E. INTERPRET FINANCIAL STATEMENTS FOR DIFFERENT STAKEHOLDERS

Question 1

Stakeholders.

Answer 1

Stakeholders. Anyone with an interest in a business; they can either affect or be affected by the business.

Question 2

Stakeholder interests in Financial statements:

 Management.

Answer 2

 Management. They may be set performance targets and use the financial statements to compare company performance to the targets se, often with a view to achieving bonuses. Also, may use them to aid them in important strategic decisions.

Question 3

Stakeholder interests in Financial statements:

 Employees.

Answer 3

 Employees. They are concerned with job stability and may use corporate reports to better understand the future prospects of their employer. They also want to feel proud of the company that they work for and positive financial statements can indicate a job well done.

Question 4

Stakeholder interests in Financial statements: Lenders and suppliers.

Answer 4

 Lenders and suppliers. They are concerned with the credit worthiness of an entity and the likelihood that they will be repaid amounts owing. Also, interested in the future direction of a business to help them plan whether it is likely that they will continue to be a business partner of the entity going forward.

Question 5

Stakeholder interests in Financial statements: Customers.

Answer 5

 Customers. They may want to know that products and services provided by an entity are consistent with their ethical and moral expectations. They typically want to feel that they are getting good value for money in the products and services they buy.

Question 6

Stakeholder interests in Financial statements: Government.

Answer 6

 Government. Often uses financial statements to ensure that the company is paying a reasonable amount of tax relative to the profit it earns. Also, to collect information and statistics on different industries to help inform policy making.

Question 7

Stakeholder interests in Financial statements: Local community.

Answer 7

 Local community. May want to know about local employment opportunities. Also, may be interested in the company’s social and environmental credentials.

Question 8

Stakeholder interests in Financial statements: Present and potential investors.

Answer 8

 Present and potential investors. Existing investors will assess whether their investment is sound and generates acceptable returns. Potential investors will use the financial statements to help them decide whether or not to buy shares in a company. They will want to understand more about the types of products the company is involved in and the way in which the company does business, which will help them make ethical investment decisions.

Question 9

Performance measures.

Answer 9

Performance measures. Traditional financial performance measures preferred by shareholders remain important, but there is an increasing focus on alternative performance measures, such as Economic Value Added and non-financial measures such as employee’s well-being and the environmental impact that entity has.

Question 10

Financial indicators of performance

Answer 10

Financial indicators of performance are useful for comparing the results of an entity to:

 Prior year(s)
 Other companies operating in the same industry
 Industry averages
 Benchmarks
 Budgets or forecasts

Question 11

Ratio analysis process (for exam).

Answer 11

Ratio analysis process (for exam).
 If comparing two years, state whether the ration has improved or deteriorated. If comparing two companies, state which company’s ratio is better.
 State why the ratio has increased/decreased or is better/worse – avoid generic reasons; use reasons in the scenario.
 Conclude – explain the longer-term impact on the company and make a recommendation for action where appropriate.

Question 12

Profitability.

Answer 12

Return of capital employed (ROCE). 
Return on equity (ROE).
Gross profit margin.
Operating profit margin. 
Net profit margin.

Question 13

Return of capital employed (ROCE).

Answer 13

Return of capital employed (ROCE). Measures how efficiently a company uses its capital to generate profits. A potential investor or lender should compare the return to a target return or a return on other investments/loans.
ROCE= (Profit before interest and tax)/(Capital employed)=(Profit before interest and tax)/(Total assets less current liabilities)

Question 14

Return on equity (ROE).

Answer 14

Return on equity (ROE). While ROCE looks at the overall return on the long-term sources of finance, ROE focuses on the return for the ordinary shareholders.
ROE= (Profit after tax and preference dividends)/(Ordinary share capital+reserves)%

Question 15

Gross profit margin.

Answer 15

Gross profit margin. Measures how well a company is running its core operations.
Gross profit margin= (Gross profit)/Revenue x100

Question 16

Operating profit margin.

Answer 16

Operating profit margin. PBIT is used to remove distortion between differently financed companies (loans vs shares). How well company is controlling its non-production overheads.
Operating profit margin= PBIT/Revenue x100

Question 17

Net profit margin.

Answer 17

Net profit margin. Extra consideration interest and tax.

Net profit margin= (Profit for year)/Revenue x100

Question 18

Efficiency.

Answer 18

Asset turnover.
Total asset turnover.
Non-current asset turnover.

Question 19

Asset turnover.

Answer 19

Asset turnover. Shows how much revenue is produced per unit of capital invested. Therefore, how efficiently the entity is using its capital to generate revenue.
Asset turnover= Revenue/(Capital Employed)= Revenue/(Total assets less current liabilities)

Question 20

Total asset turnover.

Answer 20

Total asset turnover. Is an indication of how efficiently the entity is using its assets to generate revenue.
Total asset turnover= Revenue/(Total assets)

Question 21

Non-current asset turnover.

Answer 21

Non-current asset turnover. Examines the productivity of non-current assets in generating sales (suitable for a capital-intensive entity.
Non-current asset turnover= Revenue/(Non-current assets)

Question 22

Reasons for changes in profitability and efficiency ratios.

ROCE and asset turnover ratios.

Answer 22

ROCE and asset turnover ratios.
 Type of industry (manufacturing typically have higher assets and lower ROCE/asset turnover than services)
 Age of assets (old asset=low carrying amount=low capital employed and high ROCE/asset turnover)
 Leased versus owned assets
 Revaluations (increased capital employed=lower ROCE/asset turnover, increased depreciation=lower ROCE)
 Timing of purchase (at year end=increased capital employed but no time to affect PBIT/revenue)

Question 23

Reasons for changes in profitability and efficiency ratios.

Gross profit margin

Answer 23

Gross profit margin
 Changes in sales price, sales mix,
 Changes in purchase price and/or production costs
 Inventory obsolescence (written off through COS)

Question 24

Reasons for changes in profitability and efficiency ratios.

Operating profit margin

Answer 24

Operating profit margin
 One-off non-recurring expenses
 Rapid expansion
 Relocation
 Efficiency savings (economies of scale)

Question 25

Investor ratios.

Answer 25

Investor ratios. Investors may either be seeking income (in the form of dividends; and/or capital growth (in the form of an increase in the share price).
EPS
Price/earnings (P/E ratio). 
Profit retention ratio. 
Dividend payout rate. 
Dividend yield.
Dividend cover.

Question 26

Earnings per share (EPS)

Answer 26

Earnings per share (EPS) is one of the most widely used investor ratios and is presented within financial statements (IAS 33). There are two EPS figures which must be disclosed – basic EPS and diluted EPS.

Question 27

Basic EPS.

Answer 27

Basic EPS.
EPS= (Profit after interest,after tax and after preference dividends)/(Number of ordinary shares in issue)
Calculated by dividing the net profit or loss for the period attributable to ordinary equity holders by the weighted average number of ordinary shares outstanding during the period
EPS=(Net profit or loss attributable to ordinary holders of the entity)/(Weighted average no.of ordinary equity shares outstanding during the period)
The net profit or loss attributable to ordinary equity holders of the parent is the consolidated profit after: income taxes, NCI and preference dividends (on preference shares in equity). Weighted average number of ordinary shares during the period should be adjusted for events which have changed the number of shares outstanding without corresponding change in resources.

Question 28

Diluted EPS.

Answer 28

Diluted EPS. Calculated by adjusting the net profit or loss and weighted average number of ordinary shares that are used in the basic EPS calculation to reflect the impact of potential ordinary shares (convertible loan stock or preferred shares, options and warrants).

Question 29

Price/earnings (P/E ratio).

Answer 29

Price/earnings (P/E ratio). This is a measure of the market’s confidence in the future of an entity.
P/E ratio= (Current market price per share)/EPS

Question 30

Profit retention ratio.

Answer 30

Profit retention ratio. This is useful ratio for an investor seeking capital growth and it shows the portion of the profit to be reinvested into the business for future growth (rather than being paid out as dividends).
Profit retention ratio= (Profit after dividends)/(Profit before dividends) x100%

Question 31

Dividend payout rate.

Answer 31

Dividend payout rate. This ratio is useful for an income-seeking investor as it shows portion of profit paid out to investors in the form of dividend.
Dividend payout rate= (Cash dividend per share)/EPS x100%

Question 32

Dividend yield.

Answer 32

Dividend yield. This ratio gives the cash return on the investment (valued at current market value) (useful for income-seeking).
Dividend yield= DPS/(Market price per share) x100%

Question 33

Dividend cover.

Answer 33

Dividend cover. Shows how easily an entity can allocate dividends out of its profits.
Dividend cover= EPS/DPS

Question 34

Liquidity.

Answer 34

Current ratio.
Quick ratio (acid test).

Question 35

Current ratio.

Answer 35

Current ratio. The ratio measures the company’s ability to pay its current liabilities out of its current assets. The industry the company operates in should be taken into consideration.
Current ratio= (Current assets)/(Current liabilities)

Question 36

Quick ratio (acid test).

Answer 36

Quick ratio (acid test). This is a similar to the current ratio but inventory is removed from the current assets due to its poor liquidity in the short term.
Quick ratio=  (Current assets-Inventory)/(Current liabilities)

Question 37

Working capital management.

Answer 37

Receivables collection period.
Payables payment period.
Inventory holding period.
Working capital cycle.

Question 38

Receivables collection period.

Answer 38

Receivables collection period. Shows, on average, how long it takes for the trade receivables to settle their account with the company. The average credit term granted to customers should be taken into account as well as the efficiency of the credit control function within the company.
Receivables collection period= (Trade Receivables)/(Credit sales )×365

Question 39

Payables payment period.

Answer 39

Payables payment period. This ratio is measuring the time it takes the company to settle its trade payable balances. Trade payables provide the company with a valuable source of short-term finance but delaying payment for too long a period of time can cause operational problems as suppliers may stop providing goods or services until payment is received.
Payables payment days= (Trade payables)/(Credit purchases (COS))×365

Question 40

Inventory holding period.

Answer 40

Inventory holding period. Ratio measures the number of days inventories are held by a company on average before they are sold. This will depend on the type of goods sold.
Inventory days=(Inventory )/(Cost of sales)×365

Question 41

Working capital cycle.

Answer 41

Working capital cycle. It represents the time between payment of cash for inventories and eventual receipt of cash from sale of the inventories. It shows the number of days for which finance is required.
Inventory holding period+Receivables collection period-payables payment period

Question 42

Financial leverage.

Answer 42

Gearing.

Interest cover.

Question 43

Gearing.

Answer 43

Gearing. Is concerned with long-term financial stability of the company. It looks how much the company is financed by debt.
Debt/Equity=(Long-term debt )/Equity×100%
Debt/(Debt+Equity)=(Long-term debt )/(Long-term debt+Equity)×100%

Question 44

Interest cover.

Answer 44

Interest cover. Considers the number of times a company could pay its interest payments using its profit from operations.
Interest cover=PBIT/(Interest expense)

Question 45

Limitations of ratio analysis

Answer 45

Limitations of ratio analysis
 Limitation of year-on-year comparisons
o Change in nature of the business or geographical areas in which entity operates (new product/new area)
o Increasing costs or change in the value of the currency (energy, living wage, weakening currency)
 Limitations of intersegment comparisons (between companies)

o Different accounting policies (FIFO)
o Operating at different ends of the sector (cheap vs luxury)
o Slightly different range of activities within the business (product mix)
o Difference in size of entities (economies of scale for larger companies)
o Different classification of costs (COS/admin/distribution)
o Different business decisions (operating vs financing lease)
o Age of assets

Question 46

Alternative performance measures.

Answer 46

Alternative performance measures. APM is understood as a financial measure of historical or future financial performance, financial position, or cash flows, other than a financial measure defined or specified in the applicable financial reporting framework.
APMs provide additional information not available in IFRS reporting that can enhance a user’s understanding of the performance of the business. They better allow users to evaluate performance through the eyes of management and can help make comparisons between entities easier. There is also more freedom and flexibility to tailor measures to company. However they can be misleading:
 APMs may be subject to management bias in their calculation because they can choose to report certain APMs and not others or manipulate calculation to present the entity in more favourable light.
 As there are no standards governing the use of APMs, there can be inconsistency in the calculation of APMs from year to year and also in which APMs are reported.
 APMs are often described using terminology that is not defined in accounting standards and therefore users cannot easily understand what the APM is reporting.

Question 47

EBITDA

Answer 47

EBITDA (earnings before interest, tax, depreciation and amortisation). Is considered an indicator of the earnings potential of a business. It can be used to analyse and compare profitability between companies because it eliminates the effects of financing, taxation and accounting decisions.
 It is often used internally by management as it represents the earnings of the business that management has most control over. Reporting this measure gives stakeholders an indication of management performance.
 However, it is subject to manipulation by the directors as entities have discretion as to what is included in calculation. Should be used with other performance measures to ensure it is consistent.

Question 48

EVA (economic value added).

Answer 48

EVA (economic value added). EVA is a measure of a company’s financial performance based on its residual wealth by deducting its costs of capital, from its operating profit, adjusted for taxes on cash basis. It shows the amount by which earnings exceed or fall short of the minimum rate of return that investors could get by investing elsewhere.
 Maximisation of EVA will create real wealth for the shareholders. It is likely to be less distorted by the accounting policies selected as the measure is based on figures that are closer to cash flows than accounting profits. EVA focuses on efficient use of capital
 However, it can encourage managers to focus on short-term performance. Based on historical accounts which may be of limited use as a guide to the future. A large number of adjustments are required to calculate net operating profit after taxes and the economic value of net assets.

Question 49

Non-financial performance indicators (NFPI)

Answer 49

Non-financial performance indicators (NFPI) are measures of performance based on non-financial information which may originate in, and be used by, operating departments to monitor and control their activities without accounting input. The most effective NFPIs will be both specific and measurable.
 Employees – satisfaction scores, turnover, absence, working conditions, remuneration gap, gender gap pay
 Customers – delivery times, after care, repeat customers, new accounts, social media
 Productivity – capacity utilisation, units produced, set-up time
 Social – brand awareness, reputation, charitable work
 Environmental-emissions, energy usage, renewables, resource usage, environmental fines and expenditures.

Question 50

Balanced scorecard.

Answer 50

Balanced scorecard. The balanced scorecard approach to performance measurement and control emphasises the need to provide management with a set of information which covers all relevant areas of performance. It focuses on four different perspectives and uses financial and non-financial indicators. The four perspectives are:
 Customer – what is it about us that new and existing customers value? (cost, quality, delivery, handling, response to needs)
 Internal – what processes must we excel at to achieve our financial and customer objectives? (internal processes and decision making)
 Innovation and learning – how can we continue to improve and create future value? (maintain competitive position through new skills and new products)
 Financial – how do we create value for our shareholders? (growth, profitability and shareholder value)

Question 51

Demand for transparency.

Answer 51

Non-financial reporting enables entities to be more transparent in communicating non-financial elements of their business to their stakeholders. Non-financial reporting can have significant benefits to an entity in terms of its reputation and positive stakeholder engagement.
Demand for transparency. Entities are an integral part of society. They provide us with products and services, they employ us, they pay taxes that support our economies, and they get involved in political discussions and agendas. As such, it has become increasingly important we understand how an entity does business.
There are principles (such as GRI) of non-financial reporting that have helped develop a generally accepted concept as to what non-financial reporting should achieve: materiality, stakeholder inclusiveness, completeness, sustainability context. These principles have helped to shape the types of non-financial report we see today.

Question 52

The Global Reporting Initiative (GRI)

Answer 52

The Global Reporting Initiative (GRI) is a long-term, multi-stakeholder, international not-for-profit organisation whose mission is to develop and disseminate globally applicable GRI standards on sustainability reporting for voluntary use by organizations.

Question 53

GRI reporting principles.

Answer 53

GRI reporting principles.
 Stakeholder inclusiveness. The reporting organisation shall identify its stakeholders and explain how it has responded to their reasonable expectations and interests. Unlike traditional with shareholder wealth maximisation entity is encouraged to consider the impact of its actions on its key stakeholders instead.
 Sustainability context. The report shall present the reporting organisation’s performance in the wider context of sustainability. Traditional reporting is often focused on short-term profitability, whereas GRI promotes sustainability in wider context – environmental, social and economic, and focuses on longer-term, encouraging to consider the risks and opportunities that will arise.
 Materiality. The report shall cover topics that reflect the reporting organization’s significant economic, environmental, and social impacts or substantively influence the assessments and decisions of stakeholders. Traditional reporting often considers materiality in terms of quantative values, whereas GRI consider whether an entity’s activities have economic, social or environmental effects, now and for future generations (only on significant activities).
 Completeness. The report should include coverage of material topics and their boundaries, sufficient to reflect significant economic, environmental and social impacts, and to enable stakeholders to assess the reporting organization’s performance in the reporting period. The notion of completeness considers scope (economic, social and environmental), boundary (whether external or internal to the organization) and time (the reporting period and future impacts).

Question 54

Current reporting requirements.

Answer 54

Current reporting requirements.
 IFRS requirements. There are no required disclosures for environmental and social matters, but they may disclosed where fall under specific accounting principles (IAS 37).
 National requirements. Some countries require disclosure of environmental performance under national law.
 Voluntary disclosure. Voluntary disclosure and the publication of environmental reports has become the norm for quoted companies in certain countries as a result of pressure from stakeholder groups to give information about their environmental and social footprint.
 Sustainability reporting. The initial disclosure of environmental matters has now expanded into sustainability reporting which integrates environmental, social and economic performance data and measures.

Question 55

Environmental reporting.

Answer 55

Environmental reporting. The aim of environmental reporting is the disclosure of an organisation’s corporate environmental responsibilities and the effects of its activities on its environment. The growing awareness within the general population of environmental issues plus pressure from non-governmental organizations has led to expectation that quoted organisations will make these disclosures. External reporting of social and environmental issues is now seen as a key part of a company’s dialogue with its stakeholders.

Question 56

Social reporting

Answer 56

Social reporting. The aim of social reporting is to measure and disclose the social impact of a business’s activities. Examples of social measures:
 Philanthropic donations, whether of corporate resources, profit based donations or allowing employees time to support charitable causes;
 Employee satisfaction and remuneration issues
 Community support
 Stakeholder consultation information

Question 57

Benefits of environmental and social reporting.

Answer 57

Benefits of environmental and social reporting.

 It demonstrates coherence of overall management strategy to important external stakeholders;
 It strengthens stakeholder relations
 It increases competitive advantage
 It increases public recognition for corporate accountability and responsibility
 Target setting and external reporting drive continual environmental and social improvement
 Effective self-regulation minimises risk of regulatory intervention
 It reduces corporate risk, which may reduce financing costs and broaden the range of investors
 It enhances employee morale
 It leads to improved profitability.

Question 58

Human capital accounting

Answer 58

Human capital accounting has at its core the principle that employees are assets. Competitive advantage is largely gained by effective use of people. Implications:
 People are resource which needs to be carefully and efficiently managed with overriding concern for organisational objectives
 The organizations need to protect its investment by retaining, safeguarding and developing its human assets
 Deterioration in the attitudes and motivation of employees, increases in labour turnover are costs to the company
The concept of human assets was broadened and became intellectual assets. Intellectual assets can be divided into 3 main types:
 External assets. These include the reputation of brands and franchises and the strength of customer relationships.
 Internal assets. These include patents, trademarks and information held in customer database.
 Competencies. These reflect the capabilities and skills of individuals.

Question 59

Integrated reporting (IR):

Answer 59

Integrated reporting (IR): a process founded on integrated thinking that results in a periodic integrated report by an organization about value creation over time and related communications regarding aspects of value creation.

Question 60

Integrated report:

Answer 60

Integrated report: A concise communication about how an organization’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term.

Question 61

Objectives of IR:

Answer 61

Objectives of IR:
 Improve the quality of information available to providers of financial capital to enable a more efficient and productive allocation of capital
 Promote a more cohesive and efficient approach to corporate reporting that draws on different reporting strands and communicates the full range of factors that materially affect the ability of an organization to create value over time.
 Enhance accountability and stewardship with respect to the broad base of capitals and promote understanding of their interdependencies.
 Support integrated thinking, decision-making and actions that focus on the creation of value over short, medium and long term.

Question 62

Fundamental concepts (IR)

Answer 62

Fundamental concepts. There are three elements to the fundamental concepts:
 Value creation. The framework considers value to be created when there are increases, decreases or transformations of an entity’s capitals caused by its business activities and outputs. Value may be created for the entity itself (which in turn should lead to increases in returns for the providers of financial capital) or for other external stakeholders.
 The capitals. The notions of capitals in the IR Framework are much wider than the traditional concept of shareholder capital. In the IR Framework, the capitals refer to stocks of value that are increased, decreased or transformed through the activities and outputs of an organization. These include:
o Financial capital – the source of funds available to an entity such as share capital, loans and other sources of finance.
o Manufactured capital – the equipment and tools used in an entity’s production process. Manufactured capital is man-made and does not include natural resources.
o Intellectual capital – includes an entity’s formal research and development and the less formal knowledge that is gathered, used and managed by the entity.
o Human capital – refers to an entity’s management and its employees and the skills they have developed through education, training and experience
o Social and relationship capital – refers to the relationships in place within an entity and between and entity and its external stakeholders such as suppliers, customers, governments and the community in which the entity operates.
o Natural capital - all renewable and non-renewable environmental resources and processes that provide goods or services that support the past, current or future prosperity of an organisation
 The value creation process. The process by which an entity uses its capitals as inputs and converts them to outputs. An entity’s outputs include its products services, by-products and waste.

Question 63

Guiding principles IR

Answer 63

Guiding principles. Provides the foundations for what an integrated report should be focused on:
 Strategic focus and future orientation. An integrated report should provide insight into the organization’s overall strategy and plans for the future. This insight should be provided in the context of an entity’s capitals and how they are used to create value in the short, medium and long term.
 Connectivity of information. The capitals are interrelated (increase in one = decrease in another). An integrated report should show a holistic picture of the combination, interrelatedness and dependencies between the factors that affect the organization’s ability to create value over time.
 Stakeholder relationships. An integrated report should provide insight into the nature and quality of the organization’s relationships with its key stakeholders and how and to what extent the organisation understands, takes into account and responds to their legitimate needs and interests.
 Materiality. The IR framework provides guidance for organisations as to how to determine materiality in terms of the purpose and scope of the report and its intended audience. Integrated report should disclose information about matters that substantively affect the organization’s ability to create value.
 Conciseness. An integrated report should include sufficient context to understand the organization’s strategy, governance, performance and prospects without being burdened with less relevant information
 Reliability and completeness. An integrated report should give a balanced view of the entity and should not report only positive matters. It should include all material matters, both positive and negative, without material error.
 Consistency and comparability. Information should be presented in an integrated report on a basis that is consistent over time and in a way that enables comparison with other organizations to the extent it is material to the organization’s own ability to create value over time.

Question 64

Content IR

Answer 64

Content
 Organisational overview and external environment. What does the organisation do and what are the circumstances under which it operates? IR should identify organization’s culture and ethics, markets in which it operates and under what conditions and factors affecting the external environment.
 Governance. How does an organisation’s governance structure support its ability to create value in the short, medium and long term? Relates to leadership structure, ethics and culture and process by which decisions are taken.
 Business model. What is the organisation’s business model? Process under which entity takes its input capitals and turns them into outputs and outcomes.
 Risks and opportunities. What are the specific risk and opportunities that affect the organisation’s ability to create value over the short, medium and long term? And how is the organisation dealing with them? Should identify key risks and opportunities, the likelihood of occurrence, the impact and steps to mitigate them.
 Strategy and resource allocation. Where does the organisation want to go and how does it intend to get there? Focused on objectives, how to achieve them and resources required.
 Performance. To what extent has the organisation achieved its strategic objectives for the period and what are its outcomes in terms of effects on the capitals? Both qualitative and quantitative information about performance.
 Outlook. What challenges and uncertainties is the organisation likely to encounter in pursuing its strategy, and what are the potential implications for its business model and future performance? Changes in environment and response to those changes.
 Basis of preparation and presentation. How does the organization determine what matters to include in the integrated report and how are such matters quantified or evaluated?

Question 65

IFRS 8 Operating segments

Answer 65

Financial statements are highly aggregated which can make them of limited use for stakeholders, who want to understand more about how an entity has arrived at its financial performance and position for a period (large entities in particular). In order to allow shareholders to fully understand the development of the company’s business, certain entities are required to provide segment information which discloses revenues, profits and assets by major business area. IFRS 8 Operating segments is only compulsory for entities whose debt or equity instruments are traded in a public market.

Question 66

Operating segment:

Answer 66

Operating segment: a component of an entity:
 That engages in business activities from which it may earn revenues and incur expenses (including other components)
 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;
 For which discrete financial information is available.

Question 67

Reportable segments.

Answer 67

Reportable segments. An operating segment should be reported on separately in the financial statements if any of the following criteria are met:
 Its revenue (internal and external) is 10% or more of total revenue;
 Its reported profit or loss is 10% or more of all segments in profit (or all segments in loss if greater);
 Its assets are 10 % or more of total assets.
Segments should be reported until at least 75% of the entity’s external revenue has been disclosed. If all segments satisfying the 10% criteria have been disclosed and they do not amount to 75% of total external revenue, additional operating segments should be disclosed until the 75% level is reached. Operating segments that do not meet any of the quantitative thresholds may be reported separately if management believes that information about the segment would be useful to users of the financial statements.

Question 68

Aggregation of segments.

Answer 68

Aggregation of segments. Two or more operating segments may be aggregated if the segments have similar economic characteristics, and the segments are similar in each of the following respects:
 The nature of the products or services
 The nature of the production process
 The type or class of customer for their products or services
 The methods used to distribute their products or provide their services
 If applicable, the nature of the regulatory environment

Question 69

Key items to be disclosed are reportable segments

Answer 69

Key items to be disclosed are:
 Factors used to identify the entity’s reportable segments
 Types of products and services from which each reportable segment derives its revenues
 Reportable segment revenues, profit or loss, assets, liabilities and other material items.
A reconciliation of each of the below material items to the entity’s reported figures is required. Reporting of a measure of profit or loss by segment is compulsory. Other items are disclosed if included in the figures reviewed by or regularly provided to the chief operating decision maker.

o Revenue – external and inter segment
o Interest revenue
o Interest expense
o Depreciation and amortisation
o Other material non-cash items
o Material income/expense (IAS 1)
o Share of profit of associates/joint ventures equity accounted
o Profit/loss
o Income tax expense
o Segment assets
o Investments in associates/jointly controlled entities 
o Expenditure for non-current assets
o Segment liabilities

 External revenue by each product and service (if reported basis is not products and services)
 Geographical information:
o Geographical areas: external revenue and non-current assets; by
o Entity’s country of domicile and all foreign countries
 Information about reliance on major customers (ie those who represent >10% external revenue)
o Excludes financial instruments, deferred tax assets, post-employment benefit assets, and rights under insurance contracts
o Allocated on customer’s location

Question 70

Advantages of IFRS 8

Answer 70

Advantages:
 The managerial approach used by IFRS 8 is cost effective because the marginal cost of reporting segmental data will be low (reported in the same way as managerial data)
 Users can be sure that the segment data reflects the operational strategy of the business
 Management’s selection of operating segments helps avoid releasing commercially sensitive information
 The segment report helps users of accounts better understand an entity’s past performance and it enables them to assess the effectiveness of management strategy, allowing them to make informed decisions

Question 71

Disadvantages of IFRS 8

Answer 71

Disadvantages
 Segment determination is the responsibility of diretors and is subjective
 Management may report segments which are not consistent for internal reporting and control purposes making its usefulness questionable
 The management approach may mean that financial statements of different entities are not comparable; eg there is no defined measure of segment profit or loss
 Segment reporting does not help the users to fully understand profitability, risks and returns of operations.

Question 72

IFRS 1 Firs-Time Adoption of International Financial Reporting Standards

Answer 72

The adoption of a new body of accounting standards will inevitably have a significant effect on the accounting treatments used by an entity and on the related systems and procedures. An entity applies IFRS 1 Firs-Time Adoption of International Financial Reporting Standards in its first IFRS financial statements. An entity’s first IFRS financial statements are the first annual financial statements in which the entity adopts IFRS by an explicit and unreserved statement of compliance with IFRS.

Question 73

Opening IFRS statement of financial position.

Answer 73

Opening IFRS statement of financial position. An entity prepares and presents an opening IFRS statement of financial position at the date of transition to IFRS as a starting point for IFRS accounting. Generally this will be the beginning of the earliest comparative period shown (ie full retrospective application). Given that the entity is applying a change in accounting policy on adoption of IFRS, IAS 1 requires the presentation of at least 3 statements of financial position (and 2 of each of the other statements). All adjustments are recognized directly in retained earnings not in profit or loss.

Question 74

Estimates.IFRS 1

Answer 74

Estimates. Estimates in the opening IFRS statement of financial position must be consistent with estimates made at the same date under previous GAAP even if further information is now available.

Question 75

Transition process IFRS 1

Answer 75

Transition process.
 Accounting policies. The entity should select accounting policies that comply with IFRSs effective at the end of first IFRS reporting period. These accounting policies are used in the opening IFRS statement of financial position and throughout all periods presented.
 Derecognition of assets and liabilities. Previous GAAP statement of financial position may contain items that do not qualify for recognition under IFRS.
 Recognition of new assets and liabilities.
 Reclassification of assets and liabilities
 Measurement. Value at which asset or liability is measured may differ under IFRS.

Question 76

Exemptions from applying IFRSs in the opening IFRS statement of financial position.
 Deemed cost.

Answer 76

 Deemed cost. Fair value may be used as deemed cost at date of transition to IFRS for PPE, investment properties (where using the cost model) and intangible assets (which meet IAS 38 recognition criteria). A previous GAAP revaluation ( at or before the date of transition to IFRS may also be used as deemed cost at the date of the revaluation. Further, an entity may use an ‘event-driven’ valuation (IPO) before or after the date of transition to IFRS as deemed cost at the date of measurement.

Question 77

Exemptions from applying IFRSs in the opening IFRS statement of financial position.
 Business combinations.

Answer 77

 Business combinations. For business combinations prior to the date of transition to IFRS:
o The same classification (acquisition or uniting of interests) is retained as under previous GAAP.
o For items requiring a cost measure for IFRS, the carrying amount at the date of business combination is treated as deemed cost and IFRS rules are applied thereon.
o Items requiring a fair value measure for IFRS are revalued at the date of transition to IFRS
o The carrying amount of goodwill at the date of transition to IFRS is amount as reported under previous GAAP

Question 78

Exemptions from applying IFRSs in the opening IFRS statement of financial position.
 Borrowing costs

Answer 78

 Borrowing costs. Borrowing costs need only be capitalized for assets, where the commencement date for capitalisation is on or after the date of transition to IFRS.

Question 79

Exemptions from applying IFRSs in the opening IFRS statement of financial position.
 Cumulative translation differences on foreign operations

Answer 79

 Cumulative translation differences on foreign operations. Translation differences (which must be included in a separate translation reserve under IFRS) may be deemed zero at the date of transition to IFRS. IAS 21 Is applied from then on.

Question 80

Exemptions from applying IFRSs in the opening IFRS statement of financial position.
 Adoption of IFRS by subsidiaries, associates and joint ventures.

Answer 80

 Adoption of IFRS by subsidiaries, associates and joint ventures. If a subsidiary, associate or joint venture adopts IFRS later than it parent, it measures its assets and liabilities either at the amount that would be included in the parent’s financial statements, based on the parent’s date of transition or at the amount based on the subsidiary date of transition.

Question 81

Disclosure IFRS 1

Answer 81

Disclosure.
 A reconciliation of previous GAAP equity to IFRS equity is required at the date of transition to IFRSs and for the most recent financial statements presented under previous GAAP.
 A reconciliation of total comprehensive income under previous GAAP to total comprehensive income using IFRS is required for the most recent financial statements presented under previous GAAP.

Question 82

General issues IFRS 1

Answer 82

General issues. The implementation of the changes to IFRS is likely to entail careful management in most companies. Some of the change management considerations that should be addressed:
 Accurate assessment of the task involved (do not underestimate)
 Proper planning – should take place at the overall project level, but detailed task analysis could be drawn up for better control.
 Human resource management – project needs to properly structured and staffed.
 Training – remedial training provided for skill gaps.
 Monitoring and accountability. Implementation progress should be monitored and regular meetings set so participants account for what they are doing and any problems flagged.
 Achieving milestones. Completion of key steps and tasks should be acknowledged to sustain motivation and performance
 Physical resourcing – assess the need for IT equipment and office space.
 Process review. No quick fix change in future systems assessed and properly implemented.
 Follow-up procedures. Planned to ensure that changes stick and any future changes identified and addressed.

Question 83

Issues P/L vs OCI

Answer 83

P/L vs OCI
An entity has to show separately in OCI, those items which would be reclassified (recycled) to profit or loss and those items which would never be reclassified (recycled) to profit or loss. The related tax effects have to be allocated to these sections. Profit or loss includes all items of income or expense (including reclassification adjustments) except those items of income or expense that are recognised in OCI as required or permitted by IFRS standards.
Reclassification adjustments are amounts recycled to profit or loss in the current period that were recognised in OCI in the current or previous periods. However, there is a general lack of agreement about which items should be presented in profit or loss and in OCI. The interaction between profit or loss and OCI is unclear, especially the notion of reclassification and when or which OCI items should be reclassified. A common misunderstanding is that the distinction is based upon realised versus unrealised gains. This lack of a consistent basis for determining how items should be presented has led to an inconsistent use of OCI in IFRS standards.
The Discussion Paper on the Conceptual Framework for Financial Reporting considers three approaches to profit or loss and reclassification. The first approach prohibits reclassification. The other approaches, the narrow and broad approaches, require or permit reclassification. The narrow approach allows recognition in OCI for bridging items or mismatched remeasurements. While the broad approach has an additional category of ‘transitory measurements’ (for example, remeasurement of a defined benefit obligation) which would allow the Board greater flexibility. The narrow approach significantly restricts the types of items that would be eligible to be presented in OCI and gives the Board little discretion when developing or amending IFRS standards.

Question 84

IFRS Practice Statement 2 Making Materiality Judgments

Answer 84

IFRS Practice Statement 2 Making Materiality Judgments was issued in Sept 17. It was developed in response to concerns that some companies were unsure how to make materiality judgments. This can result in excessive disclosure of immaterial information while important information can be obscured or even missed out of the financial statements (especially in the notes).
Material: ‘Information is material if omitting it or misstating it could influence decisions that the primary users of general purpose financial reports make on the basis of those reports, which provide financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature and magnitude, or both, of the items to which the information relates in the context of and individual entity’s financial report.’

Question 85

Preparers of financial statements make materiality judgments when applying IFRSs

Answer 85

Preparers of financial statements make materiality judgments when applying IFRSs
 Recognition and measurement criteria: only need to be applied when the effect of applying them is material (eg capitalizing items over 1000).
 Disclosure criteria: if the information provided by a certain disclosure requirement is not material, the entity does not need to make that disclosure, even if that disclosure is part of a list of minimum required disclosures in an IFRS
 However, the entity should consider whether it also needs to disclose information not specifically required by IFRS if that information is needed to understand the financial statements

Question 86

Financial statements provide financial information to primary users that is useful to them when making decisions about providing resources to the entity:

Answer 86

Financial statements provide financial information to primary users that is useful to them when making decisions about providing resources to the entity:
 Primary users are investors, lenders and other creditors, both existing and potential.
 General purpose financial statements cannot meet all of the information needs of primary users. Instead the entity should aim to meet the information needs common to all investors, all lenders and all other creditors
 The entity is not required to meet the information needs of other stakeholders, or the individual requirements of particular primary users.

Question 87

Local laws and regulations - materiality.

Answer 87

Local laws and regulations. In order to state compliance with IFRSs, the entity must provide all information required by IFRSs, even if local laws and regulations permit otherwise. Additionally, local laws and regulations sometimes require disclosure of information that is not material. IFRSs permit this disclosure, but it should not obscure information that is material.

Question 88

Materiality judgments: four-step process

Answer 88

Materiality judgments: four-step process
 Identify information that is potentially material
o Consider the requirements of IFRSs
o Consider the common information needs of the entity’s primary users
o Output=set of potentially material information
 Assess whether that information is material
o Consider whether the information could reasonably be expected to influence primary users in making decisions about providing resources to the entity
o Consider quantitative and qualitative factors, in the context of the whole financial statements
o Output = preliminary set of material information, including what information and in how much detail
 Organise clearly and concisely in draft financial statements
o Apply judgement in determining the best way to communicate information clearly and concisely
o Factors that help include: emphasising matters, explaining items simply, minimising duplication, ensuring immaterial information does not obscure material information
o Output=draft financial statements
 Review complete set of draft financial statements
o Assess whether information is material both individually and in combination with other information
o Determine whether on the basis of a complete set of financial statements all material information has been identified and materiality has been considered from a wide perspective and in aggregate
o Review may lead to information being added, removed, reorganized
o Output=final financial statements

Question 89

Assessing whether information is material

Answer 89

Assessing whether information is material. Common ‘materiality factors to assess information:
 Quantitative factors.
o Consider the size of the effect of the transaction/event against measures of the entity’s financial position, performance and cash flows
o Consider any unrecognized items (contingent liabilities) that could affect primary users’ perception
 Qualitative factors. These are characteristics that make information more likely to influence the decision of primary users:
o Internal include: involvement of related parties, uncommon features, unexpected changes in trends
o External include: geographic location, industry section, state of the economy
Quantitative factors can be assessed with the help of a threshold (such as 5% of profit). It is usually more efficient to assess items from a quantitative perspective first: if an item exceeds quantitative threshold, it is material and no further assessment required. If an item is considered immaterial on the basis of the quantitative threshold, qualitative factors should then be considered. The presence of a qualitative factor in a transaction/event, such as the involvement of a related party, lowers the quantitative threshold. There presence of qualitative factors does not mean that information is always material. An entity may decide that, despite the presence of qualitative factors, information is not material because its effect on the financial statements is so small that it could not reasonably be expected to influence primary user’s decisions.

Question 90

Defined benefit plan amendments, curtailment or settlement (current issues)

Answer 90

The IASB issued narrow scope amendments to IAS 19. Previously IAS 19 implied that entities should not revise the assumptions for the calculation of current service cost and net interest during the period, even if an entity remeasures the net defined benefit liability (asset) in the case of a plan amendment, curtailment or settlement. In other words, the calculation should be based on the assumption as at the start of the annual reporting period.
The amendments provide clarification that, when the net defined benefit liability or asset is remeasured as a result of a plan amendment, curtailment or settlement, updated actuarial assumptions should be used to determine current service cost and net interest for the remainder of the reporting period. The IASB believes that this change will enhance understandability and provide more useful information to users of financial statements.

Question 91

Management commentary:

Answer 91

Management commentary: a narrative report that relates to financial statements that have been prepared in accordance with IFRSs. Management commentary provides users with historical explanations of the amounts presented in the financial statements, specifically the entity’s financial position, financial performance and cash flows. It also provides commentary on an entity’s prospects and other information not presented in the financial statements. Management commentary also serves as a basis for understanding management’s objectives and its strategies for achieving those objectives.
Management commentary is a non-binding guidance document rather than IFRS. It is designed to publicly traded entities, but it is left to regulators to decide which entities required to publish and how frequently they should report.

Question 92

Management commentary: Principles.

Answer 92

Principles. Management should present commentary that is consistent with following principles:
 To provide management’s view of the entity’s performance, position and progress; and
 To supplement and complement information presented in the financial statements.
In aligning with these principles, management commentary should include:
 Forward-looking information (including prospective results); and
 Information that possesses the qualitative characteristics described in the Conceptual Framework.

Question 93

Management commentary: Presentation.

Answer 93

Presentation. The form and content of management commentary will vary between entities, reflecting the nature of their business, the strategies adopted by management and the regulatory environment in which they operate.

Question 94

Elements of management commentary.

Answer 94

Elements of management commentary. The particular focus of management documentary will depend on the facts and circumstances of the entity. However, it is required to include information that is essential to understanding:
 The nature of the business
 Management’s objectives and its strategies for meeting those objectives
 The entity’s most significant resources, risks and relationships
 The results of operations and prospects
 The critical performance measures and indicators that management uses to evaluate the entity’s performance against stated objectives.

Question 95

Compulsory management commentary

Advantages:

Answer 95

Advantages:
 Entity
o Promotes the entity, and attracts investors, lenders, customers and suppliers
o Communicates management plans and outlook
 Users
o Financial statements not enough to make decisions
o Financial statements are backward looking
o Highlight risks
o Useful for comparability to other entities

Question 96

Compulsory management commentary

Disadvantages

Answer 96

Disadvantages
 Entity
o Costs may outweigh benefits
o Risk that investors may ignore the financial statements
 Users
o Subjective and not normally audited
o Could encourage companies to delist
o Different countries have different needs