Chapter 5 & 6 - Test your knowledge Flashcards
How are changes in new accounting policy, the correction of material prior year errors and changes in accounting estimates applied in the financial statements in order to comply with IAS 8.
The application of a new accounting policy or the correction for a material prior period error requires retrospective application.
It requires the restatement of the comparative financial statements for each prior accounting period that is being presented to account for the new accounting policy and/or the material error.
The details of the changes must be disclosed in the notes to the financial statements for completeness.
- An example of a change in accounting policy would be a change in the depreciation method from straight line to reducing balance.
- Examples of a material prior period error include a material over/understatement of sales or inventory or other expenses due to mathematical mistakes, mistakes in applying accounting policies, oversights or misinterpretations of facts and fraud.
IAS 8 only allows for the prospective application of both a change in accounting policy and material prior period errors if it is impracticable to perform the retrospective adjustment.
A material change in an accounting estimate requires the prospective application.
The change would also be disclosed in the notes to the financial statements.
Examples of changes in accounting estimates include a change in the estimated lifespan of a fixed asset or a change in the estimate used in the calculation of the provision of doubtful debtors.
Cuba Ltd acquired a new plant in exchange for land with a book value of £10 million (fair value amounted to £15 million), plus cash paid upfront of £5 million.
- What will be the cost of the acquired plant in the financial
statements of Cuba Ltd?
As per IAS 16, the cost of the acquired asset will be:
[fair value of asset transferred ± cash]
Therefore, the cost of the acquired plant will be:
£15 million + £5 million = £20 million.
- What are the criteria set out by IAS 2 for the recognition of the
cost of an item of property, plant and equipment as an asset?
Answer: The cost of an item of property, plant and equipment should be recognised as an asset only if:
- it is probable that future economic benefits associated with the item will flow to the entity; and
- the cost of the item can be measured reliably
Peter Telecom Ltd signs a mobile contract for two years with a
customer. It provides a free handset as part of the contract. It also
provides an option to insure the phone at an extra monthly cost.
How are the performance obligations assessed, revenue allocated and at what point in time is revenue recognised as per IFRS 15?
An entity should recognise revenue to the extent that a performance obligation in a contract with a customer has been satisfied.
The transaction price is the amount of consideration an entity expects from the customer in exchange for transferring goods or services.
The handset sale revenue will be recognised when the phone is delivered to the customer.
The revenue relating to the mobile monthly calls will be recognised when the customer uses the phone over the life of the contract.
Any revenue relating to the sale of mobile insurance will be treated as a separate performance obligation and recognised on a monthly basis.
For services that are performed over time, an entity transfers control of a good or service over time.
It satisfies a performance obligation and recognises revenue over time.
Tea Limited is a new company which formed on 1 January 20X4.
At the date of its formation the issued share capital of Tea Ltd consists of 100,000 equity shares of £1 each with equal voting rights.
The directors of Tea Ltd retained 49,000 equity shares and Tea Ltd sold 51,000 equity shares to Ilam Ltd on 1 January 20X4 for the par value of the shares.
Does Ilam Ltd meet the criteria of a parent company?
Ilam Ltd becomes the parent company of Tea Ltd from 1 January 20X4 because it meets all the three elements of control as defined by IFRS 10.
Power over the investee, through most of voting rights (owning more than 50% of the equity shares). Exposure or rights to variable returns (a dividend).
It can control the composition of the board of directors and affect the amount of investor returns.
Why are the subsidiary’s identifiable assets and liabilities included at their fair values in the consolidated financial statements?
Consolidated accounts are prepared from the perspective of the group and must reflect their cost to the group (to the parent), not the original cost to the subsidiary.
The book values of the subsidiary’s assets and liabilities are largely
irrelevant in the consolidated financial statements.
The cost to the group is the fair value of the acquired assets and liabilities at the date of acquisition. Fair values are therefore used to calculate the value of goodwill.
Explain why it is necessary to use the fair values of a subsidiary’s
identifiable assets and liabilities when preparing consolidated
financial statements.
It is necessary to use the fair values of asubsidiary’s identifiable assets and liabilities in the consolidated accounts for the following reasons:
a) As consolidated accounts are prepared from the perspective of the group, they must reflect the cost to the group, not the book values of the subsidiary’s assets and liabilities. The cost to the group is their fair value at the date of acquisition.
b) The value of the purchased goodwill is meaningless without the use of fair values. Purchased goodwill is measured as the difference between the cost of an acquisition (the value of an acquired entity) and the aggregate of the fair values of that entity’s identifiable assets and liabilities (the value of the subsidiary’s net assets acquired).
Why are pre-acquisition profits of a subsidiary not included in the
group accounts?
Pre-acquisition profits are the retained earnings of the subsidiary which exist at the date when it is acquired.
They are excluded from group retained earnings
as they belong to the previous shareholders and were earned under their ownership.
Gorkha plc acquired Ye Ltd on 1 January 20X9. The retained
earnings at 1 January 20X9 amounted to £500,000 and £800,000
respectively.
Explain how the retained earnings of Ye ltd at 1 January 20X1 would be treated in the consolidated financial statements?
The retained earnings of Ye Ltd have accrued during the period prior to acquisition and were earned under the ownership of the previous shareholders.
They form a part of the shareholders’ equity at acquisition in the subsidiary for the purpose of computing goodwill arising on consolidation
What are non-controlling interests? How are they accounted for in consolidated financial statements?
In a situation where a parent has control but less than 100% of a shareholding, the portion of equity ownership in a subsidiary not attributable to the parent company is known as a non-controlling interest.
This is also called a minority interest. A non-controlling interest should be presented separately in the consolidated statement of financial position within equity.
Any share of a subsidiary’s results that belongs to the non-controlling interest or minority interest is disclosed at the foot of the balance sheet and income statement and
in the statement of changes in equity.
How is an investment of the parent in a subsidiary accounted for in the parent’s separate financial statements? How is it accounted for in the consolidated financial statements?
Parent company financial statements include ‘investments in subsidiary undertakings’ as an asset in the statement of financial position, as well as income from subsidiaries (dividends) in the statement of profit or loss.
The parent entity’s investment in the subsidiaries, carried as an investment in its balance sheet, is also eliminated through the process of consolidation
During the year ended 31 December 20X1, the parent company (P
Plc) sells goods to its subsidiary (S Ltd) at cost plus a mark-up of 15%.
Explain the accounting treatment of the intra-group trading and the profit arising from the intercompany sales.
Intra-group items including all transactions, balances and profits and losses must be eliminated to avoid double counting.
The consolidated totals should consist of only transactions, balances and profits and losses created through
transactions with parties outside the group.
For consolidated financial statements, it is therefore necessary to eliminate intra-group balances and transactions.
Company P will make the following accounting adjustments for unrealised profits:
- Intra-group sales and purchases are eliminated.
Reduce the retained earnings of Company P by 15% (the mark-up) or 15 ÷ 115 (13% of the selling price).
- Any unrealised profit relating to intercompany trading is eliminated.
Reduce the inventory of Company B by 15% (the mark-up) or 13% of the price.
The above adjustments only apply to unsold inventory
How does the difference between the equity method and the full consolidation method affect the decisions of investing entities if the investee were a highly geared entity?
If an investee is highly geared with a lot of debt, the investor would bring 100% of the gross debt of the investee onto its consolidated balance sheet through consolidation.
It increases the gearing for the group as a whole. This is avoided if the investee is treated as a joint venture and accounted using the equity method.
A controlling interest in the investee is not desirable in this scenario.
However, if the investee were very profitable, the consolidated accounts would consolidate 100% of the investee’s profits in its accounts with any portion relating to NCI disclosed at the foot of the balance sheet.
When is a parent exempted from preparing consolidated financial
statements?
A parent is exempted from preparing consolidated financial statements when:
- the parent is itself a wholly owned subsidiary, or a partially owned
subsidiary and the non-controlling interests do not object; - its securities are not publicly traded or in the process of being traded; or
- its ultimate or intermediate parent publishes IFRS-compliant financial statements.
When does IFRS allow subsidiary undertakings to be excluded
from consolidation? Can they be excluded on the grounds of
dissimilar activities?
An exclusion originally allowed by IAS 27 (where control is intended to be temporary or where the subsidiary operates under severe long-term restrictions) has been removed.
Instead, subsidiaries held for sale are accounted for in accordance with IFRS 5 (Non-Current Assets Held for Sale and Discontinued Operations) and the control must actually be lost for exclusion to occur.
IFRS 10 also rejects the argument for exclusion on the grounds of dissimilar activities.
More relevant information must be provided about such subsidiaries by consolidating their results and providing additional information about the different business activities of the subsidiary.
