IFRS project

kamm199

model_5_-_acca.pptx

Home >Business & Finance homework help >Accounting homework help >IFRS project

Model 5

Accounting for Assets and liabilities – Part 2

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Module 5: What you will learn - Accounting for assets and liabilities – part 2

This module deals with a number of IFRSs that give rise to the

recognition of liabilities:

x x

Fair value measurement - IFRS 13

Financial Instruments: Presentation – IAS 32, Recognition and measurement – IFRS 9 and IAS 39, Disclosure IFRS 7

Provisions, contingent liabilities and contingent assets - IAS 37

Events after the reporting period - IAS 10

Employee benefits - IAS 19

Income taxes - IAS 12

Shared-based payment - IFRS 2

Agriculture – IAS 41

Exploration for and evaluation of mineral resources – IFRS 6

x x x x x x x

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Table of contents

Select a topic to study or click next.

Fair value measurement – IFRS 13

Financial Instruments Exercise – IFRS 9 Question Exercise – IFRS 9 Answer

Provisions, contingent liabilities and contingent assets - IAS 37

Exercise - IAS 37 Question

Exercise - IAS 37 Answer

Case study - provisions, contingent liabilities and contingent assets Case study Question - provisions, contingent liabilities and contingent assets

Case study Answer - provisions, contingent liabilities and contingent assets

Events after the reporting date - IAS 10

Exercise - IAS 10 Question Exercise - IAS 10 Answer Employee benefits - IAS 19

Exercise - IAS 19 Question 1

Exercise - IAS 19 Answer 1

Exercise - IAS 19 Question 2

Exercise - IAS 19 Answer 2

Income taxes - IAS 12

Exercise - IAS 12 Question

Exercise - IAS 12 Answer

Case study Question - deferred tax

Case study Answer - deferred tax

Share-based payment - IFRS2

Agriculture – IAS 41

Exploration for and evaluation or mineral resources - IFRS 6

Frequently asked questions

Quick Quiz

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Fair Value Measurement – IFRS 13

IFRS 13 was published in May 2011 and established for the first time

a single source of guidance for fair value measurement of assets and liabilities under IFRS.

The key points from the standard are as follows:

Fair value is defined by IFRS 13 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 (appendix A).

It is effective for accounting periods beginning on or after 1 January

2013, with early application permitted. It should be applied prospectively from the period in which it is adopted (i.e. there is no need for entities to go back to prior periods and restate fair values for the new requirements of IFRS 13).

In order to measure fair value the entity must determine (paragraph B2):

The asset or liability to be measured

The principal market for the asset or liability (i.e. the one with the greatest volume and level of activity)

The appropriate valuation technique to use (to reflect the assumptions market participants would use when valuing the asset or liability)

For a non-financial asset, the highest and best use

It does not prescribe when fair value should be used, only how to

apply it when required by another standard.

This standard is applicable to all transactions and balances

requiring measurement at fair value under another standard, with the exception of share-based payments accounted for under IFRS 2 and leases falling within the scope of IAS 17.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Fair Value Measurement – IFRS 13

Measurement Guidance

Valuation Techniques

Fair value measurement should then

IFRS 13 outlines three valuation techniques that may be applied

(paragraph 62):

Take account of any characteristics that might be relevant to a

market participant (e.g. condition and location of an asset) Assume an orderly transaction between market participants at the measurement date under current market conditions

Assume the transaction takes place in the principal market (or failing this the most advantageous market)

Take account of highest and best use re a non financial asset

(even if this is not its current use)

Assume transfer of a liability or own equity instrument (i.e. assume the liability remains outstanding but is passed to a 3rd party, not that the liability is paid off or settled)

Reflect non-performance risk where a liability is concerned

(including the entity’s own credit risk).

Market approach – uses prices and other relevant information

generated by market transactions involving identical or similar assets or liabilities

Cost approach – current replacement cost

Income approach – discounted future cash flows or income and expenses

Either one, or where appropriate a combination, of these valuation

techniques should be selected and consistently applied.

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Fair Value Measurement – IFRS 13

Disclosure

The standard outlines a ‘fair value hierarchy’.

Inputs used to measure fair value are divided into three categories.,

The three categories are:

Level 1 – quoted prices in active markets for identical assets and

liabilities

Level 2 – observable inputs other than those classified in level 1

Level 3 – unobservable inputs

The standard required entities to apply Level 1 when the relevant

information is available (e.g. to value quoted shares). Where such information is not available then Level 2 should be applied. Level 3 should only be used as a last resort.

Detailed disclosure requirements are prescribed by the standard, for the

most part following the fair value hierarchy described. The disclosures are both qualitative and quantitative

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/i f r s 13.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

The topic of financial instruments is sufficiently complicated that it

was necessary to split it into three standards. Originally these were:

IFRS 9 is not yet complete. However in response to requests that the

accounting for financial instruments be improved quickly, the IFRS 9 project has been split into phases. As each phase is completed the relevant portions of IAS 39 are deleted and chapters in IFRS 9 are created.

x IAS 32 dealing with presentation issues (i.e. where to record items

in the statement of profit or loss and statement of financial position).

x IAS 39 dealing with recognition and measurement issues (i.e. when to record an item in the financial statements and at what value)

x IFRS 7 looking at disclosures (all the extra information that should be supplied about financial instruments in addition to the numbers that appear in the primary financial statements).

So far, the IASB has issued the chapters of IFRS 9 relevant to all areas

except impairment and hedging. These sections will follow with the aim that

IAS 39 will be replaced in its entirety in 2013.

For the purposes of this course, the main standard examinable is

IFRS 9. All questions in the assessment will test IFRS 9 unless specifically stated otherwise. Therefore if there is no specific reference to a standard, you should assume that the question is testing IFRS

A summary of the key points from the remaining chapters of IAS 39 on impairment and hedging are included and this is part of the examinable material of the course. If a question is testing IAS 39 this will be specifically stated.

However the IASB has been working on a new standard, IFRS 9

Financial Instruments (‘IFRS 9’) that will ultimately replace IAS 39 entirely in dealing with recognition and measurement issues. It was originally intended to be effective for accounting periods beginning on or after 1

January 2013. However the IASB deferred this to 1 January 2015. Early application is permitted though.

Following the key definitions on the next page, IAS 32, IFRS 7, IFRS 9 and the relevant remaining chapters of IAS 39 will each be covered in turn.

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

Definitions

Key elements of definitions are provided below. For full definitions refer to

paragraph 11 of IAS 32.

Financial asset – cash, an equity instrument of another entity (i.e. an

investment) or a contractual right to receive cash (e.g. trade receivables).

Financial liability – a contractual obligation to deliver cash or another

financial asset to another entity.

Equity – any contract that evidences a residual interest in the assets of

an entity after deducting all of its liabilities.

Financial instrument – any contract that gives rise to a financial asset in

one entity and a financial liability or equity instrument of another entity (e.g. debentures are a financial instrument as the issuing company has a liability and the investing entity has a financial asset, or right to receive cash).

Note that investments in subsidiaries, associates and joint ventures and

employee benefit obligations are excluded from the scope of IAS 32, 39 and IFRS 7.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IAS 32 - Presentation

Financial instruments of an issuer should be classified

on the basis of whether their substance is that they are equity or liability. For example, if an enterprise has issued some preference shares that contain elements that fit the definition of liability (the shares could be redeemable on a specified date such that the entity has an obligation to deliver cash) then the share is to be treated as a liability despite its legal classification.

Offsetting of financial assets against financial liabilities is only

allowed when there is a legally enforceable right of set off which the enterprise intends to use.

Compound instruments should be split into their

component parts. For example, a convertible debenture is in economic substance partly a debt and partly a share. Its price in the market will depend on the relative importance of these two parts. According to IAS 32 such a debenture should be presented as partly debt and partly equity.

The presentation of the returns on such instruments should follow

the above classifications. For example, any instrument shown as debt should have a return shown as an interest expense even if it is legally called a dividend..

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 3 2.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IAS 32 - Presentation

Convertible debt: Worked example

On 1 January 20X9, an entity issues convertible loan notes totalling

$500,000. Interest is payable annually in arrears at 6%. The market rate of interest for similar loan notes with no conversion rights attached is 7%. The loan notes are redeemable on 31 December 20Y2. Show how they should be treated in the financial statements when issued.

IAS 32 states that compound instruments should be split into their components parts. The liability component should be valued as if it were a similar liability with no conversion rights attached. The difference between this figure and the value of the compound instrument as a whole is the value of the equity part.

Equity component:

The equity component = (5,000 x $100) - $483,063 = $16,937

Comment:

On 1 January 20X9, the entity will record a liability equal to $483,063 and in a separate reserve in equity the amount $16,937, which represents the value of the option to convert to shares at a later date.

Subsequently the discount of 7% will unwind, creating a finance charge each year in the statement of profit or loss and increasing the value of the liability in the statement of financial position. Each annual payment of interest at 6% (i.e. $30,000) will reduce the liability.

Liability component:

Date

31 Dec 20X9

31 Dec 20Y0

31 Dec 20Y1

31 Dec 20Y2

Cash Flow

$30,000 (w)

+ $500,000

Discount Factor

1/1.07

1/1.072

1/1.073

1/1.074

Present value

$28,037

$26,203

$24,489

$404,334

Total value of Liability component:

$483,063

(w) ($500,000 x 6%) = $30,000.

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IFRS 7 - Disclosures

An entity must group its financial instruments into classes of similar

instruments and, when disclosures are required, make disclosures by class.

The two main categories of disclosures required by IFRS 7 are:

Information about the significance of financial instruments

Information about the nature and extent of risks arising from financial instruments.

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/i f r s 07.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IFRS 9 - Financial Instruments

The main elements of this standard are as follows:

4. A financial asset shall be measured at amortised cost if

both of the following conditions are met:

1. An entity shall recognise a financial asset or financial liability

when the entity becomes a party to the contractual provisions of the instrument

x The asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows

x The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding

2. All financial assets are initially measured at fair value plus

transaction costs with the exception of ‘financial assets at fair value through profit or loss’, which are held at fair value only (no transaction costs).

5. Financial assets not measured at amortised cost as described in point 4 above shall be measured at fair

value.

3. Subsequent measurement is determined by classification of the financial asset either at amortised cost or fair value on the basis of:

6. Aside from the guidance as outlined in points 3 to 5 above, an entity may also, at initial recognition, decide to

designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.

x The entity’s business model for managing the financial assets

x The contractual cash flow characteristics of the financial asset

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IFRS 9 - Financial Instruments

7. Gains and losses on both categories of financial asset described above are recognised in profit or loss, except

for an investment in equity instruments that is not held for trading where, at initial recognition, an entity chooses to make an irrevocable election to present gains and losses through other comprehensive income or where a hedging relationship exists (hedging rules from IAS 39 still apply).

10. Financial liabilities are initially measured at fair value plus

transaction costs with the exception of those held for trading or designated ‘at fair value through profit or loss’, which are held at fair value only (no transaction costs).

11. After initial recognition liabilities held for trading or those

designated at FVTPL are held at fair value. All other financial liabilities are held at amortised cost.

8. There are two categories of financial liability:

x those held for trading or designated ‘at fair value through profit or

loss’ (FVTPL)

x any other financial liability

9. An entity can only choose to designate a liability at FVTPL if doing

so eliminates or significantly reduces an accounting mismatch. The result is that most financial liabilities will fall into the second ‘default’ category of

the two listed above.

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/i f r s 09.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Financial instruments

IAS 39: Recognition and measurement

Whilst IFRS 9 remains incomplete, IAS 39 remains the only source of

guidance relating to impairment of financial assets and hedging rules.

12. Hedge accounting constitutes an extra, special set of rules that

can be applied to financial instruments when an entity enters a hedging arrangement. An entity can designate a hedging instrument so that its change in fair value is offset against the change in fair value of a hedged item. For example, if an enterprise has committed to pay an amount of foreign currency in six months time, it might buy the currency in advance in order to avoid the risk of the foreign currency

rising in value before the date of payment. Hedge accounting involves designating the advance purchase as designed to fulfil the future obligation. It is allowed when certain

conditions are met (e.g. formal documentation exists, hedge is effective).

A financial asset is only impaired where there is objective evidence

resulting from one or more events that occurred after the initial recognition of the asset. Such objective evidence could include the counterparty defaulting on repayments of interest or capital, or going into liquidation, such that the full value of the financial asset may not be recoverable.

Financial assets should be reviewed for objective evidence of

impairment at each reporting date and a full impairment review performed where evidence is identified (paragraph 58).

The amount of impairment loss is measured as the difference between the

carrying amount and the present value of estimated future cash flows recoverable (discounted at the financial asset’s original effective interest rate – paragraph 63).

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 3 9.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IFRS 9 Question

Please review the following exercise:

How can an auditor tell whether a financial asset should be held at fair

value through profit or loss or at amortised cost?

It is impossible to tell by looking at a financial asset (which is represented merely by a piece of paper) whether it should be held at amortised cost or at fair value through profit or loss. The auditors must consider the properties of the instrument.

By definition only investments in debt instruments will qualify for classification at amortised cost since these will give rise to payments of principal and interest. Examples include loans made by the entity, and investments in bonds.

As shares do not have cash flows that are solely principal and interest they cannot be measured at amortised cost. By default therefore all investments in equities must be held at fair value.

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Provisions, contingent liabilities and contingent assets - IAS 37

Key definitions of IAS 37:

Provision

x A liability of uncertain timing or amount.

Liability

x Present obligation as a result of past events

x Settlement is expected to result in an outflow of resources

(payment)

Contingent liability

x a possible obligation depending on whether some uncertain future event occurs, or

x a present obligation but payment is not probable or the amount cannot be measured reliably

Contingent asset

x a possible asset that arises from past events, and

x whose 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 enterprise.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Provisions, contingent liabilities and contingent assets - IAS 37

Basic feature of IAS 37

It defines provisions as liabilities of uncertain timing or amount.

That is, a provision must meet the definition of liability as found in the framework that there should be an expectation of an outflow of:

x resources,

x a past event

and at the reporting date:

x a legally enforceable obligation to a third party or a constructive obligation (paragraph 10).

“This standard excludes certain items covered by

other standards such as financial instruments dealt

with by

IASs 32 and 39 and IFRS 7 and also excludes

executory contracts

where both sides of the contract are equally

unperformed (paragraph 1).”

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Provisions, contingent liabilities and contingent assets - IAS 37

Provisions

A provision should be recognised in the statement of financial

position when it meets the definition of a liability, where there is a probable outflow of resources and, the extra feature as usual for the recognition of assets and liabilities, is that there should be a reliable estimate (paragraph 14).

There should be no provision for future operating losses, but there

may be provision for onerous contracts (paragraph 63).

There are a number of explanations about restructuring provisions

in the context of this standard, but they make it clear that such provision should not be set up unless there is an obligation at the reporting period end date (paragraph 72). .

Once a provision has been recognised it should be measured at the

best estimate of the future outflow. This means that it is also required to discount the numbers where this would be material, at pre-tax discount rates assuming that the provision is measured in pre-tax terms (paragraphs 36,45 and 47).

Any expected gains from disposals of assets related to the setting

up of provisions should be ignored, but reimbursements, for example from insurance contracts, should be accounted for (paragraphs 51 and

53)..

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Provisions, contingent liabilities and contingent assets - IAS 37

Liabilities

A contingent liability is defined in two different ways:

1. IPossible obligations.

2. Existing obligations at the reporting date which are not recognised as liabilities either because they will probably not lead to an outflow or are not able to be measured reliably (paragraph 10).

Contingent liabilities should be disclosed where they are material in size

and not remote.

Contingent gains should not be recognised, but should be noted where

material (paragraph 31)..

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 3 7.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IAS 37 Question

Please review the following exercise:

A provision can only be recognised when there is an obligation at the

reporting date. Should one recognise a provision for the possible loss of a law case?

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

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Case study - provisions, contingent liabilities and contingent assets

Newberg is a German company. On the right you can see Newberg’s

statement of profit or loss for 2007and 2008.

On the following page you can see some accounting policies and notes.

The facts are loosely based on a real case, but the company, year and exact numbers have been changed.

Consolidated statements of income (in billions Euro)

2007

2008

Sales

Cost of goods sold

(10)

(12)

------

Gross profit

Marketing and distribution

(8)

(10)

Research and development

(5)

(6)

Administrative

(2)

Other expenses

(1)

------

Operating profit

Non-operating income

------

Results before special charges and taxes

Special charges

Acquired in-process research and development

(9)

Restructuring

(6)

Taxes

On result before special charges

(2)

Benefit from special charges

------

(4)

------

Net income (loss)

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Case study - provisions, contingent liabilities and contingent assets

Extracts from significant accounting policies and notes

Basis of preparation of financial statements. The consolidated

financial statements of the Newberg Group are prepared in accordance with International Financial Reporting Standards.

Obtaining clearance from the regulatory authorities caused a delay

in completing the transaction. These final clearances were received on

24 February 2009 and the purchase of the shares was completed on 10

March 2009.

Consolidation policy. The consolidated financial statements of the

Group include the parent and the companies which it controls (subsidiaries). Control is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities. Control is normally evidenced when the Group owns, either directly or indirectly, more than 50% of the voting rights of a company’s share capital.

The acquisition was accounted for under the purchase method of

accounting. Accordingly, the cost of the acquisition, including expenses incidental thereto, was allocated to identifiable assets and liabilities and to in-process research and development based on their estimated fair

values. The portion of the acquisition cost allocated to in-process research and development was charged in full against income. This approach is consistent with the Group’s accounting policy for research and development costs. After consideration of these items, the excess of the acquisition cost over the fair values was recorded as goodwill.

Changes in group organisation. On 24 June 2008, a subsidiary of

Newberg entered into an agreement with the shareholders of Orange Limited to purchase all of the issued and outstanding common shares. Completion of the transaction was not possible until certain regulatory clearances had been obtained. In view of the overall materiality of the transaction and the advanced state of the integration planning, the consolidated financial statements of the Group give effect to the acquisition of Orange Limited from 31 December 2008..

When you have studied the notes and table please go to the next page to

see a question relating to the case study.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Case study Question - provisions, contingent liabilities and contingent assets

Please review the following case study question:

Do you think that a provision for restructuring costs should have been set

up at 31 December 2008? (Other questions on this case will be asked in

Module 6).

Page | 22

According to IAS 37, a provision should be set up when:

1. there is a probable expected outflow,

2. it can be measured reliably,

3. there is a past event, and

4. there is an obligation.

In this case, perhaps the first two criteria could be satisfied. It is not clear whether there is a past event, and it seems most unlikely that there was an obligation. The latter could only be set up by committing the company irrevocably to transferring resources to a third party.

The exact facts would need to be examined. However, since the subsidiary (Orange) does not seem to have been controlled by the balance sheet date, it seems unlikely that the Group could have created a liability in it.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Events after the reporting date - IAS 10

The main elements of this standard are as follows:

The standard deals with two types of event that occur after the

reporting date. First, adjusting events, which are those that provide information concerning conditions which did exist at the reporting date. These should lead to recognition changes,that is changing the numbers in the statement of financial position. The second type of events after the reporting date are non-adjusting events. These give information about conditions that did not already exist at the reporting date and they should not lead to changes to the numbers in the statement of financial position, but, if material, to disclosures in the notes (paragraphs 3, 8 and 10).

Examples of adjusting events are better information about the status of customers at the reporting date, enabling an entity to measure the size of its receivables more accurately. An example of a non-adjusting event would be the destruction of some of an entity's assets accidentally, perhaps by fire, after the reporting date (paragraph 22 for more

examples).

If dividends on ordinary shares are proposed, but not declared, after the reporting date then these should not be recognised as liabilities (paragraph 12).

Whether or not an enterprise is a going concern should be assessed

at the stage at which the financial statements are being prepared, which is, of course, after the reporting date.

If it is determined that an enterprise is not a going concern, then the accounts should be prepared on the break up basis (even if the events leading to the conclusion occurred after the reporting date). This of course does not apply if only part of the enterprise is not a going concern. The reporting unit is the whole of the enterprise and the status

of going concern should be assessed for that whole reporting enterprise

(paragraph 14).

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 1 0.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IAS 10 Question

Please review the following exercise:

Can proposed dividends be a liability?

A proposed dividend could certainly be a liability if it has been approved at the Annual General Meeting, but this will not have happened by the time that the financial statements are prepared. This led IAS 10 to conclude that proposed dividends should not be accrued.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Employee benefits - IAS 19

The main elements of this standard are as follows:

This standard applies to all employee benefits, not just to pensions,

except those to which IFRS 2 “Share Based Payment” applies

(paragraph2).

Defined benefit plans are much more complicated, and a large part

of the standard deals with them. Constructive obligations as well as written contractual ones should be accounted for (paragraph 61).

The standard deals with such issues as accounting for accumulating

paid absences and for bonus plans. In each case the standard requires an enterprise to establish whether there is a liability at the reporting date and to account for any liability (paragraphs 16 and 19).

An entity recognises the net defined benefit liability in the statement of

financial position (paragraph 63).

Where an entity has a surplus in a defined benefit plan, the net

defined benefit asset can be recognised but there are limits on the size of this asset (paragraph 64).

In a country with special forms of employee benefit systems such as

multi-employer plans and government plans, these should be accounted for as other plans on the basis of their legal and institutional arrangements (paragraphs 32 and 43).

Defined contribution plans (where the entity’s obligation for each

reporting period is simply the amount to be contributed for that period) present few difficulties for accounting but the standard does cover them (paragraph 51).

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Employee benefits - IAS 19

Actuarial gains and losses for retirement benefits are recognised in

full immediately through other comprehensive income (i.e. outside profit or loss) (paragraph 57).

Past service costs, which are caused, for example, if the benefits in

the plan are increased, should be recognised in the period they were granted, with no reference to vesting criteria (paragraph 103).

When calculating the value of the obligation, the projected unit credit

method should be used and a discount rate measured by reference to interest rates on high quality corporate bonds (paragraphs 67 and 83).

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 1 9.h t m

“The Basic Principle of IAS 19:

The cost of providing employee benefits should

be recognised in the period in which the benefit

is earned by the employee, rather than when

it is paid or payable.”

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IAS 19 Question 1

Please review the following exercise:

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

Page | 27

The issue is not whether future pay rises give rise to a present liability. The liability exists anyway and the future pay rises are a part of correctly estimating the size of the liability. Therefore the best estimate of future pay rises should be taken into account.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IAS 19 Question 2

Please review the following exercise:

When a defined benefit plan is enhanced, when should the cost of

improving the benefits for existing pensioners be recognised?

Under the revisions to IAS 19 published in June 2011, past service costs are all recognised in the period they are granted. This includes those relating to existing pensioners and also to current employees (who may or may not qualify for the enhanced benefit at the date it is granted) since no reference is made to any vesting criteria in the latest update to IAS 19.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Income taxes - IAS 12

The main elements of this standard are as follows:

This standard largely concerns accounting for deferred tax. It

changed the basis of calculation to “temporary differences”, which are calculated by reference to the difference between the tax basis and the financial reporting basis of assets and liabilities, instead of “timing differences”, which are based on tax and book differences for revenues and expenses (paragraph 5).

There are also special rules for investments in subsidiaries,

associates and joint ventures. They amount to saying that temporary differences that are unlikely to reverse where the investor is in control of that process (for example, by being able to stop the payment of dividends) need not be accounted for (paragraphs 39 and 44).

The measurement of deferred tax assets and liabilities should be

based on tax rates that are expected to apply, but that generally means current tax rates, although future rates can be used where they have been enacted (paragraphs 47 and 51).

Deferred tax liabilities should be recognised for all temporary

differences, except those relating to non-deductible goodwill amortisation and the initial recognition of certain assets and liabilities in transactions that affect neither accounting profit nor taxable profit.

Deferred tax amounts should not be discounted. At first sight, this

seems surprising because other liabilities are required to be discounted (see IAS 37). However, discounting would require knowledge of when temporary differences would reverse, which would require a large amount of guesswork (paragraph 53).

Deferred tax assets should similarly be recognised assuming that

future taxable profit is probable. Deferred tax assets include, of course, those arising on tax loss carry forwards (paragraphs 24 and 34).

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Income taxes - IAS 12

The double entry for the creation of deferred tax assets and

liabilities should be charged to profit or loss or other comprehensive income (and disclosed in the statement of profit or loss and other comprehensive income) (paragraphs 58 and 61).

Deferred tax assets should be presented on the statement of

financial position separately from deferred tax liabilities (paragraphs

69 and 74).

please click on the following hyperlink to Deloitte’s IAS Plus

For further information and a summary of this standard

website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 1 2.h t m

“Temporary difference:

A difference between the carrying amount of

an asset or liability and its tax base.

“Taxable temporary difference:

A temporary difference that will result in taxable

amounts in the future when the carrying amount

of the asset is recovered or the liability is settled.

“Deductible temporary difference:

A temporary difference that will result in amounts

that are tax deductible in the future when the

carrying amount of the asset is recovered

or the liability is settled.”

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Exercise - IAS 12 Question

Please review the following exercise:

A deferred tax liability is recognised on the revaluation of an asset that is

intended for continuing use in the business. Does this meet the framework’s definition of liability?

Despite the requirements of IAS 12 this amount does not meet the Framework’s definition of a liability because at the reporting date there is no legally enforceable obligation of the enterprise to pay any tax since the enterprise has not disposed of the asset.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Case study Question - deferred tax

Please review the following exercise:

Suppose that a British company, Acrobat, applies IFRS.

It purchases a machine for $10,000 in early 2008. The machine is expected to last for ten years and to have no residual value. The accounting year is the calendar year. The company is fairly small and is able to claim 40% tax depreciation (capital allowances) in the year of purchase. Suppose also, that Acrobat buys land at $3m in early 2008, and revalues it to fair value of $5m at 31 December 2008. What are the “temporary differences” in 2008?

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Case study Answer - deferred tax

Model Answer

The temporary differences are:

(i) Machine

Financial reporting basis of asset: 10000 - 1000 =

Tax basis of asset: 10000 - 4000 =

$9000

$6000

$3000

(ii) Land

Financial reporting basis of asset =

Tax basis of asset =

$5m

$3m

$2m

The temporary differences would be $2,003,000.

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Share-based payment - IFRS 2

The main elements of this standard are as follows:

An equity settled share-based payment is a transaction in which a

company issues equity instruments to another party in exchange for goods and services. The most common example of such a transaction is where employees receive equity instruments in exchange for services rendered.

A cash settled share based payment is where another party (again usually an employee) receives a cash payment whose amount depends on the share price of the company.

For example, if a company grants a director 200 share options on 1

January 2006, and these vest after two years, and assuming each option has a value of $3 at the date of the grant, then at 31 December 2006, the accounting entry would be:

Debit Share Option expense (1 year)

Credit Equity

300

IFRS2 applies to all entities and there is no exemption for private or

small companies.

It is important to differentiate between shares issued to acquire a company which is accounted for under IFRS3 ‘Business Combinations’ and shares issued for employee services accounted for under IFRS2.

The issue of shares or rights to acquire shares requires an increase in equity and the debit entry will be an expense when the goods or services are consumed. If the share issue is linked to past services, then the value of the shares given to the employees will be expensed immediately.

If the issue of shares relates to a future vesting period, then the value of the shares should be expensed over that period. .

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/i f r s 02.h t m

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Agriculture - IAS 41

The main elements of this standard are as follows:

It covers all biological assets to the point of harvest (paragraph 1).

Biological assets are measured at each reporting period end date at

their fair values less point-of-sale costs (paragraph 12).

Agricultural produce is measured at harvest at fair value less point-

of-sale costs. This becomes the cost of inventory (paragraph 13).

Gains and losses go to profit or loss (paragraphs 26 and 28).

If fair value is not reliably determined, then measure at cost

(paragraph 30).

Government grants are treated as income when their conditions are

met (paragraph 34).

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/ i as 4 1.h t m

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Exploration for and evaluation or mineral resources - IFRS 6

IFRS 6 imposes few requirements on companies that are engaged in

exploration for, and evaluation of, mineral resources. The ‘standard’ merely requires entities to develop a policy for the extent to which such expenditure should be capitalised and to disclose that policy clearly in the financial statements..

That said IFRS 6 does require entities recognising exploration and evaluation assets to perform an impairment test on those assets when facts and circumstances suggest that the carrying amount of the assets may exceed their recoverable amount.

IFRS 6 requires disclosure of information that identifies and explains

the amounts recognised in its financial statements arising from the exploration for and evaluation of mineral resources, including:

a. its accounting policies for exploration and evaluation expenditures including the recognition of exploration and evaluation assets

b. the amounts of assets, liabilities, income and expense and operating and investing cash flows arising from those assets.

For further information and a summary of this standard please click on the following hyperlink to Deloitte’s IAS Plus website where a summary of the standard can be accessed:

h tt p:/ / ww w . i aspl u s. c om/s t andard/i f r s 06.h t m

Certificate in International Financial Reporting

Module 5: Accounting for assets and liabilities – part 2

Frequently asked questions

If a company’s board of directors has decided on a restructuring,

should the company not make a provision for the restructuring, redundancy costs, etc?

Surely it gives useful information to the users of financial statements to show a proposed dividend as a liability?

Can a deferred tax asset be shown in the financial statements if the company is making losses?

1. It depends on the facts. A board decision does not of itself create an

obligation to a third party, and the board could change its mind. In such cases, IAS 37 does not allow a provision. This may not be “prudent” but this is overridden by the need to comply with the framework’s definition of a liability. Only when the decision is communicated to those affected by the restructuring would it be appropriate to recognise a provision

2. IAS 10 is based on the idea that it is not useful to show something

as a liability that is not in accordance with the definition of a liability.

The information about the proposed dividend can be given in the notes.

3. It is unlikely as it must be probable that future taxable profits will be

available against which to use the asset.

Certificate in International Financial

Reporting

Module 5: Accounting for assets and liabilities – part 2

Quick Quiz

Module 5 quick

quiz

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 1

Dodo Ltd is preparing its financial statements to 31 December 20X3. The accounts are due to be finalised by 31 March 20X4.

Which of the following should not be adjusted in the financial statements?

On 1st February Dodo receives written confirmation that a

customer, Looney Bin, has gone into Liquidation. At the year end the balance due from Looney Bin was material.

On 27th March torrential rain causes one of three warehouses to

flood, damaging some of the inventory held there. Dodo continues to trade successfully although at a reduced level.

Dodo manufactures a specialist component for the computer

hardware industry. It costs $3.35 to produce and would normally sell for $5.20. At the year end this component is held in inventory at cost. However due to the launch of an updated product, this component is only selling for $2.90

On 15th March a legal case against Dodo arising prior to 31

December 20X3 is settled for $300,000. In the draft financial statements a provision is included for substantially more.

The correct answer is B.

The flood is not indicative of conditions that were in place at the year end and this type of event is never reflected in the financial statements as it could not possibly have been foreseen.

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 2

The management team at Super Safe Ltd try to be as prudent as possible when preparing the annual financial statements. Under IAS 37 which of the following should they provide in the financial statements:

The overall operating loss they expect the company to record in

the following financial year.

Costs associated with the restructuring of their sales and marketing

division. Plans have been drafted by the board but not yet announced.

The loss they are anticipating on a contract they have in place to

buy rubber matting at $15 per metre. The contract runs until the end of next year and they are currently able to sell the matting for

$12 per metre.

All of the above.

The correct answer is C.

This is an onerous contract – effectively the company is tied in to recording a loss on this matting.

Forecast operating losses should not be provided because at the reporting date there is no ‘obligation’ to record that loss in the following year.

Restructuring costs may be provided, if there is an obligation. At present, management have not created any obligation to go ahead with their plans though. To create an obligation to proceed they must announce the plans.

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 3

A company purchased an item of plant for $270,000 on 1 January 20X0. The plant is depreciated in the financial statements straight line over 5 years. For tax purposes the plant is has a life of 3 years. What is the deferred tax balance in respect of the plant on 31st December 20X1?

The applicable rate of corporate income tax is 30%

Liability of $10,800

Asset of $10,800

Liability of $21,600

Asset of $21,600

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 4

I C Ltd manufactures fridge freezers and with each one sold offers a free guarantee. In one year the company expects to sell 30,000 fridge freezers. Of these they expect 1% to be returned under the guarantee requiring major repair work costing on average $300. They also expect

5% to be returned requiring minor repairs costing on average $100.

How should the company record this guarantee policy in their financial

statements?

Recognise a provision of $240,000 on the statement of financial

position and disclose details in the notes.

Disclose the details of the guarantee policy in the notes to the

financial statements

Disclose the details of the guarantee policy in the notes, including

an estimate of the likely cost to the company of fulfilling the guarantee.

No disclosure of the guarantee policy is required.

The correct answer is A.

The company has an obligation in offering the guarantee, and it is probable, over the entire population of 30,000 washing machines, that they will have to pay something in repairs cost. Disclosure alone is therefore insufficient. The provision is calculated using expected values:

(1% x 30,000 x $300) + (5% x 30,000 x $100) = $240,000

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 5

Sha La La Ltd recently suffered a small fire in one corner of the warehouse. They have placed a claim with their insurer for $220,000 to cover the cost of repairing the damage. They have not had confirmation yet but believe it is more likely than not that they will receive the payout.

How should the company treat this in the annual financial statements?

Nothing should be recognised or disclosed in relation to the claim

until the company is certain of the outcome.

A receivable for the full amount should be recognised on the

statement of financial position.

A receivable for half the value of the claim should be recognised at

this stage, as it is not certain that the money will be received and this is more prudent than recognising the full amount.

The details of the insurance claim should be disclosed in the notes

to the financial statements.

The correct answer is D.

The insurance claim represents a contingent asset that will probably result in an inflow of economic benefits and so should be disclosed but not recognised on the statement of financial position.

Certificate in International Financial

Reporting

Module 5: quick quiz

Question 6

Under IFRS 9, which of the following financial assets should be held at amortised cost:

A fixed interest rate loan

An investment in a convertible loan note

A zero coupon bond

All of the above

1 and 3

1 only

1 and 2

The correct answer is B.

IFRS 9 states that a financial asset should be held at amortised cost if the asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows and the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. An investment in a convertible loan note does not therefore qualify to be held at amortised cost because the conversion option would not be considered to represent either principal or interest.