows or the claim on future cash flows in the case of a liability. The problem with future cash flows is that they are unknown, and unless an external market price is available, the fair value of the item will be based on the company’s own cash projections.

Not all future cash flows will be directly associated with statement of financial position assets and liabilities. Future operating activities will only have an indirect relationship with some of the non-financial items in the statement of financial position. Thus there will be a difference between the overall value of a company and the fair value of the statement of financial position net assets. The difference could be rationalised as goodwill.

Historical cost accounting reports and preserves historical cash flows. This may give a sounder basis for the prediction of future cash flows than the fair value model. The historical cost system is based around actual transactions; fair value models can be based on subjective assessment. The prediction of future cash flows is not the prime reason for financial statements. They are prepared mainly for compliance purposes. Verifiability is one of the attributes which should be afforded to financial statements and historical cost accounting aligns more easily with this concept.



Martin’s answer: VALUE RELEVANCE

(a) IMPORTANT

FS are still important and I can prove it:

Proof 1 – Share price

The share price moves when FS results are announced. If nobody was listening the share price wouldn’t move.

Proof 2 - Enron

A lot of people got very upset when Enron lied in its FS. If FS were not important no-one would have got upset.

REDUCED

But on the other hand, it is true that FS importance has reduced over the years due to the new alternatives.

Alternative 1 - Internet

Probably the principle alternative to annual FS is the company website.

Alternative 2 – Analyst reports

Also analysts issue reports on their assessment of strategy and performance.

Alternative 3 - Newspapers

Even newspapers have articles on businesses and finance and this forms an alternative to the FS.

PERFORMANCE MEASURES

The modern investments analysts tend to use models based on DCF (discounted cash flow).

Example 1 – DVM (dividend valuation model)

The DVM discounts future dividend stream down to present value.

Example 2 – OVM (operating cash flow valuation models)

The OVM use discounting of estimated future operating cash flows.

HISTORICAL INFORMATION

But of course, both models use past information to estimate future cash flows.

TRADITIONAL RATIOS

And of course, analysts still use gearing and ROCE, just as they did in the 1950s.

(b) EARNINGS 1

Manipulation

Any analysts who over-focus on profit will be easily fooled by creative accounting.



EARNINGS 2

Single figure

Even if the earnings are faithful, it is still a single figure and cannot sum up the company.

CHANGING 1

Convergence

The world is increasingly adopting IFRS.

CHANGING 2

Transparent

Financial reporting is becoming increasingly transparent with clear presentation and notes.

CHANGING 3

Fair values

Financial reporting is making increasing use of fair values, to make the position statement more meaningful.

CHANGING 4

Pensions

Pensions accounting is improving carrying losses as assets is about to be banned.

CHANGING 5

Leases

Soon financial reporting will recognize a liability for all leases.

CHANGING 6

Presentation

New FS presentation is being developed to make all three FS more consistent with one another.

(c) OBVIOUSLY

FVA (fair value accounting) and HCA (historical cost accounting) are mutually exclusive. So obviously the more you use one, the less you use the other.

FAIR VALUE

This has come to mean market value.

HISTORICAL COST

This is the past cost paid at purchase.

RELEVANCE

FVA is preferred because of its greater relevance.



RELIABILITY

It is true that HCA has greater reliability, but reliability is probably less important than relevance.

CONCLUSION

So financial reporting is moving towards FVA to improve the usefulness of FS.



Examiner’s answer: World Energy (a) The way in which companies manage their social and environmental responsibilities

is a high level strategic issue for management. Companies that actively manage these responsibilities can help create long term sustainable performance in an increasingly competitive business environment. Greater transparency in this area will benefit organisations and their stakeholders. These stakeholders will have an interest in knowing that the company is attempting to adopt best practice in the area. Institutional investors will see value in the ‘responsible ownership’ principle adopted by the company. Although there is no universal ‘best practice’ there seems to be growing consensus that high performance is linked with high quality practice in such areas as recruitment, organisational culture, training and reduction of environmental risks and impact. Companies that actively reduce environmental risks and promote social disclosures could be considered to be potentially more sustainable, profitable, valuable and competitive. Many companies build their reputation on the basis of social and environmental responsibility and go to substantial lengths to prove that their activities do not exploit their workforce or any other section of society.

Governments are encouraging disclosure by passing legislation, for example in the area of anti-discrimination and by their own example in terms of the depth and breadth of reporting (also by requiring companies who provide services to the government to disclose such information). External awards and endorsements, such as Environmental league tables and Employer awards, encourage companies to adopt a more strategic approach to these issues. Finally, local cultural and social pressures are causing greater demands for transparency of reporting.

There are arguments for giving organisations the freedom to determine the contents of such reports and for encouraging common practices and measures. Standardised reports may fail to capture important information in individual organisations and may lead to ‘compliance’ rather than ‘relevance’. At the same time, best practice would encourage consistency, comparability and reliability, providing a common framework which companies and stakeholders might find useful.

(b) Corporate Environmental Governance

The reporting of corporate environmental governance by World Energy could be improved by including the following information in the financial statements:

(i) a statement of the environmental policy covering all aspects of business activity

(ii) the management systems which reduce and minimise environmental risks (reference should be made to internationally recognised environmental management systems)

(iii) details of environmental training and expertise

(iv) a report on their environmental performance including disclosing verified emissions to air/land and water, and how they are seeking to reduce these and other environmental impacts. Operating site reports for local communities for businesses with high environmental impacts

(v) details of any environmental offence that resulted in enforcement action, fine, etc, and any serious pollution incident (vi) a report on historical trends for key indicators and a comparison with the corporate targets

(vii) a simple environmental income statement and statement of financial position including income and value derived from the environment, expenditure on natural resources, licences etc, investment in anti-pollution equipment

The environmental performance statements and report should be audited and verified to recognise environmental and auditing standards, and companies should perhaps have a ‘Health, Safety and Environment Committee.’

(c) The reporting of ‘Human Capital Management’ (HCM) varies worldwide. Legal requirements tend to determine the information which is currently disclosed, with multinational companies being more proactive in publishing information especially where they feel it will help them recruit talented employees and build up their



employer brand image. Legislation generally requires the disclosure of workforce demographics, remuneration, information on disabled employees, etc.

In order to improve the understanding of the link between corporate performance and employees, reports on HCM should have a more strategic focus by communicating the links between the item practices, its business strategies and its performance. Information on the following aspects could enhance this focus:

(i) size and composition of the workforce

(ii) retention and motivation of employees

(iii) skills necessary for success, training, remuneration and fair employment practices

(iv) leadership and succession planning

Information disclosed should be comparable over time by using consistent and commonly accepted definitions.

The Management Discussion and Analysis (MDA) could be used for these additional disclosures as this document contains an analysis and discussion of the main trends and factors likely to affect the company’s performance. Key indicators and definitions need to be developed in order to ensure comparability of disclosure. In addition to reporting in published financial statements, internal reports can be made to employees, employee newsletters and web site bulletins can be issued. Specific corporate social responsibility reports can be published externally and planned media releases can be made.

ACCA marking scheme

Marks (a) Strategic issue 1 Sustainable performance 1 Transparency 1 Best practice 1 Responsible ownership 1 Performance 1 Reduction of risks 1 Reputation 1 Exploitation 1 Governments 1 External awards 1 Cultural/Social pressures 1 –– Available 12 Maximum 10 (b) 1 mark per point up to a maximum 7 –– (c) Nature of current information 4 Visibility 4 –– 8 –– Available 27 Maximum 25



Martin’s answer: World Energy

Discretion The IASB clearly think that the absolute discretion that directors have at present cannot continue. That is why they have issued a discussion paper (DP) on OFR (operating and financial review) including environmental and social reporting (ESR).

Subjective However, fundamentally ESR is subjective so necessarily involves some director discretion.

Encouragement (1) – Shareholders

Shareholders would certainly pressurize directors to ESR as evidence shows that it increases shareholder value.

Encouragement (2) – Competitors

Competitors would be putting pressure on world energy to improve its ESR because their better ESR would give them competitive advantage.

Encouragement (3) – Customers

Customers provide encouragement for companies to improve ESR. They can boycott a product when they doubt its green policies.

Encouragement (4) – Suppliers

Suppliers can pressurize companies to improve ESR. They may make ESR a necessary criterion for supply.

Encouragement (5) – Entrants

Entrants with genuine green credentials can force existing market players to improve ESR simply by threatening to enter a market.

Encouragement (6) – Substitutes

Green substitutes can make the original energy supplies, like World Energy, improve their ESR in an attempt to compete.

Encouragement (7) – Government

Governments make companies improve their voluntary ESR by threatening legislation.

Encouragement (8) – Directors

You never know, directors might even encourage each other to improve ESR simply because they are nice people.



Specific comments

Radiation dosage

I suggest the above is not disclosed at all. If disclosure is really necessary then it should be put in context.

Total acid gas

This section is not so bad but it should look at improvements.

Clean air

This is more like it. This section should be expanded and presented first.

General comments

Graphs

The present environmental reporting seems very technical. Communication to the general user could be improved by graphs/pie charts/block diagrams and colour.

Industry

World Energy performance could be better understood by comparison to industry.

Critical success factors (CSF)

The critical success factors and how World Energy addresses these issues should also be disclosed.

Targets

Also World Energy should consider disclosing targets.

Financial statements It is true that there is little information on employee value in FS.

Statement of financial position

The workforce is not capitalised as an asset due to the lack of control over them.

Profit and loss

There is disclosure in the P&L notes but this is dry, technical information about costs and remuneration.

Other channels

However, this does not mean the company should give up. If it wants to show the value of its ‘human capital management’, then it must use other channels (of communication).

Visible 1 – OFR

Perhaps most obvious is the OFR. This has a big section on social reporting where World Energy would be free to discuss the value of its workforce.



Visible 2 – Newspapers

It will be difficult to get newspapers interested in the value of our employees but perhaps an investor in people programme might work.

Visible 3 – Times list

We try to get ourselves on the ‘Times 100 best companies to work for’ list. That would certainly show the value we put in our employees.

Visible 4 – Internet website

Finally there should be a website section on employees. In this section we could even quantify estimated workforce value.

Examiner’s answer: Mineral

REPORT

To: The Directors of Mineral plc

From: Adviser

Date:

Re: Annual Reports

Terms of reference

You have requested a report setting out the nature of information which could be disclosed in annual reports in order that there may be better assessment of the performance of the company. These elements could be said to include:

1 The reporting of business performance. 2 The analysis of the business position. 3 The nature of corporate citizenship. Reporting business performance

Traditionally, annual reports have mainly disclosed historical financial data regarding the operating and financial performance of the group. The traditional return on capital employed, profit based and liquidity ratios are set out in the appendix, but these can be supplemented by a commentary which discusses the strategic objectives and external conditions.

For example, it is noted that gross profit margin has improved, while the operating margin has declined and the reasons for this could be given. In addition, the company can compare the actual results against targets.

Targets might include unit sales, market share and earnings growth. Specifically, in the case of Mineral, disclosure can be made of the projected earnings growth of 20 – 25% together with a discussion of the underlying reasons for this growth.

In reviewing the operating results, Mineral could discuss the impact of the acquisition of the competitor company together with the changes in the business environment through the increased use of aluminium and the cost reduction programme. Traditional areas of discussion relating to comparisons of company ratios with industry averages, analysis of share price movements and cash flow forecasts are still important.

Specific disclosure could be made of the company’s pricing strategy and the anticipated increase in demand together with the research and development budget. Legal advice should be taken before making reference to the formation of a cartel by the car manufacturers.



Analysis of the financial position

Having discussed the performance of the operating activities of the business, it is relevant then to explain how these activities and the future activities have been and are likely to be financed.

Traditional financial ratios such as gearing and debt to equity should be disclosed, together with the company’s policy towards its debt and equity structure and longer term funding objectives.

The company’s attitude towards and exposure to exchange, interest and credit risk should be discussed.

Mineral has been purchasing and cancelling its own shares, there is also a potential conversion of a subsidiary’s debentures and there is a further issue regarding the financing of customers. All this should be discussed and disclosed in detail.

The nature of corporate citizenship

Corporate citizenship is about acknowledging in the company’s decision making process that the maximisation of profit should not be the sole factor. Corporate citizenship means acting in an ethical and responsible way e.g. having flexible employment terms for parents, siting factories to minimise environmental damage etc. Users do want to know about companies’ attitudes to these matters.

The increased demand for this information by increasingly sophisticated investors has led to an expansion in Corporate reporting. Many companies make reference to the ‘triple bottom line’ and seek to report on economic, social and environmental performance.

Thus, Mineral should include in its annual report reference to its responsible corporate behaviour and it will not be alone in doing this. Specifically, disclosure could be made of:

1 The use of eco-productivity index. 2 The development of eco-friendly cars. 3 The company’s policy towards the regeneration of old plant. 4 The company’s attitude towards its workforce which it sees as a key factor in the

growth of the business. The company could also report specific measurements, for example, target emission levels from factories, industrial accidents and working hours.

Conclusion

I trust that the above report is of assistance and please do not hesitate to contact me should you require classification.

Appendix

Profit ratios:

$m 20X1 20X0

Return on capital employed 13+59

10 13.9% 16.4%

Salesprofit Gross

25045

! 100 18% 17.4%

SalesprofitOperating

25010

! 100 4% 4.5%

Long and short term liquidity ratios:

reserves and Capitalsliabilitie termLong

5913

! 100 22% 19.6%

sliabilitie Currentassets Current

2555

2.2 1.8



ACCA marking scheme Marks Reporting business performance. Strategy and targets

3

Operating performance 2 Risks 2 Investment 2 Analysis of financial position. Capital structure 2 Liquidity 2 Treasury measurement 2 Corporate citizenship. Corporate governance 2 Ethics 1 Employee reports 1 Environment 1 Use of information in question 4 Style and layout 4 ––– Available 28 Maximum 25 –––

Martin’s answer: MINERAL

REPORT To: Directors

From: Advisor

Date: Today

Subject: Management commentary

__________________________________________________________________

INTRODUCTION

The following report contains advice on management commentary in the context of performance position and citizenship.

REPORTING BUSINESS PERFORMANCE

Ratios

My first piece of advice is calculating ratios for shareholders. To save the shareholders the bother, calculate and explain:

EPS Liquidity ratios ROCE Gearing OPM

Growth

I would advise directors to tell shareholders about the expected growth but I would advise prudence (10%).

Business efficiencies

I would advise directors to explain their plans regarding business efficiencies but advise that they are careful not to put the fear of redundancies into the workforce.



New products

I would advise directors to be very careful about disclosures of information related to new products. After all competitors will be reading management commentary as well.

Aluminium

I would advise directors to explain all about their products and market position. In fact I would advise directors put this information first before all the above.

Acquisition

I would suggest directors dedicate a whole page to the acquisition, explaining the strategy, the price, the performance since acquisition.

Substitution

The substitution of aluminium for heavier metals is very interesting and should be explained to shareholders.

Targets

Keeping my advice simple, I would simply advise that directors avoid reference to the targets. I think this internal information could create problems if more public.

Pricing strategy

I recommend that directors are very up front about minerals pricing strategy. No need to worry about competition as they certainly know we are undercutting them.

Cartel

I advise directors are really careful what they say about the car manufacturing cartel. Any accusation could result in litigation.

ANALYSIS OF FINANCIAL POSITION

Research expenditure

I recommend that directors disclose the figure of $40m to show minerals commitment to development.

But I recommend no disclosure about individual projects.

Enlarging production

I recommend directors enlarge on enlarging production capabilities including details on which plants are due for expansion.

New aluminium body

Since I know about this project and I am an outside advisor, it seems this project is public knowledge. On this basis I advise directors explain this strategic move.

Share cancellation

This financial strategy shows directors’ confidence in their own company but shareholders may not know this so we should tell them.



Convertibles

The sub-convertible loan may convert into equity and Mineral may lose ownership. So directors should explain whether we may lose control.

Customer credit

The culture of customer credit and the part usually played by the banks is very unusual business practice and should be explained to shareholders.

CORPORATE CITIZENSHIP

Financial risk

The directors’ attitude to financial risk is part of its corporate citizenship. Its use of hedging should be explained.

Sensitivity analysis

But the sensitivity analysis sounds very technical, so I advise directors to put this in the website with a link from the management commentary.

Reputation

I recommend directors talk about the positive reputation for responsible behaviour. They should be proud of this reputation.

Workforce

Directors should also explain that it is part of their vision to see the workforce as a key factor in profitable growth.

Eco-productivity index

This is new and complicated so I suggest no mention is made of the above this year.



CHAPTER 6

Answer: Furniture

‘There is no such thing as interest free credit’. (David Tweedie 1994/95)

Unbundling

$ Revenue recognition

Furniture (DCF) 803 AT delivery (when risks and Finance (β) 197 rewards transferred) _____ Over 2 years

Contract (given) 1,000 _____

Discounted cash flow (DCF)

CF DF PV Cash flow Discount factor Present value

(1) 500 1/1.16 = 0.862 431 (2) 500 1/1.162 = 0.743 372 ___

FV 803 ___

Conclusion

Clearly your current sales will be:

Furniture 803 Finance 128 ___

Sales at end of 1st year 931 ___

(16%) Opening Finance Paid Closing

(1) 803 128 (500) 431 (2) 431 69 (500) 0

Examiner’s answer: Rockby (plant) The plant would not be classed as a ‘held for sale’ asset at 31 March 20X4 even though the plant was sold at auction prior to the date that the financial statements were signed. The ‘held for sale’ criteria were not met at the statement of financial position date and IFRS 5 prohibits the classification of non-current assets as ‘held for sale’ if the criteria are met after the statement of financial position date and before the financial statements are signed. The company should disclose relevant information in the financial statements for the year ended 31 March 20X4. The plant is not classed as ‘abandoned’ by the IFRS and would be depreciated up to its sale.



Examiner’s answer: Rockby (sub) Under IFRS 5, a non-current asset or disposal group (in this case Bye – as it is a cash generating unit) should be classified as ‘held for sale’ if its carrying amounts will be recovered principally through a sale transaction rather than through continuing use. The criteria which have to be met are: (i) a commitment to a plan

(ii) the asset is available for immediate sale

(iii) actively trying to find a buyer

(iv) sale is highly probable

(v) asset is being actively marketed

(vi) unlikely to be significant changes to the plan

These criteria seem to have been met in this case. Before classification of the item as ‘held for sale’ an impairment review will need to be undertaken irrespective of any indication or otherwise of impairment. Any loss will be charged to the income statement. IFRS 5 requires items ‘held for sale’ to be reported at the lower of carrying value and ‘fair value less costs to sell’. The latter phrase essentially means net selling price. IFRS 5 requires extensive disclosure on the face of the income statement and in the notes regarding the subsidiary. In the statement of financial position, it should be presented separately from other assets and liabilities. The assets and liabilities should not be offset. There are additional disclosures to be made concerning the facts and circumstances leading to the disposal and the segment in which the subsidiary is presented under IAS 14 Segment Reporting. Thus IFRS 5 will make a significant difference in terms of the level of disclosure but in this case will not affect any impairment provision as that will have already been triggered under IAS 36. Unlike IAS 36, any impairment loss will be offset first against the non-current assets of the subsidiary. A similar calculation to the impairment review under current IFRSs will occur in order to determine the carrying amounts of the ‘held for sale’ assets. The figure of $4.5 million will be used as ‘fair value less costs to sell’. The net assets and goodwill will be written down to $4.5 million with the write off going against non-current assets in the first instance.

Answer: Kiplin Total Professional Higher

T/O 700 350 350 OP 200 60 140 NA 500 150 350 Total US UK

T/O 700 560 140 OP 200 100 100 NA 500 350 150



CHAPTER 7

Answer: Russian Chemical Spill


There is already an estimate available in the sum of $7m.

(O) Obligation

There is a constructive obligation resultant from the public green policy.

Decision Obligation

Public Constructive Secret None

(T) Transfer

Obviously money will flow out when the land is cleaned.

Conclusion

The costs must be provided.

Double entry

The following journal is appropriate:

Dr Cleaning costs (super exceptional) (P&L) $7m Cr Provisions (B/S) $7m

Answer: Oil Rig


The company already have a guess of $120m for dismantling the rig.

(O) Obligation

There is a legal obligation derived from the licence.

(T) Transfer

Of course cash will transfer out.

Conclusion

The oil company should provide.

Measurement

The liability should be measured at the discounted present value of the future cash flow.

Provision = $120m/1.120 = $18m



Double entry

The following journal is required:

Dr Fixed asset cost (B/S) $18m Cr Provisions (B/S) $18m

Fixed asset

The above cost is slapped on top of the other two costs:

$m

Construction 200 Installation 100 Dismantling 18 ___

Initial cost 318 ___

Depreciation

Then the above is depreciated over 20 years:

Dr Depreciation - operating costs (P/L) 15.9 (318/20 yrs) Cr Fixed asset (B/S) 15.9

Unwinding

Also, quite separately, the provision is unwinding over 20 years. First year journal:

Dr Financing (P/L) $1.8m Cr Provision (B/S) $1.8m (18)(0.1)

Table

Year Opening Finance Closing 1 18.00 1.80 19.80 2 19.80 1.98 21.78 3 21.80 2.18 23.96 4 23.96 2.40 26.40 20 120.0

Answer: Outrageous

Newspaper provides, public figure discloses.

Answer: Fraud

Adjust for 10million theft.

Answer: Cheated

The entities Cheated and Cheeky are related via Mr and Mrs Cute. So any transaction between them is a related party transaction and must be disclosed.



Answer: Satellite

The marking guide was based on the usual 1 mark per idea well expressed. So the following would look good on a markers screen.

(a)

Three

There are three recognition criteria.

Reasonably reliable estimate

It must be possible to make a reasonably reliable estimate of the outflow that will result from the obligation before a provision is permitted.

Obligation

There must be a present legal or constructive obligation at the year end before a provision is permitted.

Transfer

There must be an expectation that economic benefit will flow out in the future as a result of the obligation.

Comment

Frankly, the IAS argues it is always possible to estimate the outflow and it is very rare for a transfer out to be avoidable. So in practice, the accountant can focus purely on the obligation criteria.

Framework

Perhaps it should be noted how the above closely follows the focus of the framework on assets and liabilities. The framework also defines a liability in terms of present obligations.

(b)

1 Operating lease

Actually it is irrelevant whether the above is operating or finance lease in the context of analysing related provisions. Either type of lease creates an obligation.

Present obligation

But the trick here is to spot the present obligation. Satellite does have a present obligation for the damage done during the tenure ($1.2m) but not for the damage that might be done in the future (maybe $4.8m).

Conclusion

So satellite should provide $1.2m and should probably recognise the charge to the p/l as Superexceptional on the face of the income statement given its unusual nature.



2 Universe

First we must eye this problem form the perspective of the subsidiary. It is the sub that will be putting through the double entry. Then we can look at the effect on the group.

Modification

The key term in this paragraph is ‘modify’. We can see that Universe already has made the modifications and therefore has a present obligation as a result of this past obliging event.

Provision

So a provision is required for the cost of restoration. The provision is required at the point of modification. The modification occurred at the year start.

Measurement

However, the restoration will not take place until the end of the lease; so the time value of money must be considered. But we need to be careful here, as the $2m is already discounted.

Double entry

So the year start double entry is:

Dr Non Current Asset $2m

Cr Provision $2m

Non current asset

In fact the above nca entry goes on top of the initial premium:

Premium $8m Restoration $2m ___ Initial cost $10m ___

Depreciation

Then of course the above is depreciated over its life, which is 10 years.

Depreciation double entry

This is the same every year:

Dr i/s $1m

Cr NCA $1m

Unwinding

And of course quite separately the liability unwinds. The scenario does not tell us the discount rate, so I have assumed 10%.

Unwinding double entry

This snowballs every year (grows exponentially), but the first year journal would be as follows:

Dr i/s $0.2m

Cr Prov ($2m)(10%) $0.2m



Impairment test

There is even data for an impairment test. However, there is no impairment as the carrying value of the asset at the year end ($9m) is less than the recoverable value ($9.5m).

Group effect

The above double entry will be accommodated by the sub. However, because this is a partially owned sub the group/nci effect will be 80%/20%.

3 Repairs

There appears to be no obligation for the repairs. Just an intent to repair sometime in the future.

Conclusion

So I suggest there can be no provision for the repairs.

Depreciation

I am not sure whether I am supposed to comment on the depreciation, but it looks like nonsense to me. Buildings should be depreciated over their useful lives regardless of being owned or otherwise.

4 Intangible

An intangible is recognised if it is purchased. Also development is recognised if it is recoverable. It sounds like the external costs are the former and the internal costs are the latter.

Conclusion

So it appears to be reasonable to capitalise and depreciate the asset. However, I would advise satellite to adjust the life down to 4 years, as that appears to be the real life. Also there is no obligation to revise. So no provision is possible.

5 Goodwill

Clearly if satellite had predicted the extra $8m they would have put it in the consideration and the acquisition goodwill would have been higher.

Prior period adjustment (PPA)

But the only way to adjust last year’s goodwill is via a PPA (restatement). This is only permissible if the $8m is a material error. But to me it sounds like a change in an estimate. So the $8m will simply have to be costed to the i/s.

IFRS3

IFRS3 supports this view, by giving a 12 months limit on playing with goodwill after acquisition.

Conclusion

I hope the above gave you a feel for how Graham likes to get you thinking about an issue in a focus question and how to address wider issues so you can broaden your analysis.



CHAPTER 8

Answer: Supermarket Materials 30 Labour 20 Legal 2 Interest (10%)(40)(/12) 3 __

Initial cost 55 __

Answer: Oops Cost 100 Depreciation (10) ___

Opening 90 Depreciation 30 __

Closing 60 __

Answer: Blob B S C

Before 300 400 500 Impairment (10) (170) (0) ___ ___ ___

After 290 230 500 ___ ___ ___

Answer: AB Before Impairment After

Goodwill 40 (40) - Garage 20 (10) 10 Computers 10 (5) 5 Vehicles 90 (30) 60 Intangibles 30 (5) 25 Receivables 10 - 10 Cash 50 - 50 Payables (20) - (20) ___ __ ___

230 (90) 140 ___ __ ___



Answer: Revert Cost 400 Revaluation (to OCI) 10 ___

Opening 410 Reversal (to OCI) (10) __ Historical net book value (400cost – zero depn) 400 Impairment (to I/S) (3) ___

Closing 397 ___

Note that the reversal is limited by the hnbv. Historical net book value is the figure that the entity would have been carrying had there been neither an increase nor decrease in value, only depreciation, which for land is zero.



Answer: Rethink Cost 8.00 Depreciation (8/10years) (0.80) __ Before 7.20 Revaluation gain (to OCI){balance} 2.80 ___

Current year opening 10.00 Depreciation (10/9years) (1.11) __ Before 8.89 Reversal of revaluation gain(to OCI){balance} (2.49) __ Historical net book value (8cost – 1.6depn) 6.40 Impairment (to I/S){balance} (2.40) ___

Closing 4.00 ___

Note that the reversal is limited by the hnbv. Note also (if you are particularly hot with numbers) that the reversal is 8/9 of the original gain. Here is the answer again but this time based on down to $4m at the current year start and then up to $10m at the current year end. Note how the application of hnbv is unchanged.

Cost 8.00 Depreciation (8/10years) (0.80) __ Before 7.20 Impairment (to I/S){balance} (3.20) ___

Current year opening 4.00 Depreciation (4/9years) (0.44) __ Before 3.56 Reversal of impairment loss (to I/S){balance} 2.84 __ Historical net book value (8cost – 1.6depn) 6.40 Revaluation gain (to OCI){balance} 3.60 ___

Closing 10.00 ___

Answer: Grant Mitchell NCA Building

Cost (100 + 20) 120 Depreciation (120/20) (6) ___

Closing 114 ___

Deferred income Grant

Grant 20 Income (1) __

Closing 19 __



Answer: Decided

The factory is a simple occupied property.

$m

Opening carrying value 40 Depreciation (2) __ Closing 38 __

Answer: Game $m Squad (Twenty Players) 23 Star 17 Slogan 0 __ 40 __

Examiner’s answer: Tyre The land and buildings of the former administrative centre are accounted for as separate elements. The demolition of the building is an indicator of the impairment of the property under IAS36. The building will not generate any future cash flows and its recoverable amount is zero. Therefore, the carrying value of the building will be written down to zero and the loss charged to profit or loss in the year to 31 May 2006 when the decision to demolish the building was made. The land value will be in excess of its carrying amount as the company uses the cost model and land prices are rising. Thus no impairment charge is recognised in respect of the land. The demolition costs will be expensed when incurred and a provision for environmental costs recognised when an obligation arises, i.e. in the financial year to 31 May 2007. It may be that some of these costs could be recognised as site preparation costs and be capitalised under IAS16. The land will not meet the criteria set out in IFRS5 ‘Non-current Assets Held for Sale and Discontinued Operations’ as a noncurrent asset which is held for sale. IFRS5 says that a non-current asset should be classified as ‘held for sale’ if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. However, the non-current asset must be available for immediate sale and must be actively marketed at its current fair value (amongst other criteria) and these criteria have not been met in this case. When the building has been demolished and the site prepared, the land could be considered to be an investment property and accounted for under IAS40 ‘Investment Property’ where the fair value model allows gains (or losses) to be recognised in profit or loss for the period.

Martin’s Answer: Tyre

BUILDING: DEPRECIATION

Whilst the building is in use up to the point of abandonment it should be depreciated.

BUILDING: IMPAIRMENT

At the point of abandonment the building should be written off altogether as recoverable value has fallen to zero (VIV = 0 + NRV = 0).

LAND: DEPRECIATION

The land is undepreciated throughout because of its infinite useful economic life.



LAND ‘ABANDONMENT’

At abandonment the land comes out of PPE and I suggest goes into investment properties.

HELD FOR SALE

The land is certainly not ‘held for sale’ because the intent is to hold the asset whilst the market is rising.

INVESTMENT PROPERTY

I suggest that the property is an investment property as it is literally empty after abandonment.

REVALUATION

So the land would be carried at fair value with gains and losses to PPE after abandonment.

PROVISION

A provision for the remedial works is not permitted at the year-end as the building has not been knocked down at that point.



CHAPTER 9

Answer: ABMN Part one: Statement of financial position A B

Fixed asset: Cost 800 700 Depreciation (200) (100) ___ ___

NBV 600 600 ___ ___

Creditors: < 1 year 220 112 > 1 year 418 535 ___ ___

Total 638 647 ___ ___

Profit and loss

Depreciation (200) (100) ___ ___

Interest 58 59 ___ ___

Advance Opening Instalment 10% interest Closing A 800 (220) 58 638 ___ ___ ___ ___

B 700 (112) 59 647 ___ ___ ___ ___

Part two: Statement of financial position M N

Fixed asset: Cost 500 650 Depreciation (100) (50) ___ ___

NBV 400 600 ___ ___

Creditors: < 1 year 88 5 > 1 year 332 640 ___ ___

Total 420 645 ___ ___

Profit and loss

Depreciation (100) (50) ___ ___

Interest (50) (65) ___ ___



Arrears Year Opening Interest Instalment Closing M 1 500 50 (130) 420 2 420 42 (130) 332 ___ ___ ___ ___

N 1 650 65 (70) 645 2 645 64.5 (70) 640 ___ ___ ___ ___

Clearly the new information that the machine life is actually 50 years changes the lease to an operating lease.

Part three: FS effect Profit and loss

Operating costs: Rental (70) ___

Creative accounting

The trouble is that it is relatively easy to lie and say the life of the machine is 50 years when it isn’t. This results in untrue operating lease accounting and is the classic form of off statement of financial position finance.

Discussion paper on leases

The IASB propose that only finance lease accounting be available. This would prevent the above creative accounting.

Answer: Tabular

(i) Simple secured loan of $30m.

(ii) Simple sale with proceeds of $50m.

(iii) Complex sale. Maybe the real sale proceeds are $65m and the extra $5m is a liability.

(iv) Complex sale. Maybe the real sale proceeds are $23m and the shortfall of $3m is an asset.



CHAPTER 10

Answer: Contact Details PLC On assets One Two Three Market value at start of the year 1,000 1,190 1,372 Expected return on the assets (Using the discount rate!!)

100 107 110

Contributions 90 100 110 Benefits paid (150) (180) (190) Actuarial gain (loss) – balancing fig 150

——— 155

——— (214)

——— Market value at end of the year 1,190 1,372 1,188 On obligations Obligation at start of the year 990 1,100 1,380 Interest (also using discount rate)

99 99 110

Current service cost 130 140 150 Benefits paid (150) (180) (190) Actuarial (gain) loss – balancing fig 21

——— 221

——— (42)

——— Obligation at end of the year 1,100 1,380 1,408 The statement of financial position

Pension assets 1,190 1,372 1,188 Pension obligations (1,100)

——— (1,380) ———

(1,408) ———

Net Pension asset (liability)-disclosed 90 (8) (220) The income statement Operating Current service cost - disclosed (130) (140) (150) Finance

Expected return on assets 100 107 110 Interest cost (99)

——— (99)

——— (110)

——— Finance income (expense) - disclosed 1 8 0 Other Comprehensive Income Actuarial gain (loss) on assets 150 155 (214) Actuarial gain (loss) on obligations (21) (221) 42 Net actuarial gain (loss) - disclosed 129 (66) (172)



Answer: Glossary (a) On assets Market value at start of the year 390 Expected return on the assets 39 Contributions 34 Benefits paid (26) Actuarial gain (loss) – balancing fig (67) Market value at end of the year 370 On obligations Obligation at start of the year 400 Interest 40 Service cost (14 + 100) 114 Benefits paid (26) Actuarial (gain) loss – balancing fig 2 Obligation at end of the year 530 The statement of financial position Pension assets 370 Pension obligations (530) Net pension asset (liability) (160) The income statement Operating Service cost (114) Finance Finance cost (39-40) also (390-400)10% (1) Other Comprehensive Income Actuarial (loss) on assets (67) Actuarial (loss) on obligations (2) Net Actuarial (loss) (69)



(b) Policies

There are is policy available to Glossary as regards the recognition of the above net actuarial loss. The $69m loss must be recognised in the OCI (Other Comprehensive Income, sometimes known as the SORIE, Statement of Recognised Income and Expense)

But there used to be another policy called the corridor. It was banned in June 2011 by the reissue of IAS19. You do not need to know anything about the corridor, but because you might see references to it in texts here and there, I shall describe it briefly.

The corridor policy was widely criticised for its bizarre lack of logic as it recognised the loss on the balance sheet as if it were an asset. This is subject to a tiny release of the opening loss to the p/l. This release is even more bizarre than the capitalisation of a loss and it is from this release that the name corridor derived.

(c) Curtailment

The technical name for the winding up of the policy and paying off the employees is called “curtailment”. It is a nasty business where the entity tries to pay the employees less than they are owed and the employees try to fight for every penny but in fear of their jobs. There is lots of it out there at the moment and you may have read about BA staff caught up in this mess.

Fs

The fs effect is dead easy. The asset, the liability and the settlement cash are swept into the p/l to give a profit or loss on settlement:-

$m

Asset 370

Liability (530)

____

Net pension liability (160)

Settlement cash 167

____

Settlement loss 7

____

This is a loss because Glossary has paid more than they thought they owed.



(d) Asset ceiling

The present value of the reductions in the future contributions is called the “asset ceiling”. It is so called because it sets an upper limit on any net pension asset. On rare occasions the asset ceiling may fall below the value of the net pension asset. In this case this has occurred and the top of the net pension asset is shaved off and dumped in the p/l.

Fs

The fs effect for this is also dead easy:-

$m

Asset 100

Liability (82)

____

Apparent net pension asset 18

Derecognition loss (2) to i/s as operating cost

____

Recorded net pension asset

Limited by Asset ceiling 16 to b/s as nca

____

Note that although the net pension asset at first appears to be $18m because $2m has been written off, only $16m is recorded on b/s.



CHAPTER 11

Benign Opening 0.0 Increase 12.0 ____

Closing year one (90)(0.40)(1/3) 12.0 Increase 12.8 ____

Closing year two (93)(0.40)(2/3) 24.8 Increase 12.8 ____

Closing year three (94)(0.40)(3/3) 37.6 ____

Bilberry Opening 0.0 Increase 1.2 ___

Closing year one (18)(0.20)(1/3) 1.2 Increase 0.8 ___

Closing year two (15)(0.20)(2/3) 2.0 Increase 1.2 ___

Closing year three (16)(0.20)(1/2) 3.2 ___

Beth Opening 0.0 Increase 8.9 ___

Closing (200)(10,000 – 1,100)(10)(1/2) 8.9 ___

Easy Peasy Opening 0 Increase 33,750 ______

Closing year one (750)(6)(15)(1/2) 33,750 ______



Sneaky Opening 0 Increase 13,333 ______

Closing (2)(2,000)(10)(1/3) 13,333 ______

SARS Opening (400 – 100)(700)(18)(1/3) 1,260 Increase 1,540 _____

Closing (400 - 100)(700)(20)(2/3) 2,800 _____

Jay Opening 0 Increase 900 ___

Closing (300)(500)(80%)(15)(1/2) 900 ___

Normally Dr Operating expenses 2m Cr Share capital 2m

Inventory Dr Inventory 6m Cr SBP reserve 6m



CHAPTER 12

Answer: John

This must be a loan asset carried at amortised cost. The asset is an uncomplicated loan and the intent is to keep the asset to maturity.

The amount the company would be prepared to pay:

DCF CF DF PV

1 80 0.926 74 2 80 0.857 69 3 80 0.794 63 4 8,080 0.735 5,939 ______

FV on market 6,145 ______

Accounting

Opening Finance Received Closing

1 6,145 492 (80) 6,557 2 6,557 525 (80) 7,001 3 7,001 560 (80) 7,481 4 7,482 598 (80) 8,000

Answer: Travolta

This must be a loan asset carried at amortised cost. The asset is an uncomplicated loan and the intent is to keep the asset to maturity.

Travolta would be prepared to pay the discounted present value of the future cash inflow.

Discounted cash flow

Discount factor DCF CF DF PV

1 20 0.930 18.69 2 20 0.873 17.46 3 1,020 0.816 832.32 ______

Present value 869.00 (Also known as FV) ______

Accounting

Opening Finance Received Closing

1 869 62 (20) 910 2 910 64 (20) 954 3 954 66 (20) 1,000

Strictly the asset starts at zero and closes out at zero when the nominal is repaid. But this is usually left off the table.



Answer: Blip

This financial asset is for speculating which is for trading. So it is a financial asset at fair value with gains and losses to profit and loss.

Purchase journal

Dr Investment 400 Cr Cash (bank) 400

Year end journal

Dr Financing (P&L) 70 Cr Investment (B/S) (400 – 330) 70

Closure journals

Dr Investment (B/S) 40 Cr Finance (P&L) 40 Dr Bank (B/S) 370 Cr Investment 370

Answer: Bliny

This is a short-term investment and so asset held for trading. This is a financial asset at fair value with gains and losses to profit and loss.

Purchase journal

Dr Investment (debenture) 900 Cr Bank 900

Year end journal

Dr Financing (P&L) 100 Cr Investment (B/S) 100

Closure journals

Dr Investment 50 Cr Financing 50 Dr Bank 850 Cr Investment 850

Answer: Bling

This is a derivative therefore it is a financial asset at fair value with gains and losses to profit and loss.

Purchase journal

Dr Derivative 100 Cr Bank 100

Year end journal

Dr Derivative 10 Cr Finance (P&L) 10



Answer: Footy

The equity is held with the intention of holding forever. So this is a strategic equity investment. Often these are called financial assets carried at fair value through other comprehensive income or FVTOCI for short.

Purchase journal

Dr Equity investment 780 Cr Bank 780

Year end journal

Dr Available for sale (B/S) 70 Cr Equity investment (B/S) 70

It is unspoken in the IFRS, but it is clearly implied that if we plan to keep the asset forever, then the loss is unrealized. So the loss goes into a separate equity bucket.

Answer: Special

The asset is bought with the intention to keep forever hence this is a strategic equity investment with gains and losses to reserves (even though later they change their mind). So again this is classified strategic equity investment (FVTOCI), at least until the directors intent regarding the equity changes, which we have assumed is just before the actual sale.

Purchase journal

Dr Investment 500 Cr Bank 500

Year end journal

Dr Investment 40 Cr Reserves (strategic equity reserve) 40

Closure journals

Dr Bank 540 Cr Investment 540 Dr Reserves (strategic equity reserve) 40 Cr retained earnings (accumulated profits reserve) 40

Compare and contrast

Year of gain Year of cash flow

Revaluation gain Recognised (in OCI) transferred to RE Gain on strategic equity Recognised (in OCI) transferred to RE



Answer: Gambit

(1) Pawn

Gambit must use the last transaction price on the market at the year end just before the year ends (level one input).

(2) Knight

Gambit must use Pawn share price to estimate the Knight share price. The pawn share price will almost certainly need adjusting to accommodate differences like the sizes of the two entities and the number of shares (level two input).

(3) Bishop

The purchase of bishop was a market transaction. So it is good data. The only problem is that the data is six months old and so the purchase price must be adjusted to reflect market movements since the transaction (level two input).

(4) Queen

There is nothing like Queen out there for Gambit to use as a guide. So Gambit is forced to use financial modelling. Almost certainly a discounted cash flow using the market research data would give the best available fair value (level three input).

Answer: Bad

(a) OR criteria

Objective evidence

There must be objective evidence that something has happened to make the lender think that the full amount is unlikely to be recovered.

Luck

In the context of Luck, the objective evidence is the newspaper report.

Recoverable amount

It must be possible for the lender to estimate the amount of cash that is likely to flow in. Often because the customer is in deep trouble, this recoverable amount will be zero.

Luck

In Luck the recoverable amount is $5,000. This is the future value. So to get the present value discounting is applied. The discount rate used for the present recoverable amount must be the original rate (6%). So rather oddly, the new true market rate (7%) is ignored. The present recoverable amount at the point of impairment is $4,450 (* PV = 5,000/1.062 = 4,450). In summary:-

Objective evidence

This is the newspaper reports.

Recoverable amount

This is the complete guess of $5,000.



Conclusion

Both criteria are met therefore account for bad debts.

(b) Initial FV

DCF CF DF 6% PV

1 360 0.943 339.48 2 360 0.890 320.40 3 360 0.840 302.40 4 12,360 0.792 9,789.12 ________

Initial FV 10,750.00 ________

However, as at the end of year 2 just after receiving the $360 Bad read news that the receivable is in financial difficulties. Bad believed they will receive no further interest and only $5,000 at the end.

Year Opening Finance Received Before Impairment After closing closing

1 10,750 645 (360) 11,035 (0) 11,035 2 11,035 662 (360) 11,337 (6,887) 4,450* 3 4,450 267 (0) 4,717 (0) 4,717 4 4,717 283 (0) 5,000 (0) 5,000 * PV = 5,000/1.062 = 4,450

(c) Incurred loss model

Current recognition of bad debts is driven by the OR criteria described above. The result is that impairment of receivables can only be recognised once a customer has got into trouble. Currently bad debts are recognised when they happen and not before.

Politics

The above sounds logical. It sounds logical to recognise bad debts when they happen. It sounds illogical to recognise them when they are expected. After all, sales are recognised when they happen and not when they are expected. But the trouble is that this incurred loss model has the effect of making a recession worse. If banks wait until customers struggle before posting bad debts then those bad debt charges will pile up in a recession and make the recession worse.

Expected loss model

So the IASB are trying to develop a feasible loss model that allows for expectations. They have found the going very tough. Not only have suggestions sounded wildly subjective they have also proved difficult to apply in real banks in real life.

Answer: Spot

(1) Fair Value Hedging

(2) Cash Flow Hedging



Answer: Bescafe

Opening journal


Year end journal

Dr Derivative 30 Cr Hedge reserve 30

Closure journals

Dr Inventory 530 Cr Bank 530 Dr Bank 30 Cr Derivative 30 Dr Hedge reserve 30 Cr Inventory 30

Answer: Kent

Opening journal


Year end journal

Dr Hedge reserve 10 Cr Derivative 10

Closure journals

Dr Machine 140 Cr Bank 140 Dr Derivative 10 Cr Bank 10 Dr Machine 10 Cr Hedge reserve 10



Answer: Jewellery

Opening journal

Dr Inventory 100 Cr Bank 100 Dr Derivative 0 Cr Bank 0

Year end journal

Dr Inventory 9 Cr I/S 9 Dr I/S 9 Cr Derivative 9

Closing journal

Dr Inventory 3 Cr I/S 3 Dr I/S 3 Cr Derivative 3 Dr WIP 112 Cr Inventory 112 Dr Derivative 12 Cr Bank 12



CHAPTER 13

Formula One Opening 60 Increase 20 __

Closing 80 __

Formula Two Opening 25 Increase 95 ___

Closing 120 ___

Newly Incorporated Opening 0 Increase 360 ___

Closing (1,200)(30%) 360 ___

Temporary difference Carrying value 7,200 Tax base (6,000) _____

TD 1,200 _____

Timing difference Capital allowance 2,000 Depreciation (800) _____

TD 1,200 _____

Hold

Deferred tax

Deferred tax is defined by an equation as follows:-

Deferred tax = temporary difference x corporation tax rate

Temporary difference

This is also defined by equation:-

Temporary difference = carrying value – tax base



Meaning

The carrying value is the asset value carried on the balance sheet by the financial accountant and the tax base is the asset value carried in the tax pool by the tax accountant. So the td represents the difference of opinion between two people looking at the same asset from a different perspective.

Problem

The problem is that the mathematical basis of dt does not stand up to conceptual scrutiny by reference to the conceptual framework.

Conceptual framework

The conceptual framework demands that for an asset/liability to be recognised it must be a present right/obligation to a future economic inflow/outflow.

Future obligation

However, dt is a future obligation to a future economic outflow. As such it fails the definition of a liability and should not be recognised at all.

Illustration

The equity investment by Hold conveniently illustrates this. As the fd points out, there is no obligation to the tax authorities at the year end. It is true that if Hold had sold the asset at the year end then Hold would have a tax liability. But that is the point; Hold has not sold the asset at the year end, so owes nothing.

Numbers

But regardless of this logical argument, Hold is required by IAS12 to recognise a dt liability as follows:-

Dt = (110-70) x 30%

Dt = 12k

Accentuate CV TB TD

Building 190 120 70 X 30% ___

DT (IAS12) 21 ___

Relative CV TB TD

Building 950 540 410 X 30% ___

DT (IAS12) 123 ___



Proviso CV TB TD

Provision (60) 0 (60) X 30% ___

DT (18) ___

Deviation CV TB TD

Development 12 0 12 X 30% ___

DT 3.6 ___

Inventory CV TB TD

Inventory 55 50 5 X 30% ___

DT (IAS12) 1.5 ___

Thailand CV TB TD

Sub 370 300 70 X 60% ___

DT (IAS12) 42 ___

Actually, IAS12 says that the above DT should not be provided unless there is intent to distribute. This is entirely inconsistent with other DT where intent is ignored. This is the kind of nonsense the IASB plans to sort out in their current development project on DT.

Acky

DT on goodwill is ignored because IAS12 says so.



SBP Actual carrying value = (20)(10)(1/4) = 50 __ Carrying value for DT = (20)(8)(1/4) = 40 __ CV TB TD

SBP (40) 0 (40) X 30% ___

DT (12) ___

Lost CV TB TD

Losses 0 100 (100) X 30% ___

DT (30) ___

Panellette

(a) Conceptual basis for dt

See the answer for question Hold above.

(b)

CV TB TD

(i) Options (10)(4.6)(2/2) (46.00) 0 (46.00) (ii) Plant (12)(4/5) 9.60 0 9.60 Liability (12 + (8%)(12) – 3) (9.96) 0 (9.96) (iii) Inventory 7.00 9.00 (2.00) (iv) Sub PPE(7 – 1.8) (goodwill killed off by cgu impairment) 5.200 4 1.20 _____

Group TD (47.16) _____

Tax rate 30% DT (asset) (14.148) ______



Nette CV TB TD

(i) Building 9 6 3 (ii) Grant (1.8) 0 (1.8) (iii) Provision (4) 0 (4) (iv) Losses 0 70 (70) (v) Additional 40 _____

Group TD (32.8) _____

Tax rate 30% DT (asset) (9.84) ______


ACCA STUDY GUIDE

ACCA STUDY GUIDE


ACCA STUDY GUIDE

Can I rely on these Class Notes to cover the syllabus?

The answer is YES! To quote ACCA:

This is the main document that students, tuition providers and publishers should use as the basis of their studies, instruction and materials. Examinations will be based on the detail of the study guide which comprehensively identifies what could be examined in any examination sitting. The study guide is a precise reflection and breakdown of the syllabus.

Below I have set out ACCA’s Study Guide in detail for you. The references are given in the body of your Notes.

A The professional and ethical duties of the accountant

1. Professional behaviour and compliance with accounting standards

a) Appraise and discuss the ethical and professional issues in advising on corporate reporting.

b) Assess the relevance and importance of ethical and professional issues in complying with accounting standards.

2. Ethical requirements of corporate reporting and the consequences of unethical behaviour

a) Appraise the potential ethical implications of professional and managerial decisions in the preparation of corporate reports.

b) Assess the consequences of not upholding ethical principles in the preparation of corporate reports.

3. Social responsibility a) Discuss the increased demand for transparency in corporate reports, and the

emergence of non-financial reporting standards.

b) Discuss the progress towards a framework for environmental and sustainability reporting.

ACCA STUDY GUIDE


B The financial reporting framework

1. The applications, strengths and weaknesses of an accounting framework

a) Evaluate the valuation models adopted by standard setters.

b) Discuss the use of an accounting framework in underpinning the production of accounting standards.

c) Assess the success of such a framework in introducing rigorous and consistent accounting standards.

2. Critical evaluation of principles and practices a) Identify the relationship between accounting theory and practice.

b) Critically evaluate accounting principles and practices used in corporate reporting.

C Reporting the financial performance of entities

1. Performance reporting a) Prepare reports relating to corporate performance for external stakeholders.

b) Discuss the issues relating to the recognition of revenue.

c) Evaluate proposed changes to reporting financial performance.

2. Non-current assets a) Apply and discuss the timing of the recognition of non-current assets and the

determination of their carrying amounts including impairments and revaluations.

b) Apply and discuss the treatment of non-current assets held for sale.

c) Apply and discuss the accounting treatment of investment properties including classification, recognition and measurement issues.

d) Apply and discuss the accounting treatment of intangible assets including the criteria for recognition and measurement subsequent to acquisition and classification.

3. Financial instruments a) Apply and discuss the recognition and de-recognition of financial assets and

financial liabilities.

b) Apply and discuss the classification of financial assets and financial liabilities and their measurement.

c) Apply and discuss the treatment of gains and losses arising on financial assets and financial liabilities.

d) Apply and discuss the treatment of impairments of financial assets.

ACCA STUDY GUIDE


e) Account for derivative financial instruments, and simple embedded derivatives.

f) Outline the principles of hedge accounting and account for fair value hedges and cash flow hedges including hedge effectiveness.

4. Leases a) Apply and discuss the classification of leases and accounting for leases by

lessors and lessees.

b) Account for and discuss sale and leaseback transactions.

5. Segment reporting a) Determine the nature and extent of reportable segments.

b) Specify and discuss the nature of segment information to be disclosed.

6. Employee benefits a) Apply and discuss the accounting treatment of short term and long term

employee benefits.

b) Apply and discuss the accounting treatment of defined contribution and defined benefit plans.

c) Account for gains and losses on settlements and curtailments.

d) Account for the ‘Asset Ceiling’ test and the reporting of actuarial gains and losses.

7. Income taxes a) Apply and discuss the recognition and measurement of deferred tax liabilities

and deferred tax assets.

b) Determine the recognition of tax expense or income and its inclusion in the financial statements.

8. Provisions, contingencies and events after the reporting date

a) Apply and discuss the recognition, de-recognition and measurement of provisions, contingent liabilities and contingent assets including environmental provisions.

b) Calculate and discuss restructuring provisions.

c) Apply and discuss the accounting for events after the reporting date.

d) Determine and report going concern issues arising after the reporting date.

9. Related parties a) Determine the parties considered to be related to an entity.

b) Identify the implications of related party relationships and the need for disclosure.

ACCA STUDY GUIDE


10. Share based payment a) Apply and discuss the recognition and measurement criteria for share-based

payment transactions.

b) Account for modifications, cancellations and settlements of share based payment transactions.

11. Reporting requirements of small and medium-sized entities (SMEs)

a) Outline the principal considerations in developing a set of accounting standards for SMEs.

b) Discuss solutions to the problem of differential financial reporting.

c) Discuss the reasons why the IFRS for SMEs does not address certain topics.

d) Discuss the accounting treatments not allowable under the IFRS for SMEs including the revaluation model for certain assets.

e) Discuss and apply the simplifications introduced by the IFRS for SMEs including accounting for goodwill and intangible assets, financial instruments, defined benefit schemes, exchange differences and associates and joint ventures.

D Financial statements of groups of entities

1. Group accounting including statements of cash flows a) Apply the method of accounting for business combinations including complex

group structures.

b) Apply the principles in determining the cost of a business combination.

c) Apply the recognition and measurement criteria for identifiable acquired assets and liabilities and goodwill including step acquisitions.

d) Apply and discuss the criteria used to identify a subsidiary and an associate.

e) Determine and apply appropriate procedures to be used in preparing group financial statements.

f) Identify and outline:

● the circumstances in which a group is required to prepare consolidated financial statements.

● the circumstances when a group may claim an exemption from the preparation of consolidated financial statements.

● why directors may not wish to consolidate a subsidiary and where this is permitted.

g) Apply the equity method of accounting for associates.

h) Outline and apply the key definitions and accounting methods which relate to interests in joint arrangements.

i) Prepare and discuss group statements of cash flows.

ACCA STUDY GUIDE


2. Continuing and discontinued interests a) Prepare group financial statements where activities have been discontinued,

or have been acquired or disposed of in the period.

b) Apply and discuss the treatment of a subsidiary which has been acquired exclusively with a view to subsequent disposal.

3. Changes in group structures a) Discuss the reasons behind a group reorganisation.

b) Evaluate and assess the principal terms of a proposed group reorganisation.

4. Foreign transactions and entities a) Outline and apply the translation of foreign currency amounts and

transactions into the functional currency and the presentational currency.

b) Account for the consolidation of foreign operations and their disposal.

E Specialised entities and specialised transactions

1. Financial reporting in specialised, not-for-profit and public sector entities

a) Apply knowledge from the syllabus to straightforward transactions and events arising in specialised, not-for-profit, and public sector entities.

2. Entity reconstructions a) Identify when an entity may no longer be viewed as a going concern or

uncertainty exists surrounding the going concern status.

b) Identify and outline the circumstances in which a reconstruction would be an appropriate alternative to a company liquidation.

c) Outline the appropriate accounting treatment required relating to reconstructions.

F. Implications of changes in accounting regulation on financial reporting

1. The effect of changes in accounting standards on accounting systems

a) Apply and discuss the accounting implications of the first time adoption of a body of new accounting standards.

2. Proposed changes to accounting standards a) Identify issues and deficiencies which have led to a proposed change to an

accounting standard

ACCA STUDY GUIDE


G The appraisal of financial performance and position of entities

1. The creation of suitable accounting policies a) Develop accounting policies for an entity which meet the entity’s reporting

requirements.

b) Identify accounting treatments adopted in financial statements and assess their suitability and acceptability.

2. Analysis and interpretation of financial information and measurement of performance

a) Select and calculate relevant indicators of financial and non-financial performance.

b) Identify and evaluate significant features and issues in financial statements.

c) Highlight inconsistencies in financial information through analysis and application of knowledge.

d) Make inferences from the analysis of information taking into account the limitation of the information, the analytical methods used and the business environment in which the entity operates.

H Current developments

1. Environmental and social reporting a) Appraise the impact of environmental, social, and ethical factors on

performance measurement.

b) Evaluate current reporting requirements in the area.

c) Discuss why entities might include disclosures relating to the environment and society.

2. Convergence between national and international reporting standards

a) Evaluate the implications of worldwide convergence with International Financial Reporting Standards.

b) Discuss the influence of national regulators on international financial reporting.

3. Current reporting issues a) Discuss current issues in corporate reporting.

ACCA Paper P2

Documents

Transcript of ACCA Paper P2