21 Financial Reporting

Question 1

IAS 1 - Presentation of financial statements - what do they need to contain?

Answer 1

• 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
• explanatory notes
• comparative information

Question 2

IAS 1 - Going Concern - key points

Answer 2

The financial statements are normally prepared assuming that the entity is a going concern and will continue into the foreseeable future

Significant uncertainties about an entity’s future as a going concern must be disclosed in the notes to the financial statements

Question 3

IAS 1 - Break up Basis - key points

Answer 3

The break-up basis of accounting shall be used if management intends to liquidate the company or has no realistic alternative to do so. This will mean:

-Assets will be valued at their break up values
- All assets and liabilities will become current
- Additional liabilities may need to be recognised for the costs of liquidation redundancies and legal costs

Question 4

IAS 2 - Inventories

Answer 4

IAS 2 requires inventories to be valued at the lower of cost and net realisable value.

Costs include the costs of purchase, costs of conversion and costs incurred in bringing the inventories to their present location and condition.

Question 5

IAS 2 Inventories - how are they reported if affected by FX changes

Answer 5

Non monetary assets therefore:

translated at date of purchase
If impaired retranslate @ current date
(NB inventories susceptible to impairment - electronics, especially computers)

Question 6

IAS 10 Events after the reporting period

Answer 6

IAS 10 includes a number of examples of investment and financing issues for which accounts would need to be adjusted or for which disclosure would need to be made.

These disclosures provide investors with additional important information that may significantly impact on investment decisions.

Question 7

IAS 10 - Events after the reporting period

Examples of adjusting events

Answer 7

• Subsequent evidence of impairment of assets
• Subsequent determination of the costs of assets

Question 8

IAS 10 - Events after the reporting period

Examples of events requiring disclosure (non-adjusting events)

Answer 8

• a major business combination
• announcing a plan to discontinue an operation
• major purchases of assets
• destruction of assets
• abnormally large changes in asset prices or foreign exchange rates

Question 9

IAS 10 - What does it say about going concern?

Answer 9

In relation to going concern, IAS 10 , Events after the reporting period states that where operating results and the financial position have deteriorated after the reporting period it may be necessary to reconsider whether the going concern assumption is appropriate in the preparation of the financial statements.

Question 10

IAS 19 - Employee benefits
Two elements of IAS 19 are particularly relevant to remuneration structures:

Answer 10

a) short term employee benefits (due within 12m from the end of period in which employee provides services) such as wages, bonuses, paid hols, non monetary benefits (cars, health) should be treated as an expense, with a liability recognised for any unpaid balance at the year end.

b) Post employment benefits such as pensions and post retirement health cover. Pension plans can be either defined contribution or defined benefit.

Question 11

IAS 19 - Defined contribution schemes

Answer 11

Contributions by an employer into a defined contribution plan are made in return for services provided by an employee during the period. The employer has no further obligation for the value of the assets of the plan or the benefits payable.

The entity should recognise the contributions payable as an expense in the period in which the employee provides services (except to the extend that labour costs may be included within the cost of assets).

A liability should be recognised where contributions arise in relation to an employee’s service but remain unpaid at the period end.

Question 12

IAS 19 - Defined benefit schemes

Answer 12

Characteristics of a defined benefit plan are as follows:
- The amount of pension paid to retirees is defined by reference to factors such as length of service and salary levels (ie it is guaranteed)
- Contributions into the plan are therefore variable depending on how the plan is performing in relation to the expected future obligation (ie if there is a shortfall, contributions will increase and vice versa)

IAS 19 requires that the defined benefit plan is recognised in the sponsoring entity’s statement of financial position as either a liability or an asset depending on whether the plan is in deficit or surplus.

Question 13

IAS 21 The effects of changes in foreign exchange rates

What is a functional currency?

What is a presentation currency?

Answer 13

Functional currency: The currency of the primary economic environment in which the entity operates.

Presentation currency: The currency in which financial statements are presented.

Question 14

IAS 21 The effects of changes in foreign exchange rates

Initial Recognition

Answer 14

An entity is required to recognise foreign currency transactions in its functional currency. The entity should achieve this by translating the foreign currency amount at the spot exchange rate between the functional currency and the foreign currency at the date on which the transaction took place.

Where an entity has a high volume of transactions in foreign currencies, translating each transaction may be an onerous task, so an average rate may be used. Similarly, a business whose sales occur relatively evenly throughout the year (i.e., its business is not
seasonal) could use an average rate for the year rather than using an actual rate for every transaction.

Question 15

IAS 21 The effects of changes in foreign exchange rates

Subsequent Recognition

Answer 15

At each subsequent reporting date, the following rules should be applied.

(a) Foreign currency monetary items should be translated and then reported using the closing rate. Any exchange difference is taken to profit or loss.
(b) Non-monetary items carried at historical cost are translated using the exchange rate at the date
of the transaction when the asset or liability arose.
(c) Non-monetary items carried at fair value are translated using the exchange rate at the date
when the fair value was determined.

Question 16

Foreign Operations

IAS 21 identifies the appropriate exchange rate which should be used for translating the financial statements of the foreign operation into the reporting entity’s presentation currency.

The following procedures should be followed to translate an entity’s financial statements from its functional currency into a presentation currency:

Answer 16

 Translate all assets and liabilities (both monetary and non-monetary) in the current statement of financial position using the closing rate at the reporting date.

 Translate income and expenditure in the current statement of profit or loss and other comprehensive income using the exchange rates ruling at the transaction dates. (An
approximation to actual rate is normally used; being the average rate.)

 Report the exchange differences which arise on translation as other comprehensive income.

Question 17

IAS 23 Borrowing costs
Accounting treatment

Answer 17

Borrowing costs must be capitalised as part of the cost of the asset if they are directly attributable to
acquisition/construction/production. Other borrowing costs must be expensed.

Borrowing costs eligible for capitalisation are those that would have been avoided otherwise.

Amount of borrowing costs available for capitalisation is actual borrowing costs incurred less any investment income from temporary investment of those borrowings.

Capitalisation is suspended if active development is interrupted for extended periods. (Temporary
delays or technical/administrative work will not cause suspension.)

Capitalisation ceases (normally) when physical construction of the asset is completed. When an asset
is comprised of separate stages, capitalisation should cease when each stage or part is completed.

Question 18

IAS 23 Borrowing Costs

Disclosure Required

Answer 18

Amount of borrowing costs capitalised during the period

Capitalisation rate used to determine borrowing costs eligible for capitalisation

Question 19

IAS 24 Related party disclosures

Defintion of a related party

Answer 19

A related party is a person or entity that is related to the reporting entity, for example
 An entity or person that has control, joint control or significant influence over the reporting
entity
 Any entity in the same group as the reporting entity
 One entity is an associate or joint venture of the other entity
 Both entities are joint ventures of the same third party
 Post-employment benefit plans for the benefit of the entity’s employees
 A member of key management personnel
 Close family members of the above
 Shareholders controlling more than 20% of the voting rights of the entity

Question 20

IAS 24 Related party disclosures

The following are not necessarily related parties

Answer 20

 Two entities simply because they have a director in common
 Two venturers simply because they share joint control over the same joint venture
 Providers of finance, trade unions, public utilities and government agencies
 A customer or supplier on whom the entity has significant economic dependence.

Question 21

IAS 24 Related party disclosures

Required disclosures

Answer 21

Where there have been related party transactions, disclosures should be made of:

 The nature of the relationship

 The amount of the transaction including any outstanding balances

 Any amounts written off or provided for including the related expense

Question 22

IAS 32 Financial instruments: presentation

Definitions
Financial instruments fall into 3 categories:

Answer 22

(1) Financial assets: e.g. cash, an equity instrument of another entity (e.g. shareholding in another
company), a contractual right to receive cash or another financial asset from another entity, e.g.
trade receivables or a derivative standing at a gain

(2) Financial liability: e.g. a contractual obligation to deliver cash or another financial asset to another entity; e.g. trade payables, debenture loans, redeemable preference shares or a derivative standing at a loss

(3) Equity instrument: A contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities: e.g. a company’s own ordinary shares, share options, irredeemable
preference shares

Question 23

IAS 32 Financial instruments: presentation

Substance over form - what does this mean?

Answer 23

Under IAS 32, Financial Instruments: Presentation, whether a financial instrument is classified as an equity instrument should be in accordance with the substance of the contractual terms and not with factors outside the terms. Terms may include whether the instruments are redeemable, whether the returns are mandatory or discretionary and whether they contain features such as put or call options that require the issuer to settle the instrument in cash or other financial assets.

The critical feature therefore in contractual terms is whether there is an obligation to deliver cash or another financial asset, or to exchange a financial asset or financial liability on potentially unfavourable terms. If the issuer does not have an unconditional right to avoid delivery of cash or other financial assets, then the instrument is a liability.
The definition of residual interest is not confined to a proportionate interest ranking equally with all
other interests; it may also be an interest in preference shares

Question 24

IAS 33 Earnings per share

Who does it apply to?

Answer 24

IAS 33 applies to all companies with shares which are publicly traded.

Question 25

IAS 33 Earnings per share

Where are the Earnings per Share figures disclosed?

Answer 25

EPS figures need to be disclosed on the face of the Statement of profit or loss and other comprehensive income.

Question 26

IAS 33 requires disclosure of both basic earnings per share and diluted earnings per share

What is basic EPS?

Answer 26

Basic EPS = earnings / weighted average number of ordinary shares

Where earnings = profit after tax, non-controlling interests and irredeemable preference share dividends.

Question 27

IAS 33 requires disclosure of both basic earnings per share and diluted earnings per share

What is diluted EPS?

Answer 27

A dilution is a reduction in the EPS figure (or increase in a loss per share) that will result from the issue
of more equity shares on the conversion of convertible instruments already issued.

For the purpose of calculating diluted earnings per share, an entity shall adjust profit or loss attributable to ordinary equity holders of the parent entity, and the weighted average number of shares outstanding for the effects of all dilutive potential ordinary shares.

Question 28

IAS 36 Impairment of assets

When will assets be subject to the requirements of IAS 36?

Answer 28

If their carrying amounts
exceed the amount expected to be recovered from their use or sale. The firm must reduce the carrying amount of the asset to its recoverable amount and recognise an impairment loss. The recoverable amount is the higher of fair value less costs of disposal and value in use.

Question 29

IAS 36 Impairment of assets

How is value in use defined?

Answer 29

Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.

Question 30

IAS 36 Impairment of assets

Indicators of impairment - External Indicators

Answer 30

External indicators include:

 Significant decline in market value of the asset below that expected due to normal passage of
time or normal use

 Significant changes with an adverse effect on the entity in:
-technological or market environment
Internet of things
–economic or legal environment

 Increased market interest rates or other market rates of return affecting discount rates and thus reducing value in use

 Carrying amount of net assets of the entity exceeds market capitalisation

Question 31

IAS 36 Impairment of assets

Indicators of impairment - Internal Indicators

Answer 31

 Evidence of obsolescence or physical damage
 Significant changes with an adverse effect on the entity include:
– the asset becoming idle

– plans to discontinue / restructure the operation to which the asset belongs

–plans to dispose of an asset before the previously expected date
–reassessing an asset’s useful life as finite rather than indefinite

 Internal evidence available that asset performance will be worse than expected

Question 32

IAS 37 Provisions, contingent liabilities and contingent assets

According to IAS 37, Provisions, Contingent Liabilities and Contingent Assets, a provision shall be recognised when:

Answer 32

 An entity has a present obligation as a result of a past event.
 It is probable that an outflow of resources embodying economic benefits will be required to
settle the obligation.
 A reliable estimate can be made of the amount of the obligation.

If these conditions are met,
then a provision must be recognised.

Question 33

IAS 37 Provisions, contingent liabilities and contingent assets

Future losses

Answer 33

No provision can be made for future losses of an investment, as these do not represent obligations of the firm at the period end. However, expectations of losses may be an indication of an impairment of value of assets used in an investment

Question 34

IAS 37 Provisions, contingent liabilities and contingent assets

Onerous Contracts - what is it?

Answer 34

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefit expected to be received under it.

Question 35

IAS 37 Provisions, contingent liabilities and contingent assets

Onerous Contracts - how is it measured?

Answer 35

The unavoidable costs under a contract are the lower of the cost of fulfilling the contract and any compensation or penalties arising from failure to fulfil it. In other words, it is the lowest net cost of exiting from the contract.

If an entity has a contract that is onerous, the present obligation under the contract should be
recognised and measured as a provision. An example might be vacant leasehold property.

Question 36

IAS 37 Provisions, contingent liabilities and contingent assets

Restructuring

Answer 36

Restructuring can include sale or termination of a line of business, closure of business locations, the
relocation of business activities or changes in management structure

IAS 37 treats a restructuring as creating a constructive obligation (and therefore as requiring
recognition as a provision) only when an entity has:
 a detailed formal plan and:
 has raised a valid expectation in those affected that it will carry out the restructuring by starting implementation or announcing its main features (e.g. redundancy notices to the staff involved)

Question 37

IAS 37 Provisions, contingent liabilities and contingent assets

Contingent liabilities

Answer 37

A contingent liability is either:

1. 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
2. A present obligation that arises from past events but is not recognised because:

– It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
– The amount of the obligation cannot be measured with sufficient reliability.

Contingent liabilities should not be recognised in the financial statements, but will require disclosure
(unless the likelihood of payment is considered to be remote)

Question 38

IAS 37 Provisions, contingent liabilities and contingent assets

Contingent Assets

Answer 38

A contingent asset is 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

A contingent asset must not be recognised. Only when the realisation of the related economic benefits
is virtually certain should recognition take place because, at that point, the asset is no longer
contingent.

Question 39

IAS 38 Intangible assets

Definition

Answer 39

An intangible asset is an identifiable non-monetary asset without physical substance.
An intangible asset is identifiable if it meets at least one of the two following criteria:

 It is separable (i.e. it can be sold, transferred, exchanged, licensed or rented to another party on
its own rather than as part of the business)

 It arises from contractual or other legal rights

An intangible asset should be recognised if

 It is probable that future economic benefits will flow to the entity, and
 The cost can be measured reliably

Question 40

IAS 38 Intangible assets

Amortisation vs impairment

Answer 40

If an intangible asset has a finite useful life, it should be amortised over its UEL, commencing when it
becomes available for use.
Residual values are assumed to be nil.

If an intangible asset has an indefinite life, it should not be amortised but annually reviewed for
impairment.

Question 41

IAS 38 Intangible assets

Research & Development

Answer 41

Research costs must be expensed, but development costs must be capitalised as intangible assets.

The following criteria must be met in order to qualify for recognition as development assets:
 The technical feasibility of completing the intangible asset so that it will be available for use or
sale.
 The intention to complete the intangible asset and use or sell it.
 The ability to use or sell the intangible asset.
 How the intangible asset will generate probable future economic benefits. Among other things,
the entity should demonstrate the existence of a market for the output of the intangible asset
or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible
asset.
 The availability of adequate technical, financial and other resources to complete the
development and to use or sell the intangible asset.
 The ability to measure reliably the expenditure attributable to the intangible asset during its
development.

Question 42

IFRS 2 Share-based payment

Recognition of share options

Answer 42

Transactions with employees are normally:
 Measured at the fair value of equity instruments granted at grant date
 Spread over the vesting period (often a specified period of employment)

Question 43

IFRS 2 Share-based payment

Calculation of fair value

Answer 43

Market based vesting conditions are taken into account when determining the fair value of options at
the grant date, but not when estimating the number of options likely to vest at each period end

Non market based vesting conditions are taken into account when estimating the number of options
likely to vest at each period end, but not when determining the fair value of options at the grant date.

Question 44

IFRS 2 Share-based payment

Market based vesting conditions

Answer 44

 a minimum increase in the share price of the entity
 a minimum increase in shareholder return
 a specified target share price relative to an index of market prices

Question 45

IFRS 2 Share-based payment

Non-Market based vesting conditions

Answer 45

 the employee completing a minimum period of service (e.g., remaining with the company for a further three years) – also referred to as a service condition
 achievement of minimum sales or earnings target
 achievement of a specific increase in profit or earnings per share
 successful completion of a flotation
 completion of a particular project

Question 46

IFRS 3 Business combinations

Answer 46

IFRS 3 requires that on acquisition, a company’s identifiable assets and liabilities should be recognised at fair value.
Intangible assets should be recognised in the consolidated financial statements if they meet the definition of an intangible asset (see IAS 38) and their fair value can be measured reliably.

Question 47

IFRS 5 Non-current assets held for sale and discontinued operations

Held for sale definition

Answer 47

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

A number of detailed criteria must be met.

Question 48

IFRS 5 Non-current assets held for sale and discontinued operations

Criteria to be held for sale

Answer 48

(a) The asset must be available for immediate sale in its present condition.
(b) Its sale must be highly probable (i.e., significantly more likely than not). For the sale to be highly
probable, the following must apply.
 Management must be committed to a plan to sell the asset.
 There must be an active programme to locate a buyer.
 The asset must be marketed for sale at a price that is reasonable in relation to its current
fair value.
 The sale should be expected to take place within one year from the date of classification.
 It is unlikely that significant changes to the plan will be made or that the plan will be
withdrawn

Question 49

IFRS 5 Non-current assets held for sale and discontinued operations

How to treat assets held for sale

Answer 49

An asset classified as held for sale should be presented in the statement of financial position
separately from other assets. Typically, a separate heading ‘non-current assets held for sale’ would be
appropriate.
A non-current asset that is held for sale should be measured at the lower of its carrying amount and
fair value less costs to sell (net realisable value). Non-current assets held for sale should not be depreciated, even if they are still being used by the entity

Question 50

IFRS 5 Non-current assets held for sale and discontinued operations

Discontinued operations - defintion

Answer 50

Discontinued operation: A component of an entity that has either been disposed of, or is classified as held for sale, and:
 represents a separate major line of business or geographical area of operations;
 is part of a single coordinated plan to dispose of a separate major line of business or
geographical area of operations; or
 is a subsidiary acquired exclusively with a view to resale.

Question 51

IFRS 5 Non-current assets held for sale and discontinued operations

Component of an entity (for discontinued operations purposes):

Answer 51

Operations and cash flows that can be clearly distinguished, operationally and
for financial reporting purposes, from the rest of the entity.

Question 52

IFRS 5 Non-current assets held for sale and discontinued operations

How to treat discontinued operations

Answer 52

An entity should disclose a single amount in the statement of profit or loss and other comprehensive
income comprising the total of:
 the post-tax profit or loss of discontinued operations; and
 the post-tax gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of the assets constituting the discontinued operation.

An entity should also disclose an analysis of this single amount into:
 the revenue, expenses and pre-tax profit or loss of discontinued operations
 the related income tax expense
 the post-tax gain or loss recognised on measurement to fair value less costs to sell or on
disposal of the assets constituting the discontinued operation
 the related income tax expense

Question 53

IFRS 7 Financial instruments disclosures

IFRS 7 requires entities to provide disclosures in their financial statements that enable users to
evaluate:

Answer 53

 the significance of financial instruments for the entity’s financial position and performance; and
 the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date, and how the entity manages those risks

Question 54

IFRS 7 Financial instruments disclosures

Quantitative disclosures

Answer 54

The carrying value of each of the following must be disclosed either on the face of the SFP or in the
notes to the financial statements, and the net gains and losses on the following must be disclosed either on the face of the SPL & OCI or in the notes to the financial statements:
 Financial assets/liabilities at Amortised cost
 Financial assets/liabilities at fair value through profit or loss
 Financial assets at fair value through OCI

Question 55

IFRS 7 Financial instruments disclosures

Risks

IFRS 7 requires qualitative and quantitative disclosure about the following risks associated with financial instruments:

Answer 55

 Market risk – This is the risk of changes in the market value of a financial instrument. When
changes in the market value can be attributed to changes in interest rates then the market risk
is normally called interest rate risk, and when it can be attributed to changes in exchange rates,
market risk is called currency risk.
 Credit risk – This is the risk that one party to a financial instrument will fail to fulfil the obligations that arise for the financial instrument causing loss to the other party.
 Liquidity risk – This is the risk that an entity will encounter difficulty in meeting obligations
associated with financial liabilities

Question 56

IFRS 7 Financial instruments disclosures

Hedge accounting

When an entity engages in hedging the following should be disclosed:

Answer 56

 A description of each type of hedge
 A description of the derivative being hedged and its fair value at the reporting date
 A description of the designated hedging instrument and its fair value at the reporting date
 The nature of the risks being hedged

For cash flow hedges
 Periods when cash flow is expected to take place
 Amounts recognised in OCI
 Any ineffective elements recognised in the P/L

For fair value hedges
 Separate disclosure of gains and losses made on hedged item and hedge instrument

Question 57

IFRS 8 Operating segments

Definition of an operating segment

This is a component of an entity:

Answer 57

(a) That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same entity)
(b) Whose operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance
(c) For which discrete financial information is available

Question 58

IFRS 8 Operating segments

Determining reportable segments

An operating segment is reportable where:

Answer 58

It meets the definition of an operating segment; and
 Any of the following size criteria are met:
– Segment revenue ≥ 10% of total (internal and external) revenue
– Segment profit or loss ≥ 10% of the profit of all segments in profit (or loss of all segments making a loss if greater)
– Segment assets ≥ 10% of total assets
At least 75% of total external revenue must be reported by operating segments. Where this is not the case, additional segments must be identified (even if they do not meet the 10% thresholds)

Question 59

IFRS 8 Operating segments

Required disclosures

Answer 59

Disclosure is required of:
 Factors used to identify the entity’s reportable segments
 Types of products and services from which each reportable segment derives its revenues
 For each reportable segment:
– Operating segment profit or loss
– Segment assets
– Segment liabilities
– Certain income and expense items

Question 60

IFRS 9 Financial instruments

Classification of financial assets - Debt

What are the three ways Debt can be classified?

Answer 60

Amortised cost

FV through OCI

FV through P&L

Question 61

IFRS 9 Financial instruments

When is debt held at amortised cost?

Answer 61

This is when the company intends on holding the loan (not selling it), and the
loan gives rise to both the payment of principle and interest. Amortised cost requires the entire
benefit of a loan to be spread over the life of the loan using an effective interest rate.

Question 62

IFRS 9 Financial instruments

When is debt held at FV through OCI?

Answer 62

This is when the company intends on holding the loan OR perhaps sell it, and
the loan gives rise to both the payment of principle and interest. The loan should be treated as
amortised cost AND then revalued to fair value via OCI at the year end.

Question 63

IFRS 9 Financial instruments

When is debt held at FV through P&L?

Answer 63

Fair value through profit or loss – This refers to assets which have been designated as such to
avoid an accounting mismatch. These assets are initially recognised at fair value and at the year-
end any difference is taken to the profit or loss.

Question 64

IFRS 9 Financial instruments

Classification of financial assets – Equity (Shares)

Answer 64

 Shares are usually revalued to FV each year via the P&L account.

However, if an irrevocable
election has been made these can be revalued to FV through OCI

Question 65

IFRS 9 Financial instruments

Classification of financial Liabilities

Answer 65

 Fair value through profit or loss – This refers to liabilities which have been designated as such to
avoid an accounting mismatch. These liabilities are initially recognised at fair value and at the
year-end any difference is taken to the profit or loss.

 Amortised cost – This refers to the majority of loans, debentures etc. taken out by a company.
These liabilities are initially recognised at fair value and subsequently at amortised cost using an
effective interest to spread the cost of the debt over the life of the debt

Question 66

IFRS 9 Financial instruments

Hedge accounting

What are the main components of hedge accounting?

Answer 66

(a) The hedged item: this is an asset, a liability, a firm commitment (such as a contract to acquire a
new oil tanker in the future) or a forecast transaction (such as the issue in four months’ time of fixed rate debt) which exposes the entity to risks of fair value/cash flow changes. The hedged
item generates the risk which is being hedged

(b) The hedging instrument: this is a derivative or other financial instrument whose fair value/cash flow changes are expected to offset those of the hedged item. The hedging instrument reduces/eliminates the risk associated with the hedged item.

Question 67

IFRS 9 Financial instruments

Hedge accounting

When can you use it?

Answer 67

• There is a designated relationship between the item and the instrument which is documented.
  To be eligible for hedge accounting the hedge documentation must be in place at the inception
  of the hedge relationship. Until the necessary documentation is in place hedge accounting
  cannot be applied even if the underlying hedging activity is valid. There can be no retrospective designation of a hedge relationship.
• At inception the hedge must be expected to be highly effective and it must turn out to be highly effective tover the life of the relationship.
• The effectiveness of the hedge must be reliably assessed on an ongoing basis
• In respect of a cashflow hedge, a forecast transaction must be fhighly probable
• Changes in fair value / cash flows must have potential to affect profit or loss

Question 68

IFRS 9 Financial instruments

Hedge accounting

What are the two main types of hedge?

Answer 68

 The fair value hedge: the gain and loss on such a hedge are recognised as a fair value gain or loss in profit or loss. Unless the hedged item impacts OCI in which case the gain or
loss on the hedging instrument also goes to OCI
 The cash flow hedge: the gain and loss on such a hedge are initially recognised in other
comprehensive income and subsequently reclassified to profit or loss when the underlying transaction takes place.

Question 69

IFRS 9 Financial instruments

Hedge accounting

Hedge effectiveness

Answer 69

Hedge effectiveness is the degree to which the changes in the fair value or cash flows of the hedged
item that are attributable to a hedged risk are offset by changes in the fair value or cash flows of the
hedging instrument.

Hedge effectiveness should be tested on both a prospective and retrospective
basis because hedge accounting should only be applied when:
 At the time of designation, the hedge is expected to be highly effective; and
 The hedge turns out to have been highly effective throughout the financial reporting periods for
which it was designated

IFRS 9 has a principles-based test for hedge effectiveness, where there has to be an expected
offsetting of movements and credit risk doesn’t dominate the value changes. A hedge ratio should also be stipulated, meaning a company can choose to hedge 50% of an items risk, and in doing so can only use 50% of the hedged instruments risk to mitigate/compensate

Question 70

IFRS 11 Joint arrangements

Three types of joint arrangmeent

Answer 70

Joint operation

Joint Venture

Joint Control

Question 71

IFRS 11 Joint arrangements

Define a joint operation

Answer 71

Joint operation: A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the assets and obligations for the liabilities relating to the arrangement.

Question 72

IFRS 11 Joint arrangements

Define a joint venture

Answer 72

Joint venture: A joint arrangement whereby the parties that have joint control of the arrangement
have rights to the net assets of the arrangement.

Question 73

IFRS 11 Joint arrangements

Define joint control

Answer 73

Joint control: The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.

Question 74

IFRS 11 Joint arrangements

What type of arrangement is it if it’s not structured through a separate vehicle?

Answer 74

Joint Operation - line by line accounting

Question 75

IFRS 11 Joint arrangements

What type of arrangement is it if it’s structured through a separate vehicle?

Answer 75

It could be either.

You need to consider:
- legal form
- terms of contractual arrangements
- Other facts and circumstances

Question 76

IFRS 11 Joint arrangements

For a joint operator how is a joint operation recognised in its financial statements?

Answer 76

line by line the following:

 its assets, including its share of any jointly held assets;
 its liabilities, including its share of any jointly incurred liabilities;
 its revenue from the sale of its share of the output arising from the joint operation;
 its share of the revenue from the sale of the output by the joint operation; and
 its expenses, including its share of any expenses incurred jointly. An entity may have a
previously held interest in a joint operation, held as an investmen

Question 77

For a joint venturer how is a joint venture recognised?

Answer 77

IFRS 11 requires that a joint venturer recognises its interest in a joint
venture as an investment in its consolidated financial statements, and accounts for that investment
using the equity method in accordance with IAS 28, Investments in Associates and Joint Ventures.

Question 78

IFRS 13 Fair value measurement

Brand valuation

Answer 78

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

IFRS 13 also requires the fair value to be determined on the basis of its ‘highest and best use’ from a
market participant’s perspective. This needs to consider what is physically possible, legally permissible and financially feasible. It also needs to take into account market conditions at the measurement date

Question 79

IFRS 13 Fair value measurement

Fair value hierarchy

Answer 79

FRS 13 requires that entities should maximise the use of relevant observable inputs when determining a fair value, and minimise the use of unobservable inputs. In relation to this, IFRS 13 uses a ‘fair value hierarchy’ which categories inputs into three levels:

 Level 1 inputs – Quoted prices in active markets for identical assets or liabilities that the entity can access at the measurement date.

 Level 2 inputs – Inputs (other than quoted market prices included within Level 1) that are observable for the asset or liability, either directly or indirectly.

 Level 3 inputs – Unobservable inputs for the asset or liability.

Question 80

FRS 13 Fair value measurement

Fair value hierarchy - which level inputs for brands?

Answer 80

It is not normally possible to identify Level 1 inputs when dealing with brands, due to their unique nature. By definition, if all brands are different, or have different characteristics, it will not be possible to identify any identical assets.

Therefore, the fair values of brands will have to be determined using the lower two levels of inputs (although a possible Level 2 input could be the value of similar brands which have already been valued).

Question 81

FRS 13 Fair value measurement

Bases of valuation

Within the context of the three levels of the ‘fair value hierarchy’, and the preference to use
observable over unobservable inputs wherever possible, IFRS 13 sets out three possible valuation techniques which could be used when determining the fair value of an asset:

Answer 81

(1) Market approach
(2) Cost approach
(3) Income approach

Question 82

FRS 13 Fair value measurement

Market approach - what is it?

Answer 82

Market approach – This uses prices and other relevant information generated by market
transactions involving identical or comparable assets

Question 83

FRS 13 Fair value measurement

Cost approach - what is it?

Answer 83

Cost approach – This reflects the amount of cost that would be required to replace the service
capacity of an asset (the current replacement cost)

Question 84

FRS 13 Fair value measurement

Income approach - what is it?

Answer 84

Income approach – This converts future amounts (cash flows or income and expenses) generated by an asset to a single, current (discounted) amount, reflecting current market
expectations about those future amounts.

Question 85

IFRS 15 Revenue from contracts with customers

Revenue recognition

Answer 85

IFRS 15 states that revenue is recognised to depict the transfer of promised goods and services to
customers.

Revenue is therefore generally recognised as being earned at the point of sale for goods.

For services, revenue is, in general, recognised over the period that the service is delivered.

Question 86

IFRS 15 Revenue from contracts with customers

Discounts

Answer 86

IFRS 15 requires that the transaction price should take into account the amount of any trade discounts and volume rebates allowed by the entity.

The discount should be allocated proportionately to the performance obligations in the contract. Therefore, an organisation which offers trade discounts would be expected to show a lower profit margin on its revenue than an organisation which did not
offer similar discounts.

Question 87

IFRS 15 Revenue from contracts with customers

Customer loyalty programmes

Answer 87

Accounting for customer loyalty programmes IFRS 15 requires that separately identifiable performance obligations are accounted for separately.

This suggests that when a loyalty card customer
buys a product or service, the proceeds of the sale are split into two components: an amount
reflecting the value of the goods or services delivered in the sale, and an amount that reflects the value of the loyalty award credits.

Proceeds allocated to the first component are recognised as revenue at the time of the first sale. However, proceeds allocated to the award credits are deferred as a liability until the entity fulfils its obligations in respect of the award, either by supplying free or discounted goods when a customer redeems the credit, or engaging (and paying) a third party to do so.

Question 88

IFRS 15 Revenue from contracts with customers

Construction contracts - definition

Answer 88

IFRS 15 refers to this as a contract ‘in which performance obligations are satisfied over time’.

Question 89

IFRS 15 Revenue from contracts with customers

Construction contracts - when to recognise?

Answer 89

It is necessary to be able to measure what amount of performance obligation has been satisfied during an accounting period. This determines the amount of revenue that can be recognised.

Measurement can be carried out using input methods (costs incurred/total costs) or output methods
(work certified to date as billable/total contract price).

Where performance obligations are satisfied over time, the entity recognises revenue by measuring progress towards complete satisfaction of the performance obligation.

Progress can be measured
using output methods (measuring the value to the customer of goods or services transferred to date) or input methods (measuring the cost to the entity of goods or services transferred to date)

A contract liability is recognised and presented in the statement of financial position where a customer has paid an amount of consideration prior to the entity performing by transferring control of the related good or service to the customer.

When the entity has performed but the customer has not yet paid the related consideration, this will give rise to either a contract asset or a receivable. A contract asset is recognised when the entity’s right to consideration is conditional on something other than the passage of time, for instance future
performance. A receivable is recognised when the entity’s right to consideration is unconditional except for the passage of time.

Where revenue has been invoiced a receivable is recognised. Where revenue has been earned but not invoiced, it is recognised as a contract asset.

Question 90

IFRS 16 Leases

Definitions

Answer 90

A lease is a contract, or part of a contract, that conveys the right to use an asset, the underlying asset,
for a period of time in exchange for consideration.

The underlying asset is an asset that is the subject of a lease, for which the right to use that asset has
been provided by a lessor to a lessee.

A right-of-use asset is an asset that represents a lessee’s right to use an underlying asset for the lease term.

Question 91

IFRS 16 Leases

Recognition

A lease should be recognised if the lessee has:

Answer 91

(a) The right to obtain substantially all of the economic benefits from use of the identified asset;
and
(b) the right to direct the use of the identified asset

Question 92

IFRS 16 Leases

Recognition

A lease should not be recognised if:

Answer 92

the lessor can substitute the underlying asset for another asset during the lease term and would benefit economically from doing so.

Question 93

IFRS 16 Leases

At the commencement of the lease, the lessee recognises:

Answer 93

a) a right-of-use asset, which represents the right to use the underlying asset; and
(b) a lease liability which represents the obligation to make lease payments

Question 94

IFRS 16 Leases

Initial Measurement of the Right of Use Asset

Answer 94

The right-of-use asset is initially measured at cost, which is:
 the initial measurement of the lease liability (present value of future lease payments)
 plus any lease payments made before the commencement date
 less lease incentives received (payments from lessor to lessee)
 plus initial direct costs incurred by the lessee (costs of negotiating and securing lease
arrangements)
 plus estimated dismantling and restoration costs that a lessee is obliged to pay at the end of the
lease term

Question 95

IFRS 16 Leases

Subsequent measurement of right-of-use asset

Answer 95

The right-of-use asset will be measured at cost less accumulated depreciation and impairment losses
in line with IAS 16, Property, Plant and Equipment. The right-of-use asset will be depreciated from the
commencement date to the earlier of the end of its useful life or the end of the lease term unless the
asset is expected to be transferred to the lessee at the end of the lease term. In that case, the asset
will be depreciated over the useful life of the asset.

Question 96

IFRS 16 Leases

Initial measurement of the lease liability

Answer 96

At the commencement of the lease, the lease liability is measured at the present value of future lease
payments, including any payments expected at the end of the lease and net of any lease incentives.
The discount rate used is the interest rate implicit in the lease, or if this is not available, the lessee’s
incremental borrowing rate.

Question 97

IFRS 16 Leases

Subsequent measurement of the lease liability

Answer 97

In future periods, the lease liability is amortised.
 Interest will accrue on the outstanding lease, at the rate stated in the lease contract.
 Payments made in respect of the lease by the lessee will reduce the outstanding liability.

Question 98

IFRS 16 Leases

Simplified accounting

Answer 98

A lessee can elect to apply simplified accounting to a lease with a term of twelve months or less, or a
lease for a low value asset. The election is made on a lease by lease basis for leases for low value
assets, and by class of underlying asset for short-term leases. In this case, the lessee recognises lease
payments on a straight line basis over the lease term.

Question 99

IFRS 16 Leases

Lessor accounting

Finance leases

Answer 99

A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership
of an underlying asset.

The lessor should recognise a receivable equal to ‘net investment in the lease’. This is the gross
investment (minimum lease payments plus any unguaranteed residual value accruing to the lessor) discounted at the interest rate implicit in the lease.

Question 100

IFRS 16 Leases

Lessor accounting

Operating leases

Answer 100

An operating lease is a lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

The leased asset should be retained in the books of the lessor and depreciated over its useful life.

Rentals are credited to profit or loss on a straight-line basis over the lease term unless another
systematic basis is more representative.

Question 101

IFRS 16 Leases

Sale and Leaseback

Answer 101

The accounting treatment depends on whether the transfer is a sale as defined by IFRS 15

Question 102

IFRS 16 Leases

Sale and Leaseback

If the Transfer does constitute a sale

Answer 102

Calculate the proportion of the asset effectively retained as a right-of-use asset, being PVMLP/FV

The remaining proportion of the carrying value has effectively been transferred to the buyer.
The gain on disposal is the remaining proportion as above x the full gain on disposal.

The PVMLP is recognised as a lease liability

NB: Look at CR book if more complicated - ie FV is not equal to the cash received

Question 103

IFRS 16 Leases

Sale and Leaseback

If the Transfer does not constitute a sale

Answer 103

The seller will continue to recognise the transferred asset and the sales proceeds will be treated as a loan secured on the asset.