Financial Accounting 2

ACC203 Financial Accounting 2

Workshop 4 Presentation of

Financial Statements and Provisions and Contingent

Liabilities

ACC203 Financial Accounting 2

Workshop 4 - Part 1 Presentation of

financial information

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Material adapted from Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke, Hong Ang, Karyn Byrnes. Second edition.

John Wiley & Sons Australia, Ltd

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3

Learning objectives

1. Describe and explain the main components of financial statements

2. Explain the general principles underlying the preparation and presentation of financial statements

3. Explain the purpose and requirements of the financial statements

Class Discussion

• What is the purpose of a statement of financial position? What comprises a complete set of financial statements in accordance with AASB 101/IAS 1?

• What are the major limitations of a statement of financial position as a source of information for users of general purpose financial statements?

Learning objectives

1. Describe and explain the main components of financial statements

2. Explain the general principles underlying the preparation and presentation of financial statements

3. Explain the requirements of the financial statements

Components of financial statements

• A complete set of financial statements is defined in paragraph 10 as comprising:

•

A statement of financial position

A statement of profit or loss and other comprehensive

income

A statement of changes in equity

for the period

A statement of cash flows for the period.

Source: Para. 10, AASB 101

Components of financial statements

IFRS 1/AASB 101 Para.10 explains that a complete set of financial statement should also include:

If an accounting policy is being retrospectively applied, the notes to the financial statements should also include a statement of financial position as at the beginning of the preceding period or a retrospective restatement of items in its financial statements or a reclassification of items in the financial statements in accordance with paragraphs 40A–40D.

Notes to Financial Statements

As per IFRS1/AASB 101, Para. 10, notes to financial statements should include:

1. Summary of significant accounting policies

2. Other explanatory information

Comparative information relating

to the preceding accounting period

As per IFRS1/AASB 101, Para. 38 and 38A, comparative information relating to the preceding accounting period needs to be included in a complete set of Financial Statements.

Retrospective application of

accounting policies

Source: Paras. 10-38, AASB 101

Learning objectives

1. Describe and explain the main components of financial statements

2. Explain the general principles underlying the preparation and presentation of financial statements

3. Explain the requirements of the financial statements

General principles underpinning the preparation of financial statements

• Fair presentation and compliance standards • Going concern • Accruals basis • Materiality and aggregation • Offsetting • Frequency of reporting • Comparative information • Consistency of information

Source: Para. 17, AASB 101

Class Activity

• Discuss the eight overall considerations to be applied in the presentation of financial statements. Of these, which are more subjective? Explain your answer.

Learning objectives

1. Describe and explain the main components of financial statements

2. Explain the general principles underlying the preparation and presentation of financial statements

3. Explain the purpose and requirements of the financial statements

Purpose of the Statement of

Financial Position

1. It provides a summary of the elements which help in the measurement of the financial position of an entity such as : an entity’s assets, liabilities and equity.

2. It helps in evaluating the capital structure of an entity.

3. It helps in analysing the liquidity, solvency and financial flexibility of an entity.

4. It also provides a basis for calculating rates of return.

Disclosure requirements as per IFRS 1/AASB

101

Paragraph 60 requires an entity to: 1. Classify assets and liabilities as current or non-

current in its statement of financial position, except when a presentation based on liquidity is considered to provide more relevant and reliable information.

2. When that exception arises, all assets and liabilities are required to be presented broadly in order of liquidity.

3. The criteria for classifying liabilities as current or non-current are based solely on the conditions existing at the end of the reporting period.

Source: Para. 60, AASB 101

Presentation of the Statement of Financial Position

Assets Liabilities

Current Assets

Non Current Assets

Current Liabilities

Non Current

Liabilities

The current/non-current classification is ordinarily considered to be more relevant when an entity has a clearly identifiable operating cycle

Paragraph 78 of AASB 101/IAS 1 explains that subclassifications of line items in the statement of financial position are also dependent on the size, nature and function of the amounts involved.

Additional Information to be disclosed in the

financial statement

Paragraph 58 explains that the judgment on whether additional items should be separately presented is based on an assessment of:

The nature and liquidity of assets; The function of assets within the entity; and The amounts, nature and timing of liabilities

Limitations of Statement of Financial position

Dependence on historical costs

when measuring certain assets

Many intangible assets are not

recorded as assets due to recognition and measurement requirements of

AASB 138/IAS 38 Intangible Assets.

E.g. Self generated intangible assets.

Do not have predictive value

Not always comparable across

companies

Can be subject to financial

engineering or fraud specially with off balance sheet

rights and obligations.The aggregation of amounts that are

measured inconsistently.

Class Activity

Class Activity

1. It is the prime source of information about an entity’s financial performance.

2. It assist users to predict an entity’s future performance and future cash flows.

3. It enables the identification of likely non- recurring items of income or expense which is of key importance in predicting future profits and cash flows.

4. It helps in determining other summary indicators such as earnings per share

Purpose of the Statement of Profit or Loss and other Comprehensive

Income

Disclosure requirements as per IFRS 1/AASB

101

1. AASB 101 does not prescribe a standard format to prepare the statement of profit or loss and other comprehensive income.

2. However, the comprehensive income section should include: all transactions and valuation adjustments affecting net assets other than transactions with ‘owners as owners’.

3. Para 81B also requires the following to disclosed:

1. Profit or Loss ; 2. Profit or Loss attributable to Non Controlling interests and Owners’ of the parent

Presentation of the Statement of profit or loss and other comprehensive income

Comprehensive income for the period attributable to:

– Non-controlling interests; and – Owners of the parent – Profit or loss section – Other comprehensive income section

Additional line items and labelling

Paragraph 97 of AASB 101/IAS 1 requires the separate disclosure of the nature and amount of material items of income and expense.

A reclassification adjustment is included with the related item of other comprehensive income in the period that the adjustment is reclassified to profit or loss

Disclosure of material items is important to users of financial statements wishing to predict the likely future sustainability of the reported profit.

Limitations of the statement of profit or loss and other comprehensive income.

These amounts may have been recognised in other comprehensive income in a previous period

Class Activity

Purpose of the Statement of

Changes in Equity

1. It provides a reconciliation of the opening and closing components of equity for the period

2. It reports transactions with owners such as issue of shares and payment of dividends etc.

Disclosure requirements as per IFRS 1/AASB

101

1. Profit (loss) for the period increases (decreases) retained earnings.

2. Other items of comprehensive income affect other components of equity.

Presentation of the Statement of Changes in Equity

The statement of changes in equity is usually presented in a tabular format

The various components of equity, such as share capital, retained earnings and revaluation surplus, are listed in separate columns.

The opening balance, current period movements and closing balance are shown in different rows.

Class Activity

References

Loftus, J. , Ken, L., Sorin D., Boys N., Luke B., Hong A. and Byrnes K., (2018) Financial Reporting, 2nd edn. Australia: John Wiley, pp.637-735

Australian Accounting Standard Board (2019) , AASB 101 Presentation of Financial Statement. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB101_07- 15_COMPdec17_01-19.pdf (Accessed 8 October 2019)

End of Part 1

ACC203 Financial Accounting 2

Workshop 4- Part 2 Provisions and

Contingent Liabilities

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

Class Discussion • What do you understand by the terms

– “Provisions” – “Contingent liabilities”

• Are provisions the same as liabilities? • Are contingent liabilities the same as liabilities?

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

Introduction and scope AASB 137 deals with:

Provisions Contingent Assets and Contingent Liabilities

Onerous Contracts

Specifies recognition criteria for restructuring provisions

Identifies the types of costs that may be included in restructuring provisions.

Contingent liabilities and contingent assets except: Resulting from financial instruments Resulting from executory contracts, except where the contract is onerous Specifically covered by another standard.‘Provision’ is used in the context

of items such as depreciation, impairment of assets and doubtful debts.

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

Liability

Provisions

AASB 137 defines a liability as:

1. A present obligation of the entity 2. It arises from past events 3.The settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

• A provision is a subset of liabilities, defined in AASB 137/IAS 37 as:

– A liability of uncertain timing or amount.

• An entity may have an equitable or constructive obligation, arising from normal business practice or custom, to act in an equitable manner.

• A present obligation exists only where the entity has no reasonable alternative but to make the sacrifice of economic benefits to settle the obligation.

Definition of a provision

• Distinguishing provisions from other liabilities – The key distinguishing factor is the uncertainty

relating to either the timing of settlement or the amount to be settled.

– Typical provisions: • Warranty • Restructuring • Provisions for onerous contracts.

Class Activity

• What are the characteristics of a provision? • Define a constructive obligation. • What is the key characteristic of a present obligation?

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

Definition of a contingent

liability

1. A possible obligation 2. It arises from past events *** 3. Its existence will be confirmed only by

the occurrence or non‐occurrence of one or more uncertain future events not wholly within the control of the entity.

***A present obligation that arises from past events but is not recognised because: It is not probable an outflow of resources embodying economic benefits will be required to settle the obligation The amount of the obligation cannot be measured with sufficient reliability.

Source: Para. 12, AASB 137

Difference between a contingent liability and a provision

1. Contingent liabilities do not meet the recognition criteria stated in the conceptual framework and therefore are not recognized in the financial statements 2. It must be disclosed in the notes to the financial statements unless the possibility of an outflow in settlement is remote.

contingent liability

Provisions

1. Provisions meet the recognition criteria stated in the conceptual framework and therefore are recognized in the financial statements

Source: Para. 10 -12, AASB 137

Class Activity

• At what point would a contingent liability become a provision?

Class Activity

• Provisions are recognised as a liability in the statement of financial position whereas contingent liabilities are not recognised in the financial statements but disclosed in the notes to financial statements. Paragraph 12 of AASB 137/IAS 37 Provisions, Contingent Liabilities and Contingent Assets states that ‘in a general sense, all provisions are contingent because they are uncertain in timing or amount’.

• Required: What are some of the possible reasons that provisions are recognised in the financial statements but contingent liabilities are not.

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

The recognition criteria for provisions

A past event that leads to a present obligation is called an obligating event.

An entity has a present obligation

as a result of a past event.

It is probable that an outflow of resources embodying economic

benefits will be required to settle the obligation

A reliable estimate can be made of the amount

of the obligation.

What is an obligating event?

Source: Loftus et al (2018), p.272 and Paras. 72-75, AASB 137

Decision Tree (AASB 137 Part B)

Source: Loftus et al ( 2018), p. 272

Class Activity

• Jackshire Ltd filed a lawsuit against Bormire Ltd for compensation of $23 million as a result of failure to deliver goods on time. At the end of the financial year the outcome of the hearing is unknown. The lawyer is of the opinion that there is a 40% chance that Bormire Ltd will be found liable for the damages.

• Required: Discuss how this court case should be recorded by Bormire Ltd and Jackshire Ltd.

Class Activity

• When should liabilities for each of the following items be recorded in the accounts of the business entity?

1. Acquisition of goods by purchase on credit 2. Salaries 3. Annual bonus paid to management 4. Dividends

Class Activity

Katz Ltd’s financial statements are authorised for issue on 24 August 2019.

Required: Identify whether each of the following would be a liability, a provision or a contingent liability, or none of the above, in the financial statements of Katz Ltd as at the end of its reporting period of 30 June 2019.

1. An amount of $35  000 owing to Pigz Ltd for services rendered during May 2019.

2. Long service leave, estimated to be $500  000, owing to employees in respect of past services.

Class Activity

3. Costs of $26  000 estimated to be incurred for relocating an employee from Katz Ltd’s head office location to another city. The staff member will physically relocate during July 2019.

4. Provision of $50  000 for the overhaul of a machine. The overhaul is needed every 5 years and the machine was 5 years old as at 30 June 2019.

5. Damages awarded against Katz Ltd resulting from a court case decided on 26 June 2019. The judge has announced that the amount of damages will be set at a future date, expected to be in September 2019. Katz Ltd has received advice from its lawyers that the amount of the damages could be anything between $20  000 and $7 million.

Learning objectives

1. Describe the purpose of AASB 137/IAS 37 2. Outline the concept of a provision and how it is

distinguished from other liabilities 3. Outline the concept of a contingent liability and how it is

distinguished from other liabilities 4. Explain when a provision should be recognised 5. Apply the definitions, recognition and measurement

criteria for provisions and contingent liabilities to practical situations

Application of the definitions, recognition and measurement rules

Future operating losses

It states that provisions must not be recognized for future operating losses.

The entity’s management will generally have the ability to avoid incurring future operating losses by either disposing of or restructuring the operation in question.

Onerous contracts

Definition:

A contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

Source: Para. 10, AASB 101

Application of the definitions, recognition and measurement rules

The most controversial aspect of AASB 137/IAS 37 is the recognition criteria for restructuring provisions.

The standard setters in various jurisdictions set tougher rules on when a restructuring provision could be recognised, particularly when the provision is related to the acquisition of a business.

Restructuring provisions

Examples of Restructuring provisions

Source: Loftus et al (2018), pp. 278-283

Application of the definitions, recognition and measurement rules

The entity had a present obligation for the costs of clean‐up or removal, which were independent of the cost and useful life of the asset in question. The provision would be made for the best estimate of the costs of noncompliance with the relevant legislation.

Other applications

Source: Loftus et al (2018), pp. 278-283

Class Activity

A division of an acquired entity will be closed and activities discontinued. The division will operate for 1 year after the date of acquisition. At the end of the 1 year, a few divisional employees will be retained to finalise closure of the division, but the rest will be retrenched.

Required: Which of the following costs, if any, are restructuring costs? 1. The costs of employees (salaries and benefits) to be

incurred after operations cease and that are associated with the closing of the division.

2. The costs of leasing the factory space occupied by the division for the year after the date of acquisition.

3. The costs of modifying the division’s purchasing system to make it consistent with that of the acquirer’s.

Class Activity

• Groucho Ltd acquires Harpo Ltd. The restructuring plan, which satisfies the criteria for the existence of a present obligation under AASB 137/IAS 37 and AASB 3/IFRS 3, includes an advertising program to promote the new company image. The restructuring plan also includes costs to retrain and relocate existing employees of the acquired entity.

• Required: Are these costs restructuring costs?

References

Loftus, J. , Ken, L., Sorin D., Boys N., Luke B., Hong A. and Byrnes K., (2018) Financial Reporting, 2nd edn. Australia: John Wiley, pp.266-306

Australian Accounting Standard Board (2018) , AASB 137 Provisions, Contingent Liabilities and Contingent Assets . [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB137_08- 15_COMPdec16_01-19.pdf (Accessed 8 October 2019)

End of the Workshop