Acca Ifrs

International Financial Reporting Standards
Table of contents
The nature and operations of the IASB .................................................................................................................................................. 4

Module 1 introduction – The nature and operations of the IASB ............................................................................................................. 5
The structure of the IASB................................................................................................................................................................. 6
Extant Standards of the IASB ........................................................................................................................................................... 8
The Framework ............................................................................................................................................................................ 11
Working with Stock Market Regulators ............................................................................................................................................. 13
Projects in progress ...................................................................................................................................................................... 14
Frequently asked questions - and answers! ...................................................................................................................................... 15
The status and use of IASs around the world ....................................................................................................................................... 16
Module 2 introduction – The status and use of IASs around the world................................................................................................... 17
The IASB roadmap........................................................................................................................................................................ 18
The annual IASB bound volume and its use ...................................................................................................................................... 19
Presentation and profit ..................................................................................................................................................................... 21
Module 3 introduction - Presentation and profit ................................................................................................................................. 22
Presentation of Financial Statements - IAS 1 (revised December 2003) ................................................................................................ 23
Exercises - IAS 1 .......................................................................................................................................................................... 25
Revenue - IAS 18 ......................................................................................................................................................................... 26
Accounting Policies, Changes in Accounting Estimates and Errors- IAS 8 ............................................................................................... 27
ACCAdemy.com Page 1 of 109

Asset recognition and measurement ................................................................................................................................................... 30

Module 4 introduction – Asset recognition and measurement .............................................................................................................. 31
Property Plant and Equipment (PPE) - IAS 16.................................................................................................................................... 33
Exercise - IAS 16 .......................................................................................................................................................................... 34
Intangible Assets - IAS 38 ............................................................................................................................................................. 35
Exercise - IAS 38 .......................................................................................................................................................................... 36
Investment Property - IAS 40 ......................................................................................................................................................... 37
Impairment of Assets - IAS 36........................................................................................................................................................ 38
Exercise - IAS 36 .......................................................................................................................................................................... 40
Case study – Impairment............................................................................................................................................................... 41
Borrowing Costs - IAS 23............................................................................................................................................................... 43
Accounting for Government Grants and Disclosure of Government Assistance - IAS 20 ........................................................................... 44
Exercise - IAS 20 .......................................................................................................................................................................... 45
Inventories - IAS 2 ....................................................................................................................................................................... 46
Construction Contracts - IAS 11...................................................................................................................................................... 47
Leases - IAS 17 ............................................................................................................................................................................ 48
Exercise - IAS 17 .......................................................................................................................................................................... 49
Financial Instruments: Disclosure and Presentation - IAS 32 ............................................................................................................... 50
Financial Instruments: Recognition and Measurement - IAS 39............................................................................................................ 51
Exercise - IAS 39 .......................................................................................................................................................................... 53
Agriculture - IAS 41 ...................................................................................................................................................................... 54
Case study – Investments.............................................................................................................................................................. 55
Accounting for liabilities .................................................................................................................................................................... 59
Module 5 introduction - Accounting for liabilities ................................................................................................................................ 60
Provisions, Contingent Liabilities and Contingent Assets - IAS 37 ......................................................................................................... 61
Exercise - IAS 37 .......................................................................................................................................................................... 63
Case study - Provisions, Contingent Liabilities and Contingent Assets ................................................................................................... 64
Events After the Balance Sheet Date - IAS 10 ................................................................................................................................... 67
Exercise - IAS 10 .......................................................................................................................................................................... 68
Employee Benefits - IAS 19............................................................................................................................................................ 69
Exercise - IAS 19 .......................................................................................................................................................................... 71
Income Taxes - IAS 12 .................................................................................................................................................................. 72
Exercise - IAS 12 .......................................................................................................................................................................... 73
Case study - Deferred tax .............................................................................................................................................................. 74
IFRS2 ‘Share-based payment’......................................................................................................................................................... 75

Group accounting............................................................................................................................................................................. 77
Module 6 introduction - Group accounting ........................................................................................................................................ 78
Consolidated and Separate Financial Statements - IAS 27 .................................................................................................................. 79
Exercise - IAS 27 .......................................................................................................................................................................... 80
Business Combinations - IFRS3....................................................................................................................................................... 81
Exercise - IFRS3 ........................................................................................................................................................................... 82
Case study - Business Combinations and Subsidiaries ........................................................................................................................ 83
Accounting for Investments in Associates - IAS 28............................................................................................................................. 86
Joint Ventures - IAS 31.................................................................................................................................................................. 87
Exercise - IAS 31 .......................................................................................................................................................................... 88
The Effects of Changes in Foreign Exchange Rates - IAS 21 ................................................................................................................ 89
Financial Reporting in Hyperinflationary Economies - IAS 29 ............................................................................................................... 90
Disclosure standards ........................................................................................................................................................................ 92
Module 7 introduction – Disclosure standards.................................................................................................................................... 93
Cash Flow Statements - IAS 7 ........................................................................................................................................................ 94
Segment Reporting - IAS 14........................................................................................................................................................... 95
Exercise - IAS 14 .......................................................................................................................................................................... 96
Related Party Disclosures - IAS 24 .................................................................................................................................................. 97
Earnings Per Share - IAS 33 ........................................................................................................................................................... 98
Interim Financial Reporting - IAS 34 ................................................................................................................................................ 99
Exercise - IAS 34 .........................................................................................................................................................................100
IFRS4 ‘Insurance Contracts’ ..........................................................................................................................................................101
Non-current assets held for sale and discontinued operations – IFRS5 .................................................................................................102
Exercise - IFRS5 ..........................................................................................................................................................................103
Disclosures in the Statements of Banks and Similar Financial Institutions - IAS 30 ................................................................................104
Frequently asked questions - and answers! .....................................................................................................................................105
Forthcoming projects .......................................................................................................................................................................106
Module 8 introduction – Forthcoming projects ..................................................................................................................................107
Frequently asked questions - and answers! .....................................................................................................................................108
Course conclusion ........................................................................................................................................................................109

Module 1
The nature and

operations of the
IASB

International Financial Reporting Standards Module 1 – The nature and operations of the IASB

Module 1 introduction – The nature and operations of the IASB
The International Accounting Standards Committee was founded in 1973 after a

conference in Sydney in 1972. The IASC was formed through an agreement made by the
professional accountancy bodies from Australia, Canada, France, Germany, Japan, Mexico,
the Netherlands, the United Kingdom with Ireland, and the United States of America.
The accounting “rule makers” in these countries were in many cases not the professional
accountancy bodies, e.g. in France, Germany and Japan the government is in charge of
rules. In considering the requirements for international accounting standards, it was
regarded as too difficult for governments to reach agreement – so the accountancy bodies
have worked together to try to devise a consistent set of global guidelines.
In 2001, the IASC was re-constituted into a private-sector independent standard setter
and the IASC Foundation was formed. The IASC Foundation now has 19 trustees.
The main operating arm of the IASC Foundation is the Board (IASB) of fourteen members.
The Board operates on the basis of a simple majority vote and each Board member has
one vote. The Trustees appoint the IASB Board Members.


The structure of the IASB
The Trustees
There are 19 Trustees including the chairman. The Trustees have the responsibility for
the governance, the raising of funds and the public perception of the IASB.
Standards Advisory Council
This body is designed to meet three times a year to give strategic advice to the Board,
(formerly the International Accounting Standards Committee - IASC), and provide a wider
forum for participation in the process of standard setting. It has approximately 45
members who have diverse geographical and functional backgrounds.
Board
The Board has 14 members. The chairman is Sir David Tweedie, who was formerly
chairman of the UK's Accounting Standards Board. Several of the members have liaison
responsibilities for national standard setters: Australia and New Zealand, Canada, France,
Germany, Japan, UK, and US. The IASB is extremely keen on following open due process
in its standard setting. The Board issues International Financial Reporting Standards
(IFRS) but has adopted all of the previous IASs issued by its predecessor body (IASC).


International Financial Reporting Interpretations Committee (IFRIC)
The International Financial Reporting Interpretations Committee (IFRIC) was reconstituted

in December 2001 to consider accounting issues that are likely to receive unintended or
unacceptable treatment in the absence of any other form of guidance. In order to develop
interpretations, the IFRIC will consult similar national bodies which have been nominated
by the Member Bodies.
The predecessor body was called the Standing Interpretations Committee (SIC) and many
of their statements still provide authoritative guidance. The pronouncements of IFRIC/SIC
have the same authority as a standard of the IASB.


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

IAS 2 Inventories
IAS 7 Cash Flow Statements
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10 Events After the Balance Sheet Date
IAS 11 Construction Contracts
IAS 12 Income Taxes
IAS 14 Segment Reporting
IAS 16 Property, Plant and Equipment
IAS 17 Leases
IAS 18 Revenue
IAS 19 Employee Benefits
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
IAS 21 The Effects of Changes in Foreign Exchange Rates
IAS 23 Borrowing Costs
IAS 24 Related Party Disclosures
IAS 26 Accounting and Reporting by Retirement Benefit Plans
IAS 27 Consolidated and Separate Financial Statements
IAS 28 Investments in Associates
IAS 29 Financial Reporting in Hyperinflationary Economies
IAS 30 Disclosure in the Financial Statements of Banks and Similar Financial
Institutions
IAS 31 Interests in Joint Ventures
IAS 32 Financial Instruments: Disclosure and Presentation


IAS 33 Earnings Per Share
IAS 34 Interim Financial Reporting
IAS 36 Impairment of Assets
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IAS 38 Intangible Assets
IAS 39 Financial Instruments: Recognition and Measurement
IAS 40 Investment Property
IAS 41 Agriculture
IFRS1 First time Adoption of International Financial Reporting Standards

IFRS2 Share based Payment
IFRS3 Business Combinations
IFRS4 Insurance Contracts
IFRS5 Non-current assets held for sale and discontinued operations
You will note that a number of standards seem to be missing, e.g. IASs 3, 4, 5, and 6.
This is because they have been replaced by later standards, e.g. IAS 3 (which related to
consolidated financial statements) was replaced by the much more detailed standards 27,
28 and 31. The above standards are examined in more detail in later modules in this
course as follows, in the order dealt with:
Module 3 (Presentation and profit) IASs 1, 8, 18, and IFRS2

Module 4 (Asset recognition and measurement) IASs 16, 38, 40, 36, 23, 20, 2, 11, 17,
32, 39 and 41
Module 5 (Accounting for liabilities) IASs 37, 10, 19, 12
Module 6 (Group accounting) IASs 27, 28, 31, 21 and 29, IFRS3
Module 7 (Disclosure standards) IASs 7, 14, 24, 33, 34, 35, 30, IFRS1, 4 and 5
In addition to those standards that have been deleted, as explained above, this course
does not deal with IAS 26, which is a specialist standard on accounting and reporting by
retirement benefit plans.


The extant standards will be subject to change because of the need to bring national and
international accounting standards into line. This is referred to as the 'convergence
process'.
The latest standard (IFRS5 ‘Non-current assets held for sale and discontinued operations’)
was approved in March 2004. The application dates of standards are normally somewhat
after their date of publication, e.g. IFRS5 came into force for accounting years beginning
on or after January 1st 2005.


The Framework
A major item in the list of publications is the "Framework for the Preparation and
Presentation of Financial Statements" of 1989. This establishes the purpose of financial
statements and the major principles lying behind their preparation. The Framework
suggests that the main purpose of financial statements is to give information to users
(particularly investors) so that they can make financial decisions. The most useful
information would therefore be that which enables the prediction of future cash flows. It
is clear from this that the purpose of financial statements is little to do with taxation or
management accounting. The context is that companies and users are presumed to be
living in an international world so that comparisons need to be made across national
borders. This also implies that national laws including tax laws are ignored when
international standards are being drafted. A key function of the Framework is to underpin
the standards. Often the Framework is used where there is no standard in a particular
area. For example 'Off Balance Sheet Finance.'
The Framework is particularly designed to be used by the Board itself when preparing
standards but is also addressed to companies and auditors when preparing financial
statements in accordance with IAS/IFRS.
One of the key components of the Framework is the definition of the five main elements of
financial statements. In the balance sheet, three elements can be found:
An asset is a resource controlled by the enterprise as a result of past events

and from which future economic benefits are expected to flow to the
enterprise.
A liability is a present obligation of the enterprise arising from past events,

the settlement of which is expected to result in an outflow from the enterprise
of resources embodying economic benefits.
Equity is the residual interest in the assets of the enterprise after deducting
all its liabilities.
Equity does not need to be defined separately because it is just the arithmetical difference
between total assets and total liabilities.


The Framework stresses the definitions of asset and liability such that the definitions of
income and expense are secondary i.e. for example, an expense is defined as an increase
in a liability or a decrease in an asset. This is different from conventional accounting in
most countries where in practice accounting is focussed on the definitions of income and
expenses based upon the accruals concept.
To help explain this, let’s take a look at an example. Imagine that a business needs to
repair a piece of equipment on the 20th February 20x3. The company has a financial year
running from 1st January to 31st December.
Is the repair bill an expense of financial year 20x2 or of 20x3?
Some accounting systems, such as the German system, would treat this as an expense of
20x2, as the wear and tear that caused the equipment to breakdown was in 20x2. Not
only this, but the repair is tax deductible in 20x2 if so charged.
The conventional definition of an expense of year X is that it is a payment made in any

year that relates to year X.
In this case, it could be argued, that the expense relates to 20x2. If this is the case, then
at the end of financial year 20x2, a debit has to appear in the accounts for the repair
expense, and a credit as a provision for the repair. This will mean that the balance sheet
on 31st December 20x2 will show a liability for the “provision for repair”.
While it is difficult to say that this way is “wrong”, it is certainly different from the practice
of many other countries, including the UK. The Framework suggests that you should ask
the question “Is there a liability?” on the 31st December 20x2. The answer is “no”.
Therefore there is no need for a double entry and so no expense. This is clearer. Note
also that IAS 37 'Provisions, Contingent Liabilities and Contingent Assets' would not allow
a provision to be made for this amount.
The application of the asset/liability Framework is changing conventional accounting

practice.
The Framework is very similar to that developed in the US in the late 1970s by the FASB
and similar to that adopted by the UK's ASB in the 1990s.


Working with Stock Market Regulators
Activity at the IASC up until the late 1980s was the codifying of best practice, including
many national options. In other words, in order to achieve a ¾ majority of the Board it
was often necessary to allow more than one practice within an IAS. From 1989 things
began to improve. First, with a Framework established, it was much easier to arrive at a
clearly correct answer for many accounting problems so that certain options just did not fit
the Framework and could be excluded. Secondly, in 1989 an agreement was reached with
the world body of stock market regulators (IOSCO). IOSCO came to the view that it
would be useful to have a single accounting language for the world, particularly for capital
markets, and decided that the best place to start was with the IASC’s standards.
However, in 1989 there were too many options and too many gaps in the standards.
IOSCO asked the IASC to remove as many options as possible and fill the gaps. In return
IOSCO would hope to allow the use of IASs on all the world’s stock markets for foreign
companies. At present many stock exchanges do allow the use of IASs for foreign
companies and sometimes domestic companies. For example, the London Stock
Exchange allows foreign companies to use IASs although UK companies must still follow
UK rules according to UK law. However, the major international exception to this is that,
in the US, the Securities and Exchange Commission (the US member of IOSCO) requires
foreign companies to prepare US GAAP financial statements or to reconcile to US GAAP if
they are to be listed on an American exchange.
The IASC was spurred on by this agreement and spent the whole of the 1990s trying to
satisfy IOSCO with a major programme of revised and new standards. The programme
ended with IAS 40 in early 2000 and IOSCO began looking at the so-called “core
standards” at the end of 1999.
In 2000, IOSCO recommended IASs to its members for foreign registrants. However, the
SEC has still not made a decision, but recently there have been moves as part of the
convergence process to bring US GAAP into line with IASs. IOSCO published a report in
2000 setting out the main issues that it still had to with IAS's. The report is that of the
IOSCO Technical Committee.


Projects in progress
The IASB has many projects currently in progress. Before an IFRS is issued the Board
publishes an Exposure draft (ED) on the subject area so that comments can be received
on the document. The Board always publishes an exposure draft on an 'invitation to
comment' basis before finalising its position on a particular project.
Current projects include 'Business Combinations II', 'Leases’ and ’Revenue recognition'.
The IFRIC also publishes draft interpretations for comment before finalising an
interpretation. All final interpretations have to be approved by the IASB.


Frequently asked questions - and answers!
Who, or which country, was the main driving force behind the creation of
the IASC?
Lord Benson, who had been President of one of the UK accountancy bodies, was the
driving force. The IASC grew out of a research group of the UK, the US, Canada and
Australia.
Is there anything particularly significant about the founding date of 1973

for the IASC?
1973 was the year that the UK joined the Common Market (now EU). The EU had various
accounting requirements which the UK did not like! Perhaps the IASC was seen as a
counter-balance to harmonisation run from Brussels.
Who chooses the IASC Trustees and Board?
The 17 original trustees were chosen in 2000 by a nominating body which included the
chairman of the SEC and the president of the World Bank. Any retiring trustee is now
replaced by a new trustee chosen by the remaining trustees.
The Board members are chosen by the Trustees.
Is the Framework anything like the UK's Statement of Principles?
Yes, the Framework is closely in line with that of the US standard setter (the FASB) of the
late 1970s and the UK's Statement of Principles also clearly derives from this source.
Are the IASB's standards always in line with the Framework?
Not exactly. The Framework was written after some of the standards. Also, sometimes,
practical or political necessity forces the Board to stray from the Framework. However it
is a useful basis for the development of standards, and is being used more and more as
the basis for IFRS.

International Financial Reporting Standards Module 2 – The status and use of IASs around the world

Module 2
The status and use of

IASs around the world


Module 2 introduction – The status and use of IASs around the
world
In 1998, G7 Finance Ministers and Central Bank Governors pledged that private sector
institutions in their countries should comply with international principles and practices.
They called upon a global initiative to ensure that this occurred.
The IASB has no mechanism for demanding that companies apply their standards.
Nevertheless IASs are in use extensively around the world in a variety of different ways
and for a variety of different reasons. Some examples of this can be seen in the
following:
Adoption exactly (or closely) by national standard setters (e.g. those in Nigeria,
Malaysia, Hong Kong and Singapore), followed by compliance by companies.
Use of elements of IASs by companies in countries where national rules are incomplete
or flexible. For example, financial statements of companies in Italy will contain
elements from IASs.
Use of national rules with a reconciliation to IASs, for example Nokia of Finland.
Deliberate full use of IASs by choosing options within national rules. For example,
many listed companies in France in the late 1990s published consolidated IAS
compliant statements.
Use of IASs instead of (or in addition to) national rules, perhaps because there is a
reconciliation to national rules or there is another set of financial statements in
accordance with national rules, for example Deutsche Bank prepared two sets of
financial statements in the late 1990s
Many countries already use IAS as their own or with amendment for local legislation.
Important developments are taking place in the European Union (EU) where all listed
companies in the EU will have to prepare their consolidated financial statements using IAS
by 2005. Multinational companies, partly in response to this, are looking to use IAS in
preparing their financial statements.


The IASB roadmap
The IASB has come a long way since its inception in 1973. A brief list of the major
developments that have marked the life of the IASC is set out below:
The IASC was founded in 1973 by accountancy bodies from nine countries
Activity up until the late 1980s was the codifying of best practice, including many
national options
1989 saw the publication of a conceptual Framework and initial discussions with IOSCO
1990s: gradual adoption of IASs as national standards, particularly by Commonwealth
countries
1993: ten revised standards, in force in 1995
1994+: adoption of IASs by a number of continental companies for consolidated
statements
1995: agreement between the IASC and IOSCO on list of core standards
1998: laws to permit use of IASs in France, Germany and Italy
1998: the IASC passes last major core standard (IAS 39, financial instruments)
1999: the IASC decides on reform; welcomed by SEC, etc.
2000: IOSCO recommends use of IAS to its members
2000: EU Commission proposes compulsory use of IAS for listed companies'

consolidated statements by 2005
2001: European Commission present legislation to require use of IAS for all listed
companies no later than 2005
2001: Trustees bring the new constitution into effect. IASB is responsible for setting
standards which are now named International Financial Reporting Standards.


The annual IASB bound volume and its use
In order to gain maximum advantage from this course, and before you go any further, you
should have with you the bound volume of International Financial Reporting Standards
2004. You can purchase this direct from the IASB web site (www.iasb.org.uk)
This contains the text of the current international standards and the interpretations of the
IFRIC. It also contains the text of the Framework and a glossary of terms used in IASB
documents. From time to time, this course will direct you towards particular standards to
carry out short exercises.


Which national standards are closest to the IASB's?
Because of the convergence projects undertaken by the IASB, the ASB (Accounting
Standards Board) in the UK, and the FASB (Financial Accounting Standards Board) in the
US, UK and US GAAP have moved closer to the IASs. However some national standards
(e.g. Malaysia, Singapore) actually mirror the IAS and thus these standards are the
closest to IAS.
Does the UK allow the use of IASs?
UK companies are required to follow the UK Companies Acts. Legal counsel's opinion is
that it is generally necessary for companies to comply with UK standards in order to give a
true and fair view. Basically, UK companies are not allowed to depart from UK standards
in order to obey IASs. An analogous conclusion is even clearer in the United States.
However, from 2005, UK listed companies will be required to use IAS for their
consolidated statements and there will be a need to change Company Law in order for this
to take place.
Is it necessary to comply with "grey-letter" guidance in an IAS?
Yes, in order to claim compliance with IASs. The "Big Four" audit firms have agreed to
treat grey letter as compulsory for the purposes of their audits. However, there is a "fair
representative override", as examined in Module 3 of this course. This is known in some
countries as the 'true and fair view override.'
What version of the English language is used by the IASB: British or

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

International Financial Reporting Standards Module 3 - Presentation and profit

Module 3
Presentation and
profit


Module 3 introduction - Presentation and profit
This module begins the process of looking at IASs on a topic-by-topic basis. This module
deals with three standards:
.
Presentation of Financial Statements - IAS 1

Revenue - IAS 18
Accounting Policies, Changes in Accounting Estimates and Errors - IAS 8


Presentation of Financial Statements - IAS 1 (revised December
2003)
The following represent the key points from the standard:
This standard contains several aspects taken from the Framework, including that the
purpose of financial reporting is to give useful information to investors for the
purposes of making economic decisions (paragraph 5).
The standard states that there are five components of financial statements, as follows
(paragraph 7):
Balance sheet
Income statement
Statement of changes in equity
Cash flow statement
Accounting policies and explanatory notes
A statement of changes in equity must show (para 96/97):
(a) profit/loss for period
(b) items recognised directly in equity
(c) total income/expense for period
(d) effects of changes in accounting policies or errors
Also the following may be shown in the statement or in the notes:
(a) capital transactions with owners
(b) movement in profits
(c) reconciliations of movements in share capital and reserves
IAS 1 requires that financial statements should present fairly the financial position,
performance, and cash flows of an enterprise. It is said that nearly always this will be
achieved by compliance with the requirements of the standards. However, in what are
said to be extremely rare circumstances, it may be necessary to depart from such a
requirement in order to achieve a fair presentation. IAS 1 requires departure in such
circumstances, but with extensive disclosures, including the financial impact of the
departure from the standard.


The two main requirements of accounting information are that it should be relevant
and reliable. As part of being reliable, financial statements should represent faithfully
the results and position, should reflect economic substance not merely legal form,
should be free from bias, should be prudent, and should be complete in all material
respects . Several other principles are said to be normally required, such as going
concern, accruals, consistency and materiality.
The off-setting of assets and liabilities is not allowed except where another standard
requires or permits it. Income and expense items should not be offset except where a
standard requires or permits (paragraphs 32 and 33).
IAS 1 generally requires that comparative information for the previous period should
be disclosed for all numerical information in financial statements (paragraph 36).
It is not necessary to present assets and liabilities on the basis of the distinction
between current items and non-current items (paragraph 51/52).
IAS 1 does not lay down particular formats for financial statements but does have
minimum requirements for the presentation of items on the face of the financial
statements (paragraphs 68 to 95). There are, however, illustrative financial
statements in an Appendix.
• Disclosure is required in the notes of accounting policies followed
• Disclosure of ‘extraordinary items’ is prohibited
• A liability or asset is current if it will be settled within the company’s normal

operating cycle, or is due to be settled within twelve months after the balance
sheet date. The normal operating cycle could be longer than twelve months


Exercises - IAS 1
Throughout the course exercises will be set which you should complete before moving on.
Should the going concern convention be ignored when a significant part of

the reporting entity is thought not to be a going concern?
The going concern convention should be related to the whole of the reporting entity.
So the fact that part of a reporting entity might not be a going concern should not
change the use by the preparer of the going concern convention. However, the fact
that part of the enterprise is not a going concern may well lead to the need for the
impairment of assets (see IAS 36 later) or the recognition of provisions (see IAS 37
later).
Is consistency of accounting policies from year to year required?
IAS 1 (paragraph 27) does not address consistency of accounting policies but
consistency of presentation. The policy issue is dealt with in IAS 8 but a rather
similar conclusion would be arrived at for both presentation and policies. The
conclusion is that consistency is required unless there is a change to a better
practice, or there is a change in an accounting standard. Of course, management
would only choose to change its presentation or policies if it thought that the result
was beneficial.
Can a loan which is expected to be paid back in four months be a non-

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


Revenue - IAS 18
The following represent the key points that you should take from the standard:
Revenue is to be measured at the fair value of the consideration received. This

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


Accounting Policies, Changes in Accounting Estimates and Errors-
IAS 8
The following represent the key points that you should take from the standard:.
The standard specifies how accounting policies are to be determined in the absence of
a specific standard or interpretation (paragraph 10)
The standard requires consistency in the selection and application of accounting
policies (paragraph 13)
Changes in accounting policies are to be dealt with retrospectively.
Disclosure is required of an impending change of accounting policy as a result of a new
standard that has not yet come into effect (paragraph 30)
Changes in estimates should be recorded prospectively in the income statement in
appropriate periods (paragraph 36).
The correction of material errors should be treated as a prior year adjustment.
(paragraph 42).
A change in accounting policy is allowed if it is required by a change in an accounting
standard, or if the change is to a more appropriate policy (paragraph 14).
Changes in policy caused by change in an IAS should be dealt with in accordance with
the requirements of that IAS.

IFRS1 ‘First time Adoption of International Financial

Reporting Standards’

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


Is there a "true and fair override" in IASs?
IAS 1 talks of fair presentation rather than true and fair view. However, there is an
override, which is said to be necessary only in very rare circumstances. Substantial
disclosures are required.
What is the status of IFRIC interpretations?
IASB gives IFRIC interpretations the same status as standards. That is, they must be
complied with.
Suppose that a company has entered into a binding contract to sell an

asset soon for a fixed amount. Can any implied gain be recorded?
The Framework would appear to suggest that the gain is both relevant and reliable
information. However, IAS 18 requires control to be passed, so it seems that the gain
cannot be recorded at the time of the contract.

International Financial Reporting Standards Module 4 – Asset recognition and measurement

Module 4
Asset recognition and

measurement


Module 4 introduction – Asset recognition and measurement
The treatment of assets involves a three-stage process: .
Is the item an asset?

Should the item be recognised (recorded) in the balance sheet?
How should the asset be valued/measured?
The first question takes us back to the IASB Framework where the definition of asset is:
"a resource controlled by the enterprise as a result of past events

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


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

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


Property Plant and Equipment (PPE) - IAS 16
The main elements of this standard are as follows:
An asset should initially be recognised at its cost, which includes all those costs of
bringing it to its present condition and location, ready for productive use (paragraph
15).
Costs are subsequently recognised if it is probable that future economic benefits will
flow.
PPE can be measured at cost (with depreciation, see below) but the assets may be
revalued to fair value. This alternative must be used continually at each balance sheet
date and must be applied to a whole class of assets rather than to an individual asset
only. A class of assets is a heading on a balance sheet, such as "land and buildings".
"fair value" means the amount for which the asset could be exchanged by
knowledgeable and willing parties in an arm's length transaction. This is different from
net realisable value because that amount is net of various items including costs of sale
If the revaluation model is used, then revaluation gains and losses should be taken to
equity and recorded in the statement of changes in equity. If a revaluation increase
reverses a revaluation decrease of the same asset and the decrease has been charged
as an expense, then the increase should go to the income statement. In the opposite
case, where there is a revaluation surplus on an asset, any revaluation deficit should
be charged against this surplus until the surplus is used up. Remember these rules
apply to the same asset not different ones. (paragraphs 39 and 40)
The carrying amount of an asset should be depreciated over its useful life. The
depreciable amount takes account of the residual value expected at the end of the
useful life. This value should be measured at the price level ruling when the cost or
value of the asset was determined and reviewed at least at each financial year end
(paragraph 51)
The gain or loss on the disposal of an asset is calculated as the difference between the
proceeds and the carrying amount. Since the latter could be based on either cost or
revaluation, the gain on sale would be lower if an asset had been revalued upwards.
The gain or loss should be included in profit or loss (paragraph 68) but not recognised
as revenue.
IAS36 should apply in determining whether PPE is impaired.


Exercise - IAS 16
You should refer to the text of the standard when answering exercises.
A company bought some land for £15m in 1980, revalued it at various dates
up to £23m, and sold it for £21m in 20x2, but did not receive any cash until
20x3. Ignoring tax, the profit/loss recorded in 20x2 should be:
a. zero
b. +£6m
c. -£2m
d. +£21m
The answer is c. -£2m. The gain/loss is calculated as the difference between the
proceeds, £21m, and the carrying amount, £23m. Note that this implies that the
revaluation element is never recorded as a gain in income.


Intangible Assets - IAS 38
As with any other asset, intangible items should be recognised where there is a
probable future benefit that can be measured reliably (paragraph 21). With intangibles
this may be more difficult than for tangible assets. Certain items are therefore not
recognised. For example, internally generated goodwill cannot easily be traced back to
a transaction and therefore the cost or value is difficult to measure; it is not even clear
that the enterprise has control over it, consequently it is not to be recognised as an
asset (paragraph 48). Also research expenditure cannot be capitalised for similar
reasons (paragraph 54). The same applies to several other internally generated
assets, such as brands (paragraph 63).
Development expenditure that meets certain criteria should be capitalised. One of the
conditions is that there is a technically feasible project that can be separately
measured (paragraph 57).
Just as tangible assets are allowed to be revalued by IAS 16, so intangibles may be
revalued, but there are some restrictions. Intangibles can only be revalued with
reference to an active market that involves many buyers and sellers and publicly
available prices (paragraphs 75, 81 and 82). This makes it difficult in practice to re-
value most intangibles.
Intangible assets should be carried at cost less amortisation and impairment losses if
the cost model is used. If they are carried at a revalued amount, then amortisation
and impairment losses should be deducted from the carrying amount.
The useful life of the intangible asset has to be determined by the company. If it is
finite then the asset is amortised over that life. If it is indefinite, then the asset must
be tested annually for impairment (IAS36)


Exercise - IAS 38
Can brand names be capitalised?
If the brand is internally generated, then the answer is clearly "no", because this is
specified within the standard. However, brands can be obtained in other ways, e.g.
by purchasing the brand from another company either by itself or as part of a larger
acquisition. When a brand is purchased by itself it is clear that it should be
capitalised at cost. If it is purchased as part of an acquisition, then an attempt
should be made to allocate part of the purchase cost to the brand. For example, the
Coca Cola brand name cannot be treated as an asset by the Coca Cola Company
that created it. However, if a company bought the name Coca Cola in Switzerland
for $10m then it should be capitalised at cost. If another company bought the whole
of the Coca Cola company including the brand, then part of the total acquisition cost
might be allocated to the brand name.
Can development expenditure be revalued upwards?
The whole point of development expenditure is that it is designed to create

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


Investment Property - IAS 40
This standard and IAS 39 (see later) replace the old standard on investments, IAS 25...
Investment property is property held to earn rentals or for capital appreciation or both.
An enterprise should decide whether it wishes to follow the cost model or a fair value
model for all its investment property (paragraph 30). Under the cost model, the
property is measured at depreciated cost less impairment losses. The fair value model
includes taking gains and losses to income (paragraph 28).
In the fair value model, individual properties whose fair value cannot be reliably
measured should also be measured at cost (paragraph 53).
When a property changes from investment property to owner occupied or to inventory,
the property's cost for subsequent accounting should be its fair value at the date of its
change of use. (paragraph 57).
For those enterprises that choose the cost model, there must be disclosure in the
notes of fair value (paragraph 79).
An entity must apply its chosen model to all its investment property.


Impairment of Assets - IAS 36
This standard applies to most assets, but not to inventories because they are already
valued at the lower of cost and net realisable value, which takes into account any loss
of value (paragraph 2).
The process of applying this standard begins by looking at each asset at each balance
sheet date for any indication of impairment such as physical damage or fall in selling
price of the product made with the asset (paragraphs 8 to 17).
Normally one would expect no indication of impairment, but in cases where there is,
an enterprise must then test whether there is an impairment. This involves comparing
the "carrying amount" of the asset with its "recoverable amount", which is the higher
of its selling price and value in use.
The value in use is the discounted present value of the future net cash flows expected
to relate to the asset or cash generating unit. A cash generating unit is simply the
smallest element of a company that can independently generate revenue/cash flow
(paragraph 6).
For many assets it may be impossible to measure specific cash flows relating to them,
so it becomes necessary to do the exercise with the smallest group of assets for which
independent cash flows can be measured. This group of assets is a "cash generating
unit" (paragraph 6).
There is a series of rules on cash flow projections designed to stop an enterprise from
being too optimistic (paragraphs 30, 33, 39, 44, 50, and 52). The cash flows should, of
course, be discounted and the discount rate should be pre-tax and asset-specific
(paragraph 55).
The extent to which the carrying value is in excess of the recoverable amount is the
measure of the impairment loss. This should be charged immediately to the income
statement (paragraph 60). However, there are some special rules relating to assets
that have previously been revalued upwards.

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

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


Exercise - IAS 36
Will an asset's recoverable amount usually be selling price or value in use?
For most non-current assets remaining in a balance sheet, there is presumably no

immediate intention to sell them. This implies that the value in use is above the
selling price otherwise it would make sense to sell them. Consequently the
recoverable amount is usually the value in use.


Case study – Impairment
This case study is loosely based on a real example. Suppose that a Malaysian company,
Goodtimes Co, prepares its statements according to IAS/IFRS. It has a flow of net profit
as follows:
Year 20x0 20x1 20x2 20x3 20x4
Net profit (RMB 570 630 102 610 590

million)
In the 20x2 Annual Report, the following was noted:
"In December 20x2 a review of our assets indicated that the value of the oil and gas
operations in our Sector B production area was lower than we had previously been
estimating. Management carried out an impairment test of our oil and gas pipelines by
comparing their carrying value with the present value of the expected net cash flows. This
resulted in a write down of RMB650 million, and an impairment loss of that size was
charged to income."
What sort of estimates are involved in impairment tests?
The impairment is being calculated under the rules of IAS 36, which requires annual
impairment review, followed by tests where there is any indication of impairment.
The test requires a comparison of carrying value with recoverable amount, which is
the higher of selling price and value in use. The former is unlikely to be relevant
because there is no market and no intention to sell. It would normally be lower than
the value in use, which is measured as the discounted expected net cash flows. It is
presumed here that the "cash generating unit" is the pipeline system.
However, the estimates of value in use rely on knowing the life of the pipeline to
the present owner, the disposal proceeds, the cash flows in and out over the future
life, and a suitable pre-tax discount rate. IAS 36's paragraphs 30 to 57 discuss all
this, but there is still considerable room for manoeuvre.


Do you think that there is any incentive for management to overstate or
understate the impairment loss?
The impairment loss for 20x2 is so large in the context of the five year run of profits
that analysts would probably have to ignore it on the grounds of "unusual" /
"abnormal" / "non-recurring". Once the management realises this, they might as
well make the loss as big as possible so that future depreciation expenses are lower
and gains on disposal higher.
Also the management will look at the tax implications of increasing/decreasing an

impairment loss.


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


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


Exercise - IAS 20
An enterprise has received a government grant relating to an asset which is

expected to last for ten years. It is highly probable that the conditions of
the grant will continue to be met. Does the Framework suggest the same
recognition requirement as IAS 20?
Under the Framework there can be only three elements in a balance sheet: assets,
liabilities and equity. It is clear that the grant cannot be an asset since it has a
credit balance. In the example above it also seems not to fit the definition of a
liability. Therefore it must be part of equity. Since the money is already in the bank,
it is not clear why the grant is not income. Consequently it is not clear that IAS 20 is
in accordance with the Framework, and many people think that IAS 20 should be
revised.


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


Construction Contracts - IAS 11
This standard relates to specifically negotiated contracts for the construction of assets.
It requires that when the outcome of the contract can be estimated reliably, then the
revenues and costs should be recognised at each balance sheet date by reference to
the stage of completion of the contract (paragraph 22). Any loss expected should be
recognised immediately.
There is criteria to help determine whether these estimates can be reliably made,
including that the costs and revenues of the contract must be separately identifiable
(paragraphs 23, 24).
When the outcome of a contract cannot be estimated reliably, revenue should be
recognised only to the extent of contract costs that will probably be recoverable, and
contract costs should be recognised when they are incurred. Again, expected losses
should be recognised immediately (paragraph 32).


Leases - IAS 17
This standard requires the capitalisation of finance lease assets and liabilities at the
lower of the fair value of the asset and the discounted minimum lease payments
(paragraph 20).
A finance lease is one that transfers substantially all the risks and rewards associated
with the leased asset to the lessee (paragraph 4). There are a number of suggestions
about how it is possible to identify a finance lease but no numerically based criteria of
the proportion of value or life (paragraphs 8 and 9).
The depreciation period for the capitalised leased assets is to be consistent with any
other assets as under IAS 16 (paragraph 27).
Operating leases (i.e. those leases which are not finance leases) should be treated as
rentals. Operating lease rental payments should be recognised on a straight-line basis
over the life of the lease, even where the lease is written with low rentals at the
beginning and high rentals later (paragraphs 33 to 35 and 49 to 56).
Lessors should recognise a lease as finance or operating in a mirror image way.
Consequently, although the lessor owns the assets involved in a finance lease, the
balance sheet shows a receivable rather than the leased asset.
Lessors should recognise income as a constant periodic rate of return on the net
investment in the lease (paragraph 39).
If a sale and lease back transaction results in a finance lease, any income should be
deferred and amortised over the lease term (paragraph 59).


Exercise - IAS 17
Is the definition of a finance lease consistent with the Framework's

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


Financial Instruments: Disclosure and Presentation - IAS 32
The topic of financial instruments is sufficiently complicated that it was necessary to

split it into two standards. IAS 32 deals with disclosure and presentation issues. IAS
39 (see below) deals with recognition and measurement issues.
There is a very wide definition of financial assets, including cash, the right to receive
cash, the right to receive financial instruments, and equities of another enterprise
(paragraph 5). However, excluded from the scope of IAS 32 and 39 are investments in
subsidiaries, associates and joint ventures and employee benefit obligations.
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 then the
share is to be treated as a liability despite its legal classification (paragraph 18).
Compound instruments should be split into their component parts (paragraph 28). 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 interest expense even if it is legally called a dividend.
A company's own shares, if bought back and held by the company, should not be
shown as assets but deducted from share capital. Such amounts are sometimes
referred to as treasury shares (paragraph 33).
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 (paragraph 42).
There are very extensive disclosure requirements concerning risk management
policies, interest rate risk, credit risk, fair values and hedged items (paragraphs 56 to
94).
When IAS32 and IAS39 were revised in 2003, all of the disclosures about financial
instruments that had been in the old IAS39 were moved to IAS32 which now includes
all the disclosure requirements relating to financial instruments.


Financial Instruments: Recognition and Measurement - IAS 39
Because of the complexity of accounting for financial instruments, IAS 39 was given a
lengthy implementation period.
As for IAS 32, IAS 39 does not cover investments in subsidiaries, associates and joint
ventures or employee benefits obligations (paragraph 2).
The initial recognition of a financial asset or financial liability should be at its cost,
which should be measured as the fair value of the consideration given or received. This
should include transaction costs .
After initial recognition, financial assets, including derivatives, should be measured at
their fair value except for the following types (paragraph 46):
loans and other receivables originated by the enterprise and not held for trading,
held to maturity investments and non derivative financial laibilities (e.g. loans made
by a bank as accounted for by the bank) should be measured at amortised cost using
the effective interest rate method
investments in equity instruments with no reliable fair value should be measured at
cost
Financial assets and liabilities designated as hedges should use the specific rules in
IAS39
Trading and derivative liabilities should also be measured at fair value (paragraph 93).
Comment: This requirement to measure certain assets and liabilities at fair value is
similar to the US standard (SFAS 115) which introduced this revolutionary requirement
shortly before IAS 39. It raises the problem of what to do with the gains and losses
implied by the continual re-valuations. Conventional accounting before this and most local
GAAP’s do not allow gains to be recorded until the point of sale. Since this is still the case
under IAS 39 for those investments held to maturity, management may prefer to treat
their investments as held to maturity, thereby postponing gains and losses until they want
them, whereupon the assets can be sold and bought back again if necessary.


IAS 39 requires that trading and derivative gains and losses should go immediately to
the income statement whereas other gains and losses can either be taken to income or
to equity through the statement of changes in equity.
IAS39 requires financial assets to be classified as:
(i) financial assets at fair value through profit and loss
(ii) available for sale financial assets
(iii) loans and receivables
(iv) held-to-maturity investments.
These categories are used to determine how a financial asset is treated in the financial
statements. Those assets at fair value through profit and loss are further split into
‘designated’, which means that on initial recognition the company identified them to be
valued at fair value with changes to profit and loss, or ‘held for trading’ which includes
all derivatives and assets held to make short term profit.
Financial liabilities also have two classifications: ‘Designated’ and ‘held for trading’.
These categories have the same meaning as for financial assets.
Financial assets should be reviewed for impairment at each balance sheet date.
Hedge accounting means designating a hedging instrument so that its change in fair
value is offset against the change in fair value of a hedged item. For example, if an
enterprise has committed to pay an amount of foreign currency in six months time, it
might buy the currency in advance in order to avoid the risk of the foreign currency
rising in value before the date of payment. Hedge accounting involves designating the
advance purchase as designed to fulfil the future obligation.
Hedge accounting is allowed under certain conditions such as that there is formal
documentation in advance and the hedge is effective.


Exercise - IAS 39
How can an auditor tell whether a financial asset is held for trading or
available for sale?
It is impossible to tell by looking at a financial asset (which is represented merely by

a piece of paper) whether it is, for example, available for sale or trading. This
depends upon the intentions of the management, which are not auditable.
Consequently, IAS 39 requires the management to designate the assets into the
appropriate category on the date of purchase.


Agriculture - IAS 41
It covers all biological assets to the point of harvest (paragraph 1).

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


Case study – Investments
Suppose that a Czech company, Hrad and Co, prepares its financial statements according
to IAS/IFRS. It has a 31 December year end. In February 20x3, it buys some
investments for the first time: K100 million of traded government debt and K50 million of
traded company debentures. All the debt has a 20x8 or later maturity. Under IAS 39,
these investments must be designated at purchase as (a) held-to-maturity, (b) available
for sale, (c) loans and receivable, or (d) financial assets at fair value through profit and
loss. By the middle of December 20x3, the fair value of the government debt has fallen to
K80 million, but the corporate debt has risen to K60 million.
The company's profits before any gains or loans on investments are as follows:
Year 20x0 20x1 20x2 20x3 (estimate)

Net profit (K millions) 35 29 31 19
In February 20x3, before it is clear how successful the trading year will be,
how will management designate the investments?
It would seem to be in the interests of management to designate as many

investments as possible as held-to-maturity (although this is not possible for
equities, that have no maturity date). This is because gains and losses can then be
avoided until they are needed. It is presumably management's objective to show a
gently rising trend of profits rather than a volatile one, assuming that the company
is interested in the reaction of investors. So, perhaps management would designate
all the investments as held-to-maturity and therefore use the cost basis for
valuation.
Before the end of year, what might management do with the investments?
By the end of the year, it becomes clear that trading has been unusually bad.
Management will then be tempted to sell the corporate debt, but not the
government debt, in order to record a gain of K10 million, which will largely make
up for the operating problems.


What results will follow from these actions?
If a company does sell held-to-maturity investments before maturity, IAS 39

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


What is the difference between "fair value" and "net realisable value"
(NRV)?
NRV is a market price net of selling costs. Fair value is a market price with costs neither
deducted or added. For some assets (e.g. buildings) in some countries, transaction costs
could be a large percentage.
Because revaluation increases subsequent depreciation and decreases gain

on sale, would this not discourage revaluation?
It is not the IASB's intention to discourage the use of relevant current values. A transfer
can be made from revaluation reserve to accumulated reserves of the increase in the
depreciation charge. This maintains 'realised' profits at the same level.
IAS 16's rule on the calculation of the gain on revalued assets seems to
mean that some realised gains never appear in the income statement. Can
this be right?
That is, indeed, the implication, as is the case in the UK. However, the gain does appear
in the "statement of changes in equity". This problem is one of many that may lead to a
merger of the income statement and the statement of changes in equity. However, see
the point raised in the answer to the previous question.

If investment properties and other investments can (or must) be valued at

fair value, why can this not be the case for inventories that are about to be
sold in an active market?

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

International Financial Reporting Standards Module 5 - Accounting for liabilities

Module 5
Accounting for
liabilities


Module 5 introduction - Accounting for liabilities
This module deals with a number of IASs that give rise to the recognition of liabilities:
.
Provisions, Contingent Liabilities and Contingent Assets - IAS 37

Events after the balance sheet date - IAS 10
Employee Benefits - IAS 19
Income Taxes - IAS 12


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

A contingent liability is defined in two different ways. Firstly, it includes possible

obligations and secondly existing obligations at the balance sheet date which are
unrecognisable because they will probably not lead to an outflow or are not able to be
measured reliably (paragraph 10). Contingent liabilities should be disclosed where they

are material in size and not remote.
Contingent gains should not be recognised, but should be noted where material
(paragraph 31).


Exercise - IAS 37
A provision can only be recognised when there is an obligation at the

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


Case study - Provisions, Contingent Liabilities and Contingent
Assets
The facts below are loosely based on a real case, but the company, year and exact
numbers have been changed.
Newberg is a German company. Newberg's income statements for 20x0 and 20x1 are
shown below, as are some accounting policies and notes:
Consolidated statements of income (in billions Euro)
20x0 20x1
Sales 32 38
Cost of goods sold (10) (12)
.
Gross profit 22 26
Marketing and distribution (8) (10)
Research and development (5) (6)
Administrative (2) (2)
Other expenses (1) (1)
.
Operating profit 6 7
Non-operating income 3 3
.
Results before special charges and taxes 9 10
.
Special charges
Acquired in-process research and - (9)
development
Restructuring - (6)
.


Taxes
On result before special charges (2) (2)
Benefit from special charges - 3
.
Net income (loss) 7 (4)
Extracts from significant accounting policies and notes
Basis of preparation of financial statements The consolidated financial statements of

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

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


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.
Do you think that a provision for restructuring costs should have been set
up at 31 December 20x1? (Other questions on this case will be asked in
Module 6)
According to IAS 37, a provision should be set up when:
(i) there is a probable expected outflow,

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


Events After the Balance Sheet Date - IAS 10
IAS 10 was published in revised form in December 2003

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


Exercise - IAS 10
Can proposed dividends be a liability?
A proposed dividend could certainly be a liability if it has been approved at the

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


Employee Benefits - IAS 19
This standard applies to all employee benefits not just to pensions (paragraph 1).
The standard deals with such issues as accounting for accumulating compensated
absences and for bonus plans. In each case the standard requires an enterprise to
establish whether there is a liability at the balance sheet date and to account for any
liability (paragraphs 14 and 17).
In a country with special forms of employee benefit systems such as multi-employer
plans and government plans, these should be accounted for as other plans on the
basis of their legal and institutional arrangements (paragraphs 29 and 36).
Defined contribution plans present few difficulties for accounting but the standard
does cover them (paragraph 44).
Defined benefit plans are much more complicated, and a large part of the standard
deals with them. Constructive obligations as well as written contractual ones should
be accounted for (paragraph 52).
Employee benefit liabilities are measured as the arithmetical sum of four elements.
First, there is the present value of the obligation minus the fair value of any plan
assets. But two other elements are included in the measurement of the liability
because of other requirements of the standard. The liability includes actuarial gains
not recognised less past service costs not recognised (paragraph 54).
Under certain circumstances an employee benefit asset can be recognised but there
are limits on the size of this asset (paragraph 58).
When calculating the value of the obligation, which was the first element to be
included in the liability, as noted above, the projected unit credit method should be
used and a discount rate measured by reference to interest rates on high quality
corporate bonds (paragraphs 64 and 78).
Actuarial gains and losses are allowed to be recognised immediately or can remain
unrecognised to the extent that they fall within a "corridor" which is equal in size to
10% of the larger of the obligation or the fund (paragraph 92).

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

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


Exercise - IAS 19
Do possible future pay rises give rise to a present liability for pensions?
The issue is not whether future pay rises give rise to a present liability. The liability
exists anyway and the future pay rises are a part of correctly estimating the size of
the liability. Therefore the best estimate of future pay rises should be taken into
account.
Why should a pension liability include any of the actuarial gains (paragraph
54)?
The liability has to include those actuarial gains that are not recognised yet because
otherwise the arithmetic will not add up. Unrecognised gains are credit balances so
they have to be recorded somewhere.
When a defined benefit plan is enhanced, when should the cost of

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


Income Taxes - IAS 12
This standard largely concerns accounting for deferred tax. It changed the basis of
calculation to "temporary differences", which are calculated by reference to the
difference between the tax basis and the financial reporting basis of assets and
liabilities, instead of "timing differences", which are based on tax and book differences
for revenues and expenses (paragraph 5).
Deferred tax liabilities should be recognised for all temporary differences, except those
relating to non-deductible goodwill amortisation and the initial recognition of certain
assets and liabilities in transactions that affect neither accounting profit nor taxable
profit.
Deferred tax assets should similarly be recognised assuming that future taxable profit
is probable. Deferred tax assets include, of course, those arising on tax loss carry
forwards (paragraphs 24 and 34).
There are also special rules for investments in subsidiaries, associates and joint
ventures. They amount to saying that temporary differences that are unlikely to
reverse where the investor is in control of that process (for example, by being able to
stop the payment of dividends) need not be accounted for (paragraphs 39 and 44).
The measurement of deferred tax assets and liabilities should be based on tax rates
that are expected to apply, but that generally means current tax rates, although future
rates can be used where they have been enacted (paragraphs 47 and 51).
Deferred tax amounts should not be discounted. At first sight, this seems surprising
because other liabilities are required to be discounted (see IAS 37). However,
discounting would require knowledge of when temporary differences would reverse,
which would require a large amount of guesswork (paragraph 53).
The double entry for the creation of deferred tax assets and liabilities should be
charged to income or to the statement of changes in equity depending upon the
location of the amounts to which the deferred tax relates (paragraphs 58 and 61).
Deferred tax assets should be presented on the balance sheet separately from
deferred tax liabilities (paragraphs 69 and 74).


Exercise - IAS 12
A deferred tax liability is recognised on the revaluation of an asset that is

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


Case study - Deferred tax
Suppose that a British company, Acrobat, applies IFRS. It purchases a machine for
£10,000 in early 20x0. The machine is expected to last for ten years and to have no
residual value. The accounting year is the calendar year. The company is fairly small and
is able to claim 40% tax depreciation (capital allowances) in the year of purchase.
Suppose also, that Acrobat buys land at £3m in early 20x0, and revalues it to fair value of
£5m at 31 December 20x0.
What are the "temporary differences" in 20x0? What would be the "timing
differences"?
The temporary differences are:
(i) Machine Financial reporting basis of asset: 10000 - 1000 = £9000

Tax base of asset : 10000 - 4000 = £6000
£3000
.
(ii) Land Financial reporting basis of asset = £5m
Tax base of asset = £3m
£2m
The timing differences would be:
(i) Machine Tax depreciation: £4000

Financial reporting depreciation : £1000
£3000
.
(ii) Land Tax revenue : 0

Financial reporting revenue : 0
0


IFRS2 ‘Share-based payment’
This illustrates the point that all timing differences are included in the total of temporary
differences, but there are some extra things (e.g. the revaluation of assets) that lead to
temporary differences but not timing differences
A share-based payment is a transaction in which the company received goods or

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


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

show a proposed dividend as a liability?
IAS 10 is based on the idea that it is not useful to show something as a liability that is not
in accordance with the definition of a liability. The information about the proposed
dividend can be given in the notes, and the amount can be shown separately in equity
What would be the effect of moving towards the IAS basis for companies
for pension accounting in countries which have not adopted IAS?
There would probably be greater volatility of pensions figures, because of the use of
current rather than long-run discount rates.

International Financial Reporting Standards Module 6 – Group accounting

Module 6
Group accounting


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


Consolidated and Separate Financial Statements - IAS 27
A "subsidiary" is defined as an enterprise controlled by another. Control can of course

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


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

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


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


Exercise - IFRS3
Can goodwill be amortised under IFRS3?
No, goodwill must be tested at least annually for impairment using IAS36.
When should negative goodwill could be recognised immediately as

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


Case study - Business Combinations and Subsidiaries
This case study once again reviews Newberg and the details that were presented to you in
Module 5.
The company, Newberg, is German. Its income statements for 20x0 and 20x1 are shown
below, as are some accounting policies and notes:
Consolidated statements of income (in billions Euro)
20x0 20x1
Sales 32 38
Cost of goods sold (10) (12)
.
Gross profit 22 26
Marketing and distribution (8) (10)
Research and development (5) (6)
Administrative (2) (2)
Other expenses (1) (1)
.
Operating profit 6 7
Non-operating income 3 3
.
Results before special charges and taxes 9 10
.
Special charges
Acquired in-process research and - (9)
development
Restructuring - (6)

Taxes
On result before special charges
Benefit from special charges
(2)
-
(2)
3

.
Net income (loss) 7 (4)
Extracts from significant accounting policies and notes
Basis of preparation of financial statements The consolidated financial statements of

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

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


The acquisition was accounted for using the purchase method of accounting. Accordingly,
the cost of the acquisition, including expenses incidental thereto, was allocated to
identifiable assets and liabilities and to in-process research and development based on
their estimated fair values. The portion of the acquisition cost allocated to in-process
research and development was charged in full against income. This approach is consistent
with the Group's accounting policy for research and development costs. After
consideration of these items, the excess of the acquisition cost over the fair values was
recorded as goodwill.
At what date did Orange become a subsidiary?
As the company notes, a subsidiary is a controlled enterprise. Control would appear

to have arisen in February or March 20x2. The company notes that at the end of
20x1, there was integration planning.
At what date did Newberg start consolidating Orange?
Newberg consolidated Orange at the stroke of midnight on the 31 December 20x1.

That is, there was no effect on the group operating income, but a full effect on the
balance sheet. It seems a remarkable coincidence that there was no control on the
30 December 20x1, but full control before 1 January 20x2.
Is Newberg's treatment of purchased R&D in line with IFRSs?
The acquired in-process R&D has been separately identified on 31 December 20x1
and then immediately expensed in that year.
IFRS3 requires intangible assets to be recognised as an asset separately from

goodwill if it meets the definition of an asset, is either separate or arises from
contractual or legal rights and its fair value can be measured reliably. The
intangible should be carried at cost/valuation less amortisation and any impairment
losses. The intangible should not be expensed if it meets the definition in
IAS38/IFRS3.


Accounting for Investments in Associates - IAS 28
The standard defines an associate as an enterprise over which the investor has
significant influence, which is the power to participate in financial and operating policy
decisions (paragraph 2). This is presumed to exist where the investor owns twenty
percent or more of the voting equity in the investee.
As for subsidiaries, associates are to be excluded when they are acquired and are held
for resale within twelve months of acquisition (paragraph 13). If there are severe
long-term restrictions on the transfer of funds, this does not justify not using the
equity method when significant influence still exists.
Associates are to be included in consolidated financial statements by using the equity
method (paragraph 13). IAS28 requires that unrealised profits and losses should be
eliminated in proportion (paragraph 22).
In the separate financial statements of an investor, associates can either be held at
cost, or in accordance with IAS39.


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


Exercise - IAS 31
Is proportionate consolidation consistent with the Framework?
Although IAS 31 allows the use of proportionate consolidation, there seems to be

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


The Effects of Changes in Foreign Exchange Rates - IAS 21
It is important to distinguish between foreign currency transactions and the translation

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


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

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


If a continental European company adopts IASs/IFRSs for its consolidated

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

consolidation?
The policies have to be corrected for consolidation, usually by consolidation adjustments

rather than by changing the foreign statutory accounts. Group accounting policies should
be consistent.
Do the parties to a joint venture each need to own exactly the same
proportion of shares?
No. There is nothing to stop a 30/30/40 arrangement, for example.

International Financial Reporting Standards Module 7 – Disclosure standards

Module 7
Disclosure standards


Module 7 introduction – Disclosure standards
This module concerns a number of IASs/IFRSs that do not affect the recognition and
measurement of items in the balance sheet and income statement.
However, in the case of certain standards, they do affect the presentation of numbers in
the main financial statements. This is particularly obvious for the first standard (IAS 7)
which concerns the major statement on cash flows. In most other accounting standards
dealt with in the previous modules there are many disclosure requirements which on the
whole have not been discussed so far in the course, but which you could examine by going
to the end of each accounting standard where there is a section on disclosures.
This module discusses the seven IASs that relate to disclosure:
Cash Flow Statements - IAS 7

Segment Reporting - IAS 14
Related Party Disclosures - IAS 24
Earnings Per Share - IAS 33
Interim Financial Reporting - IAS 34
IFRS5 - Non-current assets Held for Sale and Discontinued Operations
Disclosures in the Financial Statements of Banks and Similar Financial Institutions -
IAS 30
IFRS4 - Insurance Contracts


Cash Flow Statements - IAS 7
The main elements of this standard are as follows:..
This standard requires an enterprise to present cash flow statements as an integral

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


Segment Reporting - IAS 14
This standard concerns note disclosures on a segmental basis. It is compulsory for

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


Exercise - IAS 14
Would "high inflation" vs. "low inflation" be a good basis of geographical

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


Related Party Disclosures - IAS 24
A related party is defined in terms of control, joint control, or significant influence, but
some exemptions are granted. (paragraph 11).
The standard requires the disclosure of transactions between related parties.
Transactions include those that are carried out at arm's length (paragraphs 12 to 22).
The standard also requires the disclosure of control relationships even when there are
no transactions (paragraph 12).


Earnings Per Share - IAS 33
Like IAS 14, this standard is only mandatory for those enterprises with publicly traded
securities, and parent company reports can be exempted (paragraphs 2 and 4).
"Earnings" is defined as the net profit from the income statement but after deduction
of dividends on preference shares (paragraph 12).
The disclosure of earnings per share should be done on the basis of a "basic" and a
"diluted" calculation. For the "basic" calculation the earnings should be divided by the
weighted average number of ordinary shares outstanding during the period (paragraph
19). This should be adjusted for such things as bonus issues which change the number
of shares (paragraphs 26).
Diluted earnings per share is calculated by dividing earnings by the number of shares
adjusted for all dilutive potential ordinary shares (paragraphs 30 and 31). Shares are
dilutive when their conversion would decrease net profit per share (paragraph 41).
Earnings per share should be disclosed even if the amount is negative (paragraph 69).


Interim Financial Reporting - IAS 34
This standard is not mandatory and no frequency of reporting is prescribed (paragraph

1). The standard is designed to be used by those companies that are required by
regulatory authorities or stock exchanges to present interim reporting on a half yearly
or quarterly basis. If reporting is to be described as in compliance with international
standards then the rules of IAS 34 should be followed.
IAS 34 requires condensed versions of all four primary statements (see IAS 1) to be
disclosed, and earnings per share (paragraphs 8 and 11).
The minimum content of these condensed financial statements is specified (paragraph
16).
Comparative figures for previous interim periods and previous full years are specified.
This is fairly complicated in the case of quarterly reporting (paragraph 20).
The same accounting policies are required in the interim reporting as for annual
reporting, although changes in accounting policy might be made at the interim stage
rather than waiting for a year end. The frequency with which interim reporting is
carried out must not be allowed to affect the annual result (paragraph 28).
For interim reporting, the use of year end practices with respect to whether items
should be anticipated or deferred is required (paragraphs 37 and 39). That is, interim
reports should largely be seen as periods in their own right.


Exercise - IAS 34
Once development expenditure has been expensed it cannot subsequently

be capitalised (see IAS 38). Does this fit with IAS 34, paragraph 29?
At first sight this question uncovers a difficulty. Let us take the example of a
company that does not do interim reporting and discovers by the year end that it
has passed the threshold for the capitalisation of development expenditure. In
practice the question might be asked near the year-end whether the appropriate
reliability has been established for capitalisation. Perhaps the whole year's
expenditure would then be capitalised. If interim reporting were carried out on a half
yearly basis it might be clear by half way through the year that the criteria for
capitalisation had not been achieved. Consequently all the expenditure in the half
year could not be capitalised either then or later. In order to reconcile the
requirements of IAS 34 with those of IAS 38 it is necessary to carry out continuous
appraisal of when appropriate criteria are met and then capitalise expenditure only
from that date onwards.


IFRS4 ‘Insurance Contracts’
IFRS4 applies to virtually all insurance contracts and was introduced so that Insurance
companies could comply with IFRS in 2005. Many aspects of accounting by insurance
companies were incompatible with IFRS.
The IFRS exempts an insurer temporarily from some requirements of IFRS including
the ‘Framework’ document.
The IFRS prohibits provisions for claims that are not in existence at the reporting date.
For example provisions for future catastrophes that have not yet occurred.
It also requires reinsurance assets to be impairment tested and an ‘adequacy’ test for
liabilities. It prohibits the offsetting of insurance liabilities against related reinsurance
assets.
The IFRS is designed as a stop gap measure until a more comprehensive standard can
be agreed upon.


Non-current assets held for sale and discontinued operations –
IFRS5
The IFRS introduces the concept of a ‘disposal group’, which is a group of assets and
liabilities that will be transferred in a transaction.
Also the classification ‘held for sale’ is introduced and this relates to an asset or
disposal group which is to be disposed of through sale. Certain conditions have to be
met before assets can be classed as ‘held for sale’.
Assets or disposal groups classed as ‘held for sale’ are valued at the lower of the
carrying amount and fair value less costs to sell (paragraph 15). Such assets are not
depreciated (paragraph 25).
Assets classified as ‘held for sale’ must be shown separately on the face of the balance
sheet (paragraph 38).
A discontinued operation occurs when the operation meets the criteria to be classified
as ‘held for sale’ or when the operation has been disposed of.
The results of discontinued operations have to be shown separately on the face of the
income statement (paragraph 33) and if the discontinued criteria are met after the
balance sheet date, then the discontinuance cannot be retrospectively classified as
such in the balance sheet.


Exercise - IFRS5
If shares are to be sold such that a subsidiary becomes an associate, can

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


Disclosures in the Statements of Banks and Similar Financial
Institutions - IAS 30
This fairly old accounting standard requires only disclosures rather than recognition and
measurement standards. It has been recognised that it is due for an overhaul as soon as
possible...
..


Does a parent company have to produce a cash flow statement if its group
has produced one?
Yes, if the parent is required to (or wishes to) comply with IAS. This is different from UK
requirements.
Why does IFRS5 refer to "discontinued" rather than "discontinuing"

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

International Financial Reporting Standards Module 8 – Forthcoming projects

Module 8
Forthcoming projects


Module 8 introduction – Forthcoming projects
The IASB has several projects in progress at any one time. The main proposals relate to
business combinations where the IASB wish to stop the amortisation of goodwill and
outlaw uniting of interests accounting. New proposals on accounting for share based
payment have been issued also.
Future ED/IFRS are expected on the following:
Insurance contracts (Phase II)
Revenue Recognition, Liabilities, and Equity: Concepts
Consolidations (including Special purpose entities)
Convergence issues (IFRS and US GAAP)
Reporting Comprehensive Income
Accounting Standards for Small and Medium-Sized Entities
Business Combinations (Phase II)
Leases
Measurement
Currently the US, UK and the IASB are working closer together in order to achieve greater
convergence of accounting practices.


What sort of issues might be included in a new standard on business

combinations?
Recognising the minority’s share of goodwill

How to treat successive purchases of shares in an acquisition
Issues relating to the measurement of the purchase consideration and measurement
of the net assets acquired (for example over what period can the fair value of the net
assets acquired be revised).
Is the US likely to adopt IASs?
The major differences between IASB and US rules will probably be reduced in the next few
years, and the SEC may then accept IASs/IFRSs for foreign registrants.


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

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International Financial Reporting Standards

The nature and operations of the IASB .................................................................................................................................................. 4

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Asset recognition and measurement ................................................................................................................................................... 30

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The nature and

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The International Accounting Standards Committee was founded in 1973 after a

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Standards Advisory Council

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The International Financial Reporting Interpretations Committee (IFRIC) was reconstituted

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IAS 1 Presentation of Financial Statements

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IFRS1 First time Adoption of International Financial Reporting Standards

Module 3 (Presentation and profit) IASs 1, 8, 18, and IFRS2

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An asset is a resource controlled by the enterprise as a result of past events

A liability is a present obligation of the enterprise arising from past events,

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Is the repair bill an expense of financial year 20x2 or of 20x3?

The conventional definition of an expense of year X is that it is a payment made in any

The application of the asset/liability Framework is changing conventional accounting

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Is there anything particularly significant about the founding date of 1973

Who chooses the IASC Trustees and Board?

The Board members are chosen by the Trustees.

Is the Framework anything like the UK's Statement of Principles?

Are the IASB's standards always in line with the Framework?

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The status and use of

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2000: IOSCO recommends use of IAS to its members

2000: EU Commission proposes compulsory use of IAS for listed companies'

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Which national standards are closest to the IASB's?

Does the UK allow the use of IASs?

Is it necessary to comply with "grey-letter" guidance in an IAS?

What version of the English language is used by the IASB: British or

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Presentation of Financial Statements - IAS 1

Accounting Policies, Changes in Accounting Estimates and Errors - IAS 8

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The following represent the key points from the standard:

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• Disclosure of ‘extraordinary items’ is prohibited

• A liability or asset is current if it will be settled within the company’s normal

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Should the going concern convention be ignored when a significant part of

Is consistency of accounting policies from year to year required?

Can a loan which is expected to be paid back in four months be a non-