Chapter 5 - Accounting Policies based on IFRS

Question 1

How does IAS 8 define accounting policies?

Answer 1

The specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements.

Question 2

What are the 2 major concerns governing the application accounting policies?

Answer 2

• Selection and application
• Consistency

Question 3

What 2 main adjustments are required retrospectively where a company decides to change accounting policy?

Answer 3

General rule is that if policy changed - it must be applied retrospectively in the financial statements aka applied to all previous periods as if the policy has always been in place.
<br></br>1) Opening balance of current year’s statement of changes in equity (retained earnings)
2) Adjustments of all comparative amounts presented in the FS

Question 4

What 6 items does IAS 8 require be disclosed at the end of the first period where a change in policy has been applied?

Answer 4

• the IFRS that was responsible for the change;
• the nature of the change in policy;
• transitional provisions;
• for the current and each prior period presented, the amount of the adjustment to:
  – each line item affected
  – earnings per share
• the amount of the adjustment relating to prior periods not presented; and
• an explanation outlining how the change in policy was applied, if Retrospective application is impracticable.

Question 5

How is a change in accounting estimate recognised in the statement of profit or loss & OCI?

Answer 5

It will be recognised prospectively by including it in the statement of profit or
loss and OCI.
* If the change affects that period only, the effect is recognised in the period of the change.
* If the change affects both the period of the change and future periods, the effect is recognised in the current and future periods.

Question 6

H

How does IAS 8 define a prior period error?

Answer 6

Omissions from, and misstatements in, the FS, for one or more prior periods that arose from a failure to use, or misuse of, reliable information that was:
* Available when the FS were authorised for issue; and
* Could reasonably have been expected to be taken into account when preparing/presentating the FS

Question 7

What are some common examples of prior period errors?

Answer 7

• Over or under valuation of revenue, inventory or other expenses due to mathematical mistakes
• Mistakes applying accounting policies
• Oversight of or misinterpretation of facts
• Fraud

Question 8

RULES ON DISCLOSURE/RECTIFICATION OF PRIOR PERIOD ERORS

Answer 8

• restating the comparative amounts for the prior period(s) presented in which the error occurred; or
• if the error occurred before the earliest prior period presented, the opening balances of assets, liabilities and equity
  for the earliest period presented should be restated.

In this set of financial statements, full disclosure of the following should be made at the end of the first accounting period
in which a material prior period error was discovered:
* the nature of the prior period error;
* for each prior period presented, if practicable, disclose the correction to each line item affected and EPS; and
* the amount of the correction at the beginning of earliest period presented.

Question 9

Which inventories fall within the scope of IAS2 and are counted as assets?

Answer 9

• Finished goods
• Work in progress (those in production as part of the ordinary course of business)
• Raw materials (for production of goods or rendering of services)

Question 10

Which inventories fall within the scope of IAS2 and are counted as asset

Which inventories do not fall within the scope of IAS2

Answer 10

• Work in progress relating to construction contracts
• Biological assets re agricultural production and produce at the point of harvest
• Financial instruments

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There are a couple of exceptions which, whilst they fall within the scope of IAS2, will not be counted as measuring investories
* producers of agricultural and forest products and minerals and mineral products, both of which are measured at net realisable value in accordance with well-established practices in those industries
* commodity broker-traders who measure their inventories at fair value less costs to sell

Question 11

What does ‘cost of inventories’ comprise of? (3)

Answer 11

• purchase (including taxes, transport and handling), net of trade discounts received;
• costs of conversion (including fixed and variable manufacturing overheads); and
• other costs incurred in bringing the inventories to their present location and condition.

Question 12

When will inventory be recognised as an asset?

Answer 12

IAS2 does not deal with initial recongition. The general rule applies, inventory will be recognised as an asset when the entity obtains control.

Main concern - how much of cost should be recognised as an asset and carried forward until related revenue is recognised.

Question 13

What costs will not be counted as ‘cost of inventory’? (6)

Answer 13

• Abnormal waste
• Admin overheads unrelated to production
• Storage
• Selling costs
• Interest cost where inventory purchased on deferred settlement terms
• Exchange rate differences arising directly where inventory acquired and invoiced in a foreign country

Question 14

Main methods of costing inventories.

Answer 14

• Standard costing (manufacturing companies) - assign expected cost/standard cost for an actual costs, regulary review in separate components (direct material, direct labour, overheads) in order to maintain productivity
• Retail method (retails) - estimate the value of ending inventory using cost-to-retail price ratio. Clear correlation between wholesaler price to retailer to retailer to customer, consistent use of mark-ups.
• FIFO/WAVCO (weighted average cost) - used where inventory items not interchangable, specific costs attributed to individual inventory items

Question 15

What is NRV?

Answer 15

Net realisable value:- estimated selling price in ordinary course of business minus estimate cost of making it and estimate cost of selling it.

Question 16

What is the matching principle/expense recognition?

Answer 16

When inventories are sold, the carrying amount of those inventories should be recognised as an expense in the period
in which the related revenue is recognised, as per IFRS 15 (Revenue from Contracts with Customers). The amount of
any write-down of inventories to NRV and all losses of inventories should be recognised as an expense in the period the
write-down or loss occurs.
Inventories are usually written down to NRV item by item. However, it may be appropriate to group similar or related
items in some circumstances.

Question 17

What does IAS2 require be disclosed in respect of inventories?

Answer 17

accounting policuy for inventories

amount of any write-down of inventories recognised as an expense in the reporting period;
cost of inventories recognised as expense (cost of goods sold or cost of sales);
* amount of any reversal of a write-down to NRV and the circumstances that led to such reversal; and
* separate disclosure of inventories carried as assets at the period end, including:
– carrying amount, generally classified as merchandise, supplies, materials, work in progress and finished
goods;
– carrying amount of any inventories carried at fair value less costs to sell; and
– carrying amount of inventories pledged as security for liabilities.

Question 18

what are property plant and equipment

Answer 18

Property, plant and equipment are tangible items that:
* are held for use in the production or supply of goods or services, for rental basis, or for administrative purposes; and
* are expected to be used for more than one accounting period.

Question 19

Where will IAS16 (PPE) not apply?

Answer 19

• plant, property and equipment held for sale under IFRS5
• biological assets related to agricultural activity accounted for under IAS41
• exploration and evaluation of mineral assets recognised in accordance with IFRS 6 and mineral rights and mineral
  reserves such as oil, natural gas and similar non-regenerative resources.

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IAS16 WILL apply to PPE used to maintain or develop above biological assets/mineral rights/mineral reserves and similar non-regenerative resources

Question 20

How should PPE costs be measured? (recognition of PPE as an asset) **

Answer 20

Under IAS 16, the cost of an item of property, plant and equipment shall be recognised as an asset if and 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.
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Initial recognition
Property, plant and equipment shall be measured at its cost or the cash price equivalent at the recognition date. Cost
includes:
* purchase price, including duties and non-refundable purchase taxes, after deducting trade discounts;
* costs directly attributable to bringing the asset to the location and condition necessary for it to operate in the manner
intended by management; and
* the estimated costs of dismantling and removing the item and restoring the site on which it is located.
<br></br>
The capitalisation of costs should cease when the asset becomes available for operating use or intended use by the
management.

Question 21

What are the two choices of method for the accounting of property, plant and equipment?

Answer 21

Cost model: after recognising an item of property, plant and equipment as an asset, it should be carried at cost
less any accumulated depreciation/accumulated impairment losses (the carrying amount, previously known as (net)
book value).
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Revaluation model: after recognition as an asset, an item of property, plant and equipment whose fair value can
be measured reliably should be carried at the revalued amount (fair value at the date of the revaluation) less any
subsequent accumulated depreciation/accumulated impairment losses (the carrying amount, previously known as
(net) book value).

Question 22

What is depreciation?

Answer 22

Depreciation is the systematic allocation of the depreciable amount of the asset over its useful life (the period it will be used to generate benefit).

Question 23

What is the ‘recoverable amount’ for an item of property, plant or equipment?

Answer 23

The recoverable amount is the higher of an asset’s fair value less costs to sell and its value in use.

Question 24

When is an asset(PPE) impaired?

Answer 24

• When its carrying value exceeds its recoverable value i.e. the higher of fair value less costs of disposal and value in use.
• IAS 36 - companies must conduct impairment tests where there is the indication of the impairment of an asset.
• Good will and other intangible assets are an exception to IAS 36 requirement as they already require an annual impairment test

Question 25

Disclosures required by IAS 16

Answer 25

International Accounting Standard 16 requires the following disclosures for each class of property, plant and equipment:
* the basis for measuring carrying amount;
* the depreciation methods to be used or used;
* useful lives or depreciation rates;
* the gross carrying amount (cost or valuation) and accumulated depreciation and impairment losses;
* a reconciliation of the carrying amount at the beginning and the end of the period, showing:
– additions
– disposals
– acquisitions through business combinations
– revaluation increases or decreases
– impairment losses
– reversals of impairment losses
– depreciation
– net foreign exchange differences on translation
– other movements
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International Accounting Standard 16 also encourages additional disclosures for:
* restrictions on title and items pledged as security for liabilities;
* contractual commitments and expenditures to construct property, plant and equipment during the period; and
* compensation from third parties for items of property, plant and equipment that were impaired, lost or given up that
is included in the statement of profit or loss and OCI.

Question 26

What are the two types of event that could occur after the reporting period?

Answer 26

• Adjustable event
• Non-adjustable event
  ** add notes on both **

Question 27

Which contracts do not fall within the scope of IFRS 15 (contracts with customers)?

Answer 27

The requirements of IFRS 15 apply to all contracts with customers except:
* lease agreements within the scope of IFRS 16 (Leases);
* insurance contracts within the scope of IFRS 4;
* financial instruments and other contractual rights and obligations within the scope of IFRS 9 (Financial Instruments),
IFRS 10 (Consolidated Financial Statements), IFRS 11 (Joint Arrangements), IAS 27 (Separate Financial
Statements) or IAS 28 (Investments in Associates and Joint Ventures); and
* non-monetary exchanges between entities in the same line of business.

Question 28

What are the 5 steps of the IFRS’ core principle for revenue recognition?

Answer 28

Step 1: identify the contract with the customer
IFRS 15 does not rely on legal definitions, as the standard applies internationally across different legal systems. It lays
out the following criteria for a contract to exist with a customer:
* the contract (written, verbal or implied) has been approved by the parties involved who are committed to carrying it
out;
* the entity can identify each party’s rights and payment terms regarding the goods or services to be transferred;
* the contract has commercial substance (the risk, timing or amount of the entity’s future cash flows is expected to
change as a result of the contract); and
* it is probable that the entity will collect the consideration to which it will be entitled.
<br></br>
Step 2: identify the performance obligations in the contract
IFRS 15 requires contracts with more than one performance obligation to be assessed separately. The goal is to
separate the contract into parts or separate performance obligations when the promised good or service is distinct: for
example, if each part has a distinct function and a distinct profit margin and can be sold separately.
A distinct good or service is ‘separately identifiable’ from other promises in the contract. Examples include:
* a contract to supply a computer system and technical support for a specified period (the supply of the computer and
the technical support are separate performance obligations); and
* a contract to supply, as a package, a ‘free’ mobile phone handset with a call package and insurance cover (the supply
of the mobile phone, the call charges and the insurance premiums are separate performance obligations).
<br></br>
Step 3: determine the transaction price
The transaction price is the amount of consideration an entity expects from the customer in exchange for transferring
goods or services. The consideration may include fixed amounts, variable amounts or both, in addition to the effects of
the customer’s credit risk and the time value of money (if material).
Variables such as settlement discounts, rebates, refunds, incentives and penalties are included where it is highly
probable that there will not be a reversal of revenue when any uncertainty associated with the variable consideration is
resolved.
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Step 4: allocate the transaction price
An entity must allocate the transaction price to each separate performance obligation (with distinct goods or services) in
proportion to the standalone selling price of the good or service underlying each performance obligation.
If an entity sells a bundle of goods and/or services (see examples above), each performance obligation is assessed as
if it could be sold separately and revenue is allocated in proportion to those standalone selling prices. Using the second
example above, some of the consideration for the contract should be allocated to the ‘free’ handset.
The standard allows other methods (such as similar market process) when such prices are not available, as long as they
meet the overall objective of allocation.
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Step 5: recognise revenue as obligations are performed
The standard provides guidance that governs the timing of revenue recognition. It states that an entity should recognise
revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (an asset)
to the customer. An asset is transferred when (or as) the customer obtains control of that asset.
For example, handing over a car to a customer determines the timing of revenue recognition. For more complex
contracts, such as those for construction assets (buildings, ships or roads), the performance obligation is satisfied when:
* the entity has the present right to payment for the asset;
* the customer has legal title to the asset;
* the entity has transferred physical possession of the asset;
* the customer has the significant risks and rewards of ownership of the asset; and
* the customer has accepted the asset.
Contracts for services (such as cleaning services or a training programme) are generally performed over a period of time.
Where an entity transfers control of a good or service over time, it satisfies a performance obligation and recognises
revenue over time.

Question 29

How does IFRS 15 define a contract?

Answer 29

IFRS does not rely on legal definitions as the standards apply across different countries with different legal systems<br></br>
Defines a contract as one that
- Contract approved (writte, verbal, implied) by all parties who are committed to carrying it out
- Entity can identify each party’s rights / payment terms regarding goods/services to be transferred
- Contract has commercial substance
- Probable entity will receive the consideration to which it is entitled

Question 30

When is the performance obligation of an entity recognised as satisfied in more complex transactions? (per IFRS 15)

Answer 30

• the entity has the present right to payment for the asset;
• the customer has legal title to the asset;
• the entity has transferred physical possession of the asset;
• the customer has the significant risks and rewards of ownership of the asset; and
• the customer has accepted the asset.

Question 31

What obligations are exempt from IAS37 (contigent liabilities/provisions and contingent assets)?

Answer 31

International Accounting Standard 37 excludes obligations and contingencies arising from:
<br></br>

• a non-onerous executory contract, under which no party has completed any part of its performance obligation or
  both parties have carried on their obligation in part to the same extent; and
• those covered by another standard, such as:
  – financial instruments including financial guarantees (IFRS 9);
  – income tax (IAS 12);
  – leases (IFRS 16); and
  – insurance contracts (IFRS 4)

<br></br>
Provisions made to adjust the value of an asset, such as provisions for depreciation or impairment, are not covered by
IAS 37. However, the standard does apply to executory contracts which are onerous and lease contracts which have
become onerous.

Question 32

What is a provision? *******

Answer 32

A provision is defined as a liability of uncertain timing or amount. In IAS 37, a liability is defined as a present obligation
of the entity arising from past events, settlement of which is expected to result in an outflow of resources. The provision
should be used against the expenditure for which it was originally made. This is different to the Conceptual Framework
definition of a liability, although the two definitions are similar.

Question 33

When can/should a provision be recognised?

Answer 33

When all three of the following conditions are met:
* there is a present obligation (legal or constructive) as a result of a past event;
* it is probable that an outflow of economic resources will be required to settle the obligation; and
* the amount of the obligation can be estimated reliably.

Question 34

How should the amount to be recognised as a provision be measured?

Answer 34

The amount recognised as a provision should be the best estimate of the expenditure required to settle the present
obligation at the end of the reporting period.
Where a large population of items is being measured, the obligation is estimated by weighting all possible outcomes by
their associated probabilities. When measuring a single obligation or liability, the individual most likely outcome may be
the best estimate. The entity, however, should consider other possible outcomes in all cases, including:
* the use of expert opinion, legal advice or management’s own judgement based on past experience;
* the use of the expected value method (discussed in Chapter 14) that uses the most probable outcome and the
events which occur frequently for the measurement of one-off events;
* the effect of any related risk and uncertainties; and
* consideration of future events likely to occur that may affect the amount required to settle an obligation, such as
future technology likely to reduce the value of provision.

Question 35

What is a contingent liability?

Answer 35

A contingent liability is defined as:
* a possible obligation that arises from past events and whose existence depends upon the occurrence (or non-
occurrence) of one or more uncertain future events which are not in the control of the entity; or
* a present obligation that arises from past events but is not recognised because either:
– it is not probable that an outflow of economic benefits will be required to settle the obligation; or
– a present obligation which arises from past events cannot be measured with sufficient reliability.

Question 36

What is a contingent asset?

Answer 36

A contingent asset is a possible asset that arises from a past transaction or event and whose existence depends upon
the occurrence (or non-occurrence) of some uncertain future events not wholly within the entity’s control. For example,
compensation (an inflow of economic benefits) expected from the settlement of a court case where the outcome is not
certain.
A contingent asset should not be recognised in the financial statements unless it is almost certain that the entity will
be entitled to the inflow of economic benefits. However, if there is no certainty, the entity will disclose such a probable
contingent asset in the notes to the financial statement.

Question 37

What are the potential issues of lease accounting?

Answer 37

Lease accounting throws up several issues:
* The treatment of assets ‘controlled’ by the lessee (and therefore depreciated): leases are depreciated based
on the time factor (the effluxion of time), even though the asset is not legally owned by the lessee.
* Accounting for liabilities and cash flow (splitting interest and capital elements): the principal repayments of
amounts borrowed under leases will be shown as a cash flow from financing activities, whereas the cash flow from
the interst paid will be shown under operating activities.
* Short-term leases and low-value leases benefit from a recognition exemption under IFRS 16. Preparers of
financial statements can elect not to apply the initial and subsequent recognition and measurement requirements of
IFRS 16 to leases for which the underlying asset is of ‘low-value’. Instead, lessees can simply account for the cost
of the lease by recognising the cost in equal amounts (straight-line basis) over the term of the lease.