Chapter 7 Reporting of assets and liabilities

Question 1

1.1 IAS 36 Impairment of Assets

Answer 1

An asset is impaired if the carrying amount exceeds its recoverable amount. The recoverable amount of an asset is the higher of its FV less cost of disposal and its value in use (PV of future cash flows expected to be derived from an asset).
The discount rate should reflect the risks specific to the asset. Estimates of future cash flows should reflects the current condition of the asset. Usually it is only possible to reliably forecast cash flows for a max of 5 years. After 5 years, projected cash flows are extrapolated using an appropriate growth/decline rate.

Question 2

1.2 Frequency of impairment reviews

Answer 2

Perform impairment reviews annually for purchased goodwill and intangibles that are not being amortised. Perform impairment reviews for any other assets only when there is some indication that impairment has occurred.

Question 3

1.3 Recognition of impairment losses

Answer 3

Impairment losses are taken to P+L, unless the asset is held under the revaluation model, in which case losses are first set against any revaluation surplus for the asset and charged to OCI.

Question 4

1.4 Cash-generating units

Answer 4

It can be difficult the determine the value-in-use of a specific asset. When this occurs, we must consider groups of assets called cash-generating units. This is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets.

Question 5

1.5 Allocating central assets to CGUs

Answer 5

Some assets within a business do not generate cash flows. These include corporate assets and goodwill. These assets should be allocated to CGUs on a reasonable, consistent basis, such as their respective carrying amounts.

Question 6

1.6 Impairment review of a CGU

Answer 6

A CGU to which goodwill has been allocated must be tested for impairment at least annually. An impairment loss should be recognised against a CGU when the carrying amount of CGU (sum of the carrying amounts of the individual assets of the CGU) is more than the recoverable amount (higher of value in use and FV less costs to sell).
IAS36 states the carrying amount of a CGU does not include the carrying amount of any recognised liability, unless the recoverable amount of the CGU cannot be determined without consideration of this liability.

Question 7

1.7 Allocation of impairment to CGU assets

Answer 7

The impairment loss shall be allocated to reduce the carrying amount of assets of the unit in the following order:
- Reduce the carrying amount of any goodwill allocated to the CGU, and
- Then to the other assets of the unit, pro-rata on the basis of the carrying amount of each asset in the unit

Question 8

1.8 Reversal of impairment losses

Answer 8

Impairment losses can be reversed if the recoverable amount increases after an impairment has been performed. Assess whether a reversal has occurred at each YE. The reversal of the impairment loss through the SPL is capped so that the new carrying amount is not more than the carrying amount if no impairment had occurred. Any excess between the cap and the recoverable amount under the cost model is not recognised and under the revaluation model is treated as a revaluation in accordance with IAS 16.
Impairment losses against goodwill can never be reversed. Therefore, the reversal should be allocated to assets (other than goodwill) on a pro-rata basis according to their carrying amount.

Question 9

2.1 IAS 2 Inventories

Answer 9

Inventory should be valued at the lower of cost and net realisable value. The costs include costs of purchase, plus any incidental costs incurred in bringing the inventories to their net realisable value. The cost should be calculated using FIFO or AVCO. The net realisable value is the selling price less any costs to complete and selling costs.

Question 10

3.1 IAS 16 Property, plant and equipment

Answer 10

The cost of an item of PPE comprises:
- Purchase price, including import duties and non-refundable purchase taxes
- Any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management
- The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located

Question 11

3.2 Revaluation model

Answer 11

Apply consistently to the class of PPE. Carry out revaluations regularly. Revaluation gains are taken to revaluation surplus/OCI unless reverses losses previously charged to SPL. Revaluation losses are taken to SPL unless reverses gains previously recognised in revaluation surplus/OCI.

Question 12

3.3 Depreciation

Answer 12

Commences when asset available for use. Changes to depreciation method, useful life or residual value should be recognised prospectively. An entity may make a reserve transfer annually between revaluation surplus and retained earnings, for any extra depreciation resulting from a revaluation.

Question 13

3.4 Derecognition

Answer 13

Remove the SFP when an asset is sold/abandoned/scrapped with the gain or loss recognised in the SPL. Revaluation surplus balance is transferred to retained earnings on disposal. If an asset is sold, classify it as held for sale.

Question 14

4.1 IAS23 Borrowing costs

Answer 14

If a loan is taken out to finance a qualifying asset, the interest is capitalised when:
- Expenditure on the asset is being incurred
- Activities to get the asset ready are taking place
- Interest expense is being incurred
If a specific loan is taken to fund the asset, capitalise the interest suffered less any interest earned whilst the funds are on deposit. If the asset is funded from general borrowings, calculate the weighted average cost of debt and apply it to the expenditure on the asset. Cease capitalisation when the asset is ready for use. Suspend capitalisation for any periods when the asset is not being developed.

Question 15

5.1 IAS 38 Intangible assets

Answer 15

An intangible asset has no physical substance, it is identifiable (either separable or arises from a contractual or legal right) and it should be recognised if there is a probable economic benefit flowing to the entity as a result of ownership and its cost can be measured reliably.

Question 16

5.2 Types of intangibles

Answer 16

• acquired separately: recognised at cost
• acquired with a business combination: can be identified separately and recognised at FV, otherwise include it in goodwill
• internally generated: recognise at directly attributable cost if it meets the criteria of IAS 38

Question 17

5.3 Recognition and measurement

Answer 17

Initial recognition is at cost. Amortisation should be applied if there is a useful life. Impairment reviews should be performed annually if a useful life cannot be identified. If the intangible is being amortised then impairment reviews should only be performed if there is some indication of impairment. Intangibles can be revalued if there is an active market.

Question 18

5.4 Research and development (internally generated intangibles)

Answer 18

Research expenses are written off as an expense immediately. Development costs must be capitalised if they meet the following criteria: profit made on the project, intention to use/sell product, resources available to complete the project, ability to use/sell the product, technically feasible and expenditure is identifiable.
Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets.

Question 19

6.1 Intangible assets – website costs

Answer 19

There are specific rules on intangible assets used in website development. In determining costs to capitalise IAS 38 rules should be followed. Activities involved in planning a website are research costs and not capitalised. Application and infrastructure development, graphical design are similar to development stage and are capitalised. Expenditure which contributes to advertising and promotion should be expensed. The useful life of a website is likely short.

Question 20

7.1 IAS 20 Accounting for government grants and disclosure (initial recognition and measurement)

Answer 20

Recognise government grants at fair value when there is reasonable assurance that the entity will comply with any conditions and the grant will actually be received.
Match the grant income to the related expenditure. This will either be capital or revenue expenditure. For cap expenditure recognise the grant over the same period of depreciation. If the grant is to a non depreciating asset, then recognise the grant over the period when the costs of meeting the obligation are incurred. The grant can be shown as deferred income or netted off against the carrying amount of the asset.
For revenue expenditure, the grant is taken to the SPL to match the expense. If the expenditure has already been incurred, recognise the grant immediately upon receipt. Non-monetary government grants are recognised at the fair value.

Question 21

7.2 Repayment of grant

Answer 21

If the grants relates to assets, increase the carrying amount of the asset as if the grant had never been received, or reduce any deferred income (excess of the repayment over the remaining deferred income is recognised as an expense). If it relates to income, reduce any deferred income. If the repayment exceeds the carrying amount of the deferred income the excess is treated as an expense.

Question 22

8.1 IAS 10 Events after the reporting period

Answer 22

IAS 10 covers events between the end of the reporting period and the date the accounts are authorised for issue. The events are split into two types:
- adjusting events: which provide evidence of conditions that existed at the end of the reporting period. The accounts should be adjusted to reflect adjusting events
- non-adjusting events: indicative of conditions that arose after the reporting period. Disclosure should be made in the accounts where the event is material
Going concern basis: accounts are prepared on a going concern basis. Where an entity goes into liquidation after the reporting date, it is no longer considered to be a going concern and the accounts should be prepared on the break-up basis.

Question 23

9.1 IAS 37 Provisions, contingent liabilities and contingent assets

Answer 23

A provision is a liability of a uncertain timing or amount. A provision is recognised when 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 this and a reliable estimate can be made. The measurement needs to consider:
- the best estimate of the amount needed to settle the liability
- discounting to PV when the time value of money is material
- reviewing and revising at each year end, to ensure the best estimate
IAS 37 covers:
- onerous contracts: unavoidable cost of fulfilling the contract outweighs the benefit received. The excess unavoidable costs should be provided for
- future operating losses: there is no obligation to make future losses and this should not be provided for
- restructuring costs: only provided when there is constructive obligation arising from a formal plan including cost and timescale estimates and an announcement of the restructure

Question 24

9.2 Contingent liabilities and assets

Answer 24

A contingent liability is a possible obligation or present that is not recognised. It should be disclosed in the accounts unless the outflow of economic benefits is deemed remote.
A contingent asset arises from past events and existence is confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. It should be disclosed when the inflow is probable and recognised as an asset when virtually certain.
An entity may be entitled to reimbursement for all or part of the expenditure required to settle a provision. A provision and reimbursement are recognised separately. A reimbursement is only recognised when it is virtually certain the amount will be received, this cannot exceed the amount of provision.

Question 25

10.1 Audit and assurance implications of impairments

Answer 25

Risks Tests/procedures
Impaired assets might not be identified as such. On inspection of assets, identify any that appear damaged or not in use. Review management produced variance analysis for operations with adverse variances. Review minutes of management and board meetings for discussion of underperforming operations and/or plans to change strategy. Obtain management’s impairment review.
FV less costs of disposal could be hard to determine Obtain management’s estimate of fair value and ensure that FV is supported by evidence such as traded market price or other reliable data. Review costs of disposal for completeness and agree any estimates to supporting evidence e.g. quotes from selling agents etc.
Value in use involves significant judgement: estimating future cash flows
identifying an appropriate risk-adjusted discount rate. Obtain management’s calculation of value in use and: reperform calculations, compare cash flows to forecasts assessing the reasonableness of the assumptions in the forecast, agree discount rate used to rates of return available on similar assets/operations, assess the reliability of estimates by reviewing previous estimates made, ensure that estimates reflect existing condition of asset.
Cash generating units may be misidentified Review CGUs to ensure their cash flows are largely independent of other groups of assets. For any CGUs identified, assess whether there are any smaller groups of assets with independently identifiable cash flows.
Impairments may not be allocated correctly to the assets within a CGU Obtain workings and review to ensure that: any goodwill is written down first, other assets are written down pro-rata based on the carrying amount, no asset is written down below zero or its own recoverable amount.