Corporate reporting Flashcards
Treasury shares
When companies reacquire their own shares this is recorded directly in equity with no profit or loss recorded hence treasury shares are a negative equity account
If a company then reissues the shares the difference between any cash received and the balance in the treasury shares account is recognised in equity
Financial asset classification. (3)
FVPL default
Amortised cost if pass both tests
FVOCI if irrevocable election made and if not held for short term trading also used IF business model test BUT open to increase returns
Modification of debt accounting treatment. (3)
Exchange/modification of debt - in order to decide how to treat it need to decide if 10% difference (PV inc fees discounted at original effective rate of new vs PV of remaining)
If >10% substantially different
Old liab extinguished and a new liab recognised, any diff goes to SPL as are any fees
If <10% then NOT substantially different
Deemed original but modified so just restate existing liab to PV of new cash flows (again at original effective rate less fees), any diff goes to SPL.
Financial liability classification/treatment.(2)
Accounting for a financial liability: FVPL or Amortised cost
Initially recognised at fair value, accounts for discounting to PV
Transaction fees: FVPL financial liab - transaction costs are NOT included and are just expensed to the SPL // Amortised cost financial lab - deduct costs from initial FV
FVPL - they are then revalued at reporting date with gains/losses taken to the SPL
Amortised cost - Interest taken over life using effective rate
Business model test and contractual cash flow test. (2)
Business model test: Objective of holding the asset is to hold to maturity to collect the contractual cash flows
Contractual cash flow test: Cash flows are solely interest and repayments on principal
Exception - IAS 27 - for investment
A parent company, in its individual financial statements may choose to recognise an investment in a subsidiary, associate, or joint venture at either cost, fair value in accordance with IFRS 9, or using equity accounting.
Accounting treatment for derivatives with gains wb losses?(2)
Consistent with our treatment of derivatives with losses, these are classified as fair value through profit or loss (FVPL).
Easy marks in exam for financial instruments?
Mention disclosures!
The purpose of these disclosures is to provide users with useful information, both qualitative and quantitative, to evaluate:
the significance of financial instruments
the nature and extent of associated risks and the entity’s risk management.
Initial recognition of financial assets and how to treat transaction costs?
Initially at fair value (usually consideration paid) may sometimes need to discount eg if loans are below market
Transaction costs: FVPL expense to SPL (like financial liabilties FVPL)
FVOCI or amortised cost we ADD
FVPL investment in equity cost 10k with 1k transaction fees, what is the initial recognition?
At reporting the investment is valued at 12k what are the accounting entries here?
It is then sold for 15k after the reporting date, what are the subsequent accounting entries here?
Recognition:
Dr investment 10k
Dr SPL 1k (fees)
Cr Cash 11k
Reporting:
Dr investment 2k
Cr SPL 2k
Sale:
Cr investment 12k
Dr cash 15k
Cr SPL 3k
How to account for disposal of FVOCI assets in equity? What about debt?
FVOCI in equity:
Any profit or loss recognised in OCI with any balance on reserves left from FV movement not recycled to SPL
FVOCI in debt:
Any profit or loss in SPL! and any movement in reserves recycled back to SPL
How to account for transaction costs for financial assets and liabs
FVPL liab and asset, expense to SPL
FVOCI and amortised cost assets ADD costs to fair value
amortised cost liab we DEDUCT costs from fair value (no FVOCI for liabs)
FVOCI investment in equity cost 10k with 1k transaction fees, what is the initial recognition?
At reporting the investment is valued at 12k what are the accounting entries here?
It is then sold for 15k after the reporting date, what are the subsequent accounting entries here?
Initial recognition:
Dr investment 11k
Cr cash 11k
Reporting:
Dr investment 1k
Cr OCI 1k
Sale:
Dr cash 15k
Cr investment 12k
Cr OCI 3k
(for equity instruments there is no recycling of the gain on derecognition from reserves)
YZ Co acquired an investment in loan notes for £10,000. These were appropriately classified as FVOCI. Transaction costs on acquisition were £1,000 and the fair value at the year-end was £12,000.
The loan notes were subsequently sold for £15,000.
How much profit should be recognised on disposal?
4k
(being the 3k profit plus 1k in OCI from revaluation movement (11k to 12k))
As this was an investment in debt (financial asset in debt NOT equity) this reval would be recycled to the SPL!!!!
IFRS 13 FV measurement.(3)
Level 1 - best and identical eg stock price, Level 2 - similar, Level 3 - Only used if cant use above eg valuation of company not listed (no observable)
Note for level 1 the bid price vs ask price spread should be treat as a transaction cost
Have to disclose the level and methods in accounts
Does not apply to:
Inventories, impairments, share based payments, and leases
An entity purchases a financial asset as FVOCI with a brokerage fee of £3 and the following:
Acqn. Reporting
Bid price 100 110
Ask price 102 113
Show journal entries at acqn and reporting?
Show if this was FVPL instead.
IFRS 13 allows ,id market but treat the bid-ask spread (in this case £3) as an additional transaction cost! Use bid price for movements
FVOCI:
Acqn
Dr investment 105 (as all capitalised)
Cr Cash 105
Reporting
Dr investment 5 (use bid price)
Cr OCI 5
FVPL:
Acqn
Dr Investment 100 (as dont capitalise)
Cr SPL 5 (3 brokerage 2 spread in price)
Cr Cash 105
Reporting:
Dr investment 10
Cr SPL 10
Fair value in different markets.(2)
Use principle market first
If neither market is this use the most advantageous market (the one with the highest net recevied eg price less transaction and transport costs)
In all cases fair value would not include the transaction costs as this is not part of the asset
What financial asset does IFRS 9 impairment apply to and therefore what does this mean?
This is related to financial assets that are DEBT (therefore either measured as amortised cost of FVOCI) think loan notes
When this occurs the company must create a loss allowance upon initial recognition of the asset, initially the expected loss for 12 months , if credit risk deteriorates or evidence of impairment (ie evidence of lack of recoverability) then need to recognise over the life of the asset instead (lifetime expected credit losses)
Think loan note investment this would be debt financial asset so need an ECL, say the company these were from goes into financial difficulty this would be evidence of impairment thus suggesting LEL needed instead not just ECL
Credit loss definition. (3)
Difference between the PV of the contractual cash flows that are due to an entity and PV of cash flows the entity expects to receive
BOTH discounted at the ORIGINAL effective rate
note: since this considers amount anf timing an ECL could occur if full amount is recovered but later than contractually due
On initial recognition need to create a loss allowance which will be equal to 12 month expected credit losses
How to impair financial assets (the 3 stages) (3).
Has the credit risk deteriorated? If no stage 1 (12 month ECL)
If yes recognise on lifetime ECL and either stage 2 or stage 3 if there is objective evidence of impairment - see file
On 1 January 20X1, Korma purchased a debt instrument for its nominal value of £5 million. The transaction was at fair value. The entity’s business model is to hold financial assets to collect the contractual cash flows but also sell financial assets if investments with higher returns become available.
Interest is received at a rate of 4% annually in arrears. The effective rate of interest is 10%.
On 31 December 20X1, the fair value of the debt instrument was £4.5 million.
There has not been a significant increase in credit risk since 1 January 20X1, and 12-month expected credit losses are £0.3 million.
Discuss the accounting treatment of the above in the financial statements
for the year ended 31 December 20X1.
As debt investment held at FVOCI there is a problem as the fair value will already reflect market expectations for loss, to combat this we transfer from OCI to SPL the part of the fall in fair value relating to ECLs.
Accounting treatment:
The financial asset is initially recognised at its fair value of £5m. The asset will be measured at FVOCI (due to business model). Interest income is calculated using the effective rate of interest will revaluations recorded in OCI:
BF 5m + interest 10% (0.5m) -cash receipt (4%*5m=0.2m) = cf (5.3m) - loss (0.8m) gives fair value of 4.5m
Interest income of 0.5m is recorded in the SPL.
The asset is revalued to FV with the 0.8m loss to 4.5m
However, bc the asset is FVOCI the 12 month ECL are transferred to SPL from OCI (hence 0.3m)
(ie the 0.5m of downwards reval is recorded in OCI whilst 0.3m is recorded in SPL)
IFRS 9 simplified approach for trade receivables. (2)
Applying the 3-stage approach might seem like overkill when the debt instrument in question is a trade receivable balance.
IFRS 9 recognises this and provides the following simplifications:
For trade receivables with no financing element (i.e. less than 12 months credit terms), we measure the loss allowance based on lifetime credit losses.
For other trade receivables, we may choose to measure the loss allowance based on lifetime credit losses rather than applying the 3-stage approach.
Repurchase agreement
A repurchase agreement is when a company sells an asset and simultaneously enters into a contract to repurchase the asset at a fixed future date.
The details of the agreement need to be examined to determine whether the company has significantly transferred the risks and rewards of ownership of the asset and thus determine if it should be derecognised
Factoring/Invoice discounting and derecognition. (2)
A debt factor gives the company cash in exchange for the rights to the future receipts from the company’s receivables.
This is usually at a lower amount than the total value of the receivables, since there will be some uncertainty around recoverability.
If the factoring arrangement is without recourse then the company:
-does not have to compensate the factor for non-payment by the receivables has therefore passed on the risks of ownership of the asset to the factor.
In this circumstance, it is appropriate for the company to derecognise the receivables.
If the factoring arrangement is with recourse (legal right to demand repayment) then the company:
guarantees the future performance of the receivables will compensate the factor if they do not pay has therefore retained the risks of ownership.
In this circumstance, the company must continue to recognise the receivables and also recognise a liability representing the obligation to repay the factor.
1 ABC sells an investment in shares but retains a call option to repurchase those shares at any time at a price equal to their current market value at the date of repurchase.
2 DEF Co enters into a stock lending agreement where an investment is
lent to a third party for a fixed period of time for a fee.
3 XYZ Co sells the rights for some of its receivables to a debt factor for an
immediate cash payment of 90% of their value. The terms of the agreement are that XYZ Co has to compensate the factor for any amounts not recovered by the factor after six months.
Required:
Discuss whether the financial instruments above would be
derecognised per IFRS 9.
1) ABC should derecognise as the option to repurchase is at the prevailing market value therefore no risk or reward remains.
2) Dont derecognise as it has retained substantially the risks and rewards of ownership, therefore should be retained on the books even if the legal title has temporarily been transferred.
3) continue to recognise as retains risk and rewards (due to potnetially needing to reimburse the factor), the cash received should be treat as a loan, the 10% the company wont receive should be treat as interest over the 6 month period as an SPL expense and increasing the CV of the loan
At the end of the 6 months they should then derecognise the receivables by netting against the amount fo the loan that does not need repaid to the debt factor (any remaining will be bad debts and expesned to the SPL) -note: if there was any indication of irrecoverable debts sooner yhis impairment loss would be recognised sooner
M Ltd has total trade receivables of £8m. Of this, about £5m are not due for at least three months and could be sold to a debt factor.
The factor will advance cash equal to 80% of the gross receivables sold
immediately and is non-returnable. A credit protection premium of 1.25% of gross receivables sold would be payable, together with interest of 1% per month on the amounts advanced, net of any cash received from the receivables by the factor. After three months all remaining amounts would be paid by the factor to M Ltd and any further responsibility would belong to the factor.
Required:
Discuss how the trade receivables should be accounted for per IFRS 9.
The key issue is whether factored receivables should be derecognised as a financial asset. Receivables should be derecognised when M Ltd has transferred substantially all the asset’s risks and rewards of the receivables.
There is a strong case that the £4m immediately received from the factor
should be derecognised due to it being non-recourse financing.
The terms of the arrangement state interest is payable on the amounts
advanced. This means M Ltd retains some slow-moving risk and it is a
question of judgement as to whether this is ‘substantial’ in the context of the specific circumstances.
£3m not factored are to remain in receivables. Of the £5m factored, it appears £4m should be derecognised as the risk and rewards have been substantially transferred.
The balance remaining of £1m is more subjective. 1.25% * £5m = £62,500 credit protection premium.
Interest payable 1% * £4m = £40,000 per month * 3 months = £120,000. These amounts would be charged to the profit and loss account.
It would be prudent to derecognise the remaining (5m-4m-182.5k fees)=£817,500 as the factor
receives settlement.
When does IFRS 2 (SBP) not apply?(3)
If an employee obtains shares as an investor, not as an employee
Shares issued as consideration on acqn of subsid etc
a contract to buy non financial asset that can be settled net in cash
Note: IFRS 13 Fair value measurement doesn’t apply to share based payment transactions. We should follow the guidance in IFRS 2 in determining fair value
Define:
grant date
vesting period
vesting date
exercise date
grant date-when agreement is entered
vesting date-when conditions arise
exercise-when options are exercised
vesting period-between grant and vesting date
An entity grants 100 share options on its £1 shares to each of its 500
employees on 1 January 20X5.
Each grant is conditional upon the employee working for the entity over the next three years and the share price reaching £100.
The fair value of each share option as at 1 January 20X5 is £15, and the share price is £90.
The entity estimates on 1 January 20X5 that 20% of employees will leave during the three-year period and will therefore forfeit their right to share options.
The accounting year-end is 31 December.
Required:
Show the accounting entries which will be required over the three-year
period in the event of the following:
a) 20 employees leave during 20X5 and the estimate of total employee departures over the three-year period is revised to 15% (75 employees). The share price has fallen to £85, and is not expected to recover.
b) 22 employees leave during 20X6 and the estimate of total employee departures over the three-year period is revised to 12% (60 employees). The share price has fallen to £80, and is not expected to recover.
15 employees leave during 20X7, meaning that a total of 57 employees have left their employment.
The market condition around share price is IGNORED as already factored into fair value
a) 500 (no options)85%100£15 (FV of option)1/3=212.5k Cr equity Dr expenses
b) 50088%100£152/3=440k less previously recognised 212.5k=£227,500 Cr equity/Dr expenses
c) (500-57)100£15=664,500-440k previously recognised=224.5k Cr equity/Dr expenses
Modifications and repricing - why might they happen?
To remotivate employees:
Modifications to existing share option schemes can be made during the vesting period, but why might this happen?
The classic example is where a company’s share price has fallen significantly below the exercise price.
Imagine holding an option with an exercise price of £10, when the current share price has fallen to £2.
It’s not very likely the share price will recover putting the option in the money. As a result, the option’s fair value will have fallen significantly and we’ll have a somewhat demotivated employee.
But what if the company decided to modify the option by reducing the exercise price to £3? Well, now we have a good chance of making money on the option - we just need to push the share price up by more than £1 to be in the money. So BINGO! We have a remotivated employee and a more valuable option.
