CONCEEPTUAL AND REGULATORY FRAMEWORK

CONCEPTUAL FRAMEWORK OF ACCOUNTING

The IASB’s conceptual framework for the preparation and presentation of financial statements
represents the conceptual framework on which all IFRSs (International Financial Reporting Standards)
are based. A conceptual framework for financial reporting can be defined as a statement of generally
accepted theoretical principles which form the frame of reference for financial reporting. These
theoretical principles provide the basis for the development of new accounting standards and the
evaluation (reappraisal) of those already in existence in order to produce new standards.

Advantages of the conceptual framework

 The situation is avoided whereby standards are developed on a patchwork quilt basis. This
prevents lots of standards presenting seemingly different rules for similar transactions.
 The development of certain standards (particularly national standards) has been subject to
considerable political interference from interested parties.
 A conceptual framework provides guidance for faithful presentation of transactions where no
specific accounting standards currently exist.

Disadvantages of the conceptual framework

 Financial statements are intended for a variety of users, and it is not certain that a single
conceptual framework can be advised which will suit all users.
 Given the diversity of user requirements, there may be a need for a variety of accounting
standards, each produced for a different purpose (and with different concepts as a basis)
 It is not clear that a conceptual framework makes the task of preparing and then implementing
standards any easier than without a conceptual framework.

Generally Accepted Accounting Practice (GAAP)

GAAP signifies all the rules, from whatever source, which govern accounting, which may include:

 National company law

 National financial reporting standards
 Local stock exchange requirements
 It may also include International Accounting Standards.

Purpose of the framework

 Assist the IASB in the development of future IFRSs and in its review of existing IFRSs and IASs.
 Assist the IASB in promoting harmonization of regulations, accounting standards and procedures
relating to the presentation of financial statements by providing a basis for reducing the number
of alternative accounting treatments permitted by IFRSs and IASs.
 Assist national standards setting bodies in developing national standards.

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  Assist preparers of financial statements in applying IFRSs and IASs and in dealing with topics that
have yet to form the subject of an IFRS.
 Assist auditors in forming an opinion as to whether financial statements conform with IFRS
 Assist users of financial statements in interpreting the information contained in financial
statement prepared in conformity with IFRSs.
 Provide those who are interested in the work of IASB with information about its approach to the
formulation of IFRSs.

Contents of the conceptual framework

The Objectives of general purpose Financial Statements

The following are the objectives of financial statements:

 To report on the financial performance of an entity during the accounting period. This
information is reflected in the income statement/statement of comprehensive income
 To report on the financial position of an entity as at end of the accounting period. This
information is reflected in the statement of financial position.
 To report on the financial adaptability of an entity during the accounting period. This information
is reflected in the statement of cash flows.

Qualitative Characteristics of Financial Statements

The two fundamental qualitative characteristics are relevance and faithful representation.

a) Relevance

The information is relevant if it is capable of making a difference in the decisions made by the users.
Financial information is capable of making a difference in decisions if it has a predictive value,
confirmatory value or both.

Predictive value enables users to evaluate or assess past, present or future events. Confirmatory value
comfort users on the accuracy and reliability of historical transactions reported within the financial
statements.

The relevance of financial information is affected by its nature and materiality. The information is
material if omitting it or misstating it could influence decisions that users make on the basis of financial
information about a specific reporting entity. Materiality is an entity specific aspect of relevance based
on the nature or magnitude, or both, of the items to which the information relates in the context of an
individual entity’s financial report.

b) Faithful representation

Information must represent faithfully the transactions it purports to represent in order to be

useful. There is a risk that this may not be the case, not due to bias, but due to inherent

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 difficulties in identifying the transactions of finding an appropriate method of measurement or
presentation. To be perfectly faithful representation, a depiction would have three
characteristics which are complete, neutral and free from errors

Enhancing qualitative characteristics

a. Comparability
Users should be able to compare an entity’s financial statements through time to identify trends and
with other entities’ financial statements, to evaluate their relative financial position, performance
and changes in financial position.
The consistency of treatment is therefore important across like items over time, within the entity
and across all entities.
b. Verifiability
Verifiability means that different knowledgeable and independent observers could reach consensus,
although not necessarily complete agreement, that a particular depiction is a faithful
representation.
c. Timeliness
Timeliness means having information available to decision makers in time to be capable of
influencing their decisions
d. Understandability

The information presented in the financial statements may be easily understood if it has be classified,
characterized and presented clearly and concisely. Some phenomena are inherently complex and cannot
be made easy to understand. Financial reports are prepared for users who have a reasonable knowledge
of business and economic activities and who review and analyse the information diligently.

Elements of Financial statements

The following elements measure the financial position of the business

i. Assets: these are resources controlled by the entity as a result of past events from which future
economic benefits are expected to accrue to the entity.
ii. Liabilities: these are entity’s obligations to transfer economic benefits as a result of past events
or transactions.
iii. Equity interest: is the residual amount found by deducting all liabilities of the entity from all of
the entity’s assets.

The following elements measure the financial performance of the business

i. Income: it is an increase in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases in liabilities that result in increases in equity,
other than those relating to contributions from equity participants.

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 ii. Expenses: these are decreases in economic benefits during the accounting period in the form of
outflows or deductions in assets’ values or increase in liabilities that result in decreases in
equity, other than those relating to distributions to equity participant.

Recognition

Recognition is the depiction of an element in words and by monetary amounts in the financial
Statements.

Recognition of assets

An asset will only be recognised if:

 The entity has control over the asset as a result of past events
 It is probable that the asset will generate future economic benefits for the entity
 Its cost can be measured with sufficient reliability.

Future economic benefits mean the potential to contribute, directly or indirectly, to the flow of cash and
cash equivalents to the entity.

Recognition of liabilities

A liability will only be recognised if:

 The entity has an obligation arising from past events.

 It is probable that the obligation will be settled by transfer of economic benefits
 Its cost can be measured with sufficient reliability

A present obligation is a duty or a responsibility to act or perform in a certain way. Obligations may be
legally enforceable as a consequence of a binding contract or statutory requirement. Settlement of the
present obligation will involve the entity giving up resources embodying economic benefits in order to
satisfy the claim of the other party.

Reliability measurement

The conceptual framework states that the use of reasonable estimates is an essential part of the
preparation of financial statements and does not undermine their reliability. Where no reasonable
estimate can be made, the item should not be recognised, although its existence should be disclosed in
the notes, or other explanatory material.

Measurement in Financial Statements

The conceptual framework defines measurement as the process of determining the monetary amounts
at which the elements of financial statements are to be recognised and carried in the statement of
financial position and statement of profit or loss and other comprehensive income. This involves the
selection of a measurement basis.

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Historical cost

This is the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire
assets at the time of acquisition, or expected to be paid to satisfy the liability in the normal course of the
business.

Fair value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. (IFRS 13)

Replacement cost

It is the cost to the business of replacing the existing asset with a new one.

Net realizable value

This is the amount of cash or cash equivalents that could currently be obtained by selling an asset in an
orderly disposal less any costs involved in making the sale.

Economic (present) value

It is the current estimated of the present value of the future net cash flows from an asset in the normal
course of the business.

Historical cost and Fair Value

Advantages of historical cost accounting

 Amounts used in the financial statements are objective and free from bias
 Amounts are reliable, they can always be verified, they exist on invoices and documents
 Amounts in the statement of financial position can be matched perfectly with amounts in the
statement of cash flows
 Opportunities for creative accounting are less than under systems which allow management to
apply their judgement to the valuation of assets
 It has been used for centuries and is easily understood.

Disadvantages of historical cost accounting

 It can lead to understatement of assets in the statement of financial position.

 Understatement of assets leads to understatement of depreciation
 When inventory prices are rising, and when the company is operating a FIFO system, the
cheapest inventories are charged to cost of sales and the most expensive ones are being
designated as closing inventory resulting in understatement of cost of sales.

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  An organisation selling in an inflationary its market will see revenue and profits rise, but this is
“paper profit”, distorted by the understated depreciation and cost of sales.

Advantages of fair value accounting

 Fair values have more predictive value

 Some assets are traded on an active market or held for their investment potential (rather than
held to be used in the business)
 Fair value often reflects the way risks are managed (for financial instruments)
 For assets such as property, fair value provides information on the resources actually available to
an entity.

Disadvantages of fair value accounting

 Use of fair value and current values can encourage management to manipulate the amounts in
the financial statements, because current value can only be an estimate.
 Fair value accounting anticipates profits that may never be realised.
 Because market values can fluctuate, using fair value can cause volatility in the financial
statements.

Underlying assumptions

Accounting concepts: these are principles that underlie the preparation of financial statements. The
following are the accounting concepts:

Going concern concept

It is an assumption that business will continue in operation in the foreseeable future without any need
to curtail its operations significantly.

Accruals concept/matching

Revenues and costs should not be reflected in the financial statements when cash is received or paid but
when revenue and expense is earned and incurred.

Consistency concept

Consistency concept sates that once an entity has adopted a method of accounting for items in the
financial statements that policy should be maintained.

Prudence concept

The prudence concept states that an accountant must be slow to recognise income but quick to
recognise expenses .e.g. provision for doubtful debts.

Money measurement concept

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Accounting can only capture transactions that are in monetary terms. All information/transactions that
are non-monetary .e.g. good management or hard working employees in an organization cannot be
reflected in the financial statements.

Historical cost convention

All transactions in the financial statements are recorded at cost not their current value.

Duality concept

Financial transactions must be entered in the financial statements using the principle of double entry
.i.e. debit an account whenever it is receiving and credit an account whenever it is giving.

Materiality concept

Materiality varies from one entity to the other. Only material items must be recorded in the financial
statements.

Business Entity concept

The business and its owners are regarded as separate persons or separate entities. The transactions of
the owners should not be combined with that of the business.

Concepts of Capital and Capital maintenance

There are two commonly used concepts of capital.

a) Financial concept of capital

Under the financial concept of capital, which is used by most entities, capital is synonymous
with the net assets or equity of the entity. Profit is earned only if the amount of net assets at the
end of the period exceeds the amount of net assets at the beginning of the period, after
excluding any distributions to or from owners.

b) Physical concept of capital

Under the physical concept of capital, capital is regarded as the productive capacity of the
entity. A profit is earned only if the physical productive capacity of the entity at the end of the
period exceeds the physical productive capacity at the beginning of the period, after excluding
any distributions to or from owners. The physical capital maintenance concept requires the
adoption of the current cost basis of measurement.

Under both concepts, a profit cannot be recognised until capital has been maintained. The conceptual
frame work does not specify which method to adopt.

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THE REGULATORY FRAMEWORK

The regulatory framework is the most important element in ensuring relevant and faithfully presented
financial information and thus meeting the needs of shareholders and other stakeholders and other
users. Without a single body overall responsible for producing financial reporting standards (IASB) and a
framework of general principles within which they can be produced (framework), there would be no
means of enforcing compliance with GAAP.

Principles-based system: this system is intended to ensure that standards are not produced which are in
conflict with each other and also that any departure from a standard can be judged on the basis of
whether or not it is in keeping with the principles set out in the framework. The framework provides the
background of principles within which standards can be developed.

Rules-based system: in the absence of a reporting framework, a more rules based approach has to be
adopted. This leads to a large mass of regulations designed to cover every eventuality.

Advantages and disadvantages of adopting the IFRSs

The main advantages are seen to be:

(a) A business can present its financial statements on the same basis as its foreign competitors,
making comparison easier
(b) Cross-border listing will be facilitated, making it easier to raise capital abroad
(c) Companies with foreign subsidiaries will have a common, company-wide accounting language
(d) Foreign companies which are targets for takeovers or mergers can be more easily appraised

The disadvantages are perceived to be:

(a) The cost of implementing IFRS

(b) The lower level of detail in IFRS

INTERNATIONAL ACCOUNTING STANDARDS (IASs and IFRSs)

Organizational structure

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 IFRSC Foundation

IASB

IFRSAC

IFRSIC

The International Accounting Standards Board is an independent, privately-funded accounting standard

setter based in London. In 2001 the International Financial Reporting Standards Committee (formerly
known as IASC) was formed as a not-for profit making corporation based in USA. This is a parent entity
of the IASB.

Objectives of IASB

The formal objectives of the IASB are as follows:

 To develop, in the public interest, a single set of high quality, understandable and enforceable
global accounting standards that require high quality, transparent and comparable information in
general purpose financial statements.
 To promote the use and vigorous application of those standards
 To work actively with national accounting standards setter to bring about convergence of
national accounting standards and IFRS to high quality solutions.

SETTING OF IFRSs AND IASs.

IFRSs are developed through a formal system of due process and broad international consultation
involving accountants, financial analysts and other users and regulatory bodies from around the world.
The procedure for development of IFRSs is as follows:

 The IASB identifies a subject and appoints an advisory committee to advise on the issues
 The IASB publishes an exposure draft for public comment, being a draft version of the intended
standard.
 Following the consideration of comments received on the draft, the IASB publishes the final text
of the IFRS.
 At any stage the IASB may issue a discussion paper to encourage comment.
 The publication of an IFRS, exposure draft or IFRSIC interpretations requires the votes of at least
eight (8) of the 14 IASB members.

Advantages of Accounting Standards

 They reduce or eliminate confusing variations in the methods used to prepare accounts.
 They provide a focal point for deliberate and discussions about accounting practice.
 They oblige companies to disclose the accounting policies used in the preparation of accounts.
 They are a less rigid alternative to enforcing conformity by means of legislation.

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  They have obliged companies to disclose more accounting information than they would
otherwise have done if accounting standards did not exist. E.g. IAS 33.

Disadvantages of Accounting Standards

 A set of rules which give backing to one method of preparing accounts might be inappropriate in
some circumstances. E.g. IAS 16 on depreciation is inappropriate for investment properties.
 Standards may be subject to lobbying or government pressure (in case of national standards).
 Many national standards are not based on a conceptual framework of accounting, although IFRSs
are.
 There may be a trend towards rigidity, and away from flexibility in applying the rules.

SINGLE ENTITY FINANCIAL STATEMENTS

IAS 1: PRESENTATION OF FINANCIAL STATEMENTS

IAS 1 covers the form and content of financial statements. A full set of financial statements comprises:

 Statement of profit or loss and other comprehensive income

 Statement of financial position.
 Statement of changes in Equity.
 Statement of cash flows.
 Explanatory notes and accounting policies.

Fair presentation and compliance with IFRS

Most importantly, financial statements should present fairly the financial position, financial
performance and cash flows of an entity. Compliance with IFRS is presumed to result in financial
statements that achieve a fair presentation. (IAS 1: para. 15)

IAS 1 stipulates that financial statements shall present fairly the financial position, financial performance
and cash flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events and conditions in accordance with the definitions and recognition criteria for
assets, liabilities, income and expenses set out in the Conceptual Framework.

The following points made by IAS 1 expand on this principle.

(a) Compliance with IFRS should be disclosed

(b) All relevant IFRS must be followed if compliance with IFRS is disclosed
(c) Use of an inappropriate accounting treatment cannot be rectified either by disclosure of
accounting policies or notes/explanatory material

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IAS 1 states what is required for a fair presentation.

(a) Selection and application of accounting policies

(b) Presentation of information in a manner which provides relevant, reliable, comparable and
understandable information
(c) Additional disclosures where required

FORMATS

VL PLC
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31ST
DECEMBER 20X8
K
Revenue x
Cost of sales (x)
Gross profit x
Distribution costs (x)
Administration expenses (x)
Operating profit (PBIT) x
Finance costs (x)
Investment income x
Profit before tax x
Income tax expense (x)
Profit for the year x
Other comprehensive income
Gains/losses on revaluations of PPE x
Gains/losses on investments held at fair value through other
comprehensive income x
Deferred tax on gains on revaluations (x)

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Total comprehensive income x

VL PLC
STATEMENT OF PROFIT OR LOSS FOR THE YEAR ENDED 31ST DECEMBER 20X8
K
Revenue x
Cost of sales (x)
Gross profit x
Distribution costs (x)
Administrative expenses (x)
Operating profit x
Finance costs (x)
Investment income x
Profit before tax x
Income tax expense (x)
Profit for the period x

VL PLC
STATEMENT OF OTHER COMPREHENSIVE INCOME FOR THE YEAR ENDED 31ST DECEMBER 2012
K
Profit for the period x

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Other comprehensive income
Gains/losses on revaluations x
Gain/loss on investment held at fair value through other comprehensive income x
Deferred tax on revaluations (x)
Total comprehensive income x

VL PLC

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31ST DECEMBER 20X8

SHARE SHARE REVALUATION RETAINED TOTAL

CAPITAL PREMIUM RESERVE EARNINGS EQUITY
K K K K K

Balance b/f xx xx xx xx xx
Change in accounting policy and
Prior year errors - - - (xx) (xx)
Restated balance xx xx xx xx xx
Issue of shares xx xx - - xx
Revaluation - - xx - xx
Profit for the year - - - xx xx
Transfer to profit (excess dep) - - (xx) xx -
Deferred tax on revaluations - - (xx) - (xx)
Dividends - - - (xx) (xx)
Balance c/f xx xx xx xx xx

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VL PLC
STATEMENT OF FINANCIAL POSITION AS AT 31ST DECEMBER 2012
ASSETS K K
NON-CURRENT ASSETS
Property, plant & equipment xx
Investments xx
Intangible assets xx
xx
CURRENT ASSETS
Inventories xx
Trade receivables xx
Held- for-sale assets xx
Cash and cash equivalents xx
xx
Total assets xx

EQUITY AND LIABILITIES

CAPITAL AND RESERVES
Share capital xx
Share premium xx
Revaluation reserve xx
Retained earnings xx
xx
NON-CURRENT LIABILITIES
Long-term borrowing xx
Lease liabilities xx
Deferred Government grant xx
Deferred tax xx
xx
CURRENT LIABILITIES
Trade and other payables xx
Short-term borrowings xx
Current tax payable xx

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Short-term provisions xx
xx
Total Equity and Liabilities xx

NOTES TO FINANCIAL STATEMENTS

The notes to the financial statements will amplify the information given in the statement of profit or loss
and other comprehensive income, statement of changes in equity and statement of financial position.
The notes should perform the following functions:

 Statement of compliance with IFRSs

 Statement of measurement basis and accounting policies applied
 Provide information about the basis on which the financial statements were prepared and which
specific accounting policies were chosen and applied to significant transactions/events.
 Disclose any information, not shown elsewhere in the financial statements, which is required by
IFRSs.
 Show any additional information that is relevant to understanding the information which is not
shown elsewhere in the financial statements.
 The amount of dividends proposed or declared before the financial statements were authorized
for issue but not recognised as a distribution to owners during the period and the amount per
share
 The amount of any cumulative preference dividends not recognised.

IAS 2: INVENTORIES

Inventories are assets:

 Held for sale in the ordinary course of the business

 In the process of production for such sale
 In the form of material or supplies to be consumed in the production process or in the rendering
of services.

Inventories can include the following:

 Goods purchased and held for resale

 Finished goods
 Work-in-progress
 Materials and supplies awaiting use in the production process (raw materials and consumables)

Measurement of Inventories

IAS 2 states that Inventories should be measured at the lower of cost and Net realizable value (NRV).

COST: The cost of inventories includes:

 Cost of purchase which includes purchase price, import duties and other taxes, transport costs
and other directly attributable to the acquisition of finished goods costs less trade discounts,
rebates and other similar amounts.

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  Costs of conversion which includes costs directly related to the units of production e.g. direct
labour costs and fixed and variable overheads that are incurred in converting materials into
finished goods.
 Other costs incurred in bringing the inventories to their present location and condition.

NET REALISABLE VALUE (NRV): it is the estimated or actual selling price, in the ordinary course of the
business less the estimated costs of completion and the estimated costs necessary to make the sale.
Costs to sell are unavoidable costs to be incurred in order to make a sale e.g. marketing costs, agent
fees.

Example
X plc is a manufacturing company. It manufactures two products; product A and product B. The
information relating to the standard cost of each product is as follows:
Product A Product B
Raw material cost $24 $20
Conversion cost $20 $25

X plc prepares its financial statements to 31 December each year. As at 31 December 2019, each unit of
product A and product B could be sold in an active market at price of $50 and $51 respectively. The
unavoidable selling costs have been estimated at $3 and $7 for product A and product B respectively. As
at 31 December 2019 X plc had 2,000 units of product A and 1,870 units of product B in its inventory.

Required:
Calculate the amount of inventories to be included in the statement of financial position as at 31
December 2019 in accordance with IAS 2.

IAS 2 recommends FIFO and AVCO as methods of valuation for inventories.

IAS 2 states that inventory should be recorded at NRV if:

a) There is a reduction in selling price

b) There is a physical deterioration in the condition of inventory

c) There is obsolescence of products

d) The goods are slow moving goods

The following disclosures are required by IAS 2:

 Accounting policy adopted, including the cost formula used

 Total carrying amount
 Amount of inventories carried at NRV
 Amount of inventories recognised as an expense during the period
 Details of any circumstances that have led to the write down of inventories to their NRV.

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IAS 8: ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

ACCOUNTING POLICIES

These are the principles, bases, conventions, rules and practices applied by an entity which specify how
the effects of transactions and other events are reflected in the financial statements.

IAS 8 requires an entity to select and apply appropriate accounting policies complying with International
Financial Reporting Standards (IFRSs) and Interpretations to ensure that the financial statements
provide information that is:

i) Relevant to the decision making

ii) Reliable in that they:

 Represent faithfully the results and financial position of the entity.

 Reflect the economic substance of events and transactions and not merely the legal form.
 Are neutral
 Are prudent
 Are completed in all material respect.

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CHANGING ACCOUNTING POLICIES

The general rule is that accounting policies are normally kept the same from period to period to ensure
comparability of financial statements over time. However, accounting policies may be changed only if:

 The change is required by IFRSs

 The change will result in a reliable and more relevant presentation of events or transactions.

ACCOUNTING TREATMENT FOR CHANGE IN ACCOUNTING POLICY

 The change should be applied retrospectively, with an adjustment to the opening balance of
retained earnings in the statement of changes in equity.
 Comparative information should be restated unless it is impractible to do so.
 If the adjustment to opening retained earnings cannot be reasonably determined, the change
should be adjusted prospectively i.e. included in the current period’s statement of profit or loss.

Example
X plc is a Zambian company that runs supermarkets throughout the country. X plc has always used the
last in first out method to value its inventories. Following the adoption of IAS 2 in accounting for its
inventories, the company decided to switch from LIFO method to First in first out (FIFO) method as
recommended by IAS 2. The company changed its accounting policy on 1 January 2018. The closing
inventory was valued at $365,300 as at 31 December 2017. On 1 January 2018, the opening inventory
was recalculated to $402,700 as it would have been if FIFO was used.

Required:
Explain how the change in accounting policy should be accounted for by X plc, showing the journal
entries in order to effect the change.

ACCOUNTING ESTIMATES

An accounting estimate is a method adopted by an entity to arrive at estimated amounts for the
financial statements. Accounting estimates are based on:

 The exercise of judgment based on the latest information at that time.

 At a later date, estimates may have to be revised as a result of the availability of new
information, more experience or subsequent developments.

ACCOUNTING TREATMENT FOR THE CHANGES IN ACCOUNTING ESTIMATES

IAS8 requires that:

 The effects of a change in accounting estimate should be included in the statement of profit or
loss in the period of change and if subsequent periods are affected in those subsequent periods.
 The effects of the change should be included in the same income or expense classifications as
was used for the original estimate.

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  If the effect of the change is material, its nature and amount must be disclosed.

Example
X Limited bought a manufacturing plant on 1 April 2015 at a cost of $500,000. As at 1 April 2015, the
plant had an estimated useful life of ten (10 years) and a residual value of $40,000. The company revised
the original useful life and the residual value to eight (8) years and $60,000 respectively on 31 March
2018. X Limited prepares its financial statements annually to 31 March.

Required:
Explain how the revision of the useful life and residual value should be accounted for. Your answer
should include a computation of depreciation charge for the years ended 31 March 2018 and 2019.

ERRORS

PRIOR PERIOD ERRORS: These are omissions from and misstatement in, the financial statements for one
or more prior periods arising from a failure to use information that:

 Was available when the financial statements for those periods were authorized for issue.
 Could reasonably be expected to have been taken into account in preparing those financial
statements.

Such errors include mathematical mistakes, mistakes in applying accounting policies, oversights and
fraud.

Correction of prior period errors

These errors should be corrected by:

 Restating the opening balance of assets, liabilities and equity as if the error had never occurred,
and presenting the necessary adjustment to the opening balance of retained earnings in the
statement of changes in equity.
 Restating the comparative figures presented, as if the error had never occurred.
 Disclosing within the accounts a statement of financial position at the beginning of the earliest
comparative period. This means that three statements of financial position will have to be
prepared within a set of financial statements:
a) At the end of the current year
b) At the end of the previous year
c) At the beginning of the previous year.

CURRENT PERIOD ERRORS: These are discovered in the current period and should be corrected before
the financial statements are authorized for issue.

Example
X Limited a Zambian manufacturing company prepares its financial statements to 31 December each
year. On 31 December 2019, the company auditors discovered that a receivables figure amounting to
$15,000 has been stolen by the former company’s Receivables accountant. This figure is included in the

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receivables balance carried forward at 31 December 2019. This amount is in respect of $10,000 invoices
issued during the year ended 31 December 2017 and $5,000 invoices issued in February 2019. The
customers paid all the money in full but the receivables accountant did not deposit this money in the
company’s bank account.

Required:
Explain how the above error should be accounted for by X Limited in the financial statements for the
year ended 31 December 2019. Your answer should include the journal entries to correct the error.

IAS 10: EVENTS AFTER THE REPORTING DATE (PERIOD)

DEF:

A reporting date is the date to which the financial statements of an entity are prepared.

Events after the reporting date are events, both favorable and unfavorable, which occur between the
reporting date and the date on which the financial statements are approved for issue by the board of
directors.

TYPES OF EVENTS

A) ADJUSTING EVENTS: These are events after the reporting date which provides evidence of
conditions that existed at the end of the reporting period.

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 EXAMPLES

 Bankruptcy of a major customer in respect of who the amount owed was included in the
receivables at the year end. This will indicate the irrecoverable debts arising after the reporting
date, which may help to quantify that allowance for receivables as at the reporting date.
 Sale of inventory after the end of the reporting period for less than its carrying value at the end
of the year.
 Amounts received or paid in respect of legal or insurance claims which were in negotiations at
the year end.
 Discovery of fraud or error which shows that the financial statements were incorrect.
 Determination after the year end of the sale or purchase price of assets sold or purchased before
the year end.

B) NON-ADJUSTING EVENTS: These are events, after the reporting date, which are indicative of
conditions that arose after the reporting date.

EXAMPLES

 Acquisition of or disposal of a subsidiary

 Announcement of a plan to discontinue an operation
 Major purchases and disposal of assets
 Destruction of a production plant by fire after the reporting period
 Share transactions after the end of the reporting period.

ACCOUNTING TREATMENT

A) Adjusting events: these events require adjustments of the amounts recognised in the financial
statements.

B) Non-adjusting events: these events should only be disclosed by notes if they are so important
that non disclosure would affect the ability of the users of the financial statements to make
proper evaluations and decisions.

The notes should disclose the nature of the event and an estimate of the financial effect.

Example
1. Which one of the following events taking place after the year end but before the
financial statements were authorised for issue would require adjustment in accordance
with IAS 10 Events after the reporting period?
A. Three lines of inventory held at the yearend were destroyed by flooding in the
warehouse.
B. The directors announced a major restructuring.
C. Two lines of inventory held at the yearend were discovered to have faults rendering
them unsaleable.
D. The value of the company's investments fell sharply.

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 2. Which TWO of the following events which occur after the reporting date of a company
but before the financial statements are authorised for issue are classified as adjusting
events in accordance with IAS 10 Events after the reporting period?

A. A change in tax rate announced after the reporting date, but affecting the current
tax liability
B. The discovery of a fraud which had occurred during the year
C. The determination of the sale proceeds of an item of plant sold before the year end
D. The destruction of a factory by fire

3. During January 20X2, before the financial statements for the year ended 31 December
20X1 had been finalised, a number of events took place. Which one of these events
would require an adjustment to the financial statements as at 31 December 20X1 in
accordance with IAS 10 Events after the reporting period?

A. Rainbird's board announced a plan to discontinue one of its operations and dispose of
the plant. The loss on disposal is estimated at $2 million.
B. The employees of the operation to be discontinued commenced a case against the
company for constructive dismissal. The total cost could be $3 million.
C. A legal case for which Rainbird had provided $1.7 million at 31 December 20X1 to cover
possible damages was unexpectedly settled in its favour.
D. One of Rainbird's warehouses was destroyed by fire and half of the inventory on hand at
31 December 20X1, valued at $2.5 million, was destroyed.

IAS 16: PROPERTY, PLANT AND EQUIPMENT

IASB’s Framework defines an asset as a resource controlled by an entity as a result of past events and

from which future economic benefits are expected to flow to the entity.

IAS 16 should be followed when accounting for property, plant and equipment unless another
international accounting standard requires a different treatment. IAS 16 does not apply to the
following.

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(a) Biological assets related to agricultural activity, apart from bearer biological assets (IAS 41)
(b) Mineral rights and mineral reserves, such as oil, gas and other non-regenerative resources
However, the standard applies to property, plant and equipment used to develop these assets.

Following an amendment to IAS 41, bearer biological assets, especially plantation trees such as grape
vines, rubber trees and oil palms, are now classified under IAS 16. This amendment applies to plants
which are solely used to grow produce over several periods and are not themselves consumed, being
usually scrapped when no longer productive. They are measured at accumulated cost until maturity and
then become subject to depreciation and impairment charges.

Definitions

 Property, plant and equipment are tangible assets that:

- Are held for use in the production or supply of goods or services, for rental to others, or for
administrative purposes
- Are expected to be used during more than one period

 Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration
given to acquire an asset at the time of its acquisition or construction.

 Residual value is the net amount which the entity expects to obtain for an asset at the end of its
useful life after deducting the expected costs of disposal.

 Entity specific value is the present value of the cash flows an entity expects to arise from the
continuing use of an asset and from its disposal at the end of its useful life, or expects to incur
when settling a liability. (IAS 16: para. 6)

 Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. (IFRS 13)
 Carrying amount is the amount at which an asset is recognised in the statement of financial
position after deducting any accumulated depreciation and accumulated impairment losses. (IAS
16: para. 6)
 An impairment loss is the amount by which the carrying amount of an asset exceeds its
recoverable amount. (IAS 16: para. 6)

Examples of PPE include:

 Land & Buildings

 Plant & Equipment
 Fixtures & Fittings
 Furniture
 Computers
 Vehicles.

Recognition of property, plant and equipment

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An item of property, plant and equipment should be recognised as an asset when and only when:

 The entity has control over an asset as a result of past events

 It is probable that future economic benefits associated with the asset will flow to the entity
 The cost of the asset can be measured reliably.

Measurement

Initial Measurement:

An item of property, plant and equipment should initially be measured at cost. The cost of property,
plant and equipment includes the following:

 Purchase price, less any trade discounts or rebate

 Import duties and non-refundable purchase taxes
 Directly attributable costs of bringing the asset to working condition for its intended use, e.g the
cost of site preparation, initial delivery and handling costs, installation costs, pre-production
testing and professional fees (architects, engineers).
 Initial estimate of the unavoidable cost of dismantling and removing the asset and restoring the
site on which it is located (usually the costs are discounted if necessary).

The following costs will not be part of the cost of property, plant or equipment unless they can be
attributed directly to the asset's acquisition, or bringing it into its working condition.

 Administration and other general overhead costs

 Start-up and similar pre-production costs
 Initial operating losses before the asset reaches planned performance

All of these will be recognised as an expense rather than an asset. (IAS 16: para. 11)

Any subsequent expenditure incurred on the asset should only be capitalized (included in the cost of
the asset) if it results in the total economic benefits expected from the asset to increase above those
expected on original recognition.

Subsequent Expenditure

Subsequent expenditure

Parts of some items of property, plant and equipment may require replacement at regular intervals. IAS
16 gives examples of a furnace which may require relining after a specified number of hours or aircraft
interiors which may require replacement several times during the life of the aircraft.

This cost is recognised in full when it is incurred and added to the carrying amount of the asset. It will be
depreciated over its expected life, which may be different from the expected life of the other
components of the asset. The carrying amount of the item being replaced, such as the old furnace lining,
is derecognised when the replacement takes place.

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Subsequent measurement

IAS 16 provides an entity with the choice between cost model or fair value model.

Cost model: An asset is measured at its cost less accumulated depreciation and impairment losses.

Fair value (revaluation) model: an asset is measured at fair value less subsequent accumulated
depreciation and impairment losses. If the revaluation model is adopted, the following conditions must
be complied with:

 Revaluations must subsequently be made with sufficient regularity to ensure that the carrying
amount does not differ materially from the fair value at each reporting date.
 When an item of property, plant and equipment is revalued, the entire class of assets to which
the item belongs must be revalued.
The frequency of revaluation depends on how volatile the fair values of an asset are.

IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.

Accounting for revaluation

Once an item of property, plant and equipment is revalued it should be accounted for as follows:

 The asset should be restated from cost to valuation (new value) by debiting the asset account
with increase in revaluation and crediting the revaluation reserve account or crediting the asset
account and debiting the statement of profit or loss or revaluation reserve with decrease in
revaluation.
 Write off the accumulated depreciation of the revalued asset up to the date of revaluation by
debiting the depreciation account and crediting the revaluation reserve account. The
depreciation charge after revaluation should be based on the new value less residual value over
the remaining useful life from the date of revaluation.
 If the asset is revalued upwards, the revaluation surplus should be recognised as other
comprehensive income, and the revaluation surplus of the depreciable asset can be spread over
the remaining useful life of the asset and an annual transfer made from revaluation reserve to
retained earnings (excess depreciation) at the end of each year. This transfer is made in the
statement of changes in equity.
 If the asset is revalued downwards, the loss should be recognised in the statement of profit or
loss as an expense. The only exception is where the asset was revalued upwards previously, and
there is still a surplus in the revaluation reserve account, then the loss should be debited to the
revaluation reserve account.

Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. All
assets with a finite useful life must be depreciated. The depreciable amount of an asset is the difference
between the cost of an asset and its residual value.

The residual value is the amount of that the entity would currently obtain from disposal, net of selling
costs, if the asset were already of the age and in the condition expected at the end of its useful life.

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  IAS 16 does not prescribe a method of depreciation, but the method used must reflect the
pattern in which the asset’s future economic benefits are expected to be consumed.
 Depreciation begins when the asset is available for use and continues until the asset is
derecognized, even if it is idle.
 If the asset is measured at historical cost, then depreciation should be based on cost, But if the
asset has been revalued, depreciation should be based on the revalued amount.
 The residual value and the useful life should be reviewed at least at each financial year-end and
revised if necessary.

Disposal of revalued assets

The profit or loss on disposal of a revalued non-current asset should be calculated as the difference
between the net proceeds and the carrying amount.

 The profit or loss should be accounted for in the income statement of the period in which the
disposal occur.
 The remainder of the revaluation reserve relating to this asset should now be transferred to
retained earnings.

ILLUSTRATION ONE

Z plc started construction of a building for its own use on 1st April 2011 and incurred the following costs:
K
Purchase price of land 259, 000
Stamp duty 5,000
Legal fees 10,000
Site preparation and clearance 18,000
Materials 100,000
Labour (period 1st April 2011 to 1st July 2012) 150,000
Architect’s fees 20,000
General overheads 30,000
Total cost 583,000

The following information is also relevant:

 Materials costs were greater than anticipated. On investigation, it was found that materials
costing K 10 million had been spoiled and therefore wasted and a further K15 million was
incurred as a result of faulty design work.
 As a result of these problems, work on the building ceased for a fortnight during October 2011
and it is estimated that approximately K9 million of the labour costs relate to this period.
 The building was completed on 1st July 2012 and occupied on 1st September 2012.

Required

Calculate the cost of the building that will be included in tangible non-current assets additions in
accordance with IAS 16 property, plant and equipment.

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ILLUSTRATION TWO

The following is the extract from the statement of financial position of X plc as at 31st December 2011:

K’000

Land &Buildings:

Cost (land-K40,000) 500

Depreciation (120)

380

X plc revalued its land &buildings on 1st January 2012 at K600,000(land K80,000). As at that date, the
building had its estimated remaining useful life of 40 years.

Required

Show how the above will be accounted for in the financial statements for the year ended 31st December
2012.

Disclosures

The following should be disclosed for each class of Property, Plant and Equipment in accordance with
IAS 16:

 the measurement bases used for determining the gross carrying amount
 the depreciation methods used
 the useful lives or the depreciation rates used
 the gross carrying amount and the accumulated depreciation (aggregated with accumulated
impairment losses) at the beginning and end of the period
 a reconciliation of the carrying amount at the beginning and end of the period showing
additions, disposals, increases or decreases resulting from revaluations and from impairment
losses, depreciation, and other charges.

If some items of property, plant and equipment are stated at revalued amounts, information about the
revaluation should also be disclosed.

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IAS 38: INTANGIBLE ASSETS

An intangible asset is an identifiable non-monetary asset without physical substance. An intangible

asset is identifiable if:

 It is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged,
either individually or as part of the package).
 It arises from contractual or other legal rights, regardless of whether those rights are transferable
or separable from the entity or from other rights and obligations.

Examples of intangible assets

 Goodwill acquired in a business combination

 Computer software
 Development expenditure
 Patents
 Copyrights
 Motion picture films
 Customer list
 Licenses
 Franchises
 Customer and supplier relationships
 Marketing rights
 Brands etc.

Recognition of intangible assets

An intangible asset should be recognised in the financial statements only if:

 It is identifiable
 It is controlled by the entity (power to obtain economic benefits)
 It is expected to generate future economic benefits for the entity
 It has a cost that can be measured with sufficient reliability.

If an intangible asset does not meet the recognition criteria, then it should be charged to the profits as it
is incurred.

Measurement

Intangible assets should initially be measured at cost. After initial measurement, there is a choice
between a cost model and a fair value model. All intangible assets with a finite useful life must be
amortised over that life, normally using straight line basis with a zero-residual value.

Internally generated intangible assets are not recognised in the financial statements because they
cannot be reasonably measured.

GOODWILL

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Goodwill is the difference between the value of a business as a whole and the aggregated of the fair
value of its separable net assets (in accordance with IFRS 3). Separable net assets are those assets
which can be identified and sold off separately without necessarily disposing of the business as a whole.
Goodwill may exist because of any combination of a number of possible factors, which include the
following:

 Reputation for quality or service

 Technical expertise
 Possession of favourable contracts
 Good management and staff.

Types of Goodwill

Purchased Goodwill: it arises from a business combination .i.e. when a business acquires another
business as going concern.

Non-purchased Goodwill: it arises from an entity way of operating. It is also called inherent Goodwill.

Accounting treatment

Purchased Goodwill: it is recognised in the financial statements because at a specific point in time there
was a market transaction by which it can be measured.

Non-purchased Goodwill: it is not recognised in the financial statements because it does not meet the
recognition criteria of an intangible asset.

IFRS 3- Business Combination

Goodwill is defined as future economic benefits arising from assets that are not capable of being
individually identified and separately recognised. (IFRS 3 App A)
Goodwill acquired in a business combination is recognised as an asset and is initially measured at cost.
Cost is the excess of the cost of the combination over the acquirer's interest in the net fair value of the
acquiree's identifiable assets, liabilities and contingent liabilities.

After initial recognition goodwill acquired in a business combination is measured at cost less any
accumulated impairment losses. It is not amortised. Instead it is tested for impairment at least annually,
in accordance with IAS 36 Impairment of assets.

Negative goodwill (gain on a bargain purchase) arises when the acquirer's interest in the net fair value of
the acquiree's identifiable assets, liabilities and contingent liabilities exceeds the cost of the business
combination. IFRS 3 refers to negative goodwill as the 'excess of acquirer's interest in the net fair value
of acquiree's identifiable assets, liabilities and contingent liabilities over cost'. (IFRS 3: para. 34)

Negative goodwill can arise as the result of errors in measuring the fair value of either the cost of the
combination or the acquiree's identifiable net assets. It can also arise as the result of a bargain purchase.

Characteristics of Goodwill

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Goodwill may be distinguished from other intangible non-current assets by reference to the following
characteristics.

(a) It is incapable of realisation separately from the business as a whole.

(b) Its value has no reliable or predictable relationship to any costs which may have been incurred.

(c) Its value arises from various intangible factors such as skilled employees, effective advertising or a
strategic location. These indirect factors cannot be valued.

(d) The value of goodwill may fluctuate widely according to internal and external circumstances over
relatively short periods of time.

(e) The assessment of the value of goodwill is highly subjective.

RESEARCH AND DEVELOPMENT EXPENDITURE

Research is original and planned investigation undertaken with the prospect of gaining new scientific or
technical knowledge and understanding.

Development is the application of research findings or other knowledge to a plan or design for the
production of new or substantially improved materials, devices, products, processes, systems or services
before the start of commercial production or use.

Accounting treatment

Research expenditure

Research expenditure cannot be recognised as an intangible asset. Therefore, research expenditure

should be recognised as an expense in the statement of profit or loss. Tangible assets used in research
should be accounted for under IAS 16 as plant and equipment.

Development expenditure

Development expenditure should be capitalised as an intangible asset if an entity can demonstrate that:

 The project is technically feasible

 The entity intends to complete the intangible asset, and then use it or sell it
 It is able to use or sell the intangible asset
 The intangible asset will generate future economic benefits. There must either be a market for
the product or an internal use for it
 The entity has adequate technical, financial and other resources to complete the project
 It can reliably measure the attributable expenditure on the project.

Amortization
An intangible asset with a finite useful life should be amortised over its expected useful life.
(a) Amortisation should start when the asset is available for use.

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(b) Amortisation should cease at the earlier of the date that the asset is classified as held for sale in
accordance with IFRS 5 Non-current assets held for sale and discontinued operations and the date
that the asset is derecognised.
(c) The amortisation method used should reflect the pattern in which the asset's future economic
benefits are consumed. If such a pattern cannot be predicted reliably, the straight-line method
should be used.
(d) The amortisation charge for each period should normally be recognised in profit or loss.
(IAS 38: paras. 97–99)

The residual value of an intangible asset with a finite useful life is assumed to be zero unless a third
party is committed to buying the intangible asset at the end of its useful life or unless there is an active
market for that type of asset (so that its expected residual value can be measured) and it is probable
that there will be a market for the asset at the end of its useful life.
The amortisation period and the amortisation method used for an intangible asset with a finite useful
life should be reviewed at each financial year end. (IAS 38: para. 100)

Disposals/retirements of intangible assets

An intangible asset should be eliminated from the statement of financial position when it is disposed of
or when there is no further expected economic benefit from its future use. On disposal the gain or loss
arising from the difference between the net disposal proceeds and the carrying amount of the asset
should be taken to profit or loss as a gain or loss on disposal (ie treated as income or expense).
(IAS 38: paras. 112–117)

Example 1
Doug Co is developing a new production process. During 20X3, expenditure incurred was $100,000, of
which $90,000 was incurred before 1 December 20X3 and $10,000 between 1 December 20X3 and 31
December 20X3. Doug Co can demonstrate that, at 1 December 20X3, the production process met the
criteria for recognition as an intangible asset. The recoverable amount of the know-how embodied in
the process is estimated to be $50,000.
Required:
How should the expenditure be treated?

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IAS 36: IMPAIRMENT OF ASSETS

The main objective of IAS 36 is to ensure that no Asset is stated at more than its recoverable amount in
the statement of financial position. Therefore, if there is an asset in the statement of financial position
which is stated at more than its recoverable amount, then that asset has suffered impairment and its
value should be adjusted to its recoverable amount.

Impairment is a reduction (a fall) in the recoverable amount of an asset or cash generating unit below
its carrying amount. An entity should carry out an impairment review at least annually if (even if they
are no indication of impairment):

 An intangible asset is not being amortized because it has an indefinite useful life
 Goodwill has arisen on a business combination.

Otherwise, an impairment review is required only where there is evidence that impairment may have
occurred.

Indication of Impairment: Indications that impairment might have happened can come from external or
internal sources.

External sources:

 Unexpected decreases in an asset’s market value

 Significant adverse changes have taken place, or are about to take place, in the technological,
market, economic or legal environment
 Increased interest rates have decreased an asset’s recoverable amount
 The entity’s net assets are measured at more than its market capitalization

Internal sources:

 Evidence of obsolescence or damage

 There is, or is about to be, a material reduction in usage of an asset
 Evidence that the economic performance of an asset has been, or will be, worse than expected.

Calculating an Impairment loss

Impairment occurs if the carrying amount of an asset is greater than its recoverable amount.

Recoverable amount: it the higher of fair value less costs sell and value in use.

Fair value less costs to sell: it is the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants in an active market at the measurement
date, less the costs of disposal.

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Value in use: it is the present value of estimated future cash flows (inflows minus outflows) from using
an asset over its useful life, including its eventual disposal at the end of its useful life.

Carrying amount: it is the amount at which an asset is recorded in the statement of financial position.

Note: If the fair value less costs to sell is higher than the carrying amount, there is no impairment and
no need to calculate value in use.

ILLUSTRATION 1
The information about an asset is given below:
K’000
Carrying amount 500
Fair value less costs to sell 300
Future cash flows (per annum) for 2 years 200
Discount rate. 10%.
Required
Determine the outcome of the impairment review.

RECOGNISING IMPAIRMENT LOSSES

Once impairment loss is calculated, it is accounted for as follows in the financial statements:

 An impairment loss is normally charged immediately in the statement of profit or loss and other
comprehensive income to the same heading as the related depreciation e.g. cost of sales or
administration.
 If the asset has previously been revalued upwards, the impairment is recognised as
comprehensive income and is debited to the revaluation reserve until the surplus relating to that
asset has been exhausted. The remainder of the impairment loss is recognised in profit or loss.
 The asset is restated to its recoverable (impaired) amount and is then depreciated over its
remaining useful life from the date of impairment review.

ILLUSTRATION 2
A company that extracts natural gas and oil has a drilling platform in the Caspian Sea. It is required by legislation of
the country concerned to remove and dismantle the platform at the end of its useful life. Accordingly, the
company has included an amount in its accounts for removal and dismantling costs, and is depreciating this
amount over the platform's expected life. The company is carrying out an exercise to establish whether there has
been an impairment of the platform.
(a) Its carrying amount in the statement of financial position is $3m.
(b) The company has received an offer of $2.8m for the platform from another oil company. The bidder would
take over the responsibility (and costs) for dismantling and removing the platform at the end of its life.
(c) The present value of the estimated cash flows from the platform's continued use is $3.3m (before adjusting
for dismantling costs).
(d) The carrying amount in the statement of financial position for the provision for dismantling and removal is
currently $0.6m.
Required:
What should be the value of the drilling platform in the statement of financial position, and what, if anything is the

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impairment loss?

Impairment Reversal
In some cases, the recoverable amount of an asset that has previously been impaired might turn out to
be higher than the asset's current carrying amount. In other words, there might have been a reversal of
some of the previous impairment loss.
(a) The reversal of the impairment loss should be recognised immediately as income in profit or loss for
the year.
(b) The carrying amount of the asset should be increased to its new recoverable amount.

The asset cannot be revalued to a carrying amount that is higher than its value would have been if the
asset had not been impaired originally, ie its depreciated carrying amount had the impairment not taken
place. Depreciation of the asset should now be based on its new revalued amount, its estimated residual
value (if any) and its estimated remaining useful life.

CASH-GENERATING UNITS

A Cash Generating Unit is the smallest identifiable group of assets for which independent cash flows can
be identified and measured.

Cash-generating units are segments of the business whose income streams are largely independent of
each other. In practice, these may mirror strategic business units used for monitoring the performance
of the business. It could also include a subsidiary or associate within a corporate group structure.

It is usually not possible to identify cash flows relating to particular assets e.g. a factory production line
is made up of many individual machines, but the revenues are earned by the production line as a whole.
This means that value in use must be calculated, and impairment review performed for groups of
assets, rather than individual assets.

Allocating assets to cash-generating units

The net assets of the business (including capitalized goodwill) are allocated to cash-generating units.

 Corporate assets: these are assets that are used by several cash-generating units e.g. head office
buildings. They do not generate their own cash inflows, so do not qualify as cash-generating
units.
 Goodwill, which does not generate cash flows independently of other assets and often relates to
a whole business.

It may be possible to allocate corporate assets and/or goodwill over other cash-generating units on a
reasonable basis. A cash-generating unit to which goodwill has been allocated must be tested for
impairment at least annually.

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Allocation of impairment to unit’s assets

If an impairment loss arises in respect of a cash-generating unit, it is allocated among the assets in the
unit in the following order:

 Any individual assets that are obviously impaired

 Goodwill
 Other assets on pro rata basis to their carrying values.

ILLUSTRATION 3
X plc has identified an impairment loss of K41m for one of its cash-generating units. The carrying amount of the
unit’s assets was K150m, whereas the unit’s recoverable amount was only K109m.
The draft values of the net assets of the unit are as follows:
K’m
Goodwill 13
Property 20
Machinery 49
Vehicles 35
Patents 14
Net monetary assets 19
150
The net selling price of the unit’s assets was insignificant except for the property, which had a market value of
K35m. The net monetary assets will be realized in full.
Required
Show how the impairment loss will be allocated to the unit’s assets.

IMPAIRMENT OF GOODWILL

IAS 36 impairment of assets requires that once goodwill is recognised in accordance with IFRS 3 revised,
goodwill is tested for impairment annually or more frequently if circumstances indicate it might be
impaired.

An impairment loss is the amount by which the carrying amount of an asset or cash-generating unit
exceeds its recoverable amount.

 As goodwill does not generate cash flows of its own, its impairment is tested within the cash
generating unit to which goodwill belongs.
 The goodwill is allocated to a specific CGU or multiple CGUs where the goodwill cannot be
allocated to a single CGU, and the impairment test is carried out on the group of assets including
the goodwill.
 Any impairment loss is allocated as stated above
 A reversal of an impairment loss can occur if the conditions that caused the original impairment
have improved. This reversal is recognised as income in the income statement.
 If the reversal relates to a cash-generating unit, the reversal is allocated to the assets of the unit
on a pro rata basis according to their carrying value except goodwill which cannot be rewritten
into the books.

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 35

Disclosures

The main disclosure requirements of IAS 36 are:

 losses recognised during the period, and where charged in the statement of profit or loss and
other comprehensive
 reversals recognised during the period, and where credited in the statement of profit or loss and
other comprehensive income
 for each material loss or reversal:
 the amount of loss or reversal and the events causing it
 the nature of the asset (or cash-generating unit) and its reportable segment
 the recoverable amount of the asset (or cash generating unit)
 whether the recoverable amount is the fair value less costs to sell or value in use
 the level of fair value hierarch (according to IFRS 13) used in determining fair value less
costs to sell
 the discount rate used in estimating the value in use and, if applicable, the fair value less
costs to sell.

IAS 23: BORROWING COSTS

IAS 23 Borrowing costs regulate the extent to which entities are allowed to capitalise borrowing costs
incurred on money borrowed to finance acquisition of certain assets.

Borrowing (interest) costs should only be capitalised if it relates to the acquisition, construction or
production of a qualifying asset, i.e. an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale.

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 36

The interest capitalised should relate to the costs incurred on the project and the cost of the entity’s
borrowings. The total amount of finance costs capitalised during a period should not exceed the total
amount of finance costs incurred during that period.

The standard lists what may be included in borrowing costs.

(i) Interest on bank overdrafts and short-term and long-term borrowings

(ii) Amortisation of discounts or premiums relating to borrowings

(iii) Amortisation of ancillary costs incurred in connection with the arrangement of borrowings

(iv) Finance charges in respect of leases recognised in accordance with IFRS 16

(v) Exchange differences arising from foreign currency borrowings to the extent that they are
regarded as an adjustment to interest costs

Capitalization of borrowing costs should commence when:

 Expenditure for the asset is being incurred

 Borrowing costs are being incurred
 Activities that are necessary to get the asset ready for use are in progress.

Capitalization of borrowing costs should cease when:

 Substantially all the activities necessary to prepare the qualifying asset for its intended use or
sale are complete.
 Construction is suspended, e.g. industrial dispute

When construction of a qualifying asset is completed in parts and each part is capable of being used
while construction continues on other parts, capitalization of borrowing costs relating to a part should
cease when substantially all the activities that are necessary to get that part ready for use are
completed.

Where a loan is taken out specifically to finance the construction of an asset, the amount to be
capitalised is the interest payable on that loan, less any investment income on the temporary
investment of the borrowings.

ILLUSTRATION 1
st
X plc began the construction of a supermarket, on 1 January 2008, which had an estimated useful life of 40 years.
It purchased a leasehold interest in the site for K250,000. The construction of the building cost K90,000 and the
th
fixtures and fittings cost K60,000. The construction of the supermarket was completed on 30 September 2008
st
and it was brought into use on 1 January 2009.
st
X plc borrowed K400,000 on 1 January 2008 in order to finance this project. The loan carried interest at 10% pa it
th
was repaid on 30 June 2009.
Required
Calculate the total amount to be included at cost in property, plant and equipment in respect of the development
st
at 31 December 2008.

ILLUSTRATION 2
On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which were

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 37

expected to take a year to build. Work started during 20X6. The loan facility was drawn down and incurred on 1
January 20X6, and was utilised as follows, with the remaining funds invested temporarily.
Asset A Asset B
K'000 K'000
1 January 20X6 250 500
1 July 20X6 250 500

The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
Required
Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of the assets and
consequently the cost of each asset as at 31 December 20X6.

If construction of a qualifying asset is financed from an entity’s general borrowings, the borrowing costs
eligible to be capitalised are determined by applying a capitalization rate to the expenditure incurred on
the asset.

The capitalization rate is the weighted average of rates applicable to general borrowings outstanding in
the period. General borrowings do not include loans for other specific purposes, such as constructing
other qualifying assets.

ILLUSTRATION 3
X Limited Co had the following loans in place at the beginning and end of 20X6. 1 January 31 December
20X6 20X6
$m $m
10% Bank loan repayable 20X8 120 120
9.5% Bank loan repayable 20X9 80 80
8.9% debenture repayable 20X7 – 150

The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining equipment),
construction of which began on 1 July 20X6.
On 1 January 20X6, X Limited Co began construction of a qualifying asset, a piece of machinery for a hydro electric
plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on 1 January 20X6,
$20m on 1 October 20X6.
Required:
Calculate the borrowing costs that can be capitalised for the hydro-electric plant machine.

Disclosures

The financial statements should disclose:

 the accounting policy adopted for borrowing costs

 the amount of borrowing costs capitalised during the period
 The capitalization rate used.

IAS 40 INVESTMENT PROPERTIES

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 38

Investment property is land and a building held to earn rentals, or capital appreciation or both,
ratherthan for use in the entity or for sale in the ordinary course of business. Owner occupied property
is excluded from the definition of investment property.

Examples

 Land held for long-term capital appreciation

 Land held for undecided future use
 Building leased out under an operating lease
 Vacant building held to be leased out under an operating lease.

The following are not investment property

 Property held for use in the production or supply of goods or services or for administrative
purposes (IAS 16 property, plant and equipment)
 Property held for sale in the ordinary course of business or in the process of construction of
development for such sale (IAS 2 inventories)
 Property being constructed or developed on behalf of third parties (IAS 11 construction
contracts)
 Owner-occupied property (IAS 16)
 Property leased to another entity under a finance lease (IAS 17 leases)

Measurement

On recognition, investment property shall be recognised and measured at cost. After the recognition, an
entity may choose either:

Cost model: under this model the property is measured in accordance with IAS 16, i.e. cost less
accumulated depreciation and impairment losses.

Fair value model: under this model:

 The property is revalued to its fair value at the end of each year
 The gain or loss is shown directly in the statement of comprehensive income/income statement
 No depreciation is charged on the asset.

Transfers to and from Investment Property

Transfers to or from investment property should only be made when there is a change in use. For
example, owner occupation commences so the investment property will be treated under IAS 16 as an
owner-occupied property.

When there is a transfer from investment property carried at fair value to owner-occupied property or
inventories, the property's cost for subsequent accounting under IAS 16 or IAS 2 should be its fair value
at the date of change of use.

Conversely, an owner-occupied property may become an investment property and need to be carried at
fair value. An entity should apply IAS 16 up to the date of change of use. It should treat any difference at
that date between the carrying amount of the property under IAS 16 and its fair value as a revaluation

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 39

under IAS 16.

ILLUSTRATION 1
A business owns a building which it has been using as a head office. In order to reduce costs, on 30 June 20X9 it
moved its head office functions to one of its production centres and is now letting out its head office. Company
policy is to use the fair value model for investment property. The building had an original cost on 1 January 20X0 of
$250,000 and was being depreciated over 50 years. At 31 December 20X9 its fair value was judged to be $350,000.
Required:
How will this appear in the financial statements at 31 December 20X9?

Disposal

Derecognise (eliminate from the statement of financial position) an investment property on disposal or
when it is permanently withdrawn from use and no future economic benefits are expected from its
disposal.

Any gain or loss on disposal is the difference between the net disposal proceeds and the carrying
amount of the asset. It should generally be recognised as income or expense in profit or loss.

Compensation from third parties for investment property that was impaired, lost or given up shall be
recognised in profit or loss when the compensation becomes receivable

IFRS 5 NON-CURRENT ASSET HELD FOR SALE AND DISCONTINUED OPERATIONS

Classification as held for sale

A non-current asset or disposal group should be classified as ‘held for sale’ if its carrying amount will be
recovered principally through a sale transaction rather than through continuing use.

A disposal group is a group of assets that the entity intends to dispose of in a single transaction. IFRS 5
requires the following conditions to be met before an asset or disposal group can be classified as ‘held
for sale’:

(i) The asset is available for immediate sale in its present condition
(ii) The sale is highly probable in that:
(i) Management is committed to a plan to sell the asset
(ii) An active programme to locate a buyer has been initiated
(iii) The asset is being actively marketed at a reasonable price in relation to its current fair
value
(iv) The sale is expected to be completed within one year from the date of classification

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 40

 (v) It is unlikely that the plan will change significantly or be withdrawn

The asset or disposal group can still be classified as held for sale, even if the sale has not actually taken
place within one year. However, the delay must have been caused by events and circumstances beyond
the entity’s control and there must be sufficient evidence that the entity is still committed to sell the
asset or disposal group.

Measurement of assets and disposal group held for sale

(i) Items classified as held for sale should be measured at the lower of their carrying amount and
fair value less costs to sell.
(ii) Where fair value less cost to sell is lower than the carrying amount, the item is written down
and the write down is treated as an impairment loss in accordance with IAS 36.
(iii) Where a non-current asset has been previously revalued and is now classified as held for sale, it
should be revalued to fair value immediately before it is classified as held for sale.
(iv) When a disposal group is being written down to fair value less cost to sell, the impairment loss
reduces the carrying value of assets in accordance with the requirement of IAS 36.
(v) A gain can be recognised for any subsequent increase in fair value less costs to sell, but not in
excess of the cumulative impairment loss that has already been recognised, either when the
assets were written down to fair value less costs to sell in accordance with IAS 36.
(vi) An asset held for sale is not depreciated, even if it is still being used by the entity.

Illustration 1
Think Twice Ltd purchased a building for use in the ordinary course of the business on 1 January 2012 for K1m. The
building was assessed to have a 50 year economic useful life. Think Twice Ltd uses the revaluation model to
account for buildings.
On 31 December 2013, the building was revalued to K1.2m. On 31 December 2014, the building met the criteria to
be classified as held for sale. Its fair value was deemed to be K1.1m and the costs necessary to sell the building
were estimated to be K50,000.
Think Twice Ltd does not make a reserves transfer in respect of excess depreciation.
Required:
Discuss the accounting treatment of the above.

Presentation of held for sale assets

IFRS 5 states that assets classified as held for sale should be presented separately from other assets in
the statement of financial position. The liabilities of a disposal group classified as held for sale should be
presented separately from other liabilities in the statement of financial position.

 Assets and liabilities held for sale should not be offset and presented as a single amount.
 Where an asset or disposal group is classified as held for sale after the reporting date, but
before the issue of the financial statements, details should be disclosed in the notes (this is a
non-adjusting event in accordance with IAS 10).
 Assets and liabilities classified as held for sale should be presented and current assets and
current liabilities respectively.

Changes to a plan of sale

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 41

If the sale does not take place within one year, an asset (disposal group) can still be classified as held for
sale if:

 the delay has been caused by events or circumstances beyond the entity’s control
 There is sufficient evidence that the entity is still committed to the sale.

If the criteria for ‘held for sale’ are no longer met, then the entity must cease to classify the assets or
disposal group as held for sale. The assets or disposal group must be measured at the lower of:

I. its carrying amount before it was classified as held for sale adjusted for any depreciation,
amortization or revaluations that would have been recognised had it not been classified as held
for sale, and
II. Its recoverable amount at the date of subsequent decision not to sell.

Any adjustment required is recognised in profit or loss as a gain or loss from continuing operations

Discontinued Operation

A discontinued operation is a component of an entity that has either been disposed of or is classified as
held for sale and:

(a) Represents a separate major line of business or geographical area of operations.

(b) Is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations
(c) Is a subsidiary acquired exclusively with a view to resale

If the component/operation has not already been sold, then it will only be a discontinued operation if it
is held for sale. An operation is held for sale if its carrying amount will not be recovered principally by
continuing use.

The following conditions must be met before an operation can be classified as discontinued operation:

 the operation is available for immediate sale in its present condition

 the sale is highly probable and is expected to be completed within one year
 management is committed to the sale
 the operation is being actively marketed
 the operation is being offered for sale at a reasonable price in relation to its current fair value
 it is unlikely that the plan will change or be withdrawn

Discontinued operations are required to be shown separately in order to help users to predict future
performance. An entity must disclose a single amount on the face of the income statement, comprising
the total of:

(a) The post tax profit or loss of discontinued operations

(b) The post-tax gain or loss recognised on the measurement to fair value less costs to sell, or
on disposal, of the assets constituting the discontinued operation.

The net cash flows attributable to the operating, investing and financing activities of discontinued
operations must be shown, either on the face of the statement of cash flows or in the notes.

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 42

If a decision to sell an operation is made after the year-end but before the accounts are approved, this is
treated as a non-adjusting event after the reporting date and disclosed in the notes. The operation does
not qualify to as a discontinued operation at the reporting date and separate presentation is not
appropriate.

Illustration 2
The Luapula group of companies has a financial year-end of 30 September. The group prepared the financial
statements for the year ended 30 September 2014.The financial statements were authorized for issue three
months later, on 1 January 2015. The group is disposing of many of its subsidiaries, each of which is a separate
major line of business or geographical area.
1. A subsidiary, Mwense, was sold on 1 April 2014.
2. On 1 April 2014, an announcement was made that there were advanced negotiations to sell subsidiary
Kawambwa and that, subject to regulatory approval, this was expected to be completed by 31 January 2015.
3. The board has also decided to sell a subsidiary called Mansa. Agents have been appointed to find a suitable
buyer but none have yet emerged. The agent’s advice is that potential buyers are deterred by the expected
price that Luapula hopes to achieve.
4. On 12 October 2014, an announcement was made that another subsidiary, Chembe, was for sale. It was sold
on 15 December 2014.

Required:
Explain whether each of these subsidiaries meets the definition of a ‘discontinued operation’ as defined by IFRS 5

Disclosures

In the period in which a non-current asset or disposal group has been either classified as held for sale, or
sold, the notes to the accounts must include:

 a description of the non-current asset (disposal group)

 a description of the facts and circumstances of the sale or expected sale
 any impairment losses or reversals recognised
 if applicable, the segment in which the non-current asset (disposal group) is presented in
accordance with IFRS 8.

Prepared by: Mr V Lukonde F7, DA 8 & CA 2.1- Financial Reporting Page 43