MODULE 1: The role and importance of financial reporting

Part A: The role and importance of financial reporting 2

The role of financial reporting 2
The importance of financial reporting 3
Who must prepare general purpose financial reports? 7
Part B: The Conceptual Framework for Financial Reporting 12
The purpose and application of the Conceptual Framework 12
Objectives and limitations of general purpose financial reporting 13
Part C: Qualitative characteristics of useful financial information 15
Fundamental qualitative characteristics 15
Enhancing qualitative characteristics 18
Application of qualitative characteristics in IFRS 21
Part D: The elements of financial statements 21
Defining elements of financial statements 22
Criteria for recognising elements of financial statements 25
Derecognition of assets and liabilities 26
Part E: Measurement of elements of financial statements 27
Cost based and value based measures used in IFRS 27
Present value as a valuation techniquie 36
Part F: Application of measurement principles in the IFRSs 38
Leases 38
Employee benefits 43
Accounting for share based payments 48
Investment property 49
Professional judgement 51
Disclosures 52
PART A: The role and importance of financial reporting p2
Financial reporting is a process that provides entities with an important communication tool allowing the
management of an entity (preparers) to produce financial information for external stakeholders (users).
The role of financial reporting p2
Identification of target users of financial statements is critical
Effective financial reporting communicates the story of the entity during the period.
The IASB is focused on improving the communication effectiveness of financial statements (IASB 2016a).
Financial reports provide information about an entity’s financial position, and the effects of transactions and
other events that give rise to changes in financial position (Conceptual Framework, paras OB12–OB16).

The importance of financial reporting p3

Financial reporting is important because of the level of resources under the care of managers and the
significance and financial impact of the decisions made by users that are based on this information.

Information needs of the user

The focus of financial reporting is on the information needs of primary users, but this does not mean that
financial reports will be irrelevant to other users. Although the reports may not be specifically tailored to meet
their needs, other parties, such as regulators and members of the public, may find general purpose financial
reports useful (Conceptual Framework, para. OB10).
The IASB’s approach to resolving conflicting user information needs is to seek to provide the information that
will meet the needs of the maximum number of primary users. However, it is noted that focusing on common
information needs does not prevent an entity from providing additional information that may be useful to a
group of users (Conceptual Framework, para. OB8).

Understanding the international financial reporting standards p5

The information included in GPFSs must comply with the International Financial Reporting Standards (IFRSs)
and achieve fair presentation in accordance with the definition and recognition criteria in the Conceptual
Framework.
If a conflict is identified between provisions of an IFRS and the Conceptual Framework, the IFRS will take
precedence.

There are two series of international accounting standards.

1. The International Accounting Standards (IASs), are those standards issued from 1973 to 2001, before
the new International Accounting Standards Board (IASB) was formed.
2. International Financial Reporting Standards (IFRSs), are those standards issued under the IASB since
2001 and reflect the changes in accounting and business practices since that date.

Who must prepare general purpose financial reports? p7

IFRS are silent on which entities should prepare GPFRs. This matter is left to governments and regulatory
agencies.
Australia:
s292 of the Corps Act states that financial reports must be prepared by all disclosing entities, public
companies, large proprietary companies and registered schemes.
Section 296 stipulates that the report must comply with accounting standards.
In addition to formal regulations, there are examples of guidance on who should prepare reports based on
professional judgment linked to the needs of external users (e.g. Statement of Accounting Concept (SAC) 1,
para. 41)
The objective of general purpose financial reporting is to provide useful financial information to various users
to support their decision-making needs. In addition, there is a stewardship function, which involves reporting
on how efficiently and effectively management has used the resources entrusted to it.

International initiatives to decrease financial reporting complexity p9

An ongoing criticism of financial reporting is the complexity of financial reports. Improving the communication
effectiveness of financial reporting is a key focus for the IASB currently, and there are a growing number of
initiatives to help combat the issue, including:
- reducing differences in reporting standards between countries
e.g. working to converge US GAAP with IFRS
- reducing reporting requirements of specific organisations
e.g. small and medium-sized entities per IASB OR entities with Reduced Disclosure Requirements per
the AASB
- catering to the information needs of multiple stakeholders
e.g. users wish to measure performance from a range of perspectives – so there is a lot of non-
mandatory information in annual reports which make the preparation of financial statements seem
like compliance only.
IASB initiatives:
- Principles of disclosure – develop a disclosure standard that binds financial statements (IAS1 and
IAS8)
- Standard level review of disclosure – improve disclosure related to the respective standards
- Materiality – guidance on the application of materiality (discussion on also removing overwhelming or
distracting immaterial information)
Financial Reporting Council, UK: introduced a forum (Financial Reporting Lab) to provide companies and
investors with an opportunity to solve contemporary reporting needs.
PART B: The Conceptual Framework for Financial Reporting p12
The Conceptual Framework sets out the concepts that underlie the preparation and presentation of financial
statements. It is a practical tool that assists the IASB when developing and revising IFRSs (Conceptual
Framework, para. 1).

The purpose and application of the Conceptual Framework p12

When standards do not provide guidance or sufficiently specific guidance, it is the role of the Conceptual
Framework to provide guidance to facilitate consistency in the reporting of transactions and events.
The Conceptual Framework provides a formal frame of reference for:
- the types of transactions and events that should be accounted for;
- when transactions and events should be recognised;
- how transactions and events should be measured; and
- how transactions and events should be summarised and presented in financial statements.

Objectives and limitations of general purpose financial reporting p13

Decision-usefulness objective
Standard setters should seek to determine what types of information are most useful for decisions made by
users of financial statements.
Limitations of the decision-usefulness objective
 - Lack of familiarity with new types of information – any evaluation of the usefulness of items of
information to users is biased by their familiarity with the information
- Decision-usefulness may vary among users – users make different types of decisions, such as whether
to sell their shares or whether to extend credit. Even the same type of user can make decisions based
on different models or frameworks
- Capable of multiple interpretations – criterion appears to be capable of supporting too many different
measurement bases
Types of financial reporting
General purpose financial reporting (broad focus) – users do not have the right to request reports to meet
their needs and rely on the financial statements for decision making
Under OB5 of the Conceptual Framework, primary users of GPFRs are existing and potential investors, lenders
and other creditors. Others, such as management, regulators or the general public, may find the info useful
but the reports are not specifically directed at them
Special purpose financial reporting (narrow focus) – users can request specialised reports (e.g. banks,
regulators) and use special purpose financial statements for decision making

Limitations of general purpose financial reporting

There are limitations to the extent that financial reporting can provide useful information to all users:
- Lack of familiarity with new types of information
- Decision usefulness may vary among users (see above for more detail)
- Capable of multiple interpretations
- Time and costs constraints in preparing GPFS

The IASB recommends the use of other sources (Conceptual Framework, para. OB6) to help gain a clearer
understanding and also explains that the reports are ‘not designed to show the value’ of the organisation but
to help decision-makers make their own estimates as to its value (Conceptual Framework, para. OB7).
In addition, financial reporting has a historical focus that may be an indicator of future performance.

Principles established in the Conceptual Framework (p14)

Accrual basis of accounting: recognises the effects of transactions and other events when they occur (which
may not relate to the time that cash is exchanged)
Going concern: presumes that the entity will continue to operate for the foreseeable future.
PART C: Qualitative characteristics of useful financial information p15
Chapter 3 of the Conceptual Framework focuses on qualitative characteristics.
To be useful, financial information must be relevant and faithfully represent what it purports to represent.
The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable
(Conceptual Framework, para. QC4).
Fundamental qualitative characteristics p15
Relevance
Information is relevant when it is capable of influencing the decisions of users (Conceptual Framework, para.
QC6). This influence can occur through the predictive value or the confirmatory value of information, or both.

Relevance also encompasses materiality, which is affected by the nature or size of an item of information, or
both. It is a matter of judgement.
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 (Conceptual Framework, para. QC11).
IASB released a draft Practice Statement that highlights ways management can identify whether information is
useful to primary users:

Faithful representation (p17)

Faithful representation requires that financial statements faithfully represent the transactions and events that
they purport to represent (Conceptual Framework, para. QC12).
Faithful representation means that financial information is complete, neutral and free from error.
Faithful representation implies that there should be a fair representation of economic outcomes or reality.
Application of fundamental qualitative characteristics
For information to be useful, it must be both relevant and faithfully represented. This may involve professional
judgment in making a trade-off between relevance and faithful representation.
Enhancing qualitative characteristics p18
Comparability
Financial information is more useful if it can be compared with similar information about other entities and
with similar information about the same entity over different timeframes.
The Conceptual Framework refers to the concept of consistency, which is defined as ‘the use of the same
methods for the same items’ (para. QC22). Consistency of accounting methods is seen as contributing to the
goal of comparability.
Note that comparability is not satisfied by mere uniformity of accounting policies and methods (Conceptual
Framework, para QC23)
Verifiability
Verifiability exists if knowledgeable and independent observers can reach a consensus that the information is
faithfully represented.
Verification can be direct (e.g. confirming a market price in an active market) or indirect (checking the inputs
and processes used to determine the reported information).
Timeliness
Undue delays in reporting information may reduce the relevance of that information to users’ decision making.
In some cases, it may be more appropriate to report estimates than wait until more directly observable
information becomes available.
Understandability
Understandability requires the information in financial statements to be clearly and concisely classified,
characterised and presented (Conceptual Framework, para. QC30).
Understandability cannot be interpreted independently of the capability of users of the financial statements.
Users are presumed to have reasonable knowledge of business and economic activities (Conceptual
Framework, para. QC32). This implies that the informed user should readily understand the measurement
attribute adopted for a particular financial statement item.
Information is not excluded from a financial report merely because it is difficult for users to understand
(Conceptual Framework, para. QC31). This would be inconsistent with the characteristic of completeness
incorporated in faithful representation.
Application of enhancing qualitative characteristics
Enhancing characteristics improve the relevance or faithful representation of information – but they do not
make irrelevant or unfaithfully represented information useful.
Preparers need to exercise professional judgement in balancing the qualitative characteristics and in assessing
the relative importance of enhancing characteristics in different contexts.
Cost constraint on useful financial reporting p20
The Conceptual Framework (para. QC35) notes that a pervasive constraint on financial statements is the
balance between the costs of providing information versus the benefits derived from their preparation and
presentation.
Providing useful financial information also facilitates the efficient functioning of capital markets and lowers the
cost of capital (Conceptual Framework, para. QC37).
Application of qualitative characteristics in the IFRSs p21
The qualitative characteristics are reflected in the underlying principles of the IFRSs. IAS 1 Presentation of
Financial Statements, paras 15–24, refers to the Conceptual Framework definitions and recognition criteria,
objectives and qualitative characteristics.
PART D: The elements of financial statements p21
Key decision areas in accounting for transactions and other events:
1. Definition: does it meet the definition of an element of a financial statement?
2. Recognition: does it need to be incorporated in the financial statement?
3. Measurement: how should you measure the item?
4. Disclosure / presentation: how should it be disclosed or presented?
Defining elements of financial statements p22
Assets
An asset is a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity (Conceptual Framework, para. 4.4(a)).
The three key components of the asset definition are:
1. the requirement for the entity to have control of the asset;
2. that a past event has occurred; and
3. the need for future economic benefits to arise.
Can be a physical asset or an intangible.
Note that control does not mean ownership (consider a lease which gives control but not ownership).
Liabilities
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits (Conceptual Framework, para.
4.4(b)).
The key components of the liability definition are:
1. the requirement for the entity to have a present obligation (may be legally enforceable or equitable);
2. that a past event has occurred; and
3. the need for an outflow of future economic benefits.
Equity
Equity is defined as ‘the residual interest in the assets of the entity after deducting all its liabilities’ (Conceptual
Framework, para. 4.4(c)).
Income
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions
from equity participants (Conceptual Framework, para. 4.25(a)).
The two essential characteristic of income are:
1. an increase in assets or a reduction in liabilities; and
2. an increase in equity, other than as a result of a contribution from owners.
Expenses
Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions
of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions
to equity participants (Conceptual Framework, para. 4.25(b)).
The two essential characteristics of an expense are:
1. a decrease in economic benefits that may arise through outflows or depletions of assets or an
increase in a liability; and
2. a decrease in equity, other than those arising from distributions to equity participants.
Criteria for recognising elements of financial statements
An item that meets the definition of an element of financial statements should be recognised if:
 (a) it is probable that any future economic benefit associated with the item will flow to or from the
entity; and
(b) the item has a cost or value that can be measured with reliability (Conceptual Framework, para.
4.38).
Probability: not defined in the CF, however, refers to the degree of uncertainty associated with the flow of
future economic benefits to or from the entity (para 4.40)
Measured with reliability: does not require the cost or value to be known or directly observable. Can use
estimates - ‘use of reasonable estimates is an essential part of the preparation of financial statements and
does not undermine their reliability (para 4.41)

Criteria for recognising elements of financial statements p25

The monetary amount at which an asset, liability or equity is recognised in the statement of financial position
is referred to as its carrying amount (Conceptual Framework, para. 5.1). However, not all items that meet the
definition of elements of financial statements are recognised.
Other relevant paragraphs:
- Para 5.7: assets and liabilities
- Para 5.4: income and expenses

Derecognition of assets and liabilities p26

Applies only to recognised assets and liabilities – occurs when the item no longer meets the definition of an
asset or liability per para 5.26.

Constraints on the framework p26

Although a framework may establish principles, it does not necessarily remove the need for professional
judgement by accountants.
Possible constraints:
- economic constraints or consequences (impact of accounting policy on share price, volatility or
management remuneration)
- Social or political constraint (professional accountants may feel constrained – social, or regulators –
political)
- Human resource / cost constraint
PART E: Measurement of elements of financial statements p27
In relation to assets and liabilities, there are two stages of the measurement decision:
- how to measure the asset or liability at initial recognition; and
- how to measure the asset or liability subsequent to initial cognition.
Cost base and value based measures used in the IFRS p27
Measurement base Advantages Disadvantages
Cost / historical cost Easily understood—by users and preparers of Limited relevance to decision-making – not forward
page 28 financial statements. looking and therefore has limited predictive value
The amount of cash or cash equivalents paid or the Relevant to decision-making—as it is the value of the Undermines the comparability of financial reports –
fair value of the consideration given to acquire them consideration given or received in exchange for an doesn’t capture time value of money when
at the time of their acquisition (para 4.55(a)) asset or a liability. aggregating items incurred at different points of time
Reliable—historical cost provides evidence for income Problems with reliability – difficulties when
based on actual transactions with external parties. calculating the fair value of consideration and other
Applies to assets (e.g. PPE IAS 16) and liabilities (para
Inexpensive to implement—the measurement of incidental costs. Historical cost may reflect
4.55(a))
historical cost is linked to the occurrence of management expectations rather than market value
transactions and is therefore readily available at little
Most commonly adopted basis (CF para 4.56) or no additional cost.
Amortised cost
page 30
The amount at which the financial asset or financial
liability is measured at initial recognition minus the
principal repayments, plus or minus the cumulative
amortisation using the effective interest method of
any difference between that initial amount and the
maturity amount, and, for financial assets, adjusted
for any loss allowance (IFRS 9, Appendix A).
Fair value Considered by many to be more relevant than cost Lack of relevance to decision-making—in relation to
page 32 based measures assets that the entity does not intend to sell, such as
financial instruments that the entity intends to hold to
The price that would be received to sell an asset or
maturity; and
paid to transfer a liability in an orderly transaction IFRS 13 establishes a hierarchy for the measurement
of fair value: Reliability problems—in relation to measuring the fair
value of assets that are not traded in an active market.
between market participants at the measurement Level 1: quoted market prices for identical assets /
date (IFRS 13, para. 9). liabilities
IFRS 13, Appendix A defines an orderly transaction Level 2: estimated using a model with no significant
(which is important for fair value) unobservable inputs
Level 3: use best available information on assumptions
market participants would use to value an A / L
Current cost The reproduction cots is commonly interpreted as the Lack of relevance to decision-making – Current cost is
page 33 most economic cost to replace the asset (IASB 2005, not a measure of the value received but of the amount
p97) of the sacrifice that would be required to replace an
The current cost of an asset is the amount of cash or
asset, and therefore, it has limited predictive value.
cash equivalents that would have to be paid if the
same or an equivalent asset were acquired currently Reliability problems – challenge to identify assets of
(para. 4.55(b)). equivalent productive capacity (e.g. technology
continues to improve) and by measuring their most
The current cost of a liability refers to the
economic current cost (e.g. brands).
undiscounted amount of cash or cash equivalents that
would be required to settle the obligation currently Assessment also reliant on management’s strategy /
(para. 4.55(b)). use of assets
Comparability problems – Management strategies
and expectations may change in response to changes
In relation to assets, the definition implies that there
in the business environment or over time. There may
are two concepts of current cost:
be significant differences between entities in the
1. reproduction cost—current cost of replacing an determination of current cost.
existing asset with an identical one; or
2. replacement cost—current cost of replacing an
existing asset with an asset of equivalent productive
capacity or service potential.
Fair value less cost of disposal
page 34
Costs of disposal are the incremental costs directly
attributable to the disposal of an asset or
cash-generating unit, excluding finance costs and
income tax expenses (IAS 36, para. 6).
Net realisable value May reflect entity specific expectations – may not be
page 34 in accordance with market expectations on which fair
value would generally be based
Net realisable value is: Netting costs to complete an asset can result in
The estimated selling price in the ordinary course of recognising liabilities for future costs, for which there
business less the estimated costs of completion and is no present obligation. This does not apply in the
the estimated costs necessary to make the sale (IAS 2, case of inventory, as the lower of cost or NRV results
para. 6). in decreasing the value of inventory (rather than
increasing).
The use of net realisable value in financial reporting is
largely restricted to its role in measuring inventories at
the lower of cost and net realisable value, in
accordance with IAS 2 Inventories.
Fulfilment value Note that a liability is measured as the amount that is
page 35 paid to settle the liability with the counterparty (e.g.
the lender) rather than the market value to transfer
The present value of the cash / resources obliged to
the liability to a third party.
be transferred to settle a liability. (para 6.17)
Assets are carried at the amount of cash or cash
Value in use Management is in the best position to judge the Reliability problems – It is specific to each entity and
page 35 expected amount, timing and risk of future cash flows. to each specific use. It therefore relates to only one
specific future course of action.
The present value of future cash flows expected to be
derived from an asset or cash-generating unit’. Management would be held more accountable against Value in use is subjective and is not capable of being
measurements that reflect entity-specific independently verified by others.
Value in use is also frequently referred to as the
‘entity-specific value’. management objectives. The application of value in use to assets that do not
generate contractual cash flows is problematic.
The value in use should reflect the estimated future
cash flows that ‘the entity expects to derive from the An individual asset may work with other assets,
asset’ (IAS 36, para. 30(a)). creating the need to allocate expected cash flows
across assets. These allocations may be arbitrary.

Understandability – The lack of clarity regarding

whether value in use should reflect management or
market expectations.
Present value as a valuation technique p36
Assets are carried at the present discounted value of the future net cash inflows that the item is expected to
generate in the normal course of business. Liabilities are carried at the present discounted value of the future
net cash outflows that are expected to be required to settle the liabilities in the normal course of business
(para. 4.55(d)).
Issues that arise in the application of the valuation techniques include:
- the uncertainty of future cash flows; and
- the selection of an appropriate discount rate.
Uncertainty of future cash flows
The reliable measurement of the PV of individual assets and liabilities is problematic because future cash flows
often occur under conditions of uncertainty. Even for contractual amounts, future cash flows may differ from
those originally expected.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets requires that the amount recognised as a
provision must be ‘the best estimate of the expenditure required to settle the present obligation at the end of
the reporting period’ (para. 36). This is often expressed as the amount required to settle the obligation
immediately or to transfer it to a third party.
A further difficulty can arise in determining the appropriate level of aggregation of cash flows. The need to
allocate cash flows to particular items when those cash flows are produced by the interaction of more than
one factor of production may introduce additional subjectivity into PV calculations.
Selection of appropriate discount rates
Investors require a rate of return that is commensurate with the systematic risk of an investment, irrespective
of whether the investment is in a financial asset or a project involving non-monetary assets.
Systematic risk is sometimes referred to as market risk or non-diversifiable risk.
Unsystematic risk is specific to a particular asset due to that asset’s unique features. Investors can drive asset-
specific (unsystematic) risk towards zero by holding a diversified portfolio of assets.
Historical rates
In the context of a historical cost system, the historical interest rate implicit in the original contract is usually
considered to be the rate at which the cash flows specified in the contract are to be discounted.
Current rates
Current rates are based on a discount rate that is current at the end of the reporting period. Most consistent
with the fair value method.
PART F: Application of measurement principles in the IFRSs p38
Mixed measurement models are adopted in various forms with a focus on different measures and applications
to provide accounting policy choice and, in some instances, to determine the required measurement basis.
Leases p38
There are two recognition exemptions available to lessees: ‘short-term leases’ and low value leases (IFRS 16,
para. 5).
Short term lease
No more than 12 months (IFRS 16, Appendix A)
The short-term lease exemption can only be applied to a class of underlying assets, not on the basis of the
terms of each lease contract (IFRS 16, para. 8).
Low value lease
Assess when the asset is new. Cannot be applied to subleases.
The underlying asset is only of low value if:
a) the lessee can benefit from use of the underlying asset on its own or together with other resources
that are readily available to the lessee; and
b) the underlying asset is not highly dependent on, or highly interrelated with, other assets (IFRS 16,
Appendix B, para. B5).
Examples: tablets and personal computers, telephones, and small items of office furniture are examples of
underlying assets of low value (IFRS 16, Appendix B, para. B8) – value of approx. USD5000 or less.
How to determine if there is a lease?
Where a contract ‘conveys the right to control the use of an identified asset for a period of time in exchange for
consideration’ (IFRS 16, para. 9). The period of time is commonly greater than 12 months but it may also be
expressed as an ‘amount of use’.
The existence of a lease must be reassessed each time there is a change to the terms and conditions of the
contract (IFRS 16, paras 9–11).
Recognition criteria for the lessee
At the commencement date of a lease the lessee recognises a right-of-use asset at cost and a lease liability
(IFRS 16, paras 22–3).
A right-of-use asset is the asset specified in the lease contract that the lessee has the right to use during the
lease term. The recognition and measurement criteria for a lessee are summarised in the table below.
Right-of-use asset Lease liability
Initial measurement Initial measurement
The cost of the right-of-use asset shall comprise: The lease liability is measured at the present value
 the amount of the initial measurement of the of future lease payments, ‘discounted using the
lease liability …; interest rate implicit in the lease’, or using ‘the
lessee’s incremental borrowing rate’ if the implicit
 any lease payments made on or before the
interest rate cannot be easily determined (IFRS 16,
commencement date, less any lease incentives
para. 26).
received;
Future lease payments include:
 any initial direct costs incurred by the lessee;
and  fixed payments … less any lease incentives
receivable;
 an estimate of costs to be incurred by the
lessee in dismantling and removing the  variable lease payments …;
underlying asset, restoring the site on which it  amounts expected to be payable by the lessee
is located or restoring the underlying asset to under residual value guarantees;
 the condition required by the terms of the lease  the exercise price of a purchase option if the
(IFRS 16 Leases, para. 24). lessee is reasonably certain to exercise that
option …; and
 (e) payments of penalties for terminating the
lease’ (IFRS 16, para. 27).
Subsequent measurement Subsequent measurement
Unless alternative measurement models (see The lease liability is measured by:
‘Alternatives’) are applied, the lessee applies the  increasing the carrying amount to reflect
cost model under which the right-of-use asset is interest on the lease liability;
measured.
 reducing the carrying amount to reflect the
To apply a cost model: lease payments made; and
 measure at cost less accumulated  (c) remeasuring the carrying amount to reflect
depreciation and accumulated impairment any reassessment or lease modifications … or to
losses reflect revised in-substance fixed lease
 adjust for any remeasurements of the lease payments (IFRS 16, para. 36).
liability (IFRS 16, paras 29–30).
Alternatives
Other measurement models may be used under the following circumstances:
‘If a lessee applies the fair value model in IAS 10 Investment Property to its investment property’, then the
fair value model is applied to the right-of-use assets.
The revaluation model may be applied per IAS 16 Property, Plant and Equipment if the lessee has applied
that model to a class of property, plant and equipment to which the right-of-use asset relates (IFRS 16,
paras 34–5).

Recognition criteria for the lessor (p41)

A lessor is required to classify each of its leases as either a finance lease or operating lease (IFRS 16, para. 61).
Finance lease: ‘a lease that transfers substantially all the risks and rewards incidental to ownership of an
underlying asset’.
Operating lease: ‘a lease which does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset’. It is the substance of the transaction rather than the form of the contract
that determines whether a lease is classified as a finance or operating lease.
Situations that lead to classification of a finance lease include:
 ownership is transferred to the lessee by the end of the lease term;
 an option for the lessee to purchase the underlying asset at a price that is sufficiently lower than its
fair value at the date the option becomes exercisable for it to be reasonably certain;
 the term of the lease is for the majority of the underlying asset’s economic life (matter of professional
judgement);
 the present value of the lease payments amount to substantially all of the fair value of the underlying
asset;
 the specialised nature of the underlying asset means only the lessee can use it without major
modifications;
 the lease is cancellable and the lessor’s associated losses are to be incurred by the lessee thus
indicating a transfer of risks and rewards of the underlying asset to the lessee;
 gains or losses from changes in the residual amount’s fair value are accrued to the lessee;
 the lessee may continue the lease for another period with the rent amount ‘substantially lower’ than
market value (IFRS 16, paras 63–4).
 Finance lease Operating lease
Initial measurement Initial measurement
The net investment in the lease comprises: Lease payments received are recognised as income
 initial direct costs incurred by lessor ‘other on a straight-line or other systematic basis that is
than those incurred by manufacturer or representative of the pattern of benefit from the
dealer lessors’ (IFRS 16 Leases, para. 69) use of the underlying asset.
 fixed payments, less lease incentives Initial direct costs are added to the carrying amount
payable of the underlying asset and recognised as an
expense on the same basis as the lease income (IFRS
 variable lease payments 16, paras 81–3).
 residual value guarantees provided by the
lessee or a third party
 exercise price of purchase option if lessee is
reasonably certain they wish to exercise
that option
 payments of penalties for terminating the
lease.
The interest rate implicit in the lease is used to
measure the net investment in the lease.
Subsequent measurement Subsequent measurement
Finance income is recognised on a systematic basis Depreciation is recognised as an expense in
over the lease term. Lease payments are applied accordance with IAS 16. The underlying asset should
against the gross investment to reduce the principal be tested for impairment and any impairment loss
amount and the unearned finance income (IFRS 16, recognised in accordance with IAS 36 Impairment of
paras 75–8). Assets (IFRS 16, paras 84–6).

Presentation and disclosure

Lessee
The right-of-use assets and the lease liabilities shall be reported separately from other assets and liabilities in
either the financial statements or the notes.
Exception: where the right-of-use asset is classified as investment property, which shall be presented in the
statement of financial position as investment property.
Interest incurred on the lease liability must be included as a component of finance costs and presented
separately from depreciation expense on the right-of-use asset.
Lessor
Include additional qualitative and quantitative information regarding the nature of their leasing activities and
their risk management strategy for the rights they retain in the underlying assets (extent of disclosure depends
on the type of lease).
Employee benefits p43
Short-term employee benefits
Employee benefits are ‘all forms of consideration given by an entity in exchange for service rendered by
employees or for the termination of employment’ (IAS 19, para. 8).
Wages and salaries, non-monetary benefits and short-term compensated absences such as annual leave and
sick leave (IAS 19, para 9)
Compensated absences that are expected to be settled beyond 12 months after the end of the reporting
period are measured using the PV technique (IAS 19, paras 153–5).
Accumulating Non-accumulating
Where the employee can carry The benefit is restricted to a particular
forward the benefit to future periods year
Vesting A liability for accumulated amounts is Cost of benefit should not be
Where the employer has an recognised – nominal amount for recognised until the absence occurs
obligation to pay that is not within 12 months, PV thereafter (IAS 19, 13(b)).
conditional on future employment (IAS19)
A liability is not recognised as the
e.g. annual leave employee’s service does not increase
the amount of the benefit
Non-vesting Per IAS19 need to determine the Cost of benefit should not be
The employee is not compensated for probability that a payment will be recognised until the absence occurs
any unused entitlement made. Recognise only the part of the (IAS 19, 13(b)).
leave that will be taken
A liability is not recognised as the
e.g. sick leave employee’s service does not increase
the amount of the benefit

Long service leave

IAS 19 is based on the view that the definition of a liability or expense is satisfied as soon as employees provide
services that result in LSL entitlements. This is so, irrespective of whether the employee is legally entitled to
LSL.
Paragraph 155 of IAS 19 requires the amount of the liability for such long-term employee benefits to be
measured on a net basis as the PV of the obligation at the reporting date (see paras 56–98) minus the fair
value at the reporting date of plan assets (if any) out of which the obligations are to be settled directly (see
paras 113–19).
Necessary to:
1. Complete a probability assessment to determine the number of employees that will eventually be
paid LSL
2. Determine the timing and amount of the payments – requires projection of salary (capturing
inflation and promotions)
3. The estimated future LSL must be discounted to PV at the reporting date (use a rate with reference to
current market yields on high quality corporate bonds, if no corp bonds, use govt bonds. Need to use
discount rate appropriate to the country where the employee will be paid – IAS19)
Accounting for share based payments p48
Accounting for share-based payments falls within the scope of IFRS 2 Share-based Payment.
A share-based payment transaction is a transaction in which the entity:
(a) receives goods or services from the supplier of those goods or services (including an employee) in a
share-based payment arrangement, or
(b) incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement
when another group entity receives those goods or services (IFRS 2, Appendix A).
Measurement of share-based payment transactions
Cash-settled Equity-settled

Definition The entity acquires goods/services by The entity acquires goods/services by

incurring a liability to transfer cash, the using its own equity instruments as
amount of which is based on the price of the consideration.
entity’s equity instruments.

Example e.g. Pay a cash bonus for employees’ services e.g. Executive stock options
= 10 times the company’s share price

e.g. Purchase plant for cash consideration =

the value of 10,000 shares of the company
Recognition and 1. On purchase date: 1a. On purchase date:
measurement
Measured at the FV of the liability incurred; If the FV of goods/services received
(e.g. = share price on purchase date x shares) can be estimated reliably:

Dr. Goods / bonus expense xx Measured directly, using the FV of the

goods/services received;
Cr. Liability (increase) xx
(e.g. purchase an asset)

Until the liability is settled, it may be

remeasured Dr. Goods/services xx
Cr. Equity (increase) xx
2. At the end of each reporting period &
upon settlement: 1b. On grant date:

Recognize FV gain / (loss) in P/L. If the FV of goods/services received

Dr. Liability (decrease) xx cannot be estimated reliably:
Cr. P/L (gain) xx
Measured indirectly, using the FV of
the equity instruments on grant date.
(e.g. employees provide services)

Dr. Bonus expense xx

Cr. Equity (increase) xx

2. NO re-measurement
Fair value is not remeasured at the end
of the year.
Investment property p49
Investment property applies a mixed measurement model based on the purpose and nature of the asset.
IAS 40 Investment Property:
- Cost model: provides faithful representation but would, arguably, be less relevant in future reporting
periods.
- Fair value model: provides the reverse relationship. Gains or losses are recognised in the P&L
Investment property is defined in IAS 40, para. 5, as property (land or a building—or part of a building—or
both) held (by the owner or by the lessee as a right-of-use asset) to earn rentals or for capital appreciation or
both, rather than for:
(a) use in the production or supply of goods or services or for administrative purposes; or
(b) sale in the ordinary course of business.
Challenge for comparability if different entities use different methods:
IAS40 requires entities that choose to hold their investment properties at cost to disclose the fair value of the
investment properties in the notes to the financial statements.
Consider whether unrealised gains on fair value movements satisfy the definition of asset in the CF (i.e. gain
from sale may not be probable or likely to occur in the near future)
Professional judgement p51
Professional judgment is an important characteristic of professional practice. It requires a combination of
conceptual and practical knowledge and is described as the ability to diagnose and solve complex,
unstructured values-based problems of the kind that arise in professional practice (Becker 1982).
Professional judgment may often involve making a trade-off between relevance and faithful representation,
which are two qualitative characteristics that accounting information should possess.
West (2003) suggests that without judgment, accounting becomes nothing more than a book of rules for
compliance. Moreover, the Conceptual Framework acknowledges that to a large extent judgment is required
when preparing financial reports (para. OB11).
IFRS reflects a principles based approach and both IFRS and Conceptual Framework support the use of
professional judgement.
Can apply professional judgement to making estimates per OB11 of the CF. A combination of professional
judgement and disciplined approach to estimation ensure the information is still reliable and relevant.
Disclosures p52
Effective disclosures play an important role in helping the decision-making of users.
The role and purpose of disclosures
The role of these disclosures is linked to the objective of financial reporting, which is to provide an account of
the organisation so that users have useful information with which to guide their decision-making.
When disclosure is required
Disclosure is included in financial statements in accordance with the disclosure requirements of the accounting
standards. In addition, IAS 1 Presentation of Financial Statements, para. 15, notes that compliance with the
IFRSs, with additional disclosures when necessary, is presumed to result in the fair presentation of the financial
statements.
If management believes that compliance with IFRS would be misleading / conflict with the overall objective of
financial statements, they can depart from the standard, provided the local legislation allows it.
The importance of a consistent approach to disclosure
A consistent approach to disclosure can be clearly linked back the CF’s qualitative requirements of
comparability and understandability.
A consistent approach to disclosure should be maintained and any deviations should be clearly justified and
carefully explained.
MODULE 2: Presentation of financial statements

Part A: Presentation of financial statements 60

Complete set of financial statements 61
Accounting policies 67
Revision of accounting estimates and correction of errors 72
Events after the reporting period 75
The impact of technological advancements on the presentation of financial statements 79
Part B: Statement of profit or loss and other comprehensive income 82
Presentation of comprehensive income 82
The concept of other comprehensive income and total comprehensive income 83
IAS 1—disclosures and classification 84
Tips on how to analyse the statement of profit or loss and other comprehensive 89
income
Part C: Statement of changes in equity 91
IAS 1—disclosures of changes in equity 91

Part D: Statement of financial position 94

Format of the statement of financial position 94
Presentation of assets and liabilities 95
IAS 1—disclosures in the notes to the statement of financial position 96
Tips on how to analyse a statement of financial position 97
Part E: IAS 7 Statement of Cash Flows 99
How does a statement of cash flows assist users of the financial statements 100
Information to be disclosed 100
Common methods adopted on how to prepare a statement of cash flows 102
Consolidated financial statements 105
Tips on how to analyse the statement of cash flows 105
PART A: Presentation of financial statements p61

IAS 1 Presentation of Financial Statements:

Complete set of financial statements 10 – 14

Fair presentation and compliance with IFRSs 15 – 24
Going concern 25 – 26
Accrual basis of accounting 27 – 28
Materiality and aggregation 29 – 31
Offsetting 32 – 35
Frequency of reporting 36 – 37
Comparative information 38–38D, 40A–44
Consistency of presentation 45 – 46

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

Selection and application of accounting policies 7 – 12

Consistency of accounting policies 13
Changes in accounting policies 14 – 27
Disclosure of changes in accounting policies 28 – 31
Changes in accounting estimates 32 – 40
Errors 41 – 42

IAS 10 Events after the Reporting Period:

Definitions 3
Adjusting events after the reporting period 8–9
Non-adjusting events after the reporting period 10 – 11
Dividends 12 – 13
Disclosures 17 – 22

Complete set of financial statements p61

A complete set of financial statements as stated in para. 10 of IAS 1 contains the following:

 a statement of financial position;

 a statement of profit or loss and other comprehensive income;
 a statement of changes in equity;
 a statement of cash flows;
 notes, which include accounting policies and explanatory notes;
 comparative information regarding the preceding period; and
 a statement of the financial position as at the beginning of the earliest comparative period when any
of the following occurs:
o an accounting policy is applied retrospectively;
o items in the financial statements are retrospectively restated; or
o items in the financial statements are reclassified.

IAS 1 applies to GPFS (prepared by a reporting entity)

Non-reporting entities prepare SPFS and only need to apply the accounting standards that are considered
necessary to present a ‘true and fair’ view.

Per AASB para 9, and entity is required to disclose in its accounting policy note whether the financial
statements are GPFS or SPFS.

Entities are required to give equal prominence to all of the financial statements in a complete set of financial
statements (para 11).

The requirements of IAS 1 also apply to interim financial reports (IAS 34, para 5).

Segment reporting

The aim of providing such information is to help financial statement users ‘to evaluate the nature and
financial effects of the business activities in which it engages and the economic environments in which it
operates’ (IFRS 8, paras 1 and 20).

IFRS 8 requires that a company with listed debt or equity provide the following information for each of its
reportable operating segments:

 Financial info (profit or loss, revenues, expenses, assets and liabilities) and
 General information (products and service,; geographical areas of operations, and major customers)

An operating segment is identified as a component of the entity that:

 undertakes business activities from which it may generate revenues and incur expenses;
 has its operating result regularly reviewed by the chief operating decision maker within the entity,
such as the general manager, managing director or chief executive officer (CEO); and
 has discrete financial information available (IFRS 8, para. 5).

Fair presentation and compliance with IFRS

IAS 1 requires financial statements to present fairly the entity’s financial performance, financial position and
cash flows. May require additional disclosures (per para. 15 of IAS 1)

Paragraph 16 of IAS 1 requires entities to make an explicit and unreserved statement of IFRS compliance in the
notes to the accounts.

Where compliance with an IFRS would not result in a fair presentation, departure from that IFRS is permitted,
provided:

 the regulatory framework permits such departure; and

 the entity discloses detailed information about the departure (IAS 1, para. 19).

This detailed information includes:

 a statement that management believes the departure provides financial statements that present
fairly;
 details of the departure;
 reasons why the IFRS treatment is considered misleading; and
 the financial impact of the departure on the entity’s profit, financial position and cash flows (IAS 1,
para. 20).
 - EITHER:
1a) Adjust from the date of the initial transaction
OR
If the period is not 1b) If date outside the fin statements, adjust the
covered by the FS: opening balance of R/E (equity) of the earliest
prior period; and
2) The comparative amounts for each prior
period presented must be restated as if the new
policy had always been applied (para 22)
- e.g. where data is no longer available / not able
If ‘impractical’ for
to be collected:
prior periods:
Adjust from the earliest practicable date (para
44 and 45);
1. The title of the IFRS, description 1. The nature of the change;
of transitional provisions if any;
2. The reasons why the change provides ‘more
2. The nature of the change; reliable and relevant information’;

3. The amount of adjustment for 3. The amount of adjustment for each FS item
each FS item affected; affected (current and prior period, but NOT
subsequent period);
4. The adjustments relating to
Disclosures: prior periods. 4. The amount of the adjustments relating to
periods before the earliest prior period
5. Accounting standards has been presented in the FS;
issued but not effective at time of
statements or not adopted: 5. (If applicable) advice the impracticability of
- Disclose the potential impact of the retrospective adjustments, details of why
applying (per para 30) and a description of how the error has been
corrected.

6. Three-column balance sheet.

IAS 8 specifically excludes the following as changes in accounting policy:

 application of an accounting policy for events or conditions that differ in substance from previous
events or conditions; and
 application of a new accounting policy for events or conditions that in previous reporting periods did
not exist or were immaterial (para. 16).

Revision of accounting estimates and correction of errors p72

Change in accounting estimates

Examples of 1. Bad debts;

estimates: 2. Inventory obsolescence;
3. Fair value of FA and FL;
4. The useful life of PPE, or a change in depreciation method
5. Warranty obligations.
 What to do: Prospective adjustments to current and future periods.

1. For income and expense:

- Adjust either the current OR current and future periods that the change of estimates
affects (para 36);
2. For assets, liabilities and equity items:
- Adjust in the reporting period of changes of estimates (para 37).

Disclosures: 1. The nature and amount of such change of estimates if it affects current reporting
period;
2. The effect on future reporting periods if practicable (para 39).

Material errors in a prior period

Examples of errors: 1. Mathematical mistake, mistakes in applying accounting policies, oversights or

misinterpretations of facts, fraud;

2. Financial statements are considered not compliant with the accounting standards,
if they ‘contain material errors’ or ‘immaterial errors made intentionally to achieve a
particular presentation’ (para 41 of IAS 8)

What to do: Retrospective adjustments to prior reporting periods, in the first set of FS issued after
the error’s discovery.

By either:

1. If the comparative amounts relate to reporting periods that were affected by the
error then comparative amounts in the FS;

2. If the error occurred before the earliest prior period presented in the FS then:
restate ‘the opening balances of assets, liabilities and equity for the earliest prior
period presented’ (para 42).

If the date that the error was made is not covered y the financial statements, the
adjustment should be made to the opening balance of R/E (para 19(b) and 22)

If ‘impractical’ for Adjust the beginning of the current reporting period (para 47);
prior periods:

Disclosures: 1. The nature of the error;

per para 49 of IAS8
2. The amount of the correction for each FS line item affected; and if EPS applies, the
impact on basic and diluted EPS

3. The amount of the correction at the beginning of the earliest prior period
presented;

4. (If applicable) advice the impracticability of the retrospective adjustments, details

of why and a description of how the error has been corrected (para 49);

5. Three-column balance sheet.

Events after the reporting period p75

An event after the reporting period, or a subsequent event, is defined in para. 3 of IAS 10 as an event,
favourable or unfavourable, that occurs between the end of the reporting period and the date when the
financial statements have been authorised for issue.

Selection of event type of IAS 10

 Adjustable events Non-adjustable events
1. New information available after the 1. New information arose after the
reporting period; AND reporting period; BUT

Definition
2. This event is related to a condition 2. This event is not related to a pre-
that already exists at the reporting date. existing condition at the reporting date.

1. An update outcome of a court case; 1. MV of an investment declines;

2. The ascertainment of the selling price 2. A major drop in share price;

for inventory;
3. An agreement to refinance a long-
3. A debtor whose account was term liability is made;
significantly overdue is now declared
Examples of events bankrupt; 4. A major explosion causing significant
that occur after the losses for the company;
reporting period 4. Fraud or errors that reveals the FS
were incorrect. 5. Dividends declared after the end of
the reporting period; (p106)

6. Changes in tax rates;

7. A major business combination.

1. Adjust figures in FS; 1. Not adjust figures in FS;

2. Disclose about the updated 2. Disclose as a note in FS including:

conditions
- The nature and description of the
Recognition (e.g. Progress in the court case) event;

- An estimate of the financial effect, or a

statement that such an estimate cannot
be made.

1. The date of authorization for issue;

2. Details of who gave the authorization;
Other disclosures
3. An update of the conditions.

The impact of technological advancements on the presentation of financial statements p79

Software companies like IBM, Oracle, SAP and many others are now offering powerful cloud-based disclosure
management applications that can automatically generate reports that combine an entity’s structured
financial data with narrative analysis. Those reports are not only prepared faster but can be updated
automatically as new events occur; they can also be subject to less human errors as human intervention is kept
at a minimum.
PART B: Statement of profit and loss and other comprehensive income p82

IAS 1 Presentation of Financial Statements:

Definitions 7
Complete set of financial statements 10A
Statement of profit or loss and other comprehensive income 81A
Information to be presented in the profit or loss section or the 82
statement of profit or loss
Information to be presented in the other comprehensive income 82A – 87
section
Profit or loss for the period 88 – 89
Other comprehensive income for the period 90 – 96
Information to be presented in the statement(s) of profit or loss 97 – 105
and other comprehensive income or in the notes

The concept of other comprehensive income and total comprehensive income p83

‘Other comprehensive income’ is defined in para. 7 of IAS 1 and comprises items of income and expense
(including reclassification adjustments) that are not recognised in profit or loss as required or permitted by
other IFRSs.

Paragraph 88 of IAS 1 requires all income and expense items to be included in the determination of profit or
loss for a reporting period ‘unless an IFRS requires or permits otherwise’.

In broad terms, income and expense items excluded from the profit or loss (and recorded in other
comprehensive income) include items:

 arising from the correction of errors or changes in accounting policies in accordance with IAS 8; and
 meeting the Conceptual Framework definition of income or expense, but that are required or
permitted to be excluded by the requirements of another IFRS (para. 89).

Other comprehensive income typically includes:

 unrealised foreign exchange gains and/or losses arising from translating the financial statements of a
foreign operation under IAS 21;
 unrealised gains and losses on remeasuring financial instruments under IFRS 9;
 revaluation increments resulting from the revaluation of non-current assets under IAS 16;
 unrealised gains and losses on remeasuring cash flow hedges under IAS 21; and
 actuarial gains and losses on remeasuring defined benefit plan assets under IAS 19.

Total comprehensive income = Profit or Loss (after tax) + Other Comprehensive Income

IAS 1 – disclosures and classifications p84

Paragraph 10A of IAS1 requires an entity to present either:

1. A single statement of profit and loss and OCI with two sections presented together; or
2. Two statements, one P&L and one OCI
PART C: Statement of changes in equity p91

IAS 1 Presentation of Financial Statements:

Information to be presented in the statement of changes in equity 106

Information to be presented in the statement of changes in equity or in the notes 106A – 110

IAS 1 – disclosures of changes in equity p91

A statement of changes in equity should explain and reconcile the movement in net assets of an entity over a
reporting period. The two primary sources of change in an owner’s equity (and therefore net assets) are:

 ‘the transactions with owners in their capacity as owners’; and

 ‘the total income and expenses ‘generated by the entity’s activities’ (para. 109).

Disclose in the statement of changes in equity:

Total OCI
Effect of any retrospective adjustments required by IAS 8
Reconciliation of opening and closing balances for each component of equity, with separate
disclosures of changes from P&L, OCI and transactions with owners

Disclose in the notes to FS:

 Each component of equity affected by OCI (can be in statement or notes) – includes tax on items
involved and any non-controlling interest portion deducted.
Amount of dividends recognised as distributions to owners and the related DPS (can be in statement
or notes)
PART D: Statement of financial position p94

IAS 1 Presentation of Financial Statements:

Information to be presented in the statement of financial position 54–59

Current/non-current distinction 60–65
Current assets 66–68
Current liabilities 69–76
Information to be presented either in the statement of financial position or in the 77–80A
notes

Format of the statement of financial position p94

IAS 1 does not stipulate a strict format of the statement of financial position

However, paras 54-59 specify the minimum line items that must be presented:

Presentation of assets and liabilities p95

Can be presented as current and non-current OR in order of liquidity (only when it provides reliable and more
relevant information per para 60).

Definitions

Current asset An asset which satisfies any one of the following criteria:
 it is expected to be realised in, or is intended for sale or consumption in, the
Para 66 IAS 1 entity’s normal operating cycle;
 it is held primarily for trading purposes;
 it is expected to be realised within 12 months after the reporting period; or
 it is cash or a cash equivalent (as defined in IAS 7 Statement of Cash Flows),
provided there is no restriction on its use by the entity until 12 months after the
reporting period.
 The operating cycle of an entity is the time between the acquisition of assets for
processing and their realisation in cash or cash equivalents’ (IAS 1, para. 68). If an entity’s
operating cycle is not clearly identifiable, it is assumed to be 12 months (para. 68)
Non-current All other assets are to be classified as non-current assets, including tangible, intangible and
asset long-term financial assets. The term ‘non-current assets’ is recommended, but IAS 1
Para 67 IAS 1 permits other descriptions to be used for this category, such as ‘fixed assets’ or ‘long-term
assets’
Current A liability that satisfies any one of the following criteria:
liability  it is expected to be settled in the entity’s normal operating cycle;
Para 69 IAS 1  it is held primarily for trading purposes;
 it is due to be settled within 12 months after the reporting period; or
 there is no unconditional right of deferring settlement beyond 12 months after
the reporting period. (Liabilities that could potentially require settlement by the issue of
equity instruments are not covered by this requirement, as settlement must involve cash
or other assets.)
Non-current Liabilities that do not satisfy the preceding criteria are classified as non-current liabilities
liabilities
Para 69 IAS 1
Financial Show portion of long term liability due for repayment within 12 months as a current
liabilities liability, even if:
Para 72 IAS 1  the original term was for a period longer than 12 months; and
 an agreement to refinance, or to reschedule payments, on a long-term basis is
completed after the reporting period and before the financial statements are
authorised for issue (may provide further detail in notes).

If an entity has discretion to refinance an obligation for at least 12 months after the
reporting date and expects it to happen, the obligation is non-current, even if due within
12 months

In some instances, entities may breach loan conditions that cause an obligation to
become due on demand. The obligation is regarded as current even if the lender agrees
not to demand repayment after the reporting period (IAS 1, para. 74).

IAS 1 – Disclosures in the notes to the statement of financial position 96

Many line items contained in the statement of financial position require additional subclassifications and
disclosures, usually in the notes, as a result of other accounting standards (IAS 1, para. 77).

Paragraphs 79 and 80 of IAS 1: specify additional disclosures for equity items, including shares issued,
rights attaching to shares and details of reserves.
Para. 79: requires disclosure of authorised capital (not relevant to all jurisdictions (e.g. Australia)).
Finally,
Para. 137: requires disclosure of information relating to dividends not recognised

Tips on how to analyse the statement of financial position p97

1. Review the value of total assets. Have total assets increased or decreased from the previous
reporting? What are the drivers behind this increase or decrease? If total assets are increasing, this
indicates that the financial position has expanded (grown). Has the change been primarily as a result
of changes in current assets or non-current assets?
2. Review the value of total liabilities. Have total liabilities increased or decreased from the previous
reporting? What are the drivers behind this increase or decrease? If total liabilities are increasing, this
 indicates that the entity has taken on more debt and has increased its gearing (leverage). Has the
change been primarily as a result of changes in current liabilities or non-current liabilities?
3. Review the value of total equity (or net assets). Is total equity positive? If so, this indicates that the
company is a going concern. Has total equity increased from the previous reporting period? If so, this
indicates that the entity’s financial position has grown. The stage of the business' life cycle will also
impact on this figure. More mature businesses are likely to have greater amount of retained profits,
whereas start-ups may experience losses in the first years of trading.
4. Analyse the relationship between current assets and current liabilities. This is an indication of the
company’s liquidity position or the entity’s ability to be able to pay its short-term debts as and when
they fall. Are current assets greater than current liabilities? The general rule of thumb for the current
ratio is 2:1. This means that ideally current assets should be approximately two times larger than
current liabilities.
PART E: IAS 7 Statement of Cash Flows p99

IAS 7 Statement of Cash Flows:

Scope 1–3
Benefits of cash flow information 4–5
Definitions 6
Cash and cash equivalents 7–9
Presentation of a statement of cash flows 10–17
Reporting cash flows from operating activities 18–20
Reporting cash flows from investing and financing activities 21
Reporting cash flows on a net basis 22–24
Interest and dividends 31–34
Taxes on income 35
Non-cash transactions 43
Components of cash and cash equivalents 45
Other disclosures 48–52

How does a statement of cash flows assist users of the financial statements p99

A statement of cash flows is useful for communicating information about an entity’s liquidity and solvency
(paras 4 and 5 of IAS 7):
generate cash flows in the future;
meet its financial commitments as they fall due, including the servicing of borrowings and payment of
dividends;
fund changes in the scope and/or nature of its activities; and
obtain external finance.
Other purposes:
predicting future cash flows (both inflows and outflows);
evaluating management decisions;
 determining the ability to pay dividends to shareholders and repay debt—both interest and
principal—to creditors; and
showing the relationship of net profit to changes in the cash balances.

Information to be disclosed p100

A statement of cash flows, prepared in accordance with IAS 7, must be included in a set of financial statements
(IAS 7, para. 1) for each period for which financial statements are presented.

The statement of cash flows discloses separately:

cash inflows and outflows for the reporting period concerned (paras 18 and 21); and
the amounts of cash and cash equivalents at the beginning and end of the reporting period.

Reporting cash flows on a net basis

Cash flows that can be reported on a net basis (para 22 to 24):

 ‘cash receipts and payments on behalf of customers’ (para. 22(a)), such as the acceptance and
repayment of demand deposits by banks; and

 items where ‘the turnover is quick, the amounts are large, and the maturities are short’ (para. 22(b)),
such as advances for and repayments of principal amounts relating to credit card customers.

Other information to be disclosed in the statement of cash flow

Must be included:

interest and dividends, income taxes and loss of control of subsidiaries. (paras 31, 35, 39 and 40.)
A reconciliation of cash and cash-equivalent amounts in the statement of cash flows with the
equivalent items reported in the statement of financial position (para. 45).
The amount of significant cash and cash-equivalent balances held by the entity that are not available
for use by the group (para 48 and 49)

Classification of cash flows (p100)

Cash inflows Cash outflows

Operating cash flows Receipts from customers (cash Payments to suppliers and
sales) employees (cash expenses)
Para 13–15 of IAS 7
Insurance proceeds Borrowing costs (interest paid)
These cash flows relate to the principal Grants Income tax paid
revenue-producing activities of the Commissions Other operating payments
entity Other operating receipts

Investing cash flows Proceeds from the sale of Purchase of property, plant
property, plant and equipment and equipment
para. 16 of IAS 7
Proceeds from the sale of Purchase of investments
Cash flows from investing activities investments Loans made to other entities
typically include the purchase and sale Interest received
of non-current assets Dividends received

Financing cash flows Proceeds from the issue of Dividends paid

shares Repayment of borrowings
para. 17 of IAS 7
Proceeds from borrowings
Financing cash flows relate to changes in
the financing activities of the entity (i.e.
movements in debt and equity)

Exceptions / options:
para. 33 of IAS 7 states that an entity may elect to show interest received and dividends received as a
cash inflow from operating activities.
 para. 34 of IAS 7 states that an entity may elect to show dividends paid as a cash outflow from
operating activities.

Common methods adopted on how to prepare a statement of cash flows p102

There are three common methods used to prepare a statement of cash flows. These methods include:

 the worksheet method (typically prepared in a spreadsheet tool such as Excel™);

the formula method; and
 the ‘T’ account reconstruction method.

Formula method

Receipts from Opening balance of + Sales revenue - Bad debt written - Closing balance of
customers = trade receivables off (see below) trade receivables
Bad debts = Opening balance of + Doubtful debts - Closing balance of
allowance for expense (from allowance for
doubtful debts P&L) doubtful debts
Inventory Closing balance of + Cost of goods - Opening balance
purchased on inventory (from P&L) of inventory
credit =
Payments to Opening balance of + Expenses (from + Inventory - Closing balance of
suppliers and trade payables P&L) purchased on trade payables
employees = credit (from above)
Income taxes paid Opening balance of + Income tax - Closing balance of
= income tax payable expense (from income tax payable
P&L)
Purchase of PPE = Closing balance of + Disposals (at - Opening balance
PPE cost) of PPE
Dividends paid = Opening balance of + Interim dividend + Final dividend - Closing balance of
dividends payable dividends payable
(liability) (liability)

Consolidated financial statements p105

Consolidated cash flows should be presented:

net of cash flows among entities comprising the group; and

with a foreign currency translation when a foreign subsidiary is a member of a domestic group.

Tips on how to analyse the statement of cash flows p105

1. Review the cash balance at the end of the reporting period. Is this value positive? Is it greater than
or less than the balance at the beginning of the reporting period?
2. Review the cash flows from operating activities. This figure is essentially the entity’s cash profit
figure. Is this value positive? A positive value is a good sign that the entity has made a cash profit
during the reporting period. How does this value compare to the previous reporting periods’ cash
 flows from operating activities? If the result for the current period is higher, this is a good sign as it
indicates that the entity’s cash profit has increased.
3. If the cash profit figure has decreased, this would firstly indicate that the entity has had a cash loss
during the current reporting period. The entity has spent more money on its operating day-to-day
activities than it has received. This is a less positive sign, as all entities should be looking to make an
underlying cash profit from their day-to-day business operations. As a general rule of thumb, the
entity should report a positive cash flow from operating expenses, and this amount should (in
principle) be enough to cover net cash used in investing and financing activities.
4. Review the cash flows from investing activities (i.e. purchasing and disposing of non-current assets
and investments). Is this value positive or negative? If negative, this indicates that the entity has
invested in non-current assets. This could mean that the entity is expanding its operations or that the
entity may be in the start-up or growth phase of the business life cycle.
5. Review the cash flows from financing activities (i.e. is the business funding the acquisition of assets
through debt or equity?) Review the increases or decreases in external borrowings. Has the entity
borrowed or paid back funds? Review the increases and decreases in equity. Has the entity paid
dividends or issued more shares to raise capital? How does the payout of dividends compare to the
net cash flow from operating activities? Has the entity paid out a high percentage of profits to its
shareholders, or has it retained the funds to cover operating costs and repayment of financing
arrangements?
6. Review the net increase or decrease in cash and cash equivalents. Is this value positive or negative?
A positive value indicates that the entity has retained (and banked) funds for the reporting period.
This also indicates that the entity has generated substantial cash profits from operating activities. This
will be particularly pleasing for shareholders who are interested in the ability of their investment to
generate positive returns.

Note: Webprod case study not included in notes – refer to page 108 of the textbook for the worked examples.
MODULE 3: Revenue from contracts with customers; provisions, contingent liabilities and contingent assets

Part A: Revenue from contracts with customers 117

Recognition of revenue 120
Contract costs 136
Disclosure 138
Part B: Provisions 142
Recognition of provisions 143
Measurement of provisions 145
IAS 37—disclosure 147
Provisions and professional judgment 149
Part C: Contingent liabilities and contingent assets 151
Contingent assets 151
Contingent liabilities 152
Contingencies and professional judgment 154
PART A: Revenue from contracts with customers p117

Overview of IFR 15 Revenue from contracts with Customers p118

Purpose:
To overcome the deficiencies of previous revenue standards;
Provide a comprehensive single model for revenue recognition that can be consistently applied by all
entities to their contracts with customers.
Providing a more robust framework for addressing revenue recognition issues;
Improving comparability of revenue recognition practices across entities, industries, jurisdictions and
capital markets;
Simplifying the preparation of financial statements by reducing the amount of guidance to which
entities must refer; and
Requiring enhanced disclosures to help users of financial statements better understand the nature,
amount, timing and uncertainty of revenue that is recognised (IFRS 15 Basis for Conclusions, para.
BC3).
Types of contracts covered by IFRS 15:
contracts with a right of return period;
warranties;
contracts in which a third party provides the goods or services to the customer (principal versus agent
considerations);
contracts with options for customers to purchase additional goods or services at a discount or free of
charge;
customer prepayments and payment of non-fundable upfront fees;
licensing and repurchase agreements; and
consignment and bill-and-hold arrangements.
Scope of IFRS 15
IFRS 15 applies to all contracts with customers, except those contracts that are (in their entirety or in part):
lease contracts within the scope of IAS 17 Leases;
insurance contracts within the scope of IFRS 4 Insurance Contracts;
financial instruments and other contractual rights or obligations within the scope of IFRS 9 Financial
Instruments, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IAS 27 Separate
Financial Statements and IAS 28 Investments in Associates and Joint Ventures; and
non-monetary exchanges between entities in the same line of business to facilitate sales to customers
or potential customers (IFRS 15, para. 5).
A contract with a customer may be partially within the scope of IFRS 15 and partially within the scope of one of
the above standards. In such cases:
If the other standard specifies how to separate or initially measure one or more parts of the contract,
apply that standard first. The transaction price of the contract is reduced by that amount accounted
for by the other standard, and IFRS 15 applies to the remainder
If the other standard does not specify a way to separate, then IFRS shall apply to the contract (para 7)

Impact of IFRS (examples)

Telecommunications: bundled plan and handset

IFRS 15 requires the allocation of the total contract price between the sale of the handset and the monthly
plan. This will change when these entities recognise revenue, with revenue allocated to the handset now being
recognised earlier (i.e. at the time of its sale).

Software entities: contracts for the implementation, customisation and testing of software, with post-
implementation support

IFRS 15 requires the contract price to be allocated to each distinct service, with revenue recognised when that
service is completed. This will alter the timing of revenue recognised by software entities.

Effective date

Applies to annual reporting periods beginning on or after 1 January 2018.

Early application of IFRS 15 is permitted, although an entity must disclose the fact it has applied IFRS 15 early
(IFRS 15, para. C1).

Recognition of revenue p120

The core principle of IFRS 15 is that an entity should recognise ‘revenue to depict the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the entity expects to be
entitled in exchange for those goods or services’ (IFRS 15, para. 2).

Step 1: Identify the contract with the customer p121

Customer: ‘a party that has contracted with an entity to obtain goods or services that are an output of the
entity’s ordinary activities in exchange for consideration’ (IFRS 15, Appendix A).

Contract: ‘an agreement between two or more parties that creates enforceable rights and obligations’ (IFRS
15, Appendix A). The agreement can be written, oral or implied by an entity’s customary business practices.

An entity shall apply the requirements of IFRS 15 to each contract that has all of the following attributes:
the parties have approved the contract and are committed to perform their obligations;
 the entity can identify each party’s rights regarding, and the payment terms for, the goods or services
to be transferred;
 the contract has ‘commercial substance’; and
it is likely that the entity will collect the consideration that it is entitled to in exchange for the goods
or services that it transfers to the customer (IFRS 15, para. 9).
If the contract has all of the above attributes – move to Step 2.

Combining multiples contracts

Paragraph 17 of IFRS 15 requires an entity both to combine two or more contracts entered into at or near the
same time with the same customer and to account for them as one contract if at least one of the following
criteria is met:

 the contracts are negotiated ‘with a single commercial objective’;

 the consideration ‘to be paid in one contract depends on the price or performance of the other
contract’; or
 ‘the goods or services promised in the contracts (or some goods or services promised in each of the
contracts) are a single performance obligation’ (defined in ‘Step 2: Identify the performance
obligation(s) in the contract’).
However, if the entity reasonably expects that the financial statement effects of accounting for multiple
contracts as a single contract will be materially different from accounting for the contracts individually, the
entity is not required to combine multiple contracts into one contract (IFRS 15, para. 4).

Contract modifications

A contract modification exists when the contracting parties approve a modification that creates new, or
changes existing, enforceable rights and obligations of the parties.

Modification accounted for as a separate contract

If the modification has been approved by both contracting parties, it shall be accounted for as a separate
contract if both of the following conditions are met:
 the scope of the contract increases because of the addition of promised goods or services that are
‘distinct’ (IFRS 15, para. 20(a)) (defined in ‘Step 2: Identify the performance obligation(s) in the
contract’); and
 ‘the price of the contract increases by an amount of consideration that reflects the entity’s stand-alone
selling prices of the additional promised goods or services and any appropriate adjustments to that price
to reflect the circumstances of the particular contract’ (IFRS 15, para. 20(b)). An example of price
adjustment is when discounts are allowed to customers.
Contract modification:
If both of these conditions are met, apply the remaining steps of the five-step model to the contract
modification.
Future revenues associated with the contract modification will be accounted for separately.

Existing contract:
Unaffected by the modification, therefore, there are no changes to revenue treatment (current and
future)
Modification not accounted for as a separate contract
Determine if the goods / services under the modification are distinct from those already transferred before the
modification.

The three accounting approaches are outlined in the following scenarios:

1. If they are distinct, the contract modification is accounted for as a replacement of the existing contract
with the creation of a new contract.
Revenue recognised to date under the existing contract is not adjusted.
Remaining revenue (existing contract and modification) is then recognised on a ‘prospective’ basis when these
performance obligations are completed.
2. If they are not distinct, the contract modification is accounted for as part of the existing contract.
Retrospectively adjust recognised revenue to reflect the contract modification’s effect on the transaction price
and the entity’s progress towards completing the performance obligation.
This retrospective adjustment to recognised revenue would typically arise when the existing contract relates to
a single performance obligation that is partially satisfied at the time of the modification.
After the modification, revenue is recognised according to the satisfaction of the single performance
obligation.
3. If they are a combination of 1 and 2, the contract modification is accounted for as partly the creation of a
new contract and partly the modification of the existing contract (IFRS 15, para. 21). (i.e. a combination of
approach in items 1 & 2)
Step 3: Determine the transaction price of the contract p125

The transaction price is ‘the amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties’
(IFRS 15, para. 47). Note it is net of amounts collected on behalf of another party (e.g. sales tax)
When determining the transaction price, an entity shall consider the effects of:
variable consideration, including any constraining estimates of that consideration;
 the ‘existence of a significant financing component in the contract’;
non-cash consideration; and
consideration that is payable to a customer (IFRS 15, para. 48).
Variable consideration
If the consideration includes a variable amount, an entity ‘shall estimate the amount of consideration to which
[it] will be entitled in exchange for transferring the promised goods or services to a customer’ (IFRS 15, para.
50).
IFRS 15 specifies examples of when consideration may vary. These include:
 discounts, rebates, refunds, credits and price concessions (whether explicit in the contract or implied
from an entity’s customary business practices, published policies or statements to the customer)
offered to customers; or
incentives or performance bonuses offered to the entity on the occurrence of a future event, or
penalties imposed on the entity on the occurrence of a future event.
Estimating variable consideration
Expected value Sum of the probability weighted amounts in a range of possible consideration
amounts. Identify:
1. Possible outcomes
2. Probability of each outcome occurring
3. The consideration amount under each outcome
Most likely amount The most likely possible outcome (not probability weighted)

Constraining estimates of variable consideration

Variable consideration that is too uncertain should not be included in the transaction price.
Variable consideration is included in the transaction price ‘only to the extent that it is highly probable that a
significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty
associated with the variable consideration is subsequently resolved’ (IFRS 15, para. 56).
Should consider likelihood and magnitude
Significant financing component in the contract
To determine if a significant financing component:
the difference, if any, between the amount of promised consideration and the price that a customer
would have paid for the good or service (i.e. the cash selling price); and
 the combined effect of: (1) the ‘expected length of time between when the entity transfers the
promised good or service to the customer and when the customer pays for the good or service’; and
(2) ‘the prevailing interest rates in the relevant market’ (IFRS 15, para. 61).
Only applies if the period between transfer of goods and payment is greater than one year
A significant financing component may exist irrespective of whether the promise of financing is explicitly
stated in the contract or implied by the payment terms of the contract (IFRS 15, para. 60).
Adjustment: for the time value of money using a discount rate commensurate to the rate between the parties
in an explicit financing transaction (i.e. considering the credit characteristics of the borrowing party)
Recognise the revenue from the contract (equal to the cash selling price) and then the interest revenue (if
seller benefits from the financing) or interest expense (if customer benefits from financing)
Non-cash consideration
Measure the non-cash consideration should be measured at fair value according to IFRS 13 Fair Value
Measurement and included in the transaction price.
When fair value cannot be reasonably estimated, the non-cash consideration is measured as the stand-alone
selling price of the goods or services promised to the customer in exchange for the consideration (IFRS 15,
paras 66 and 67).
Consideration payable to the customer
Consideration may be payable by entities to their customers:
in exchange for a distinct good or service that the customer transfers to the entity; or
as an incentive provided by the entity to the customer to encourage the customer to purchase a good
or service from the entity (e.g. a credit, coupon, voucher, or free product or service that can be
applied against amounts owed to the entity).
Consideration payable to a customer in exchange for a distinct good or service is accounted for in the same
way that the entity accounts for other purchases from suppliers (i.e. as a cost rather than offsetting revenue).
If the consideration payable exceeds the fair value of the distinct good or service, the entity accounts for the
excess as a reduction of the transaction price owed to the entity.
If the entity cannot reasonably estimate the fair value of the distinct good or service, all the consideration
payable to the customer is accounted for as a reduction of the transaction price owed to the entity.
Step 4: Allocate the transaction price to each performance obligation p131

Under this step, the transaction price of the contract (as determined under step 3) is allocated to each
separate performance obligation in the contract (as determined under step 2).
Single performance obligation: allocate full price to that obligation
Multiple performance obligations: determine the stand-alone selling price of each distinct good or service
underlying each performance obligation in the contract. Once all stand-alone selling prices have been
determined, the entity allocates the transaction price in proportion to those stand-alone selling prices (IFRS 15,
para. 76).
The ‘best evidence’ of the stand-alone selling price is ‘the observable price’ from stand-alone sales of that
good or service to similar customers (IFRS 15, para. 77). If a stand-alone selling price is not directly observable,
entities must estimate that price (estimate should be a faithful representation).
Allocation of a discount
An entity must allocate a discount proportionately to all performance obligations in the contract.
Discount relates to some (but not all) performance obligations:
Allocate the entire discount to those specific performance obligations only (i.e. not to all obligations).
Requires observable evidence: (satisfy both criteria)
the entity regularly sells each (or bundles of each) distinct good or service in the contract on a stand-
alone basis and regularly at a discount to the stand-alone selling price; and
the discount in the contract is substantially the same as the discount regularly given on a stand-alone
basis.
Allocation of variable consideration
Generally speaking, an entity is to allocate the variable consideration in a transaction price proportionately to
all performance obligations in the contract. IFRS 15, however, acknowledges that this may not always be
appropriate (IFRS 15, para. 84). For example, a bonus may be payable on delivery of the second item,
therefore, it should be attributable to the second item only.
Step 5: Recognise revenue when each performance obligation is satisfied p133

Under IFRS 15, a performance obligation is satisfied when a promised good or service is transferred to the
customer.
A good or service is considered to be transferred when the customer ‘obtains control’ of that good or service
(IFRS 15, para. 31).
According to IFRS 15, a good or service is an asset to a customer: the standard states, ‘control of an asset refers
to the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset’ (IFRS 15,
para. 33). The benefits of an asset are the potential cash inflows or savings in cash outflows obtained directly
or indirectly from the asset.
Performance obligations satisfied over time
Either satisfied at a point in time or over time (over time only if criteria below is satisfied) (IFRS 15, para 35).
Criteria (satisfy ONE of the below) Comment Example
(a) the customer simultaneously Applies only to services (not goods) Routine or
receives and consumes the recurring
benefits provided by the services, such as
entity’s performance as the If unclear, consider if another entity would cleaning or
entity performs; need to substantially re-perform work in order transaction
to fulfil the remaining performance obligation. processing
If substantial re-performance is not required, services
the obligation is satisfied over time
(b) the entity’s performance Definition of control is above Construction of
creates or enhances an asset building on land
Asset can be tangible or intangible
that the customer controls as (where customer
the asset is created or controls the work
enhanced; or in progress)
(c) the entity’s performance does 1. No alternative use: seller would need to Manufacture of
not create an asset with an rework the asset (incurring costs) to sell to bespoke widgets
alternative use to the entity another customer OR sell it at a significantly
and the entity has an reduced price
enforceable right to payment
2. Right to payment: entitled to an amount
for performance completed to
that compensates for performance to date
date (IFRS 15, para. 35).
should the contract be terminated
Measuring progress on performance obligations satisfied over time
If one of the above are met, the entity ’shall recognise revenue over time by measuring the progress
towards complete satisfaction of that performance obligation’ (IFRS 15, para. 39).
An entity applies a single method of measuring progress for each performance obligation, with the chosen
method being the one that best depicts the ‘entity’s performance in transferring control of goods or services
promised to a customer’ (IFRS 15, para. 39). Must apply method consistently from inception until complete
satisfaction of the performance obligation.
Two types of measure methods:
Output: based on direct measurement of the value to the customer of the goods / service transferred to
date, relative to the remaining items promised under the contract. Examples: surveying performance
completed to date, appraising results or milestones achieved, determining time elapsed under the contract
and measuring units produced or delivered to date (IFRS 15, para. B15).
Input: based on the seller’s effort / inputs towards satisfying the obligation relative to the total input
required to satisfy the contract. Examples: measuring (to date) resources consumed, labour hours
expended, costs incurred, time elapsed under the contract or machine hours used (IFRS 15, para. B18)

Performance obligations satisfied at a point in time

If none of the three criteria for recognising revenue over time are met, an entity must recognise revenue at a
point in time. The time to recognise revenue is when the entity transfers control of the asset to the customer.
Contract costs p136

In some instances, can recognise the cost of obtaining or fulfilling a contract as an asset.
Incremental costs of obtaining a contract
Under para. 91 of IFRS 15, the incremental costs of obtaining a contract shall be recognised as an asset if the
entity expects to recover those costs.
Need to demonstrate:
1. Costs are incremental: would not have been incurred had the contract not been obtained (IFRS 15,
para. 92),
2. Costs will be recovered: either direct (i.e. reimbursement by the customer under the terms of the
contract) or indirect (i.e. incorporated into the profit margin of the contract).
If not incremental, recognise as an expense when incurred, unless they are chargeable to the customer
regardless of whether the contract is obtained (IFRS 15, para. 93).
If the asset’s amortisation period is up to one year, IFRS 15 permits the incremental costs of obtaining a
contract to be expensed.
Costs to fulfil a contract
First determine if the costs all under another standard (e.g. IAS 2 Inventories, IAS 16 PPE and IAS 38 Intangible
Assets)
If the costs incurred are not within the scope of another standard, an entity recognises an asset from the
incurred costs only if all of the following criteria are met:
 the costs ‘relate directly to a contract or to an anticipated contract that the entity can specifically
identify’
(e.g. direct labour, direct materials, allocation of overheads that relate directly to the contract, costs
explicitly chargeable to the customer under the contract, and other costs that are incurred only
because an entity entered into the contract);
 the costs ‘generate or enhance resources of the entity that will be used in satisfying … performance
obligations in the future’; and
 the costs ‘are expected to be recovered’ (IFRS 15, paras 95 and 96).
Amortisation and impairment
Under IFRS 15, an asset recognised from the incremental costs of obtaining a contract or from the costs to
fulfil a contract is subject to amortisation and impairment.
Amortisation shall occur ‘on a systematic basis that is consistent with the transfer to the customer of the goods
or services to which the asset relates’ (IFRS 15, para. 99).
Unless the asset relates to a particular performance obligation, the amortisation period will be the life of the
contract
Change of accounting estimate (IAS 8): where the contract is renewed for a longer period which was not
anticipated at inception (would need to update the amortisation profile to reflect this change)
Impairment loss: will occur when the asset exceeds the remaining amount of consideration that the entity will
receive from the contract, less the yet-to-be-incurred costs of delivering on the contract (i.e. the asset exceeds
the profit to be made)
Disclosure p138

To overcome deficiencies in disclosure, the objective of the IFRS 15 disclosure requirements is:
… for an entity to disclose sufficient information to enable users of financial statements to understand the
nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers (IFRS
15, para. 110).
Contract with customers
Disaggregation of Under IFRS 15, an entity must disclose revenue recognised from contracts with
revenue customers that has been disaggregated into categories that depict how the
nature, amount, timing, and uncertainty of revenue and cash flows are affected
by economic factors (IFRS 15, para. 114).
Examples: type of good or service, geographical region, market, type of contract,
duration of contract, sales channels
Contract balances In relation to contract balances, an entity must disclose all of the following:
 the opening and closing balances of receivables, contract assets and contract
liabilities from contracts with customers;
 revenue recognised in the reporting period that was included in the contract
liabilities opening balance; and
 revenue recognised in the reporting period from performance obligations that
were either completely or partially satisfied in previous periods (IFRS 15, para.
116).
Contract liability: received consideration / unconditional right to receive
consideration before transferring the good / service
Performance In relation to performance obligations, an entity must disclose a description of all
obligations of the following:
 ‘when the entity typically satisfies its performance obligations’ (e.g. on
shipment, on delivery, as services are rendered or when they are completed);
 ‘the significant payment terms’ (e.g. when payment is due, and if the contract
includes a significant financing component, the amount of consideration is
variable or its estimate is constrained);
 ‘the nature of the goods or services that the entity has promised to transfer’;
 ‘obligations for returns, refunds and other similar obligations’; and
 ‘types of warranties and related obligations’ (IFRS 15, para. 119).
Transaction price The final disclosure requirement related to contracts with customers requires an
allocated to remaining entity to disclose the amount of the transaction price that is allocated to the
performance unsatisfied performance obligations in a contract (whether partial or complete)
obligations at the end of the reporting period.
An entity must also provide an explanation of when it expects to recognise as
revenue the transaction price amount allocated to the unsatisfied performance
obligations. This explanation can be either quantitative (e.g. amounts to be
recognised as revenue according to specified time bands) or qualitative (IFRS 15,
para. 120).
Significant judgements in the application of IFRS 15
An entity is required to disclose and explain the judgments and changes in judgments used to determine the:
timing of satisfaction of performance obligations; and
transaction price and amounts allocated to performance obligations (IFRS 15, para. 123).
Assets recognised from contract costs
In relation to assets recognised from the costs to obtain or fulfil a contract with a customer, an entity must:
provide a description of the judgments made in determining the amount of the costs, and of the
amortisation method used for each reporting period;
disclose the closing balances of the assets recognised; and
disclose the amount of amortisation and any impairment losses recognised in the reporting period
(IFRS 15, paras 127 and 128).
PART B: Provisions p142

IAS 37 Provisions, Contingent Liabilities and Contingent Assets (IAS 37): outlines specific existence, recognition
and measurement criteria to be applied to provisions; it also requires extensive disclosures

Scope of IAS 37 p142

IAS 37 applies to all provisions (and to contingent liabilities and contingent assets discussed in Part C) other
than those that:
result from executory contracts, except for onerous contracts; and
are covered by another standard (IAS 37, para. 1).
Executory contracts are ‘contracts under which neither party has performed any of its obligations or both
parties have partially performed their obligations to an equal extent’ (IAS 37, para. 3).
Definition of provisions
The IASB Conceptual Framework for Financial Reporting (Conceptual Framework) defines a liability as:
… a present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits (Conceptual
Framework, para. 4.4(b)).

Provisions are defined in IAS 37 as ‘liabilities of uncertain timing or amount’ (IAS 37, para. 10).
- Requires a reliable estimate to be made (if you can’t reliably estimate the timing or amount, it is a
contingent liability)
Recognition of provisions p143

Consistent with this requirement, IAS 37 requires the following conditions to be met for a provision to be
recognised:
(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
(c) a reliable estimate can be made of the amount of the obligation (IAS 37, para. 14).
Present obligation and past Where it isn’t clear: take into account all available evidence (at the
event closing date of the FS) and determine if it is ‘more likely than not’ (para
15)
Present obligation: may be a legal obligation or established by a pattern
of past practice (constructive obligations – e.g. from normal business
practices or by a desire to act in an equitable manner)
- Sales with warranty attached

- No past event in case of legislation compelling action

Probable outflow of economic Probable: probability that the event will occur is greater than the
benefits probability that it will not (IAS 37, para. 23). (i.e. more than 50%)
Where there are a number of similar obligations, such as warranty
obligations arising from product sales, the class of obligations is
considered as a whole in determining whether an outflow of resources is
probable (IAS 37, para. 24).
 - Legislation compelling action – no probable obligation, however, there
may be an obligation for the amount of the fine for non-compliance
(assuming fines are enforced)

Reliable measurement A provision is considered to be capable of being reliably measured even if

a number of possible outcomes exist
IAS 37 states that in almost all cases an entity will be able to make a
sufficiently reliable estimate of an obligation
Consider availability of benchmarks from comparable companies

Examples of provisions
- Decision to shut down a division of a business – approved by board and customers. Provision for legal
and redundancy costs
- Expected costs of meeting a warranty claim from customers in relation to sales made
- An obligation to repair or replace goods if they are determined to be faulty (past event – sale; present
obligation that is probable for an uncertain amount of the goods returned)
- Constructive obligation to remediate environmental damage from a fire due to public commitments
to environmental leadership
- Direct costs from a major management restructure that has been announced
- Lawsuit with 60% probability of 500K damages. Legal cost of 10K damages. Provision is 500K and
record an accrual for legal costs (costs are certain regardless of outcome).
Measurement of provisions p145

IAS 37 requires that:

… the amount recognised as a provision shall be the best estimate of the expenditure required to settle the
present obligation at the end of the reporting period (IAS 37, para. 36):
- Including any considerations for risks and uncertainties
- Including time value of money (if material)
- Including future events when there is sufficient objective evidence that they will occur
- Excluding gains from the expected disposal of assets
Best estimate (consistent with the enhancing qualitative characteristic of verifiability):
Obligation Approach Description
Large population of Expected value (para 39) Obligation is estimated by weighting all possible
items outcomes by their associated probabilities
If there is a continuous range of possible outcomes
and all are equally likely, select the mid-point
e.g. warranty claim over sales of 450K products
Single obligation Individual most likely Select the most likely outcome (don’t probability
outcome (para 40) weight)
Note that this approach does not take a especially prudent view as it looks to adopt best estimate / likely
outcome, rather than worst case scenario
Discounting
Provisions are discounted when the effect of this discounting is material.
Discount rate: pre-tax rate that reflects current market assessments of the time value of money and the risks
specific to the liability. The discount rate must not reflect risks for which the future cash flow estimates have
been adjusted (IAS 37, para. 47).
IAS 37 – disclosure p147

Qualitative and quantitative disclosures to help users understand the reasons, uncertainty and subjectivity
relating to the provision.
The disclosure requirements of IAS 37 aim to reduce the ability of entities to use provisions as a means of
earnings management. The key disclosures required by IAS 37 relating to provisions are outlined as follows:
For each class of provision, an entity shall disclose:
(a) the carrying amount at the beginning and end of the period;
(b) additional provisions made in the period, including increases to existing provisions;
(c) amounts used (i.e. incurred and charged against the provision) during the period;
(d) unused amounts reversed during the period; and
(e) the increase during the period in the discounted amount arising from the passage of time and the
effect of any change in the discount rate.
Comparative information is not required.
An entity shall disclose the following for each class of provision:
(a) a brief description of the nature of the obligation and the expected timing of any resulting
outflows of economic benefits;
(b) an indication of the uncertainties about the amount or timing of those outflows. Where necessary
to provide adequate information, an entity shall disclose the major assumptions made concerning
future events, as addressed in paragraph 48; and
(c) the amount of any expected reimbursement, stating the amount of any asset that has been
recognised for that expected reimbursement (IAS 37, paras 84 and 85).
Exemptions
Used only in rare cases – can be exempt from compliance with the disclosure requirements where it could
seriously prejudice the position of the entity in a dispute
Provision should still be recognised and the general nature of the dispute disclosed

Provisions and professional judgement p149

Professional judgement required:

1. To determine if there is a provision

2. In measuring the provision

IAS 37 and the Conceptual Framework summary

CF: an obligation is a duty or responsibility to act in a particular way. Must be legally enforceable due to a
binding contract or statutory requirement. May arise from normal business practice or custom.

IAS 37: captures both legal and constructive obligations (where an entity creates a valid expectation of a
course of action)
PART C: Contingent liabilities and contingent assets p151

Contingent assets p151

Note the definition of an asset per para 4.4(a) of the Concept F: A resource controlled by the entity as a result
of past events and from which future economic benefits are expected to flow to the entity

A contingent asset is defined in IAS 37 as:

… a possible asset that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the control of
the entity (IAS 37, para. 10).
Example: ‘a claim that an entity is pursuing through legal processes, where the outcome is uncertain’ (IAS
37, para. 32).

Possible asset The existence of the asset is unclear and will not be clarified until an uncertain
future event (which is not wholly in the control of the entity) occurs / does not
Disclose only when If there is a possible asset / contingent asset for which future benefits are probable,
probable but not virtually certain, disclose a contingent liability
Where the future benefits are virtually certain – recognise an asset (para 33)
Not probable – do nothing
Disclosure
Contingent assets are not recognised in the statement of financial position.
requirements
They are disclosed in the notes to the financial statements.
IAS 37 requires disclosure of the nature of the contingent assets at the end of
the reporting period and, where practicable, an estimate of their financial
effect.
Estimates of contingent assets are measured using the principles set out for the
measurement of provisions in paras 36–52 of IAS 37 (IAS 37, para. 89).

Contingent liabilities p152

IAS 37 adopts a broad concept of contingent liabilities. Contingent liabilities are defined as:

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the control of
the entity; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required
to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability (IAS 37, para. 10).

IAS 37 requires the disclosure of contingent liabilities in the notes to the financial statements unless the
possibility of an outflow of resources is remote (IAS 37, para. 28).

Contingencies and professional judgement p154

An accountant must exercise professional judgement – consider all available evidence and if an asset or
liability exists, recognise in the financial statements.

See decision tree below on how to apply the questions in the standards.
MODULE 4: Income Taxes

Part A: Income tax fundamentals 159

Tax expense 160
Current tax 161
Deferred tax 163
Part B: Recognition of deferred tax assets and liabilities 178
Recognition of deferred tax liabilities 178
Recognition of deferred tax assets 179
Recoupment of tax losses 186
Part C: Special considerations for assets measured at revalued amounts 192
Assets carried at revalued amounts 192
Recognition of deferred tax on revaluation 193
Part D: Financial statement presentation and disclosure 199
Presentation of current tax and deferred tax 199
Major components of tax expense 201
Relationship between tax expense (income) and accounting profit 203
Information about each type of temporary difference 205
Balance sheet liability method summery

Balance sheet liability method results in the recognition of current and future tax consequences of:

- transactions and other events of the current period that are recognised in an entity’s financial
statements
- the future recovery of the carrying amount of assets (or settlement of the carrying amount of
liabilities) that are recognised in an entity’s statement of financial position
The need for deferred tax arises because of the temporary differences that exist between amounts recognised
for accounting purposes and those recognised for tax purposes. In many (but not all) cases, these differences
result in profits being recognised in the financial statements in an accounting period that is different from the
period in which the entity is liable to pay tax on such profits. This results in a mismatch between the tax
expense in profit or loss and the profit against which it is being charged.
The purpose of deferred tax is to alleviate this mismatch by recognising the tax effect of transactions in the
period in which such transactions are recognised in the financial statements rather than the period in which
the tax effect actually crystallises in the tax computation.
Deferred tax and the Balance Sheet or P&L

Under the balance sheet liability method, deferred tax assets and liabilities arise as a result of temporary
differences. A temporary difference is calculated as the difference between the carrying amount of an item
and its tax base (being the amount attributable to the item for tax purposes). Therefore, deferred tax is driven
by amounts that are recognised in the balance sheet (or statement of financial position).

An alternative approach to deferred tax could be driven by the difference in timing between the recognition of
income and expenses in the statement of profit or loss compared with their recognition for tax purposes (e.g.
an expense may be recognised in one year but is not allowable for tax until paid). If this approach were
adopted, however, deferred tax would not be recognised on items that are recognised in profit or loss but not
for tax purposes or vice versa eg assets that do not benefit from tax allowances.

Deferred tax and going concern

Accounting for deferred tax is entirely consistent with the going concern concept. By recognising a deferred
tax liability, the entity is essentially recognising a tax liability that has yet to crystallise but will become due and
payable in a future period when the temporary difference that caused it reverses. Hence the implicit
assumption is that the entity will continue in operational existence until this reversal occurs i.e. the entity is a
going concern.

Temporary differences summary

Temporary difference defined as the difference between the amount attributed to an asset or liability for tax
purposes and its carrying amount.
A taxable temporary difference arises where the carrying amount of an item exceeds its tax base, as is the
case here:
The asset has a carrying amount of $800 and a tax base of $500. In this case, it is anticipated that in the future:
- the $800 carrying amount of the item will be recovered (either through using the asset to generate
income or through selling it), so resulting in $800 taxable income; and
- the $500 tax base will be allowable for tax purposes.
The net position is therefore that there will be $300 excess of income over allowable expense, which is
taxable. By applying the relevant tax rate to the $300, the amount of additional tax payable in the future as a
result of owning the asset is calculated. Future tax payable is a deferred tax liability.
A deductible temporary difference arises where the carrying amount of an item is less than its tax base.
Here the liability has a carrying amount of ($700) and a tax base of nil. In this case, it is anticipated that in the
future:
- the $700 carrying amount of the liability will be settled so resulting in $700 allowable expense; and
- no amount will be allowable or taxable for tax purposes.
The net position is therefore that there will be $700 of allowable expense, which is deductible in the tax
computation. By applying the relevant tax rate to the $700, the amount of saved tax arising in the future is
calculated. Future saved tax is a deferred tax asset.
Tax expense p160

Statement: P&L & OCI

Tax expense = Current tax expense + Deferred tax expense

Amount payable for the period Movement in deferred tax assets
(determined from the tax return) & liabilities for the period
recognised in the P&L recognised in the P&L

Current tax (component of tax expense) p161

Statement: P&L & OCI

Steps to calculate:

1. Calculate the ‘amount of tax expected to be paid to (recovered from) the taxation authorities, using
the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the
reporting period’ (IAS 12, para. 46).
2. Recognise the amount of current tax in profit or loss for the period, in other comprehensive income,
or directly in equity, as appropriate (IAS 12, para. 58)

Recognition of current tax: in the P&L except where it is a transaction affecting OCI / equity OR it is a business
combination

Deferred tax (component of tax expense) p163

Statement: P&L & OCI

Step 1 Determine the tax base of assets and liabilities (IAS 12, paras 7–11).
Step 2 Compare the tax base with the carrying amount of assets and liabilities to determine
taxable temporary differences and deductible temporary differences (IAS 12, para. 5).
Step 3 Measure deferred tax assets (arising from deductible temporary differences) and
deferred tax liabilities (arising from taxable temporary differences) (IAS 12, paras 46–56).
Step 4 Recognise deferred tax assets (arising from deductible temporary differences) and
deferred tax liabilities (arising from taxable temporary differences), taking into account
the limited recognition exceptions (IAS 12, paras 15–45).

Step 1: determining the tax base of assets and liabilities (p166)

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic
benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic
benefits will not be taxable, the tax base of the asset is equal to its carrying amount.
 Tax base of an asset = Carrying amount + Future deductible - Future taxable
amounts amounts
Amount in financial The deductions allowed The taxable amounts on
statements, net of any on a tax basis an accounting basis (e.g.
adjustments (e.g. the value in use –
allowance for doubtful carrying value will come
debts, accum depn) through as revenue)

PPE (p253) Original cost – accum Original cost – accum tax Value of asset in use (i.e.
depn depn its carrying value)
Tax base = 60 = 100 – 50 = 50 = 100 – 40 = 60 = 50
= 50 + 60 - 50
Interest receivable of Carrying value in BS = No deduction – tax is - the total revenue
$10, taxed on a cash $10 payable on full amount received (i.e. $10)
basis when cash is received
Tax base = nil (10-10)
Trade receivable Carrying amount = $100 No deduction – tax is Revenue has already
Tax base = $100 payable on full amount been taxed on full
$100 - $0 when cash is received amount in P&L when
booked = $0
Trade receivables w Carrying amount = $40 Tax deduct irrecoverable Revenue was taxed
doubtful debt Net of $15 irrecoverable debt only = $15 when received = $0
Tax base = $55 debt
$40 + $15 = $55
Dividends receivable Carrying amount = $100 No deduction – tax is Revenue has already
from a subsidiary payable on full amount been taxed on full
Tax base = $100 when cash is received amount in P&L when
$100 - $0 booked = $0
Loan receivable Carrying amount = $100 No tax consequences No tax consequences
Tax base = $100 = $0 = $0
Investment portfolio Carrying amount = $20 Original purchase price Will need to pay tax on
Tax base = $15 (inc $5 unrealised gain) is deductible +$15 full amount when sold
20 + 15 - 20 -$20
The tax base of land is its acquisition value (IAS 12 contains a rebuttable presumption that the carrying amount
of a non-depreciable asset will be recovered through sale.)

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in
respect of that liability in future periods.

Tax base of liability = Carrying amount - Future deductible + Future taxable

amounts amounts
$250 loan
Tax base = $250 $250 - nil + nil
Accrued expense, The benefits are There is no revenue
deducted for tax on a deductible when paid associated with paying
cash basis the benefit
Tax base = nil $100 - 100 + nil
Accrued expense Has already been
deducted for tax
purposes
Tax base = $100 $100 - nil + nil
Accrued fines and Not deductible for tax
penalties purposes
Tax base = $100 $100 - nil + nil
Alternative view for fines is that there is a tax base of nil and the resulting deductible temporary difference
is multiplied by a zero tax rate to result in NO DTA
 Loan payable No tax consequences No tax consequences
Tax base = $100 $100 - nil + nil

The tax base of revenue which is received in advance is its carrying amount, less any amount of the revenue
that will not be taxable in future periods.

Tax base revenue Carrying amount - Amount of revenue not taxable in the future
received in advance
(liability) =
Revenue received in Revenue received in advanced has already been
advance Carrying amount taxed, therefore the amount not taxable in the
future is 400
Tax base = nil 400 - 400
Revenue received in
advance, taxed on a
cash basis
Tax base = nil

Step 2: compare the tax base to the carrying amount to determine temporary differences (p169)

Deductible temporary difference X Tax rate = DTA

Taxable temporary difference X Tax rate = DTL

Asset Liability
Carrying amount > tax base DTL DTA
Future taxable amounts from There will be future deductible
recovery of the asset1 benefits from settling the liability
(accounting) exceed the future
deductible amounts (tax)
Carrying amount < tax base DTA DTL

Carrying amount = tax base None None

1. Recovery of asset is via use or sale

Step 3: measure deferred tax assets and deferred tax liabilities (p172)

Measurement must reflect:

1. The expected manner of recovery (settlement) of the underlying asset / liability (para 51)
2. The tax rates that will apply in the period that the asset / liability is settled (para 47)

Example: there may be a tax rate for selling an asset (e.g. CGT treatment) or a tax rate for income earned
from the asset in use. You would calculate the DTL based on how the asset is expected to be recovered.

Discounting of deferred tax assets and deferred tax liabilities is not permitted (note that the carrying amount
of the asset or liability may be determined on a discounted basis)
The practical application of this core principle is that when tax losses are recouped, the benefit from the
recoupment of those losses is allocated:

 first to tax losses for which no deferred tax asset was previously recognised (which, in effect, results
in the recognition of an income tax benefit); and
 second to tax losses for which a deferred tax asset was previously recognised (which, in effect, results
in the reduction of the previously recognised deferred tax asset).

Reassessment of the carrying amounts of deferred tax assets and liability

IAS 12 contains several requirements relating to the reassessment of the carrying amounts of deferred tax
assets and liabilities:

1. Can recognise a previously unrecognised DTA to the extent it has become probable that future
taxable profit will allow the DTA to be recovered (para 37)
2. Reduce the carrying amount of the DTA to the extent it is no longer probable there will be sufficient
profit to allow the realisation of the asset.

The carrying amounts of deferred tax assets and deferred tax liabilities may change following:

(a) a change in tax rates or tax laws;

(b) a reassessment of the recoverability of deferred tax assets; or
(c) a change in the expected manner of recovery of an asset (IAS 12, para. 60).

The resulting deferred tax should be recognised in profit or loss, unless it relates to items previously
recognised in OCI or directly charged or credited to equity.
Additional guidance on recovery of non-depreciable assets

The tax consequences to consider are those that would follow from the recovery of the carrying amount of
that asset through sale, regardless of the basis of measuring the carrying amount of that asset.

The tax law may specify a tax rate applicable to the taxable amount derived from the sale of an asset. If that
rate differs from the rate applicable for using an asset, the former rate (i.e. sale) is applied in measuring the
deferred tax liability or asset related to a non-depreciable asset.
PART D: Financial statement presentation and disclosure p199

Introduction p199

The presentation and disclosure requirements of IAS 12 focus primarily on the presentation of tax balances in
the statement of financial position and the disclosure of information about the following matters:

- major components of tax expense (tax income);

- relationship between tax expense (tax income) and accounting profit;
- particulars of temporary differences that give rise to the recognition of deferred tax assets and the
deferred tax liabilities; and
- particulars of temporary differences, unused tax losses and unused tax credits for which no deferred
tax asset was recognised (i.e. because the probability criterion was not satisfied).
P&L: there is no requirement to disclose the deferred tax change in the P&L – tax expense is presented as a
single line item and the notes to the accounts detail the components of this expense including the deferred tax
change
B/S: deferred tax balances must be disclosed as non-current in the B/S. Can have separate totals for DTA and
DTL (per offsetting rules below)
Notes: the amount of deductible temporary differences not recognised as a DTA must be disclosed in the
notes

Presentation of current and deferred tax p199

Offsetting tax assets and liabilities

Current tax assets (tax recoverable from the taxation authority) and current tax liabilities (tax payable) are
offset when the entity:
(a) has a legally enforceable right to set off the recognised amounts; and
(b) intends either to settle on a net basis, or to realise the asset and settle the liability
simultaneously (IAS 12, para. 71).

IAS 12 requires deferred tax assets and deferred tax liabilities to be offset when:
(a) the entity has a legally enforceable right to set off current tax assets against current tax
liabilities; and
(b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same
taxation authority (IAS 12, para. 74).

Major components of tax expense p201

Para 79 requires the major components of tax expense to be disclosed separately.

Components of tax expense (income) may include:

(a) current tax expense (income);

(b) any adjustments recognised in the period for current tax of prior periods;
(c) the amount of deferred tax expense (income) relating to the origination and reversal of temporary
differences;
(d) the amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new
taxes;
(e) the amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary
difference of a prior period that is used to reduce current tax expense;
(f) the amount of the benefit from a previously unrecognised tax loss, tax credit or temporary difference of a
prior period that is used to reduce deferred tax expense;
(g) deferred tax expense arising from the write-down, or reversal of a previous write-down, of a deferred tax
asset in accordance with paragraph 56; and
(h) the amount of tax expense (income) relating to those changes in accounting policies and errors that are
included in profit or loss in accordance with IAS 8, because they cannot be accounted for retrospectively.

Relationship between tax expense (income) and accounting profit p203

Para 81(c) requires an explanation of the relationship between tax expense (income) and accounting profit be
provided in the notes to the financial statements.

Key steps in providing the tax reconciliation

1. Reconcile accounting profit to taxable profit (i.e. understand the differences between the accounting
treatment and the tax treatment)
2. Determine and present the relationship between tax expense (income) and accounting profit

$ @ 30% tax rate

Accounting profit/(loss) before tax Prima facie tax
Adjust for non deductible items e.g.
+ Statutory fines (non-deductible expenses)
- Dividend exempt (non-taxable incomes)
Accounting profit – adj for non deductibles Tax expense
Adjust for movements in temporary differences
- Increase in Taxable TD
+ Decrease in Taxable TD
+ Increase in Deductible TD
- Decrease in Deductible TD
+ Accounting depreciation
- Tax depreciation
- Recoupment of previously recognized tax losses
Taxable profit / (loss) after utilising tax losses

Information about each type of temporary difference p205

IAS 12 requires the following information to be disclosed in respect of each type of temporary difference:

(a) the amount of the deferred tax assets and liabilities recognised in the statement of financial position
for each period presented; and
(b) the amount of the deferred tax income or expense recognised in profit or loss, if this is not apparent
from the changes in the amounts recognised in the statement of financial position (para. 81(g)).

Unrecognised deferred tax assets and deferred tax liabilities

Paragraph 80(e) of IAS 12 requires the disclosure of the ‘amount (and expiry date, if any) of deductible
temporary differences, unused tax losses, and unused tax credits for which no deferred tax asset is recognised
in the statement of financial position’.
MODULE 5: Business combinations and group accounting

Part A: Business Combinations 222

The acquisition method 224
Applying the acquisition method to different forms of business combinations 233
Deferred tax arising from a business combination 235
Disclosures: business combinations 238
Part B: Consolidated financial statements 241
Introduction to consolidated financial statements 242
The group 243
Preparation of consolidated financial statements 246
Revaluation 250
Depreciation 252
Transactions within the group 254
Non-controlling interest 262
Disclosures: Consolidated financial statements 275
Part C: Investment in associates 279
Identifying associates 279
The equity method 280
Application of the equity method 283
Disclosures for associates 293
Part D: Joint arrangements – overview 296
PART A: Business combinations p222

Two types of business combinations:

Direct acquisition: acquiring the assets and liabilities (i.e. net assets) of another business that does not
represent a separate legal entity or subsequently ceases to exist as a separate legal entity

IFRS 3 is applied to the acquirer’s financial statements.

Indirect acquisition: acquiring the shares of another separate legal entity in order to obtain control over that
entity, in which case a parent–subsidiary relationship arises
IFRS 10 requires the preparation of consolidated financial statements, the acquirer’s statements record an
investment in B, and the consolidated statements show the combined assets of the entities.

The acquisition method p224

In accordance with IFRS 3, all business combinations must be accounted for by using the acquisition method,
which involves four steps:
1. identifying the acquirer;
2. determining the acquisition date;
3. recognising and measuring the identifiable assets acquired, liabilities assumed and any
non-controlling interest in the acquiree; and
4. recognising and measuring goodwill or a gain from a bargain purchase.
Identifying the acquirer
As such, IFRS 10, para. 7 specifies the essential criteria of control that must be satisfied by the acquirer
(investor) in order to be considered as having control over the acquiree (investee), that is:
 power over the investee;
 exposure, or rights, to variable returns from its involvement with the investee; and
 the ability to use its power over the investee to affect the amount of the investor’s returns.
IFRS 3 states that if a business combination involves an exchange of equity interests, the entity issuing shares is
normally the acquirer (IFRS 3, para. B15).
Determining the acquisition date
The date that the acquirer obtains control of the acquiree (IFRS 3, para 8)
Recognising and measuring the identifiable assets acquired, liabilities assumed and any non-controlling
interest in the acquiree
Recognition
In order to be recognised in a business combination, need to meet the following criteria:
 It meets the definition of an asset or liability in the Conceptual Framework at the acquisition date.
 It must be part of what the acquirer and the acquiree exchanged in the business combination
transaction, rather than be a result of separate transactions.
Identifiable assets: inventory, receivables, property, plant and equipment and intangible assets
Non-identifiable asset: a customer list or employees’ satisfaction – included in goodwill
Identifiable liabilities: accounts payable, loans and taxes payable
Note: not limited to assets / liabilities previously recognised by acquiree
NCIs: only recognised in business combinations that are structured as indirect acquisitions
Measurement
Identifiable assets & liabilities: measured at their acquisition date fair values (IFRS 3, para 18)
NCIs: either fair value or the NCI’s proportion of the acquiree’s identifiable net assets (IFRS 3, para 19)
Exceptions
Exceptions to the recognition IFRS 3 requirements
principle
Contingent liabilities The acquirer shall recognise a contingent liability if it is a present
obligation that arises from past events and its fair value can be measured
reliably, even if it is not probable. These requirements are contrary to IAS
37 Provisions, Contingent Liabilities and Contingent Assets.
Journal entries – including DTA created – shown later in notes (p356)
Exceptions to the measurement principles
Reacquired rights Measured on the basis of the remaining contractual term of the related
contract, regardless of whether market participants would consider
potential contractual renewals.
Share-based payment awards Measured in accordance with the method in IFRS 2 Share-based Payment.
Assets held for sale Measured in accordance with IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations.
Exceptions to both the recognition and measurement principles
Income taxes Recognised and measured in accordance with the requirements of IAS 12
Income Taxes.
Employee benefits Recognised and measured in accordance with the requirements of IAS 19
Employee Benefits.
Indemnification assets Recognised and measured on the same basis as the indemnified item.

Recognising and measuring goodwill or a gain from a bargain purchase

Identifying and measuring consideration
IFRS 3, para 37 measures the following at the acquisition date fair value;
- Assets transferred by the acquirer
- Liabilities incurred by the acquirer on behalf of the previous owners
- Equity interests issued by the acquirer
Does not include any acquisition related or funding costs
Identifying and measuring non-controlling interest
NCI is the equity in the acquiree not owned by the acquirer
Value at:
- Fair value of the equity interest (will include goodwill)
- Proportionate share of the fair value of the acquiree’s identifiable net assets (no goodwill)
Measurement and recording of goodwill subsequent to the date of purchase
Goodwill is not permitted to be amortised and is required to be tested annually for impairment (IAS 36)
Applying the acquisition method to different forms of business combinations p233

1. Direct acquisition: purchase of assets and liabilities of a business

Assets and liabilities will be transferred directly to the acquirer.
The acquirer will need to recognise them in its financial statements in a similar way to an acquisition of
individual assets.
2. Indirect acquisition: purchase of shares (equity interests) of an entity
Purchasing a single asset – the investment in the shares of the acquiree
Required to present separate financial statements:
- Financial statements of the acquirer: record an investment in B and the outflow of funds
- Consolidated financial statements: will reflect the assets / liabs of B if a controlling stake is acquired

Deferred tax arising from a business combination p235

Deferred tax related to assets and liabilities acquired in a business combination

A difference in the measured fair value of the asset acquired and the tax base may give rise to a DTA or DTL
Recognising additional DTAs or DTLs in a business combination affects the amount of goodwill recognised (IAS
12, paras 19 and 66)
IAS 12 prohibits the recognition of a DTL arising from goodwill (IAS 12, paras 15 and 21)
Deferred tax related to tax losses in a business combination
Losses of acquirer
The acquirer may recognise a DTA for losses that it had previously considered not recoverable
As it relates to the tax losses of the acquirer, the deferred tax asset recognised cannot be identified as part of
the asset acquired and therefore, does not impact on goodwill (IAS 12, para 67).
Losses of acquiree
If the aquirer considers it probable that it will realise the benefit of the acquiree’s tax losses, it can be
recognised as part of the assets acquired and will be taken into account when calculating goodwill.
Recognising a contingent liability
Dr DTA xxx
Dr Goodwill (via Business Combination Reserve) xxx
Cr Contingent liability xxx

Disclosures: business combinations p238

IFRS 3 includes extensive disclosure requirements that are designed to:

1. Enable financial statement users to understand the financial effects of the business combination
2. Understand the effect of adjustments relating to the business combination
PART B: Consolidated financial statements p241

Introduction to consolidated financial statements p242

The purpose of consolidated financial statements is to disclose the financial performance, position and the
cash flows of a group of interrelated entities that operate as a single economic entity (but not a single legal
entity).
Economic entity: group of entities comprising a controlling entity and one or more controlled entities
operating together to achieve objectives consistent with those of the controlling entity (SAC 1, para. 6).
IFRS 10 is concerned with:
1. Defining the group
2. Preparing consolidated financial statements
The group p243

Control is used to define the group

IFRS 10, para 7 specifies three essential characteristics of control:
1. Power over the investee
2. Exposure, or rights, to variable returns from its involvement with the investee
3. The ability to use its power over the investee to affect the amount of the investor’s returns

Power over Current ability to direct the activities that significantly affect the investee’s returns
an investee Relevant activities: operating and financial activities
Rights can be (IFRS 10, para 11):
- Voting rights (>50% or a large stake when remaining shareholders are small /
apathetic)
- Rights to appoint, reassign or remove the investee’s key mgmt. personnel
- Contractual rights
Need to ensure there are no barriers to exercising the rights (e.g. legal or regulatory)
The right exists regardless of whether it is exercised
Exposure to Examples include:
variable - Dividends that vary with profit
returns - Changes in capital value
- Performance fees or remuneration for managing an investee’s assets
- Other returns from combining operating functions achieving economies of scale,
cost savings and access to intellectual property
Link Investor should be able to use its power to affect the variable returns it receives from its
between involvement with the investee
power and Need to distinguish if the investor has actual power or whether it is acting as an agent on
variable behalf of another party.
returns
Consider the following (IFRS 10, para B60):
- Scope of decision making authority
- Rights held by other parties
- Entitlements to remuneration
- Exposure of the decision0making to variability of returns from other interests held
in the investee
Depreciation adjustments related to revaluation of depreciable assets
When, in accordance with IFRS 3, a depreciable non-current asset has to be revalued to fair value at the
acquisition date in the consolidation worksheet, further consolidation adjustments will have to be
undertaken in subsequent reporting periods to adjust the depreciation charges.
At acquisition date Fair value adjustments on assets
(determine whether this Dr Accum Depn (reduced to zero if any) xxx
occurs in the individual Cr PPE (i.e. increase per revaluation) xxx
statements of the sub – if
Cr DTL (i.e. increase liab)1 xxx
not, it will need to be
repeated each year as part Cr Business combination reserve xxx
of consolidation) 1 – an increase in value of the asset in the consol statements will mean the
P&L will deduct more than allowed for tax / in the sub accounts, giving rise
to a taxable temporary difference.
In subsequent periods Recognise additional depreciation between consolidated statements (due
to FV adjustment) and subsidiary accounts
Dr Depreciation expense xxx
Cr Accum Depn xxx
Dr DTL xxx
Cr Income tax expense xxx
Pre-acq elimination entry Eliminates the investment by the parent in the subsidiary and the pre-acq
p375 equity of the subsidiary (incl the BCR recognised on reval of PPE)
Dr Issued Capital xxx
Dr Retained Earnings (opening balance) xxx
Dr Business Combination Reserve xxx
Dr Goodwill xxx
Cr Investment in Subsidiary xxx

Transactions within the group (p254)

The group must eliminate in full all the effects of intra-group transaction – achieved via adjusting entries in the
consolidation worksheet
Intra-group transactions – sale of inventory
Unrealised profit (recognised by legal entity) Profit recognised by the group
Eliminate unrealised intra-group profit or loss If held as inventory by the purchaser within the group—
in the period of sale and any remaining recognise profit or loss when the inventory is sold to party
unrealised profit in later reporting periods external to group.
while the inventory remains in the group. If held as depreciable asset by the purchaser within the
group— recognise profit or loss consistent with the
depreciation allocation of asset.
Example: Parent sells inventory with a carrying value of 30K to Subsidiary for 40K
Original Parent (seller)
entries Bank 40
Sales 40
COGS 30
Inventory 30
Subsidiary (buyer)
Inventory 40
Bank 40
If all inventory Eliminate unrealised profit from
is sold to group’s perspective
external Dr Sales (seller) 40
parties in
Cr COGS (buyer) 30
current period
If all inventory Dr RE – Sales (seller) 40
is still on hand Cr RE – COGs (seller) 30
in current
Cr Inventory (buyer) 10 Difference between Sub’s BS and actual cost
period
Dr DTA 3 Created by Parent paying tax on 10K unreal profit)
Cr Income tax expense 3 Tax expense in Parent’s P&L)
If the Adjustments required to the Assume that half of the inventory is sold for 24K
inventory is above journal entries:
then sold to Dr Inventory 5 10 above reduces for half of the inv not yet sold
external
Cr COGs 5 Sub’s P&L would have COGs of 20, actual cost is 15
parties in
subsequent Dr Income tax expense 1.5 Net tax payable is half, reduce the 3K above by 1.5K
periods Cr DTA 1.5 Half of the DTA is used for half the profit realised

Intra-group transactions – sale of depreciable asset

Unrealised profit (recognised by legal entity) Profit recognised by the group
Eliminate unrealised intra-group profit or loss If used as depreciable asset by the purchaser within the
in the period of sale and any remaining group— recognise profit or loss consistent with the
unrealised profit in subsequent reporting depreciation allocation of asset.
periods while the asset remains in the group. If the depreciable asset becomes inventory for the
purchaser within the group—recognise profit or loss when
the inventory is sold to party external to group.
Example: Subsidiary sells PPE with a carrying value of 40K to Parent for 50K
For a gain on intra-group sale For a loss on an intra-group sale
Original Subsidiary
entries Bank 50
Accum depn 60
Plant 100
Profit on sale 10
Parent
Plant 50
Bank 50
Depn expense 10
Accum depn 10
Current period Dr Gain on sale (seller) 10 Dr PPE (buyer) xxx
Cr PPE (buyer) 10 Cr Loss on sale (seller) xxx
Dr DTA 3 Dr Tax expense xxx
Cr Tax expense 3 Cr DTL xxx
Subsequent Adjust group’s depn bc previously unrealised profit is now realised through depn
periods NOTE: all depn calcs should use the depn method and rate applied by the user of the PPE
Dr Accum depn (buyer) 2 Dr Depn (buyer) xxx
Cr Depn (buyer) 2 Cr Accum depn (buyer) xxx
Dr Tax expense 0.6 Dr DTL xxx
Cr DTA 0.6 CR Tax expense xxx
Proforma Dr Retained earnings 5.6
consol Dr DTA 2.4
worksheet
Dr Acc depn 2 Retained earnings calculation
entries
Cr PPE 10 Elimination of after tax profit (7)
Recognition of profit realised via depn 2.4
Dr Acc depn 2 Net effect on consol RE = 5.6
Cr Depn exp 2
Dr Tax expense 0.6
Cr DTA 0.6

Intra-group transactions – dividend

Dr Dividend income (parent) xxx
Cr Dividend declared (RE) (subsidiary) xxx
Dr Dividend payable (subsidiary) xxx
Cr Dividend receivable (parent) xxx
Note: only to the extent of the parent’s share

Non-Controlling Interest (p262)

The non-controlling interest is classified as an equity participant in the group
The non-controlling interest is entitled to the respective proportionate interest in the equity of the subsidiary
after making adjustments for unrealised profits and losses of the subsidiary arising from intra-group
transactions
Using the entity concept of consolidation, the existence of a non-controlling interest requires three
modifications to the consolidation process. These affect:
1. the pre-acquisition elimination entry;
2. the treatment of dividends paid by the subsidiary; and
3. the measurement and disclosure of the non-controlling interest in the consolidated financial
statements.
Pre-acquisition elimination entry
Where the parent entity acquires less than a 100 per cent interest in the subsidiary, the consolidation pre-
acquisition elimination entry should eliminate the carrying amount of the parent’s investment in the subsidiary
and the parent’s portion of equity in the subsidiary at the acquisition date (IFRS 10, para. B86(b)).
The pre-acquisition equity balances of the subsidiary not eliminated on consolidation represent the non-
controlling interest in the fair value of the net assets of the subsidiary at the acquisition date and form part of
its equity in the group.
Subsidiary accounts: NCI calc:
Issued Capital 100 Consideration 160
Retained earnings 100 NCI (30% of FV net assets) 60
Less FV net assets (200)
Goodwill 20
Note that FV NCI = share of sub’s equity + share of business combination reserve

Dividends paid by subsidiary

The proportion of dividend paid / payable by the subsidiary to the non-controlling interest shareholders will
not be eliminated because a party external to the group is involved
Measurement of non-controlling interest
The non-controlling interest in the net assets of consolidated subsidiaries should consist of:
(i) the amount of the non-controlling interest at the date of the original combination calculated in
accordance with IFRS 3 (i.e. pre-acquisition equity); and
(ii) the non-controlling interest’s share of changes in equity since the date of the combination (i.e.
post-acquisition changes in equity).
The calculation of the NCI must be adjusted for unrealised profits or losses relevant to it (i.e. only intra-group
transactions that affect the subsidiary’s equity)
The transaction must be from the subsidiary (e.g. sale of assets such as inventory, plant or land from the
subsidiary to the parent for a profit or loss)
 1. NCI in opening R/E of S = NCI% * (Opening R/E balance)
– Unrealized profit after tax c/f from prior periods
+ Unrealized loss after tax c/f from prior periods)
2. NCI in profit of S = NCI% * (Profit for the year)
– Unrealized profit after tax made in current periods
+ Unrealized loss after tax made in current periods
+ Previously unrealized profit after tax which is realized in current period
– Previously unrealized loss after tax which is realized in current period)
3. NCI in closing R/E of S = NCI in opening R/E (Step 1) = NCI% * Closing R/E balance
+ NCI in profit for the year (Step 2) - Unrealized profit after tax c/f to
– NCI in dividends subsequent periods
– NCI in transfer of R/E to reserves + Unrealized loss after tax c/f to
subsequent periods)

4. NCI in reserves -
(including BCVR)
5. NCI in issued capital -
NCI in Statement of = Step 3+4+5
Financial Position

Disclosures: Consolidated financial statements p275

Consolidated statement of financial position

Should recognise all the assets and liabilities under the control of the group
Separately recognise the equity attributable to the owners of the parent and that of the non-controlling
interest (IFRS 10, para 22)
Consolidated statement of profit or loss and other comprehensive income
Requires the disclosure of the share of profit or loss and total comprehensive income attributable to the
parent and the NCI
Consolidated statement of changes in equity
Must present the total comprehensive income and the amounts attributable to the parent and the NCI (IAS 1,
para 106(a))
Consolidated statement of cash flows
Required to prepare a consolidated statement of cash flows in accordance with IAS 7.
Notes including accounting policies and explanatory notes
IAS 12 requires entities to disclose information about interests in subsidiaries.
Entities with a subsidiary must disclose information that focused on:
- significant judgements / assumptions in determining whether control exists
- composition of the group’s and NCI’s interests in the activities and cash flows
- details on any restrictions on the entity being able to access or use the group’s assets or settle its
liabilities
- consequences of changes in the entity’s ownership interest in a subsidiary which did not lead to a loss
of control
- consequences of the entity losing control of the subsidiary.
PART C: Investment in associates p279

Identifying associates p279

‘Significant influence’ is defined in IAS 28, para. 3 as ‘the power to participate in the financial and operating
policy decisions of the investee but is not control or joint control of those policies’. The investee in this type of
relationship is known as an ‘associate’.
Importantly, it is the power to participate, regardless of whether it is active participation or a passive
investment.
Significant influence would normally stem from the investor having 20 per cent or more of the voting power,
but less than 50 per cent (IAS 28, para. 5).
An assessment should only take into account potential voting rights that are presently exercisable or presently
convertible (IAS 28, para. 7).
IAS 28, para. 6 lists some of the other factors that, singly or in combination, may indicate that the investor has
significant influence, including:
- representation on the board of directors (or equivalent governing body);
- participation in policy making;
- material transactions between investor and investee;
- interchange of managerial personnel; and
- provision of essential technical information (IAS 28, para. 6).

Use of equity method p280

IAS 28, para. 16 requires an investment in an associate to be accounted for using the equity method, subject to
the exemptions specified in paras 17–19.
Recognise the investment in the associate originally at cost and then adjusting its carrying amount for the
investor’s share of:
- changes in post-acquisition in the associate’s equity, including changes that result from the
associate’s profit or loss;
- dividends; and
- other comprehensive income (IAS 28, para. 3).
Key differences of equity method and cost method of accounting:
- Carrying value: Cost method uses the amount originally invested, whereas equity method includes the
investor’s share of undistributed profit or loss and OCI after acquisition
- Dividends: Cost method treats dividends from the investee as dividend income, whereas the equity
method form part of calculating the changes in the investee’s equity and affect the carrying value
Application of the equity method p283

Basic features
The equity method displays the following basic features:
- the initial investment is recorded at cost (inc any goodwill – not separately disclosed);
- the carrying amount is adjusted for the investor’s share of associate post-acquisition profits / losses;
- the investor’s share of associate post-acquisition profits and losses is also recognised in the investor’s
profit or loss (line item: share of profit of associate);
- the investment carrying amount is reduced by all dividends received or receivable from the associate;
- the investment carrying amount is also adjusted for the investor’s share of post-acquisition changes in
the associate’s OCI after tax (which will be reflected in the equity (net assets) of the associate).
Identifying the share of associate that belongs to the investor
Consider only the present ownership interest (distinguish from voting power)
If an investor is a parent in a group, the ownership interest by that investor should recognise all of the
associate’s shares held by any entity within the group. However, the equity interests held by other associates
of the investor or its subsidiaries are ignored (IAS 28, para. 27). Potential ownership interests arising from
options, or other instruments that are convertible into shares, are not included except under the special
circumstances outlined in para. 13 (IAS 28, para. 12).
Direct share: 5%
Indirect share (via X) = 80% x 25% = 20%
Total = 25%

Application of equity method:

1. Identify the ‘ownership Exclude:
interest %’ - % held by other associates of the investor or its subsidiaries;
- Potential % from options;

2. Cost of acquisition 1. Initially recognized at cost;

(initial investment) 2. FV adjustments for identifiable assets at acquisition date are already
reflected as part of the ‘Investment in associate’ ;
3. Goodwill is already reflected as part of the ‘Investment in associate’; (p409)
- NO separate disclosure;
- NO amortization;
- NO impairment in its own right
(BUT test the total carrying amount of Investment in associate – IAS36)
3. Share of post- Dr. Investment in associate xx
acquisition profit or loss Cr. Share of P/L of associates (current period) xx
p410 Cr. R/E (prior periods) xx
4. Share of post- Dr. Investment in associate xx
acquisition changes in OCI Cr. Share of OCI of associates xx
after tax
Exclude: - any transfer from R/E to reserves;
- any FV changes reflected in cost of acquisition
5. Share of dividends Dr. Dividend receivable / bank xx
Cr. Investment in associate xx
(Note may need to reverse dividend revenue in investor’s statements)
 Adjustments for post-acquisition changes in equity (3+4+5)
1. Cumulative preference Dividends attached to cumulative preference shares held by other
shares (p407) parties
Exclude from the profit of the associate prior to allocating to the
investor, irrespective of whether declared or not
2. FV adjustment (p407) Assume inventory which was undervalued at acquisition date in current
(ONLY IF it hasn’t been period (net of tax effect):
reflected in associate’s book) Dr. Share of P/L of associates – unrealised profit (net) xx
Cr. Investment in associate xx
3. FV adjustment (p414) Assume a FV increment on land (net of tax effect):
(ONLY IF it hasn’t been Dr. Investment in associate xx
reflected in cost of acquisition) Cr. Share of OCI of associates xx

4. Intra-group transactions Both ‘upstream’ and ‘downstream’ transactions:

(p414) Dr. Share of P/L of associates – unrealized profit (after tax) xx
(ONLY IF there’s URP from sale Cr. Investment in associate xx
of inventory or PPE)

In case of share of post-acquisition losses

1. Allocate the losses to ‘Investment in Dr. Share of P/L of associates xx
associate’s ordinary shares’: Cr. Investment in associate xx
2. Secondly, allocate the losses to In reverse order of priority in liquidation:
‘Investment in associate’s long-term Dr. Share of P/L of associates xx
receivables, loans, preference shares’:
Cr. Investment in … xx
3. If the losses exceed 1 + 2: DO NOT recognize these losses, unless there’s an obligation to
make payments; AND
Disclose the amount of unrecognized losses;
4. If there are profits in subsequent Recognize profits ONLY after offsetting those previously
periods: unrecognized losses in Step 3.

Disclosures for associates p293

IAS 1 requires the following line items to be presented:

- B/S: ‘investments accounted for using the equity method’

- P&L: ‘share in the profit or loss of associates and JVs accounted for using the equity method’
- P&L (OCI): for each line item of OCI, ‘including share of OCI from associates and JVs accounted for using
the equity method’

To satisfy the objective of IFRS 12 (enable FS users to assess the entity), entities need to disclose both:

- significant judgments and assumptions made in determining that the entity has significant influence over
another entity (IFRS 12, para. 7(b)); and
- financial and other information for entities that are determined to be associates (IFRS 12, para. 20).
IFRS 12, para. 20 requires entities with interests in associates to disclose information that focuses on:

- the nature, extent and financial effects of its interests in associates including contractual arrangements
with other investors in the associates (IFRS 12, paras 20(a), 21 and 22); and
- the nature of, and changes in, the risks related to interests in associates (IFRS 12, paras 20(b) and 23).

IFRS 12, paras 21 to 23 contain extensive disclosure requirements that include information such as:

- details of each material associate (name, nature of its relationship with the entity, principal place of
business, proportion of ownership interest held by the entity);
- financial information for material associates (whether investment in the associate is measured using
equity method or fair value, summarised financial information);
- nature and extent of any significant restrictions on the associate paying dividend to entity or repaying
loans and advances;
- unrecognised share of losses if the entity has ceased to apply the equity method; and
- contingent liabilities incurred in relation to associates.
PART D: Joint arrangements – overview p296

A joint arrangement is defined by IFRS 11 as an ‘arrangement of which two or more parties have joint control’
(IFRS 11, para. 4). There are two essential characteristics of a joint arrangement:

- the parties to the arrangement must be bound by a contractual agreement in relation to the terms on
which the parties participate in the activities of the arrangement; and
- the contractual agreement gives rise to two or more parties having joint control of the arrangement (IFRS
11, para. 5).

Two forms Joint control Accounting treatment

1. Joint operation Joint rights to the assets and Recognize individually its share of assets,
liabilities liabilities, revenues and expenses;

2. Joint venture Joint rights to the net assets of the Equity method (as for an associate)
arrangement

This assessment involves professional judgment, and IFRS 11, para. 17 requires the entity to consider factors
such as:

- the legal form of the arrangement;

- the terms agreed in the contractual arrangement; and
- other facts and circumstances when relevant.
MODULE 6: Financial Instruments

Part A: What are financial instruments? 304

Definition of a financial instrument (fixed-for-fixed test) 304
Liability or equity? 306
Contract to buy or sell non-financial items 307
Derivative financial instruments 308
Part B: Recognition and derecognition of financial assets and financial liabilities 313
Recognition of FAs and FLs 313
Derecognition of FAs and FLs 313
Part C: Classification of financial assets and financial liabilities 323
Classification of FAs 323
Classification of FLs 326
Reclassification 329
Part D: Measurement 331
Initial measurement 331
Subsequent measurement of financial assets 331
Subsequent measurement of financial liabilities 335
Investment in equity securities 336
Compound financial instruments 337
Part E: Hedge accounting 342
Hedging relationships 342
Accounting for hedging relationships 344
Special accounting rules 353
Assessing hedge effectiveness 353
Discontinuing hedge relationships 354
Increased disclosures 354
Part F: Disclosure items 356
Scope and level of disclosure 356
Significance of financial instruments for financial position and performance 356
Statement of financial position 357
Statement of profit or loss and OCI 358
PART A: What are financial instruments? p304

Definition of a financial instrument p304

According to IAS 32, a financial instrument creates a financial asset for one entity and a financial liability (or
equity instrument) for another entity (IAS 32, para. 11).
Equity IAS 32 defines an equity instrument as one that 'evidences a residual interest in the
instruments assets of an entity after deducting all of its liabilities' (IAS 32.11).
e.g. shares on Fixed for fixed test: fixed dollar amount to be settled with a fixed number of the entity’s
ASX own equity instruments, the financial instrument will pass the fixed-for-fixed test.
Financial assets A financial asset is an asset that is:
(a) cash;
(b) an equity instruments of another entity;
(c) a contractual rights (e.g. trade receiv, loans receiv, instruments settled w govt bonds);
(d) a contract that will or may be settled in the entity’s own equity instruments (where
the fixed-for-fixed test fails but it isn’t a liability – rare scenario)
Financial A financial liability is based essentially on:
liabilities (a) contractual obligations (e.g. trade payables); and
(b) settlement in an entity’s own equity instruments (settled with a variable amount of
its own interest, in order to achieve a set monetary total)

Mix of liability For example, convertible debt – where the lender has the option to either accept
and equity repayment of the notes at maturity or convert the notes into shares of the issuer.

Contracts to buy or sell non-financial items p307

If an entity enters into a contract and continues to hold it for the purpose of receipt or delivery of the non-
financial items (rather than settled net or in cash) —in accordance with its expected purchase, sale or usage
requirements—it is not a financial instrument (IFRS 9, para. 2.4).
Derivative financial instruments p308

IFRS 9 defines a derivative as having all three of the following characteristics:

(a) its value changes in response to the change in a specified interest rate, financial instrument price,
commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other
variable, provided in the case of a non-financial variable that the variable is not specific to a party to
the contract (sometimes called the ‘underlying’).
(b) it requires no initial net investment or an initial net investment that is smaller than would be
required for other types of contracts that would be expected to have a similar response to changes in
market factors.
(c) it is settled at a future date (IFRS 9A).
All derivatives have, at a minimum, the following fundamental features:
(a) an issuer;
(b) a holder;
(c) an underlying item; and
(d) settlement and maturity dates.
Forward contracts
A forward exchange contract arises where two parties agree, at a point in time, to carry out the terms of the
contract at a specified time in the future.
Futures contract
A futures contract is a contract to buy or sell a stated quantity of a specified item, on a specified date in the
future, at a set price. The contract is with the exchange, which acts as a clearing house.
Requires a margin account. Open positions (where a party has only purchased or sold a futures contract) in a
futures market are not generally settled by physical delivery but by the trader entering an opposite position in
the market before maturity of the contract.

Option contract (p310)

An option contract is a derivative instrument that gives the holder of the contract the right but not the
obligation to buy or sell an asset from or to the issuer (commonly called the ‘writer’) of the contract on or
before a specified date.
The contract includes the following details:
 the exercise price, which is the amount at which the asset may be bought or sold;
 whether the option gives the holder the right to buy (call option) or the right to sell (put option) the
underlying asset at the exercise price;
 the maturity or expiration date—an option that can be exercised at any time up to a certain date is
called an American-type option, whereas an option that can only be exercised at a certain date is
called a European-type option;
 the name of the underlying asset; and
 the number of units of the asset that may be bought or sold with the option.
Tailored product: OTC
Traded on an exchange: standardised and provide liquidity
Swap contract
A swap contract is an arrangement whereby two counterparties contractually agree to swap or exchange one
stream of cash flows for another, over a period of time. Swap contracts are very popular for managing cash
flow risk.
Interest rate swaps
Interest rate swaps generally involve two parties swapping fixed and floating-rate interest obligations.
In an interest rate swap, two parties agree to swap fixed and variable rate interest payments based on an
underlying notional principal.
Cross currency swaps
A cross-currency swap involves the exchange of principal and interest payments for a loan in one currency for
principal and interest payments in another currency.
The currency principals are normally exchanged at the outset of the swap and re-exchanged at its conclusion.
PART B: Recognition and derecognition of financial assets and financial liabilities p313

Recognition of financial assets and financial liabilities p313

Paragraph 3.1.1 of IFRS 9 requires the initial recognition when an entity becomes party to the contractual
provisions of the instrument
This may not always result in the reporting of an amount on the statement of financial position because at
inception the fair value of the financial instrument could be zero (as is the case with many derivative
instruments).
Paragraph 42 of IAS 32 requires the financial asset and financial liability to be set off under certain conditions,
which most derivatives will normally satisfy.
Offsetting
A financial asset and a financial liability can be offset in certain conditions – Para 42 of IAS 32. Most derivatives
satisfy this criteria
A transferred asset and any associated liability shall not be offset– need to separately show the collateral that
has been provided
Derecognition of financial assets and financial liabilities p313

Financial assets

Full derecognition
Contractual right to CFs have expired Remove Financial Asset from SOFP
Qualified transfer (para 3.2.6 of IFRS 9) Dr Cash xxx
Cr Financial asset xxx
Cr Gain on sale xxx
Partial derecognition
Where the entity transfers a specifically identified CF (e.g. Dr Cash xxx
principal repayment portion)
Cr Financial asset xxx
A pro rata portion of all cash flows
Cr Guarantee liability xxx
A combination of the two above
Cr Gain on sale xxx
Transaction that creates a new FA / FL
No derecognition
Retains control of the FA Dr Cash xxx
Not exposed to variable returns (i.e. agmt to repurchase at Cr Loan payable xxx
fixed price)
See example below for more detail
Retains the risks and rewards of ownership / continuing
involvement
Financial liabilities
Full derecognition
Where the obligation is discharged, cancelled, expired Dr Loan xxx
When released by a court or the creditor Cr Cash / issued capital xxx
[Cr Gain on settlement xxx]
Exceptions
Debt defeasance Financial liability still exists
i.e. transfer assets to a trust in order to repay to creditor with
the proceeds from the assets in the trust
Substantial modification to or replacement of existing debt 1. Derecognise the old debt
2. Recognise the new debt
3. Recognise a gain or loss

Transfers of financial assets (p314)

Securitisation transaction: where an entity issues securities backed by the underlying cash flows associated
with all or part—of one or more— of its financial assets, such as mortgage loans or credit card receivables.
Collateralised Debt Obligations: bonds whose income payments and principal repayments are dependent on a
pool of instruments. Convert a bank’s mortgage baked assets into cash so that it can lend more money.
Journal entry when an entity transfers a financial asset to another entity (alternatives in table below):
Sale of financial assets Borrowing
Dr Cash xxx Dr Cash xxx
Cr Financial asset xxx Cr Loan payable xxx
Example – sell an asset worth 100K for 150K Example – as per left but with agmt to repurchase
for 175K
Dr Cash 150
Does not qualify for derecognition as the ‘seller’ is
Cr Financial asset 100
still exposed to the risks and rewards of ownership
Cr Gain on sale 50
Dr Cash 150
Cr Loan payable 150
At repurchase:
Dr Loan payable 150
Dr Interest expense 25
Cr Cash 175

With respect to securitisation – industry has developed around the ability to record the transaction as a sale of
a financial asset (rather than a loan on balance sheet)
PART C: Classification of financial assets and financial liabilities p323

Classification of financial assets p323

Business model for managing the FA

To hold and collect To both collect and sell
Solely payments of 1. Amortized cost – [transaction costs] 2. FV through OCI
principal and interest IFRS 9, para 4.1.2 IFRS 9, para 4.1.2A
3. FV through P&L
e.g.
- A loan but convertible into shares in five years;
Not solely payments of principal and
- leverage ‘1.5 times LIBOR’;
interest
- linked to the debtors’ performance or shares;
- penalties involved in extension terms;
- derivatives
4. FV through OCI (irrevocable election)

Except:
Investment in equity instruments
- held for trading;
(with irrevocable decision)
- a contingent consideration in BC.

Note: dividends received from the equity instrument go through P&L

5. FV through P&L (irrevocable election)
To avoid accounting mismatch For example, there may be measurement inconsistency when the assets
and liabilities are closely linked, as they would be for an insurer.
Derivatives 6. FV through P&L
Part of a hedging relationship 7. Hedge accounting (FV)

Business model: as determine why the entity’s key management personnel. Possible for entities to hold
portfolios of financial objectives with different objectives.
Interest: consideration for the time value of money and for the credit risk associated with the principal
amount outstanding during a particular period of time – where the interest represents more than this, the FA
cannot be measured at amortised cost.
Leverage: a contractual cash flow characteristic that increases the variability of the contract cash flows, which
means the instrument does not have the economic characteristics of interest.
Classification of financial liabilities p326

1. Amortized cost
Except:
- FL at FV through P&L via irrevocable election (e.g. derivatives);
Standard - FL that arise in an transfer of FA that does not qualify for derecognition (e.g. ‘guarantee
approach liability’, ‘loan payable’);
- Financial guarantee contracts (where the guarantor is now required to make payments
to the lender based on some form of default by the original borrower);
- Loan commitments at a below-market interest rate;
- Contingent consideration of an acquirer in business combination.
To avoid
accounting 2. FV through P&L (irrevocable election) – ß
mismatch
3. FV through P&L (irrevocable election) – ß
Where a group of
Where it eliminates or significantly reduces measurement or recognition inconsistency
FL is managed
e.g.
based on FV /
- a superannuation fund
 Accounting - a property trust that holds assets entirely to meet the obligations of the entity
mismatch

Derivatives 4. FV through P&L

Financial liability
designated as a 5. Hedge accounting (FV)
hedged item

Embedded derivatives
Derivative: one of the characteristics of a derivative is that ‘it requires no initial net investment or an initial net
investment that is smaller than would be required for other types of contracts that would be expected to have
a similar response to changes in market factors’.

An embedded derivative will result in some or all of the cash flow—that otherwise would be required by a
contract—to vary in response to the change in the underlying item or other variable. In the case of a non-
financial variable, the derivative must not be specific to a party to the contract.

The host contract The embedded contract

A three-year debt instrument: The holder will receive appreciation or
A principal amount of $10m; depreciation in the FV of 100 shares of X.
Indexed to X’s share price;
At maturity, the holder will receive
$10m;
A debt instrument An equity-based derivative
(i.e. Requires no initial net investment, or an
amount that is smaller than …)
Usually amortized cost. Derivatives are initially valued at zero.

If: The host contract is a FA: Measured with the entire hybrid contract;

Classification If: The host contract isn’t a FA: Separated from the host contract and
measured as a derivative;
Where:
 the economic characteristics and risks of
the embedded derivative are not similar to
those of the host;
 a separate instrument with the same terms
as the embedded derivative would meet
the definition of a derivative; and
 the hybrid contract is not measured at fair
value through profit or loss (IFRS 9, para.
4.3.3).

The entire hybrid contract is permitted to be accounted for as FV through P&L, if:
1. Required to but unable to separate the embedded derivative from the host
contract;
2. The embedded derivative is closely related to the host contract;
Except:
1. The embedded derivative doesn’t significantly alter CFs;
2. Separation of the embedded derivative from the host contract is prohibited.

Closely related to host contract:

 Account for in a single instrument: USD purchase by an Australian company – the
currency embedded derivative is closely related to the contract as the payment is
made in the functional currency of the supplier – and this would be the normal risk
expected when purchasing from a US based supplier
Not closely related to host contract:
Account for the embedded derivative separately: where there is the same contract
but you could settle it with another currency, because this isn’t the functional
currency of either party, would need to be recorded separately

Reclassification p329

In IFRS 9, the only circumstances where it is permissible to reclassify a financial asset is where an entity
changes its business model (IFRS, 9 para. 4.4.1). It is stated that this is expected to be rare, and para. B4.4.1
provides two examples of a change in a business model.
Situations that are not examples of a change in a business model include:
 where an entity transfers financial assets between different portfolios;
 where a market for financial assets temporarily disappears; and
 where an entity changes its intention to hold a financial asset are not.
Financial liabilities are not permitted to be reclassified in accordance with IFRS 9, para. 4.4.2.
Refer to the Measurement section
Note that financial liabilities cannot be reclassified

Reclassification of financial assets

Permitted Only when the entity changes its business model for managing the
financial asset
1. Do not restate any previously
recognised gains or losses
2. At the date of reclassification:
Amortised cost Recognise the FV as the new carrying amount
FV through P&L Recognise the FV as the new carrying amount AND
Recognise any gain / loss between the new and old carrying amount
in the P&L
PART D: Measurement p331

Initial measurement p331

Paragraph 5.1.1 of IFRS 9 states that all financial assets and financial liabilities should be initially measured at
fair value.
Measurement Financial asset
Amortised cost For instruments recorded at amortised cost – adj for transaction costs
Transaction costs are added to the fair value for a financial asset and
deducted from the fair value for a financial liability.
Fair value through profit or All financial assets and liabilities per para 5.1.1 of IFRS 9
loss

‘Fair value’ is defined, in Appendix A of IFRS 9, 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.
IFRS 13 prescribes a fair value measurement hierarchy, which includes three levels for inputs to fair value
measurement:
 Level 1 inputs refer to quoted prices for identical assets;
 Level 2 inputs refer to inputs where there are no significant unobservable inputs, such as a quoted
price for comparable assets; and
 Level 3 inputs refer to valuation models with significant unobservable inputs that must be estimated.

Where FV is different to the transaction price:

 If the fair value is determined by reference to an active market price / another valuation technique
that uses observable inputs, then the difference between the fair value and the transaction price is
recognised as a gain or loss.
 In all other cases, the difference is deferred and recognised over time based on the change in a factor
such as the unwinding of a discount over time.

Subsequent measurement of financial assets p331

Measurement Financial asset

Amortised cost 1. Held within a business model (whose objective is to hold assets
in order to collect contractual cash flows), and
2. Have contractual terms that give rise (on specified dates) to cash
flows that are solely payments of principal and interest on the
principal amount
Fair value through profit or loss All other financial assets (including derivatives)
(unless hedging)
Fair value through OCI Irrevocable decision for investments in equity instruments to show fair
value movements in OCI
Dividends received are recognised in profit or loss

Carrying amount of financial asset carried at amortised cost

Carrying amount of the notes at initial recognition = Issue price (FV) + establishment fees
Carrying amount of the loan at end of first year = Initial recognition – Coupon repayment + Interest expense
Dr Interest expense 281 627 (total interest expense)
Cr Cash 225 000 (coupon repayment amount)
Cr Financial liability 56 627 (difference that increases carrying amount)
Impairment of financial assets carried at amortised cost
The asset is impaired when its carrying amount is greater than its recoverable amount.
For financial assets carried at amortised cost, an entity recognises impairment for expected credit losses, even
if there is currently no indication of impairment (IFRS 9, para. 5.5.1).
Impairment proceeds on a three-stage basis dependent on the credit status of the financial instrument.
Stage Level of credit risk Effective interest rate
1. Credit risk has not increased 12 months of expected credit losses Computed on the gross
significantly since initial are recognised (IFRS 9, para. 5.5.5). amortised cost base (IFRS 9,
recognition para. 5.4.1).
2. Risk of default has significantly Recognise the ‘lifetime expected Computed on the gross
increased since the initial credit loss’ on a financial instrument amortised cost base (IFRS 9,
recognition (IFRS 9, para. 5.5.3). para. 5.4.1).
3. The financial instrument is Recognise the ‘lifetime expected Computed net of impairment
‘credit impaired’ credit loss’ on a financial instrument. losses (IFRS 9, para. 5.4.1b).

Dr Impairment loss (P&L) xxx

Cr Provision for expected credit loss xxx

Subsequent measurement of financial liabilities p335

Measurement Financial liability

Amortised cost Financial liabilities
Fair value Financial liabilities at fair value through profit or loss
Higher of amount determined from applying IAS 37 and Financial guarantee contracts
the amount initially recognised
Higher of amount determined from applying IAS 37 and Loan commitments at below market interest rates
the amount initially recognised
Apply the hedge accounting rules from IFRS 9, which are Financial liability designated as a hedged item
covered in Part E

Carrying amount of financial liability carried at amortised cost

Carrying amount of the notes at initial recognition = Issue price (FV) + establishment fees
Carrying amount of the loan at end of first year = Initial recognition – Coupon repayment + Interest expense

FV gain / loss in financial liabilities designated at fair value through profit and loss
FV changes are due to changes in credit risk of the Recognise in OCI (in FV through OCI)
liability Except: financial guarantees, loan commitments
The remaining amount of Fair Value changes Recognise in P&L (in FV through P&L)
Credit risk: the risk that one party to a financial instrument will cause a financial loss for the other party by
failing to discharge an obligation

Recognising gains and losses on the subsequent measurement of financial assets and liabilities p336

When a financial asset or a financial liability is measured to fair value, the changes in fair value must be
recognised in the accounts. The changes are reported in the profit or loss for the period in all cases unless:
 it is part of a hedging relationship, in which case the hedge accounting rules in IFRS 9 apply
 it is an investment in an equity instrument and the entity has elected the option of reporting gains
and losses in OCI; or
  it is a financial liability at fair value through profit or loss, and the gain or loss arises from changes in
the credit risk of the financial liabilities, which must be reported in OCI (this issue is discussed towards
the end of this section).
Investment in equity securities p337

1. All Investment in equity Measured at FV, with NO exceptions;

securities:
FV through P&L, unless the entity has made an irrevocable election for
FV through OCI.
2. Investment in equity FV through OCI (irrevocable election);
securities not held for trading:
This election can be made for each share investments, NOT necessarily
for the entire class of investments.
3. Investment in unlisted equity Cost may be an appropriate estimate of FV, unless:
securities: 1) The investee is performing significantly better/worse than normal;
2) The investee experiences significant internal problems (e.g. fraud).

Liabilities designated at fair value through profit or loss p338

Entities are required to report the part of the change in the fair value of such liabilities (other than financial
guarantees and loan commitments) that is due to changes in the credit risk in OCI.

Credit risk is defined in Appendix A of IFRS 7 as ‘the risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation’.

Compound financial instruments p338

Convertible notes = a liability component (to pay interest and principal) + an equity component (the right to
purchase a fixed number of shares, or convert the obligation into a fixed number of shares)

The liability component The equity component

1. Separately classified as a liability + an equity;

Classification 2. No subsequent revise to the classification, irrespective of the probability of

conversion of the right to purchase shares.

1. FV of the liability component = PV of 2. Equity component = FV of the

principal + PV of coupon interest instrument - FV of the liability
payments component
using prevailing market rate for a similar
Initial instrument without conversion rights.
measurement
Dr. Cash xxx
Cr. Financial liability xxx
Cr. Equity xxx

1. Carried at amortized cost; NEVER revalued.

Subsequent 2. Recognize interest expense using
measurement prevailing market rate.

1. If not converted The liability component is redeemed for n/a

into shares: its face value.
2. If converted into The liability component is extinguished The equity component is reclassified to
shares: with the issue of new shares. reserves.
PART E: Hedge accounting p342

Hedging relationships p342

A hedging relationship requires:

(a) a hedging instrument; and
(b) a hedged item—this can be a risk component arising from a risk exposure, the entire risk exposure, or
a group of similar risk exposures.
A hedged item can be:
 a recognised asset or liability;
 an unrecognised firm commitment;
 a highly probable forecast transaction; or
 a net investment in a foreign operation.
Hedging instruments
Can be a derivative or non-derivative financial asset / liability.
It is the intention of management that determines whether a financial instrument will be regarded as a hedge
(cf if the intention is to hold to maturity and collect the cash flows)
Type of transactions that can be hedged
Transaction that is a firm commitment
Highly probable forecast transaction (para 6.3.1 of IFRS 9)
Hedging risk components
IFRS 9 permits the hedging of various financial risks (e.g. foreign exchange, interest, commodity) or
components of them.
The designation of risk components of hedged items can only occur if they are separately identifiable and
reliably measurable, irrespective of whether the item that includes the risk component is a financial or non-
financial item.
Examples:
 foreign currency price risk is separately identifiable and reliably measureable (if currency is liquid)
 bespoke raw material prices would not be identified separately

Accounting for hedging relationships p344

Requirements as per para 6.4.1 in IFRS 9:

 the relationship consists only of eligible hedging instruments and eligible hedged items;
 there is formal designation and documentation at the inception of the hedging relationship about
the hedging relationship and the entity’s risk management objective and strategy for undertaking the
hedge;
 there is an economic relationship between the hedged item and the hedging instrument;
 the effect of credit risk does not dominate the value changes that result from that economic
relationship; and
 the hedge ratio of the hedging relationship is the same as the ratio between the hedged item and the
quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged
item. However, the hedge ratio cannot be set in such a way that it would give rise to an accounting
outcome that is inconsistent with the purpose of hedge accounting.
The hedge ratio compares the value of a position protected through the use of a hedge with the size of the
entire position itself. A hedge ratio may also be a comparison of the value of futures contracts purchased or
sold to the value of the cash commodity being hedged.
Fair value hedges p346

A hedge of the exposure to changes in the fair value of a recognised asset, liability or an unrecognised firm
commitment to buy or sell resources, or to a portion of such an asset, liability or firm commitment. There also
must be the potential for this risk to affect profit or loss.

Example: the value of a fixed-rate loan increases for the borrower if interest rates decline

FV through P&L
The hedging instrument is measured at fair value through profit or loss and the hedged item must also be
measured at fair value through profit or loss. Therefore, any mismatch between the fair value movements of
the hedged item and hedging instrument is automatically recognised in profit or loss.
FV through OCI
If the hedged item is an equity instrument measured at fair value through OCI (as discussed in Part D), the fair
value movement of the hedged item is also recorded in OCI.

Extension of fair value option – alternative to formal hedge accounting

(a) Use of credit derivatives in hedging
When an entity uses a credit derivative, measured at fair value through profit or loss, to manage credit risk of
all or a portion of credit exposure on a financial asset or liability, it may designate all or a portion of the credit
exposure at fair value through profit or loss, provided the name and seniority of the financial instrument
referenced in the credit derivative matches the hedged credit exposure.
(b) Own-use contracts
IFRS 9 permits entities to account for ‘own-use’ contracts (i.e. contracts to buy or sell non-financial items for
own use) at fair value through profit or loss, if it eliminates an accounting mismatch. For example, company
can value its customer contracts at fair value – if selling fixed price electricity. It would then have these
contracts offset the FV movements in the fixed price swap it purchased from a electricity generator.
Cash flow hedges p349

A hedge of the exposure to variability in cash flows that is attributable to a particular risk with some or all of a
recognised asset or liability (such as all or some future interest payments on a variable rate debt) or a highly
probable forecast transaction that could affect profit or loss.
Example: an entity with a variable rate loan will be required to pay higher amounts of interest if interest rates
increase. Can also be for movements in exchange rates

For cash flow hedges, IFRS 9, para. 6.5.11, states the accounting treatment as follows:
Portion Definition As the hedging instrument is
remeasured to FV:
Effective The lower of (in absolute amounts) the Gains and losses on the effective portion
cumulative gain or loss on the hedging are recognised in OCI (e.g. as an
instrument since inception of the hedge, and the adjustment to the cash flow hedge
cumulative gain or loss on the hedged item reserve in equity)
Ineffective Any positive amount remaining after deducting The ineffective portion (if any) should be
the effective portion from the gain or loss on the recognised in profit or loss
hedging instrument

The cash flow hedge reserve (in OCI) is transferred:

To be included in the Applies if:
initial cost or other 1. The cash flow hedge was either a hedge of a forecast transaction that
carrying amount of the results in the recognition of a non-financial asset or non-financial liability, or
asset or liability
2. Was a hedge of a forecast non-financial asset or non-financial liability that
becomes a firm commitment and is designated as a fair value hedge
To profit or loss Where the cash flows from the hedged item occur in the same period (for
cash flow hedges other than those covered by the point above)
Reclassified to profit or If the amount in the hedge reserve is a loss that the entity does not expect to
loss immediately. be recovered in the future

Examples
Hedging instruments Hedged items
Forward derivative contract Inventory
1. No initial entry when the contract is 1. FV gain/(loss) in P/L:
signed, as FV of the contract is zero;
1. Fair value hedges
Loss (will offset the gain at left)
2. FV gain/(loss) in P/L: Dr. Loss – P&L xxx
e.g. hedges against
Dr. Forward contract xxx Cr. Inventory xxx
change in FV of
Cr. Gain – P/L xxx
inventory
Gain (Dr. Inventory, Cr. Gain – P/L)
At settlement:
Dr. Cash xxx or via OCI for ‘investment in equity not
Cr. Forward contract xxx held for trading’.
Forward FX contract Foreign Currency payable for inventory
2. Cash flow hedges
1. No initial entry when the contract is 1. No entry (recognition or re-
signed, as FV of the contract is zero; measurement) until firm commitment;
e.g. hedges of a
purchase of inventory
2. FV gain/(loss) in OCI for effective 2. Purchase the inventory:
portion: Dr. Inventory xxx
 Dr. FC contract xxx Cr. Cash xxx
Cr. OCI xxx Note that this will record the full price
or in P/L for ineffective portion; for the inventory purchased, and then
the offsetting transaction comes via 4
3. Settle the forward contract: on the LHS to set it to the actual cost
Dr. Cash xxx locked in by the derivative)
Cr. FC contract xxx

4. Transfer from equity:

Dr. CF hedge reserve (OCI) xxx
Cr. Inventory xxx
3. Hedges of a net Similar to cash flow hedges (FV through OCI)
investment in a
foreign entity
e.g. use a FC
dominated liability to
offset the investment

Special accounting rules p353

Accounting for the time value of options

Component of option Accounting treatment
An intrinsic value – this is the Paragraph 6.2.4 of IFRS 9 permits an entity to designate only the
difference between the current changes in the intrinsic value of the option in a hedging relationship.
spot price and the strike price
The time value of the option – Where the hedged item is ‘transaction related’ (e.g. hedge of a forecast
the time remaining until the transaction such as sales), the time value of the hedging instrument
option’s expiry and the (e.g. foreign exchange option) is reversed from equity at the same
probability of the option expiring time as the transaction is recognised.
on favourable terms. The reversal may be to profit or loss, or as an adjustment to the
carrying value of the hedged item. (para 6.5.15)
For a hedged item that is ‘time period related’ (e.g. debt), the time
value of the hedging instrument (e.g. an interest rate cap) is reversed
over the same period as those of the hedged item, specifically the
period when cash flows from the hedged item affect profit or loss.
This is usually done on a straight-line basis. (para 6.5.15)

Amortisation of forward element of forward contracts

IFRS 9 allows the recognition of the forward element of a forward contract, that existed at inception of a
hedging relationship, to be accounted in the same way as the time component of option contracts.
i.e. the difference between the forward price and the spot price is the forward element of the forward
contract and this gradually declines as the forward contract approaches maturity.
Spreads
Basis spreads are charged in cross-currency swaps as a way of balancing the supply and demand of currencies.
IFRS 9 specifically allows foreign currency basis spread in foreign currency derivatives to be treated similarly to
the forward element in a forward contract.
Derivatives may be included as part of the hedged item
IFRS 9 permits a derivative to be aggregated together with the non derivative hedged item. This creates a new
qualifying hedged item referred to as an ‘aggregated exposure’.
E.g. derivative (currency swap) and non-derivative (commodity – oil price) can be hedged by a single
instrument.
Assessing hedge effectiveness p353

Under IFRS 9, a hedge is considered to be an effective hedge when:

(i) there is an economic relationship between the hedged item and the hedging instrument. That is,
the hedging instrument and the hedged item have values that generally move in the opposite
direction because of the same risk, which is the hedged risk;
(ii) the effect of credit risk does not dominate the value changes that result from the economic
relationship; and
(iii) the hedge ratio of the hedging relationship is the same as that resulting from the quantity of the
hedged item that the entity actually hedges and the quantity of the hedging instrument that the
entity actually uses to hedge that quantity of hedged item
It is a requirement that the hedge is effective at designation and thereafter.
At a minimum, the assessment must occur at the earlier of (a) each reporting date, or (b) a significant change
in circumstances that affects the hedge effectiveness requirements.
Discontinuing hedge relationships p354

Under IFRS 9, a hedging relationship is discontinued when:

1. the hedging instrument expires, is sold or terminated; or
2. the forecast cash flow hedge is no longer expected to occur.
However, an organisation cannot voluntarily de-designate a hedge relationship.
If cash flow hedge accounting is discontinued, the amount accumulated in the cash flow hedge reserve:
1. remains in equity if the hedged future cash flows are still expected to occur; or
2. is reclassified to profit or loss if the hedged cash flows are no longer expected to occur (IFRS 9, para.
6.5.6).
Increased disclosures p354

Along with the changes in IFRS 9, IFRS 7 disclosures have been modified to require disclosures of information
on risk exposures being hedged, and for which hedge accounting is applied.
Specific disclosures will include:
 a description of the risk management strategy;
 the cash flows from hedging activities; and
 the impact that hedge accounting will have on the financial statements.
PART F:Disclosure issues p356

Scope and level of disclosure p356

The IFRS 7 disclosure requirements relate to all financial instruments, irrespective of whether they are
recognised in the financial statements or are unrecognised (e.g. some loan commitments).
Requires disclosures by class of financial instrument:
- at a minimum, measure amortised cost and FV instruments separately
The main intention of IFRS 7 is to provide more information to users about financial assets and financial
liabilities that are currently not recognised on the statement of financial position.

Significance of financial instruments for financial position and performance p356

Paragraph 7 of IFRS 7 is very general, as it requires an entity to:

disclose information that enables users of its financial statements to evaluate the significance of financial
instruments for its financial position and performance

Statement of financial position p357

The requirements for disclosures in respect of the statement of financial position are specified in paras 8–19 of
IFRS 7, and include the following:
Categories of FA and FL IFRS 7 requires the carrying amounts for each of the categories for financial assets
and for financial liabilities to be disclosed.
FAs at FV through P&L - Maximum credit risk of the FA and extent any credit derivatives mitigate the
exposure
- Info on change in FV associated with credit risk as distinct from changes in
market conditions
FL at FV through P&L Where change is due to credit risk via OCI –
- disclose cumulative amount of FV change attributable to credit risk
- difference between carrying amount and contractual payment at maturity
- any transfers of cumulative gain / loss transfers within equity
- if liability is derecognised, the amount impacting OCI
In P&L
- changes for the period plus cumulative changes
Investments in equity Disclose the instruments, the FV at the end of the period and any dividends rec
securities in OCI If sold, include reasons for sale, FV at date of sale and cumulative gain / loss
Reclassification of FA - Date of reclassification and amount reclassified
- Explanation of the change in the business model
For FAs reclassified to amortised cost:
- Effective interest rate
- Interest income or expense from the date of reclassification until
derecognised
- FV at time of reclassification and FV gain / loss that would have been
recognised if not reclassified
Offsetting FAs and FLs See also Part B
Enforceable master netting arrangement: where an entity enters an agreement
with a counterparty that, in the event of default, allows the entity to offset all
amounts with the counterparty and settle the net amount outstanding
Collateral The carrying amount of financial assets it has pledged as collateral, including
amounts that have been reclassified
 Where an entity holds collateral and is permitted to sell or repledge the collateral,
it must provide details about the fair value of such collateral—including the fair
value of any sold or repledged—and the terms and conditions.
Allowance account for Provide a reconciliation of changes to the provision during the period
credit losses e.g. allowance for doubtful debts account
Compound financial Disclosure of any such instruments the entity may have is required.
instruments with
multiple embedded
derivatives
Defaults and breaches Paragraphs 18 and 19 of IFRS 7 require entities to disclose details of any defaults
or breaches of loans payable during the period.
This includes details of where the default was remedied by a renegotiation of the
loan payable before the financial statements were authorised for issue.

Statement of profit or loss or OCI p358

Entities are required to disclose certain information about the following items of income, expense, gains or
losses (IFRS 7, para. 20)
- Net gains or losses on FAs or FLs – separating those that were through P&L from initial recognition vs
subsequently, or shown due to mandatory rules in IFRS 9 (e.g. accounting mismatch).
- Net gains or losses on financial liabilities measured at fair value through profit or loss
- Net gains or losses on financial assets measured at fair value through OCI.
- Net gains or losses on financial assets or financial liabilities measured at amortised cost.
- Total interest income and total interest expense for financial assets or financial liabilities that are not
at fair value through profit or loss.
- Fee income and expense (except for amounts included in the calculation of the effective interest rate)
from financial assets or financial liabilities that are not at fair value through profit or loss or from trust
and fiduciary activities. This is an important activity of many financial institutions and may be a
significant source of fee income.
- Interest income on impaired financial assets.
- The amount of impairment loss for each class of financial asset.
- A separate analysis of the gains and losses arising from the derecognition of financial assets measured
at amortised cost and the reasons for the derecognition.

Other disclosures
Accounting policies Summary of significant accounting policies, the measurement methods and other
accounting policies that are relevant to understanding the statements
Hedge accounting Disclosures with respect to risk and the associated hedges
Credit exposure Any FAs or FLs measured at fair value through profit or loss because the entity
uses a credit derivative to manage the credit risk.
Fair value Information about fair value for each class of financial assets and financial
liabilities in a way that permits it to be compared with its carrying amount.
Exceptions:
- Where the carrying amount is a reasonable approximation of FV (e.g.
acocunts receivable or payable)
- Contract contains a discretionary participation feature such that the FV
cannot be reliably measured (e.g. certain insurance contracts)

Nature and extent of risks arising from financial instruments

Risk: the degree of variance in a set of numbers, with a greater degree of variance representing a higher level
of risk.
Disclosures that assist users to assess the risks associated with financial instruments involve statements by the
company that outline its objectives for using financial instruments

An entity is required to describe its exposure to risk and how the exposure arises (IFRS 7, para. 33), including a
discussion of the entity’s financial management objectives and policies, its policy for managing risk (e.g.
internal controls and procedures) and the methods used to measure the risk. It is also necessary to report in
each period any changes to the risks or policies used to measure and manage the risk.

The minimum quantitative disclosures in paras 34 to 42 of IFRS 7 relate to:

- credit risk;
- liquidity risk;
- market risk; and
- transfers of financial assets.

Credit risk
Credit risk: the risk that one party to a financial instrument will cause a financial loss for the other party by
failing to discharge an obligation.
Paragraph 36 of IFRS 7 requires the following disclosures about credit risk for financial instruments that are not
subject to the impairment requirements of IFRS 9:
- the maximum credit risk without taking into account any collateral;
- a description of any collateral; and
- information about the credit quality of financial assets that are neither past due for collection nor
impaired.

Financial assets that are past due or impaired

Paragraph 37 of IFRS 7 requires an entity to disclose the following details:
- an analysis of the age of financial assets that are past due at reporting date but not impaired; and
- an analysis of individual financial assets that are determined as impaired and the reasons why.

Collateral and other credit enhancements p363

The entity must disclose the nature and carrying amount of any assets that it takes possession of during the
period, as a result of having the collateral or credit enhancements, provided that such items meet the
recognition criteria for assets.
Also, when such assets are not readily convertible into cash, an entity must disclose its policies for disposing
of such assets or for using them in the entity’s operations

Liquidity risk
Liquidity risk: the risk that an entity will encounter difficulty in meeting obligations associated with financial
liabilities
Provide a maturity analysis for financial liabilities that shows the remaining contractual maturities and a
description of how it manages the inherent liquidity risk (para 39 of IFRS 7).
Para 39(a) of IFRS 7 requires the use of contractual dates (legal repayment) rather than the normal payment /
collection approach in ordinary business.

Market risk
Market risk: that the fair value or future cash flows of a financial instrument will fluctuate because of changes
in market prices. Market risk comprises currency risk, interest rate risk and other price risk.
Other price risk: that the fair value or future cash flows of a financial instrument will fluctuate because of
changes in market prices (other than those arising from interest rate or currency risk), whether those changes
are caused by factors specific to the individual financial instrument or its issuer or factors affecting all similar
financial instruments traded in the market.
Sensitivity analysis: disclose for each market risk to which the entity is exposed at balance date
Value at risk: an assessment of potential losses for a portfolio of on statement-of-financial-position positions
and off-statement-of-financial-position financial instrument hedges due to adverse movements in market risk
factors over a certain holding period. It involves assumed changes in market conditions together with
probabilities and calculation of value at risk under differing market conditions.

Transfer of financial assets

Paragraphs 42A–H of IFRS 7 require disclosures of transactions involving the transfer of financial assets that
fail the derecognition requirements of IFRS 9.
The two possible types of transactions are:
1. where an entity transfers only part of a financial asset, such as a portion of its receivables; and
2. where an entity transfers the entire amount of financial assets but maintains a continuing involvement,
such as when an entity transfers all of its receivables but guarantees the acquirer for a portion of
uncollectible accounts (this situation creates a liability)
MODULE 7: Impairment of Assets

Part A: Impairment of assets – an overview 371

Basic principles for the impairment of assets 371
Identifying assets that may be impaired 373
Part B: Impairment of individual assets 378
Measurement of recoverable amount 378
Fair value less cost of disposal 380
Value in use 381
Recognising and measuring an impairment loss 388
Reversal of impairment losses 389
Part C: Impairment of CGUs 392
Recoverable amount: individual asset or CGU? 392
Identifying a CGU 393
Recoverable amount and carrying amount for a CGU 394
PART D: IAS 36 – disclosure 404
Disclosures of impairment losses and reversals 404
Disclosures of estimates used to measure recoverable amounts in cash-generating 405
units
PART A: Impairment of assets – an overview p371

Basic principles for impairment of assets p371

The underlying principle of IAS 36 is that the carrying amount of an asset (tangible, intangible or goodwill)
must not exceed its recoverable amount. An impairment loss is recognised to the extent that an asset’s
carrying amount exceeds its recoverable amount.
Why is impairment important for users?
Existing and potential investors, lenders & other creditors: impairment losses may give information on the
quality of management decisions, impact on key financial ratios, profile of future earnings of the entity? They
will evaluate whether the timing and the quantum of the impairment loss is appropriate.
Corporate regulators: ASIC have reported that compliance with impairment requirements is problematic (there
may be inappropriate determination of the carrying amount of CGUs, overstated recoverable amounts,
insufficient monitoring, lack of disclosure.
Key definitions
Carrying amount ‘The amount at which an asset is recognised after deducting any accumulated
depreciation (amortisation) and accumulated impairment losses thereon’
Recoverable amount ‘The higher of its fair value less costs of disposal and its value in use’
(of an asset or CGU)
Fair value ‘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 (see IFRS
13 Fair Value Measurement)’
Costs of disposal ‘Incremental costs directly attributable to the disposal of an asset or
cash-generating unit, excluding finance costs and income tax expense’
Value in use ‘The present value of the future cash flows expected to be derived from an asset or
cash-generating unit’
Cash-generating unit ‘The smallest identifiable group of assets that generates cash inflows that are largely
(CGU) independent of the cash inflows from other assets or groups of assets

Scope of IAS 36 (p373)

Applies to Does not apply to
All assets, regardless of whether they are:
 current or non-current  Inventories
 tangible or intangible  Assets arising from construction contracts
 measured at cost or revalued amount  Deferred tax assets (refer to Module 4)
(i.e. fair value) unless specifically  Assets arising from employee benefits
excluded.  Financial assets within the scope of IFRS 9 (refer to
Module 5)
Examples of assets IAS 36 applies to include:  Investment properties that are measured at fair value
 property, plant and equipment  Biological assets related to agricultural activity that are
 intangible assets (purchased or measured at fair value less costs of disposal
internally generated) and goodwill  Deferred acquisition costs and intangible assets arising
 investments in subsidiaries, associates from an insurer’s contractual rights under insurance
and joint ventures contracts within the scope of IFRS 4 Insurance Contracts
 investment properties measured at  Non-current assets (or disposal groups) classified as
cost. held for sale under IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations
Identifying assets that may be impaired p373

Step 1: determine whether there is any indication that an asset is impaired (IAS 36, para. 9). There is a range of
indicators to consider (refer to the section ‘Impairment indicators’).
Step 2: If there is an indication of impairment, formally estimate the recoverable amount of the asset
Specific requirements for certain intangible assets and goodwill
Intangible asset: an identifiable non-monetary asset without physical substance (para. 8 of IAS 38)
Internally generated intangibles: in order to recognise:
1. Needs to be an identifiable asset; and
2. The cost of which can be reliably determined.
Not permitted to be recognised: internally generated brands, mastheads, publishing titles, customer lists and
similar items (para 63 of IAS 38). Cannot be distinguished from the cost of developing the business as a whole
(IAS 38, para. 64) – treatment as an expense is consistent with faithful representation.
Intangible assets with indefinite useful lives or not yet available for use AND goodwill
These assets are not subject to amortisation.
The recoverable amounts of these assets to be formally estimated once a year regardless of whether there is
an indication of impairment (IAS 36, para.10).
Asset Example Timing of recoverable amount estimate
Intangible assets with indefinite Brand name with no At any time during an annual period,
useful lives foreseeable limit on its useful provided it is done at the same time
life each year (IAS 36, para. 10(a))
Intangible assets not yet Computer software being At any time during an annual period,
available for use developed in-house provided it is done at the same time
each year (IAS 36, para. 10(a))
Goodwill acquired in a business At any time during an annual period, provided it is done at the same time
combination each year (IAS 36, para. 96)

Can adopt the most recent calculation of the asset recoverable amount where:
(a) if the intangible asset is tested for impairment as part of the cash-generating unit to which it
belongs, the assets and liabilities making up that unit have not changed significantly since the
most recent recoverable amount calculation;
(b) the most recent recoverable amount calculation resulted in an amount that exceeded the asset’s
carrying amount by a substantial margin; and
(c) based on an analysis of events that have occurred and circumstances that have changed since the
most recent recoverable amount calculation, the likelihood that a current recoverable amount
determination would be less than the asset’s carrying amount is remote (IAS 36, para. 24).
Impairment indicators
IAS 36 provides a list of external, internal and other indicators that an entity must consider when assessing
whether an asset is impaired.
An entity may also identify its own indicators that an asset may be impaired (IAS 36, para. 13).
Indicator Explanation
Significant decline in the Value has declined during the period significantly more than would be
asset’s value expected as a result of the passage of time or normal use
Significant adverse changes in Change or expected future change in technological, market, economic or
environment or market legal environment in which the entity operates or in the market to which an
asset is dedicated
Increase in interest rates or Increase in market interest rates or other market rates of return on
other market rates of return investments which will increase the discount rate and thereby reduce the
on investment asset’s carrying amount
 Market capitalisation Where the carrying amount of the net assets of the entity is more than its
exceeded market capitalisation
Obsolescence or physical Evidence of obsolescence or physical damage
damage
Change in asset use Possible changes include the asset becoming idle, plans to discontinue or
restructure the operation to which an asset belongs, plans to dispose of an
asset before the previously expected date, and reassessing the useful life of
an asset as finite rather than indefinite
Economic performance of Evidence is available from internal reporting that indicates that the
asset worse than expected economic performance of an asset is, or will be, worse than expected

For a subsidiary, associate or JV, consider whether an entity is impaired after the payment of a dividend. Does
the evidence indicate:
 the carrying amount of the investment in the separate financial statements exceeds that in the
consolidated financial statements of the investee’s net assets, including associated goodwill; or
 the dividend exceeds the total comprehensive income of the subsidiary, jointly controlled entity or
associate in the period the dividend is declared (IAS 36, para. 12(h)).
PART B: Impairment of individual assets p378

Measurement of recoverable amount p378

Recoverable amount: the higher of an asset’s ‘fair value less costs of disposal and its value in use (IAS 36, para.
6). Note that it is only necessary to demonstrate that one of these measures exceeds an asset’s carrying
amount in order to conclude that an asset is not impaired (IAS 36, para. 19).

Individual assets: Recoverable amount is estimated on an individual asset basis where an asset generates its
own cash inflows that are largely independent of the cash inflows generated by other assets or groups of
assets.

Fair value less costs of disposal p380

Fair value: 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 (IAS 36, para. 6)
Costs of disposal: incremental costs directly attributable to the disposal of an asset or cash-generating unit,
excluding finance costs and income tax expense (IAS 36, para. 6)

Examples of costs of disposal Items not included in costs of disposal

 Legal costs  Interest expense incurred in financing the
 Stamp duty and similar transaction taxes purchase of an asset to be disposed of
 Costs to remove an asset from a particular  Income tax incurred on an asset’s disposal
location to effect a disposal  Employee termination benefits incurred due to
 Costs to prepare an asset for its disposal employee redundancies that occur after the
asset is disposed of
 Restructuring costs incurred after the asset is
disposed of

Value in use p381

Value in use: the present value of the future cash flows expected to be derived from an asset or CGU’ (IAS 36,
para. 6).
Estimating the value in use of an asset (or a CGU) involves two steps:
Step 1: estimating the future cash inflows and outflows expected to be derived from the continuing use of an
asset (or a CGU) and from its ultimate disposal (IAS 36, para. 31(a)).
Step 2: determining an appropriate discount rate to apply to those cash flows so that they are stated in
present value terms (IAS 36, para. 31(b)).
The estimation of future expected cash flows and determination of an appropriate discount rate represent
areas where significant professional judgment is required under IAS 36.
Step 1: future cash inflows and outflows
Factors to consider in value in use calculations
The following five elements, or factors, in Table 7.7 are considered when calculating the value in use of an
asset (IAS 36, para. 30).
Element Where taken into account
Estimated future cash flows expected to be derived Future cash flows
from an asset (IAS 36, para. 30 (a))
Expectations about possible variations in the amount Future cash flows or discount rate
or timing of those future cash flows (IAS 36, para.
30(b))
The time value of money (IAS 36, para. 30(c)) Discount rate
The price for bearing the uncertainty inherent in the Future cash flows or discount rate
asset (IAS 36, para. 30(d))
Other factors, such as illiquidity, that market Future cash flows or discount rate
participants would reflect in pricing the future cash
flows the entity expects to derive from the asset (IAS
36, para. 30(e))

Traditional approach: addressing the items in the table above by identifying an interest rate that is
proportionate to the risk. This approach is difficult to apply where no market for the asset exists or in
circumstances where there are no assets with similar characteristics
Expected cash flow approach: this approach is based on forming expectations about possible cash flows rather
than about the single most likely cash flow, with the possible cash flows assigned probability weightings.
This approach is subject to a cost-benefit constraint.

Estimating future cash flows

Requirement Principles
Base cash flow  Based ‘on reasonable and supportable assumptions that represent
projections management’s best estimate of the range of economic conditions that will
exist over the remaining useful life of the asset’ (IAS 36, para. 33(a))
 ‘Greater weight … given to external evidence’ than management
expectations (IAS 36, para. 33(a))
 Based on the ‘most recent financial budgets/forecasts approved by
management’ (IAS 36, para. 33(b))
 Must exclude cash flows ‘expected to arise from future restructurings or
from improving or enhancing the asset’s performance’ (IAS 36, para. 33(b))
 Must ‘cover a maximum period of five years, unless a longer period can be
justified’ (IAS 36, para. 33(b))
 Cash flow projections must take into account management’s accuracy in
estimating past cash flows
Cash flows beyond the  Estimated by ‘extrapolating the projections based on the budgets/ forecasts
budget/forecast period using a steady or declining growth rate for subsequent years, unless an
increasing rate can be justified’
 Growth rate to ‘not exceed the long-term average growth rate for the
products, industries or country … in which the entity operates … unless a
higher rate can be justified’ (IAS 36, para. 33(c))
Composition of future cash flows (p385)
Cash flows included Cash flows excluded
 ‘Cash inflows from the continuing use of asset’  Cash flows that are generated by a different, and
(IAS 36, para. 39(a)) independent asset (IAS 36, para. 43(a))
 ‘Cash outflows … necessarily incurred to  Cash outflows relating to obligations for which a
generate the cash inflows from continuing use’ liability has been recognised (e.g. payables,
(IAS 36, para. 39(b)) pensions or provisions) (IAS 36, para. 43(b))
 Net cash flows from disposing asset ‘at end of  Cash outflows relating to ‘a future restructuring
its useful life’ (IAS 36, para. 39(c)) to which an entity is not yet committed’ (IAS 36,
para. 44(a))
Note: Includes cash flows directly attributed  Future capital expenditures that will ‘improve or
to the asset or allocable ‘on a reasonable enhance’ the performance of the asset beyond
and consistent basis to the asset’, including its current condition (IAS 36, para. 44(b))
an appropriate proportion of future  No tax or financing flows should be included
overheads (IAS 36, para. 39(b))

Inflation
Match the discount rate to the cash flows (real or nominal).
Note that specific price inflation (i.e. increases or decreases that are particular to an asset) exist in cash flows
whether expressed in real or nominal terms.
Current asset condition
Future cash flows are ‘estimated for the asset in its current condition’ (IAS 36, para. 44) – i.e. would include
maintenance capex (routine maintenance)
Excluded from value in use calculations are estimated future cash inflows or outflows arising from:
 a future restructuring to which an entity is not yet committed; or
Note if it was committed – you include the impacts (benefit and costs) of the restructure in the calc
 future capital expenditures that will improve or enhance the performance of the asset beyond its
current condition (IAS 36, para. 44).
Disposal value
Disposal value: the amount that an entity expects to obtain from the disposal of the asset in an arm’s length
transaction between knowledgeable, willing parties, after deducting the estimated costs of disposal (IAS 36,
para. 52).
Can use previous current prices and costs for similar assets that have reached the end of their useful lives as at
the date of the value in use estimate and been used in a similar manner to that in which the asset is expected
to be used (IAS 36, para. 53).
Foreign currency cash flows
Estimate the future cash flows ‘in the currency in which they will be generated and then discounted at a rate
appropriate for that currency’ (IAS 36, para. 54). The resulting present value is then translated using the spot
exchange rate at the date of the value in use calculation (IAS 36, para. 54).

Step 2: Determining an appropriate discount rate (p387)

The discount rate must be a pre-tax rate (IAS 36, para. 55)
Reflect the current market assessments of:
(a) the time value of money; and
(b) the risks specific to the asset for which the future cash flow estimates have not been adjusted’ (IAS
36, para. 55).
Where an asset-specific rate is not available, IAS 36 specifies that the following ‘surrogate’ (substitute) rates
can be used:
(a) the entity’s WACC determined using techniques such as CAPM;
(b) the entity’s incremental borrowing rate; and
(c) other market borrowing rates (IAS 36, Appendix A, para. A17).
These ‘surrogate’ rates must be adjusted to:
 ‘reflect the way that the market would assess the specific risks associated with’ the projected cash
flows (including ‘country risk, currency risk and price risk’); and
 ‘exclude risks that are not relevant to the asset’s estimated cash flows or for which the estimated
cash flows have already been adjusted’, such as the entity’s credit risk, which are not relevant to the
market’s assessment of the risks specific to the asset (IAS 36, Appendix A, para. A18).
Capital structure: the discount rate must be independent of the entity’s capital structure and the way that it
has financed the purchase of the asset.

Recognising and measuring an impairment loss p388

An impairment loss is recognised to the extent that an asset’s carrying amount exceeds its recoverable amount
(IAS 36, para. 59). This loss is immediately recognised in profit or loss, unless the asset is carried at a revalued
amount (IAS 36, paras 60 and 61).
Where the asset is revalued: any impairment loss of the revalued asset is treated as a revaluation decrease
under that other standard (IAS 36, para. 60):
1. the loss is recognised in other comprehensive income as a reduction in the asset revaluation surplus
to the extent that the loss is covered by the surplus
2. Any amount not covered by the reserve is charged to profit or loss (IAS 36, para. 61).

Account entries
Dr Impairment loss xxx
Cr Accumulated impairment loss (or Asset*) xxx
* Alternatively, the credit entry could have been processed against the asset account.

Reversals of impairment losses p389

IAS 36 requires entities to review whether a previously recognised loss may have reversed, either wholly or
partially (IAS 36, para. 110). If any indication of reversal exists, the entity is required to formally estimate an
asset’s recoverable amount.
Indications of reversal exist when:
1. an indication that an impairment loss has reversed occurs when ‘there are observable indications that
the asset’s value has increased significantly during the period’ (IAS 36, para. 111(a)); or
2. ‘evidence is available from internal reporting that indicates that the economic performance of the
asset is, or will be, better than expected’ (IAS 36, para. 111(e)).
There are constraints on the amount of a reversal of an impairment loss that can be recognised. A reversal is
limited to the lower of the:
 recoverable amount; and
 carrying amount of the asset, net of amortisation or depreciation, had no impairment been
recognised (IAS 36, para. 117).
Cannot reverse the impairment of goodwill.
Step 1: Recognise an impairment Impairment loss = Carrying Amount – Recoverable Amount
loss Dr. Asset revaluation reserve (OCI) xxx (reduce to zero if any)
Dr. Impairment loss (P/L) xxx
Cr. Accumulated impairment loss xxx
Step 2: Depreciation after Go forward depreciation is based on the Recoverable Amount above
impairment Dr. Depreciation expense (P/L) xxx
Cr. Accumulated depreciation xxx
Step 3: Reversal of a previously 1. Reversal = limited to the lower of a) and b)
recognised impairment loss after a a) The reassessed Recoverable Amount; AND
new recoverable amount estimate b) The ‘should-be’ Carrying Amount of the asset, net of depreciation or
amortisation, if the original impairment loss were not recognized.

1-a) For assets measured at cost in Step 1:

Dr. Accumulated impairment loss xxx
Cr. Reversal of impairment loss (P/L) xxx

1-b) For assets measured at a revalued amount in Step 1:

Dr. Accumulated impairment loss xxx
Cr. Asset revaluation reserve (OCI) xxx

2. No reversal for goodwill.

PART C: Impairment of CGUs p392

Recoverable amount: individual amount or CGU? p392

IAS 36 requires the recoverable amount to be determined on an individual asset basis (IAS 36, para. 66), unless
this is not possible because:
(a) the asset’s value in use cannot be estimated to be close to its fair value less costs of disposal; and
(b) the asset does not generate cash inflows that are largely independent of those from other assets (IAS
36, para. 67).

Identifying CGUs p393

CGU: the smallest identifiable group of assets that generates cash inflows that are largely independent of the
cash inflows from other assets or groups of assets (IAS 36, para. 6).
This definition requires entities to consider the lowest level of aggregation of assets that work together to
generate their own cash inflows (note this requires professional judgement)
The following key factors should be considered:
 At what level does management monitor the entity’s operations? For example, is it by product lines,
businesses or geographical areas?
 At what level does ‘management make decisions about continuing or disposing of the entity’s assets
and operations’ (IAS 36, para. 69)?
Active market for output produced: a market in which transactions for the asset or liability take place with
sufficient frequency and volume to provide pricing information on an ongoing basis (IFRS 13, Appendix A).
This will be satisfied even if some or all of the output is used internally (IAS 36, para. 70).
Value in use calculations arising from internal transfers of product must be based on an arm’s length transfer
price when estimating cash flows for the relevant CGUs (IAS 36, para. 70).
Change in identified CGUs: Once CGUs are identified, they are consistently applied across reporting periods,
unless a change is warranted, such as a company restructure (IAS 36, para. 72).

Recoverable amount and carrying amount of a CGU (impairment of CGUs) p394

The carrying amount of a CGU must be determined consistently ‘with the way in which its recoverable amount
is determined’ (IAS 36, para. 75).
The two exceptions to the requirement that the carrying amount of a CGU must not include recognised
liabilities are:
 when the sale of a CGU would require a buyer to assume a liability (or liabilities) – reduce the value in
use and carrying amount by the liability (IAS 36, para. 78); and
 when it is only practical to determine the recoverable amount of a CGU by including assets (e.g.
receivables and other financial assets) or liabilities (e.g. payables, pensions or other provisions) (IAS
36, para. 79). In this case, the carrying amount of the CGU is increased for those assets and decreased
for those liabilities.

Testing CGUs with goodwill for impairment

When goodwill has NOT The CGU is tested for impairment whenever there is an indication that the CGU
been allocated to a CGU may be impaired (IAS 36, para. 88) (as for individual assets)
Where there is an indication, the carrying amount of the CGU (excluding any
goodwill) is compared to its recoverable amount, and any impairment loss
recognised.
When goodwill has been IAS 36 requires a formal estimate of the recoverable amount of a CGU at least
allocated to a CGU once per year, regardless of whether there is any indication of impairment (IAS
36, para. 10(b)).
IAS 36 also requires that the recoverable amount of a CGU must be formally
estimated whenever there is an indication of impairment (para. 90).
A CGU with an intangible Must be formally estimated at least once per year, regardless of whether there
asset with an indefinite is any indication that the CGU may be impaired (IAS 36, para. 10(a)).
useful life or is not yet
available for use

Timing of impairment tests

In accordance with para. 96 of IAS 36, the following requirements in Table 7.10 apply to the annual testing of
goodwill for impairment.
Scenario Timing of annual impairment test
CGU (or group of CGUs) to which Any time during an annual period, but must be at the same time each
goodwill has been allocated year
Different CGUs may be tested for impairment at different times
throughout the year
Some or all of the goodwill Before the end of the current annual period
allocated to a CGU (or group of
CGUs) arose from a business
combination that occurred during
the current annual period

Impairment of asset within a CGU: if there is an indication of impairment of an asset (excluding goodwill) that
is within a CGU that includes goodwill, the asset is tested for impairment first, and any impairment loss is
recognised on that individual asset before the entire CGU is tested for impairment.
Can use the calculation of the recoverable amount from last period, provided that the following conditions are
satisfied:
(a) the assets and liabilities making up the unit have not changed significantly since the most recent
recoverable amount calculation;
(b) the most recent recoverable amount calculation resulted in an amount that exceeded the carrying
amount of the unit by a substantial margin; and
(c) based on an analysis of events that have occurred and circumstances that have changed since the
most recent recoverable amount calculation, the likelihood that a current recoverable amount
determination would be less than the current carrying amount of the unit is remote (IAS 36, para. 99).
Allocating goodwill to CGUs
As goodwill works with other assets to generate economic benefits, its carrying amount must be allocated to
each CGU that is expected to benefit from the goodwill.
Required to consider:
- Goodwill is allocated to a CGU / CGUs expected to benefit from an acquisition (IAS 36, para. 80)
- Goodwill is allocated to ‘the lowest level’ at which the entity monitors goodwill ‘for internal management
purposes’ (IAS 36, para. 80(a)).
- The CGU / CGUs to which goodwill is allocated cannot be higher than an operating segment (IAS 36, para.
80(b)).
- When a CGU to which goodwill has been allocated includes a number of operations and one of those
operations is disposed of, it may be necessary to consider whether a portion of the goodwill relates to
the operation that has been disposed of (IAS 36, para. 86(a)). This portion of goodwill is determined ‘on
the basis of the relative values … disposed of and the portion of the CGU’ that is ‘retained, unless the
entity can demonstrate that some other method better reflects the goodwill associated with the
operation disposed of’ (IAS 36, para. 86(b)).

Corporate assets
Corporate assets include the head office of an entity, information technology (IT) infrastructure and research
facilities.
The key characteristics of corporate assets are that:
- ‘they do not generate cash inflows independently from other assets or groups of assets’ (similar to
purchased goodwill); and
- ‘their carrying amount cannot be fully attributed to the [CGU] under review’ (IAS 36, para. 100).

Requirements for allocating a corporate cost to a CGU

If the carrying amount of a corporate asset ‘can be allocated to a CGU(s) on a reasonable and consistent basis’,
then do so (IAS 36, para. 102(a)).
If the carrying amount of a corporate asset is not allocable on a reasonable and consistent basis to a CGU(s),
then:
1. test the carrying amount of the CGU, excluding the corporate asset, for impairment and recognise any
impairment loss (para. 102(b)(i)); and
2. determine the smallest group of CGUs to which the corporate asset can be allocated, test for
impairment at this level and recognise any impairment loss. (para. 102(b)(ii) and (iii)).

Identifying and allocating an impairment loss for a CGU

An impairment loss exists if the carrying amount of a CGU (or group of CGUs) to which goodwill or a corporate
asset has been allocated exceeds its recoverable amount.
The process of allocating any impairment loss is as follows:
1. the carrying amount of any goodwill allocated to the CGU (or group of CGUs) is reduced— this is
consistent with the view that the asset most likely to be impaired is goodwill; and
2. the remainder of any impairment loss is allocated on a pro rata basis to other assets in the CGU (or group
of CGUs) on the basis of their carrying amount in that CGU (or group of CGUs) (IAS 36, para. 104).
IAS 36 places an important constraint on the amount of an impairment loss that can be allocated to an
individual asset. The standard provides that the carrying amount of an asset cannot be reduced below the
highest of:
- its fair value less costs of disposal (if these costs are measurable);
- its value in use (if this can be determined); and
- zero (IAS 36, para. 105).
Allocating an impairment loss to individual assets in the CGU

Step 1: Impairment loss = Carrying Amount of (goodwill + net assets) – Recoverable Amount

Step 2a: Allocate the impairment loss to the asset most likely to be impaired (if it is evident); OR

Step 2b: Allocate the impairment loss to reduce the CA of goodwill allocated to the CGU;

Step 3: Allocate the remainder of the impairment loss to other assets (including corporate assets
and intangible assets) in the CGU on a pro rata basis

NOTE: The Carrying Amount of an asset cannot be reduced below the highest of:
1. Its fair value less costs of disposal;
2. Its value in use; AND
3. Zero.

Intangible assets
Impairment testing for intangible assets is similar to impairment testing for goodwill, with the following
differences:
- Previously recognised impairment losses may be reversed (IAS 36, para. 114).
- Intangible assets should be allocated to individual CGUs rather than to groups of CGUs, unless the
intangible asset meets the definition of a ‘corporate asset’.
- Impairment losses are not allocated to intangible assets first. Rather, they are allocated on a pro rata
basis to all assets in the CGU (IAS 36, paras 104 and 105).

Reversal of impairment losses

The reversal of an impairment loss for a CGU is allocated to the assets of the CGU, except for goodwill, on a
pro rata basis according to the carrying amounts of those assets. Those reversals are treated as reversals of
impairment losses on individual assets.
When a reversal of an impairment loss for a CGU is allocated, the carrying amount of an asset cannot be
increased above the lower of its recoverable amount and the carrying amount if no impairment loss was
recognised in previous years. Any remaining reversal not otherwise allocated to the asset is allocated on a pro
rata basis to the other assets of the CGU other than goodwill.
Cannot reverse an impairment of goodwill.
PART D: IAS 36 – disclosure p404

Disclosures of impairment losses and reversals p404

IAS 36 requires numerous disclosures when an entity recognises an impairment loss in its financial report. For
example, for each class of assets, the financial report must disclose the following:
(a) The amount of impairment losses (in P&L and OCI)
(b) The amount of reversals of impairment losses (in P&L and oCI)
(c) The amount of impairment losses on revalued assets (in OCI); and
(d) the amount of reversals of impairment losses on revalued assets (in OCI) (IAS 36, para. 126).

An entity that reports segment information under IFRS 8 is required to disclose the following for each
reportable segment:
(a) the amount of impairment losses recognised in profit or loss and in other comprehensive income
during the period; and
(b) the amount of reversals of impairment losses recognised in profit or loss and in other comprehensive
income during the period (IAS 36, para. 129).
For an individual asset or CGU in respect of which an impairment loss has been recognised, or reversed, during
a period, the following disclosures are required:
- events and circumstances (e.g. internal or external to the entity) that resulted in the need for the
impairment loss (or reversal);
- the amount recognised or reversed;
- the nature of the impaired asset and, for an entity that reports segment information under IFRS 8, the
reportable segment to which the asset has been allocated;
- for a CGU:
o a description of the CGU (e.g. whether it is a product line or geographical area);
o the amount recognised by class of assets and, for an entity that reports segment information
under IFRS 8, the amount recognised by reportable segment;
o if the assets that make up a CGU have changed, a description of how the composition of
assets has changed and the reasons for the change

Detail on the basis of calculating the recoverable amount:

Fair value in use less cost of disposal: details regarding the fair value measurement (e.g. the level of the fair
value hierarchy in IFRS 13 to which the fair value measurement is categorised and, for certain levels within that
hierarchy, key assumptions made in estimating fair value);
Value in use: the discount rate(s) used in estimating both the current and previous (if any) value in use.

Disclosures of estimates used to measure recoverable amounts in CGUs

When an entity has goodwill or intangible assets with an indefinite useful life, IAS 36 requires significant
additional disclosures.
Disclosures include the key assumptions made by management in estimating the future cash flows of such
assets. The provision of such disclosures may involve management exercising high levels of professional
judgment.
Financial Reporting – practice questions
Question 1
A property which cost $1 300 000 is measured for reporting purposes at $2 million, which is the
amount of cash (or cash equivalents) that could be obtained by selling the property in an orderly
disposal.
Which measurement basis does this describe?
A current cost
B historical cost
C realisable value
D present value of future cash flows
Question 2
Users of Green Co's financial statements can compare the market price used to measure its equity
shareholding in Blue Co, a listed company to that company's quoted share price as at the reporting
date.
Which characteristic of financial information does this reflect?
A timeliness
B verifiability
C comparability
D understandability
Question 3
Which of the following statements is true in accordance with the Conceptual Framework?
A Individual primary users have different and possibly conflicting information needs.
B General purpose financial reports are designed to show the value of the reporting entity.
C General purpose financial statements must provide all the information that existing and
potential investors need.
D Focusing on common information needs prevents the reporting entity from including
additional information that might be useful to a particular subset of primary user.
Question 4
Which of the following statements is incorrect in relation to the IASB Conceptual Framework for
Financial Reporting?
A It facilitates consistency in financial reporting.
B It is applied by auditors to help them to form their opinion.
C It provides a framework for the formulation of accounting standards.
D In a conflict with an IFRS the requirements of the Conceptual Framework override those of
the IFRS.
Question 5
Which of the following is NOT a constraint on the concept of a conceptual framework for financial
reporting?
A Its application may only benefit certain groups.
B A framework is time-consuming and costly to develop.
C There is a historical lack of consistency between accounting standards.
D External regulators impose their own desires on reporting requirements.
Question 6
Which of the following transactions are material to Skipton Co, which has reported net assets of
$1.9 million and profits of $450 000?
1 a loan to a director of $10 000
2 sales to a customer of which represent 25 per cent of total sales
3 share options currently worth $25 000 issued to middle-grade employees
A 2 only
B 1 and 2 only
C 1 and 3 only
D 2 and 3 only
Question 7
An entity must disclose the accounting policies adopted in the preparation of its financial reports.
Which of the qualitative characteristics does this requirement reflect?
A relevance
B verifiability
C comparability
D faithful representation
Question 8
Stanza Co operates a scheme under which certain employees may qualify for long-service leave. In
accordance with IAS 19 Employee Benefits, how should the liability for long-service leave be
measured, assuming that the company does NOT hold any assets specifically to fund long-term
employee benefits?
A at fair value
B at historic cost
C at present value
D at settlement value
Question 9
Craswall Co has acquired a substantial plot of land. The company's management does not intend to
sell the land or to use it in any way in the near future. Craswall does not own any other similar
properties.
Which of the following statements is correct?
A The land should be measured at fair value and gains and losses on remeasurement should
be recognised in profit or loss.
B The land should be measured at fair value and gains and losses on remeasurement should
be recognised in other comprehensive income.
C The land may be measured either at its historic cost less accumulated depreciation or at its
fair value, in which case gains and losses on remeasurement are recognised in profit or loss.
D The land may be measured either at its historic cost less accumulated depreciation or at its
fair value, in which case gains and losses on remeasurement are recognised in other
comprehensive income.
Question 10
A complete set of financial statements includes a third statement of financial position at the start of the
earliest period presented in which of the following circumstances?
A The year end date has changed.
B The method of depreciating plant has changed from straight line to reducing balance.
C The reporting entity has started reporting operating segment information in line with IFRS 5.
D Management have changed the measurement model applied to investment properties from
the cost model to the fair value model.
Question 11
Which of the following statements is correct?
A There is no requirement for A Co to disclose accounting policies unless they do not conform
to the requirements of IFRS.
B An entity should select its accounting policies by reference to IFRS. If no relevant IFRS
exists, management should apply the requirements of local accounting standards.
C C Co must disclose information about IFRS that have been issued but that are not yet
effective and so have not been applied in the preparation of the financial statements.
D D Co can choose to change the measurement basis applied to property from the
revaluation to the cost model because this will result in information that is more comparable
with information about other non-current assets.
Question 12
Which of the following best describes the disclosures required by IAS 10?
A the nature and financial effect of both adjusting and non-adjusting events, categorised
separately
B the date of authorisation of the financial statements and the nature and financial effect of
nonadjusting events
C the nature and financial effect of adjusting events and any indication that the reporting
entity is not a going concern as a result of a non-adjusting event
D the date of authorisation of the financial statements and any indication that the reporting
entity is not a going concern as a result of a non-adjusting event
Question 13
Which one of the following is disclosed in the statement of changes in equity?
A an exceptional item of expense or income
B tax arising on the revaluation of an owner-occupied property
C adjustments made to correct errors relating to periods before those presented
D dividends received from equity investments measured at fair value through other
comprehensive income
Question 14
In accordance with IAS 10, which of the following provides the minimum disclosure required in respect
of the acquisition of equity shares in Flood Co by Water Co after the reporting date?
A No disclosure is required.
B An event after the reporting date has resulted in a cash outflow of $800 000.
C After the reporting date, Water Co acquired 80 per cent of the equity share capital in Flood
Co.
D After the reporting date, Water Co acquired 80 per cent of the equity share capital in Flood
Co at a cost of $800 000.
Question 15
Ansty Co is a company which builds houses. Its normal operating cycle is 18 months and the year
end is 30 June. The company presents assets and liabilities as current and non-current. According to
IAS 1 Presentation of Financial Statements which of the following assets should be classified as
'current assets' in the statement of financial position at 30 June 20X5?
1 A house constructed by Ansty Co which is expected to be sold in December 20X5
2 A house constructed by Ansty Co which is expected to be sold in July 20X6
A 1 only
B 2 only
C 1 and 2
D neither 1 nor 2
Question 16
The following information has been extracted from Arial Co's draft financial statements for the year
ended 31 December 20X2:
 A production machine was acquired at a cost of $95 000.
 $120 000 was raised through a share issue.
 Tax paid was $45 000.
 Cash receipts from customers was $345 000.
 Payments to suppliers and employees amounted to $120 000.
 A grant of $55 000 was received.
What was net cash flow from operating activities for the year ended 31 December 20X2?
A $140 000
B $180 000
C $235 000
D $250 000
Question 17
Which of the following transactions is NOT within the scope of IFRS 15 Revenue from Contracts with
Customer?
A the sale of a non-controlling equity shareholding owned by a retailer
B the sale of an extended warranty by a manufacturer of electrical goods
C the sale of an investment property owned by a manufacturing company
D an agreement licensing another party to use an anti-virus package created by a software
designer
Question 18
Step 1 of the IFRS 15 five-step model requires the contract with the customer to be identified.
IFRS 15 is applied only if a contract has specific attributes. To which one of the following contracts is
IFRS 15 NOT applied?
A an oral contract with a customer to deliver goods at a specified price with payment on
delivery
B a contract to deliver goods to a customer that entitles the customer to return the goods in
exchange for a full refund
C a contract to receive payment from a corporate customer to invest in continued research
and development. Exactly how the money is spent is at the discretion of the recipient
D a contract with a customer that operates in a region that is suffering severe economic
recession meaning that at the inception of the contract, only 90 per cent of the contract price
is expected to be received from the customer
Question 19
On 25 June 20X9 Cambridge received an order from a new customer, Circus, for products with a
sales value of $900 000. Circus enclosed a deposit with the order of $90 000.
On 30 June Cambridge had not completed credit checks on Circus and had not despatched any
goods. Cambridge is considering the following possible entries for this transaction in its financial
statements for the year ended 30 June 20X9.
1 Create a trade receivable for $810 000.
2 Include $90 000 in revenue for the year.
3 Recognise $90 000 as a contract liability.
4 Include $900 000 in revenue for the year.
5 Do not include anything in revenue for the year.
According to IFRS 15 Revenue from Contracts with Customers, how should Cambridge record this
transaction in its financial statements for the year ended 30 June 20X9?
A 1 and 4
B 2 and 4
C 2 and 5
D 3 and 5
Question 20
Fonesell enters into a contract on 1 September 20X5 to conduct telephone marketing activities on
behalf of a customer. The contract has a price of $8 000 and requires Fonesell to contact 10 000
households over a period of six months in order to enquire about buying habits and promote its
customer. The customer is invoiced equal amounts three months and six months after the
commencement of the contract. By Fonesell's year end of 31 December 20X5, it has contacted 3500
of the 10 000 customers.
What amounts does Fonesell recognise in its financial statements in the year ended 31 December
20X5?
A revenue of $4000 and a receivable of $4000
B revenue of $4000 and a contract liability of $4000
C revenue of $2800, a receivable of $4000 and a contract asset of $1200
D revenue of $2800, a receivable of $4000 and a contract liability of $1200
Question 21
White Company operates an oil rig off Western Australia. As part of its contractual arrangements with
the government, it is required to make good the sea bed when the oil rig ceases to operate after 10
years. There is a 75 per cent likelihood that the costs of making good the seabed will be $2.5 million
(present value $1.9 million) and a 25 per cent likelihood that they will be $1.8 million (present value
1.35 million). What amount of provision should White Co make in respect of the legal obligation?
A $1 762 500
B $1 900 000
C $2 325 000
D $2 500 000
Question 22
In which of the following circumstances is a provision recognised in accordance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets in the financial statements for the year ended
30 September 20X6?
1 the direct costs of a major management restructuring that is due to take place from 1 December
20X6 (the restructuring was announced publicly on 15 September 20X6)
2 warranty costs expected to be incurred in the future as a result of sales in the year ended 30
September 20X7
3 retraining costs to be incurred due to the management restructuring Reliable estimates of costs can
be made in all cases.
A 1 only
B 2 only
C 1 and 3
D 2 and 3
Question 23
Which of the following will NOT give rise to a taxable temporary difference?
A receipt of a non-taxable government grant
B accelerated depreciation of a machine for tax purposes
C prepaid expenses that benefitted from tax relief when paid
D capitalised development costs that were fully relieved for tax purposes when paid
Question 24
Which of the following best describes a temporary difference when applying the balance sheet liability
method of accounting for deferred tax?
A amounts that will be taxable or deductible in future periods
B the amount that will be deductible for tax purposes when the carrying amount of an asset is
recovered
C the difference between the amount attributed to an asset or liability for tax purposes and its
carrying amount
D differences between taxable profit and accounting profit that originate in one period and
reverse in another
Question 25
Which of the following provides an example of an outflow of economic benefits associated with the
reversal of a taxable temporary differences?
A receipt of $300 accrued interest receivable which is taxed on a cash basis
B payment of $500 accrued expenses that are allowable for tax purposes on a cash basis
C receipt of $6000 owed by credit customers; revenue is taxed when recognised as income
D payment of $900 accrued expenses that were allowable for tax purposes when recognised
as an expense for accounting purposes
Question 26
Which of the following correctly describes deferred tax?
A an accounting device
B tax which has been avoided
C tax due back from the tax authority
D tax which will not be paid until the following period
Question 27
On 1 January 20X2 Big Co purchased 100 per cent of the equity shares in Small Co for $2 000 000.
At that date the fair values of the identifiable net assets were as follows:
$'000
Plant and equipment 1 300
Inventory 425
Trade receivables 100
Trade payables and loans 500
The tax base of the above assets and liabilities was equal to their fair value.
Small Co disclosed a contingent liability with a fair value of $150 000 in its financial statements. The
liability was contingent as it was not probable that an outflow of resources would occur. Tax relief will
be given on the $150 000 as and when it is paid. The tax rate is 30 per cent.
What amount is recognised for goodwill at 1 January 20X2?
A $(220 000)
B $675 000
C $780 000
D $825 000
Question 28
Which of the following is NOT a business combination within the scope of IFRS 3?
A Company W is merged into Company X.
B Company T and Company U transfer their net assets to a newly formed entity, Company V.
C An unincorporated entity transfers its net assets to a company in exchange for
consideration.
D The shareholders of Company Y and Company Z sell the shares of Company Z to
Company Y.
Question 29
Which of the following statements are true?
1 The consolidated statement of profit or loss and other comprehensive income should include
dividends paid by subsidiaries to the parent company.
2 The consolidated statement of profit or loss and other comprehensive income should not include
dividends paid by subsidiaries to the parent company.
3 The parent company should not include its share of dividends received from subsidiaries in its
individual company statement of profit or loss and other comprehensive income.
4 The parent company should include its share of dividends received from subsidiaries in its individual
company statement of profit or loss and other comprehensive income.
A 1 and 3 only
B 1 and 4 only
C 2 and 3 only
D 2 and 4 only
Question 30
Which of the following statements concerning the presentation of non-controlling interest in the
consolidated statement of profit or loss and other comprehensive income is correct?
A Only profits attributable to the group appear in the consolidated statement of profit or loss
and other comprehensive income.
B The non-controlling interest share of profit after tax is separately disclosed as a line item
above the group profit before tax for the period.
C Total profit or loss for the year is allocated between profit or loss attributable to owners of
the parent and profit or loss attributable to non-controlling interests.
D The non-controlling interest share of profit after tax is shown as a line item and deducted
from total profit for the period, so that the last line in the consolidated statement of profit or
loss and other comprehensive income is profit or loss attributable to the group.
Question 31
Talbot Co purchased 80 per cent of the equity share capital of Perkins Co on 1 January 20X2. On 31
December 20X2 Perkins Co sold an item of non-depreciable plant with a net carrying amount of $120
000 to Talbot Co for $150 000. The profit for the year in the financial statements of Perkins Co at 31
December 20X2 was $2 000 000. The tax rate is 30 per cent.
What is the non-controlling interest in consolidated profit?
A $394 000
B $395 800
C $1 970 000
D $1 979 000
Question 32
In accordance with IAS 1 Presentation of Financial Statements which of the following does a parent
company have to disclose as a line item in the consolidated statement of profit or loss in respect of its
associates?
A share of revenue
B share of profit after tax
C share of interest payable
D share of profit before tax
Question 33
Monty Co acquired 30 per cent of the share capital of Tiger Co for $75 000 on 1 July 20X8. This
resulted in Monty Co having joint control over Tiger Co. During the year to 30 June 20X9 Tiger Co
made a profit after tax of $270 000 and paid a dividend of $50 000.
What amount will appear in the consolidated statement of financial position of Monty Co at 30 June
20X9 in respect of its investment in Tiger Co?
A $75 000
B $81 000
C $141 000
D $156 000
Question 34
White Co holds 50 per cent of the equity shares in Black Co. The remaining shares are held equally
by Pink Co and Red Co. A contract between White Pink and Red stipulates that a 75 per cent majority
is required in a vote to make decisions about the relevant activities of Black Co.
Which of the following statements best describes the relationship between White Co and Black Co?
A Black Co is not an associate of White Co because there is no evidence of significant
influence.
B Black Co is jointly controlled by White Co, Red Co and Pink Co because these parties are
bound by a contractual arrangement.
C White Co controls Black Co because it has the greatest shareholding in Black Co and no
decision can be passed without White's consent.
D White Co does not jointly control Black Co because it could achieve the necessary 75 per
cent majority of votes by joining with either Red Co or Pink Co.
Question 35
Which of the following are NOT financial liabilities in accordance with IAS 32 Financial Instruments:
Presentation?
A loan notes
B equity shares
C trade payables
D redeemable preference shares
Question 36
Which of the following preference shares are classified as equity in the issuer's financial statements in
accordance with IAS 32 Financial Instruments: Presentation?
A redeemable preference shares with a fixed redemption date
B preference shares that are redeemable on request by the holder
C preference shares that are redeemable at the discretion of the issuer
D preference shares that are redeemable at the discretion of the issuer and the issuer has
informed the holders of its intention to redeem
Question 37
Carroll Co has a financial asset debt investment with a carrying amount of $500 000 based on
measurement at amortised cost. At 31 March 20X6 the financial controller of Carroll Co is unsure
whether the financial asset is at stage 2 or stage 3 of the IFRS 9 credit losses model.
How does the accounting treatment differ if the asset is determined to be at stage 3 rather than stage
2 of the model?
 A The impairment allowance is the same amount, however, interest is calculated on the
carrying amount of the gross asset rather than the carrying amount net of the allowance.
B The impairment allowance is the same amount in both cases, however, interest is
calculated on the carrying amount of the asset net of the allowance rather than the gross
amount.
C Interest is calculated on the carrying amount of the asset net of the allowance in both
cases, however, the impairment allowance is based on lifetime rather than 12 month
expected credit losses.
D The impairment allowance is based on lifetime rather than 12 month expected credit losses
and interest is calculated on the carrying amount of the asset net of the allowance rather than
the gross amount.
Question 38
Which of the following disclosures is NOT required by IFRS 7 Financial Instruments: Disclosures?
A the carrying amount of any financial assets that have been pledged as collateral
B the amount of impairment loss recognised in the period for each class of financial asset
C the original cost of any equity investments measured at fair value through profit or loss or
fair value through other comprehensive income
D where a financial liability is measured at fair value through profit or loss, the difference
between carrying amount and the amount that the reporting entity is contractually required to
pay at the maturity of the liability
Question 39
Which of the following are the main components of market risk, in accordance with IFRS 7 Financial
Instruments: Disclosures?
A credit risk and liquidity risk
B currency risk and credit risk
C interest rate risk and liquidity risk
D interest rate risk and currency risk
Question 40
Which of the following is a primary financial instrument?
A a contract to swap a fixed rate of interest on a notional $1 million for a variable rate
B a contract to buy 2 million Euro at a fixed date in the future at a specified exchange rate
C a contract to deliver a fixed number of ordinary shares in the future equal to a fixed
currency amount
D a contract giving the holder the option to sell 500 troy ounces of gold on a fixed date in the
future at a specified price
Question 41
8 What is the impairment loss (if any) relating to G Co's property, plant and equipment in this
situation?
$'000
Carrying amount 900
Fair value less costs of disposal 600
Value in use 800
A $Nil
B $100 000
C $200 000
D $300 000
Question 42
9 Barton Co recognised goodwill of $210 000 on the acquisition of another business, which qualified
as a CGU several years ago. Last year as a result of poor trading conditions the goodwill was written
down to $90 000. Barton Co now wishes to reverse the impairment loss on the basis that internal
reporting suggests that the economic performance of the business will be better than expected.
Which of the following statements is true?
A A reversal an impairment loss is permitted at the discretion of the management; this results
in a revised carrying amount of goodwill of $210 000.
B The reversal of an impairment loss that originally arose on the goodwill of a CGU is not
permitted as this represents internally generated goodwill.
C An impairment loss on a CGU can be reversed, however it must be attributed to the other
assets of the CGU rather than recognised as an increase in the carrying amount of goodwill.
D A reversal of the full $120 000 loss can be recognised in this instance and attributed to
goodwill, as there is evidence that the original factors that indicated impairment no longer
apply.
Question 43
13 In accordance with IAS 36 Impairment of Assets which of the following must be tested for
impairment annually?
A a brand name that is being amortised over 10 years
B non-depreciable land held for an undetermined use
C a machine that has previously suffered an impairment loss
D capitalised costs associated with an ongoing development project
Question 44
16 M Co owns two production plants, N and O. A significant component used in the final product
produced by O is a component produced by N. 85 per cent of O's final production is sold to customers
outside the entity. 70 per cent of the components produced by N are sold to O with the remainder
being sold to external customers. N could sell the components sold to O to external customers.
Based on this information which of the following statements is true in accordance with IAS 36
Impairment of Assets?
A The cash-generating unit is M Co as a whole.
B N and O are likely to be separate cash-generating units.
C N and O together are likely to be a cash-generating unit.
D O is likely to be a separate cash-generating unit. N will form part of the cash-generating unit
of M Co.
Question 45
27 An asset's value in use is the present value of the future cash flows expected to be derived from it.
According to IAS 36 Impairment of Assets, which of the following items should be included in the
calculation of value in use?
A income tax payments and cash inflows from the continuing use of the asset
B cash inflows from the continuing use of the asset and net cash flows to be received from
the disposal of the asset at the end of its useful life
C cash inflows from the continuing use of the asset and cash flows expected to arise from
improving or enhancing the asset's performance
D cash inflows from the continuing use of the asset and net cash flows to be received from
the disposal of the asset at the end of its useful life and income tax payments
Answers
1 C Conceptual Framework (4.55c)
2 B Verifiability exists if observers can reach a consensus that information is faithfully
represented.
In this case, financial information is directly verifiable by confirming to quoted price.
3 A Conceptual Framework (OB 7 and 8)
4 D In a conflict, the requirements of the IFRS override those of the Conceptual Framework.
5 C A conceptual framework addresses the issue of historical inconsistency between
accounting standards through the application of core principles when standards are being
amended OR revised. Therefore this is not constraint, but an advantage of a conceptual
framework.
6 B Transactions may be material by nature or by amount. A transaction with a director is
generally regarded as material, even where the amount is not numercially significant,
because directors are engaged to run a company by its shareholders. The sales
transaction is material by amount. The transaction with employees is not material by
nature or amount.
7 C The disclosure of accounting policies enables users to compare the financial statements
of one entity with those of another.
8 C IAS 19 states that long-term employee benefit obligations (liabilities) such as these
should be measured at the present value of the obligation at the reporting date.
9 C Land held for a currently undetermined use meets the definition of investment property.
IAS 40 states that an entity may use either the cost model (in accordance with IAS 16) or
the fair value model to measure investment property. The fair value model is not the
same as the revaluation model in IAS 16. Changes in fair value are recognised in profit or
loss, rather than in other comprehensive income. Note that all assets in the category
must be treated in the same way.
10 D A third statement of financial position forms part of a complete set of financial statements
when there has been retrospective application of a new accounting policy or retrospective
correction of an error.
11 C A: All significant accounting policies should be disclosed.
B: Where no IFRS exists, management judgment should be applied to select accounting
policies; reference should be made to the Conceptual Framework and management may
also consider national standards however there is no requirement to apply them.
12 B Disclosures relating to adjusting events are updated, however the requirement to
disclose nature and financial effect relates only to non-adjusting events. An event that
indicates that the going concern assumption no longer applies results in the financial
statements being presented on a different basis.
13 C Exceptional income and expenses and dividends received are recognised in profit or loss.
Tax arising on a revaluation surplus forms part of other comprehensive income and so is
included within an aggregate figure for other comprehensive income in the statement of
changes in equity, however, it is not separately disclosed.
14 D In the case of a material non-adjusting event, the nature of the event and an estimate of
its financial effect must be disclosed.
15 C As the company is a house builder both properties represent inventory. Property 1 is
realised within 12 months of the period end. Property 2 is realised after 12 months but
within the normal operating cycle for the business. Both are therefore current assets. (IAS
1 (66) and (68))
16 C The acquisition of a machine is an investing activity.
The share issue is a financing activity.

Cash receipts from customers 345 000

Payments to suppliers and employees (120 000)
Grant income 55 000
Tax paid (45 000)
Net cash flow from operating activities 235 000
17 A The sale of a non-financial asset, such as investment property or plant and equipment,
falls within the scope of IFRS 15. Contracts relating to financial instruments and group
interests are, however, out of scope.
18 C A contract may be oral, written or implied and must be between an entity and its
customer.
The contract must:
 be approved by the parties to it
 have commercial substance
 identify each parties' rights and payment terms.
In addition, it must be likely that the entity will collect consideration that it is entitled to
(although this may be subject to a price concession, as in cases B and D).
In the case of C, although the contract is with a customer, that customer is not acting in
the capacity of customer within the context of the contract. This is because the payment
to be made is not in exchange for goods or services.
19 D No sale has taken place as control of the goods has not been transferred, but Cambridge
must recognise a contract liability to reflect the fact that it is has received $90 000 prior to
transferring goods to its customer.
20 C Revenue should be recognised as the contract progresses using either input or output
methods. Time elapsed (as opposed to hours worked on contract) is not an appropriate
method to assess progress. The number of calls made as a proportion of all calls is an
appropriate output method and therefore 35 per cent of revenue is recognised. As the
amount invoiced exceeds the performance obligation that has been satisfied, a contract
liability is also recognised.
21 B This is a single obligation and so the best estimate of the liability is $2.5 million. An
expected values approach would be used if the provision related to a large population of
items. IAS 37 requires discounting of a provision where the time value of money is
material therefore the initial provision is $2.5 million discounted to $1.9 million.
22 A Direct costs of a management restructuring which has been announced publicly are
provided for. The public announcement creates a constructive obligation
Warranty costs are not provided for as they relate to sales that have not yet taken place
ie there is no past event.
Retraining costs are not provided for as there is no present obligation to provide these
costs.
23 A Receipt of a government grant creates a permanent difference between accounting and
taxable profits. The other options all create temporary differences and so give rise to
deferred tax liabilities.
24 C B describes the tax base of an asset; C is driven by the statement of profit or loss rather
than statement of financial position and so does not refer to the balance sheet liability
method.
25 B A initially resulted in a deductible temporary difference (carrying amount of $300 and tax
base of nil). The receipt is therefore a reversal of a deductible temporary difference. This
results in an inflow of economic benefits (the receipt of the interest).
B initially resulted in a taxable temporary difference (carrying amount of ($500) and tax
base of nil). The payment is therefore a reversal of a taxable temporary difference. This
results in an outflow of economic benefits (the payment of the accrued expenses).
No temporary difference arose in the case of C – the carrying amount of $6000 was equal
to the tax base of $6000; no temporary difference arose in the case of D – the carrying
amount of ($900) was equal to the tax base of ($900).
26 A Deferred tax does not affect the amount of tax actually payable in the period. It is an
accounting measure used to match the tax effects of transactions with their accounting
impact.
27 C $'000
Fair value of identifiable net assets: (1300 + 425 + 100 – 500) = 1 325
Less contingent liability (150)
Add deferred tax asset (150 x 30%) = 45
1 220
2 000 000 – 1 220 000 = $780 000
In line with IFRS 3 the contingent liability is recognised as part of the fair value of assets
and liabilities acquired by Big Co, provided it is a present obligation from past events and
can be reasonably estimated.
28 D A business combination is a transaction or event in which an acquirer obtains control of a
business. Mergers are also business combinations. There is no transfer of control in the
case of D; the same shareholders control Company Z before and after the transaction.
29 D The parent company should include dividends received from subsidiaries in its profit or
loss as this is valid income for it as an individual company.
The consolidated profit or loss should not include dividends paid by subsidiaries. They
are intra-group items.
30 C The full results of the subsidiary are included within the consolidated statement of profit or
loss and other comprehensive income, in order to show the total profit or loss and total
comprehensive income for the period. Profit or loss for the period and total
comprehensive income for the period is then allocated between that attributable to
owners of the parent and that attributable to non-controlling interests.
31 B $
NCI share of profit for the year (20%  $2 000 000) 400 000
NCI share of unrealised profit on disposal of plant (20%  $30 000) (6 000)
NCI share of reduction in deferred tax liability due to elimination of unrealised profit and
so reduction in carrying amount of plant (20%  $30 000  30%)
1 800
395 800
32 B Other disclosures are required in the notes to the financial statements but not in the
consolidated statement of profit or loss and other comprehensive income.
33 C $
Cost of investment 75 000
Share of post-acquisition retained earnings: ((270 000 – 50 000) x 30%) = 66 000
Total 141 000
34 D Joint control only exists where there is a contractual agreement between parties and the
unanimous consent of the controlling parties is required in order to make decisions about
relevant activities. Since White Co could join with either Red Co or Pink Co to make
decisions, there is no unanimous consent and this is not a joint arrangement.
White Co does not control Black Co because its vote can be blocked by Red Co and Pink
Co opposing it.
White Co is assumed to have significant influence over Black Co by virtue of its 50 per
cent shareholding.
35 B Equity shares do not carry a contractual obligation to transfer cash. Dividends on equity
shares are paid at the discretion of the issuing entity.
36 C There is no present obligation for the issuer to redeem the shares and therefore they
are not a liability.
37 B At stage 2 the impairment allowance is based on lifetime expected credit losses and
interest is calculated on the gross carrying amount of the asset; at stage 3 the impairment
allowance is based on lifetime expected credit losses and interest is calculated on the
carrying amount of the asset net of allowance.
38 C IFRS 9 does not require disclosure of the original cost of any financial instrument
measured at fair value.
39 D The other risks are mentioned in IFRS 7 Financial Instruments: Disclosures, but are not
main components of market risk.
40 C A, B and D are all derivative financial instruments and share the following characteristics:
 Their value changes in response to an underlying item (the variable interest rate
in A, exchange rate in B and market price of gold in D).
 Initial investment is nil or a nominal amount.
 It is settled at a future date.
41 B If the asset's recoverable amount is higher than the carrying amount then there is no
impairment; recoverable amount is measured as the higher of fair value less costs of
disposal and value in use.
In this case the recoverable amount is $800 000, leading to an impairment loss of
$100 000.
42 B An impairment loss relating to goodwill can never be reversed.
43 D Capitalised costs associated with an ongoing development project represent an intangible
asset that is not yet available for use. IAS 36 requires that such assets are tested
annually for impairment.
44 B N could sell its products in an active market and therefore could generate independent
cash flows.
45 B Refer to IAS 36 Impairment of Assets