Financial Reporting Treatments Flashcards
Impairment: Refone is a cash generating unit. The net assets of the Refone business should be carried at no more than the recoverable amount which is defined as the higher of the fair value less costs to sell and the value in use.
Indicators of impairment:
The launch of the new product with a guaranteed replacement of the device rather than repair, is one
factor which could indicate impairment. The amount of third party business is not known but if a
significant part of its business comes from Konext customers then a decline in the number of devices
needing repairs will be an indicator of impairment.
However, the trend of results would indicate too that there is impairment of the Refone CGU.
The Refone business has generated £2.1 million in revenue in the first six months. The results from
the previous year suggest that the business is in decline. The business generated £5.2 million in the six months to 30 June 20X3 and only £2.6 million in the second half of the year.
Timing of the impairment:
There is uncertainty about when this impairment should be recognised. IAS 34 states that the same
recognition and measurement principles should be used in the interim financial statements as in the annual financial statements. Therefore, if the conditions for impairment were met at 30 June 20X4 the impairment should be recognised.
Further enquiries should be made of the directors to determine the future of this business after the launch of the new mobile device. Particularly regarding the recent offer for the net assets.
Deferred Advertising cost:
In March 20X4, Nika, an advertising company, was engaged to market the new mobile device, Denwa+. On 30 June 20X4, Konext recorded invoices totalling £1 million from Nika for marketing services delivered by that date by debiting the statement of profit or loss and crediting the Nika payable account. Konext has agreed to issue 100,000 of its £1 ordinary shares to Nika, in full settlement of the £1 million owed to Nika. The date of the share issue is expected to be 1 September 20X4.
However, Jacky has accounted for the £1 million as a prepayment in the interim financial statements for the six months ended 30 June 20X4 by debiting prepayments and crediting the statement of profit or loss. She explained to me that the final cost for the marketing services will depend on the share price on 1 September 20X4 and it should, in any case, be matched against the deliveries of the Denwa+, which start in August 20X4. I am concerned that this treatment is not correct.
The cost of the advertising services should be recognised when the service has been delivered.
There does not appear to be any grounds for deferring the costs. IAS 34 states that a guiding principle is that an entity should use the same recognition and measurement principles in its interim statements as it does in its annual financial statements.
As the costs would not be regarded as an asset at the year-end it would not be appropriate to recognise the deferral of the costs as a prepayment since they have already been incurred before 30 June 20X4.
Share Based Payment:
In March 20X4, Nika, an advertising company, was engaged to market the new mobile device, Denwa+. On 30 June 20X4, Konext recorded invoices totalling £1 million from Nika for marketing services delivered by that date by debiting the statement of profit or loss and crediting the Nika payable account. Konext has agreed to issue 100,000 of its £1 ordinary shares to Nika, in full settlement of the £1 million owed to Nika. The date of the share issue is expected to be 1 September 20X4.
However, Jacky has accounted for the £1 million as a prepayment in the interim financial statements for the six months ended 30 June 20X4 by debiting prepayments and crediting the statement of profit or loss. She explained to me that the final cost for the marketing services will depend on the share price on 1 September 20X4 and it should, in any case, be matched against the deliveries of the Denwa+, which start in August 20X4. I am concerned that this treatment is not correct.
The issue of shares to Nika falls within the scope of IFRS 2, Share-based Payment. It is an equity settled share-based payment because essentially Konext has received a service in exchange for an issue of shares.
This type of transaction with a third party is normally measured at the fair value of the services received.
The value of the shares at the settlement date will therefore be irrelevant. The cost should be shown in profit or loss when the service has been delivered – therefore the cost has been incorrectly prepaid.
Wayte has sustained a fair value loss in respect of the investment in PSN, held at fair value through other comprehensive income. This is recognised in other comprehensive income in the year ended 30 September 20X7. The tax base of the asset is £430,000, but the carrying amount is £387,000.
The deductible temporary difference is therefore £43,000. At an income tax rate of 20% this creates a deferred tax asset of (£43,000 × 20%) £8,600, rounded to £9,000. This amount is recognised as a deferred tax asset and is credited to other comprehensive income. The related deferred tax effect is also recognised in OCI so has no impact on profit or loss.
The treatment of the increase in fair value of the investment in LXP is different however. This is recognised in profit or loss in the year ended 30 September 20X7, and a current tax expense is increased in respect of the gain.
This is because, in this jurisdiction, tax treatment follows accounting treatment in respect of recognition of gains and losses through profit or loss. At an income tax rate of 20% this increases the current tax expense by (£27,000 × 20%) £5,400.
IFRS 15, Revenue from Contracts with Customers sets out the steps that must be taken in recognising and measuring revenue, one of which is to identify separate performance obligations. In this case, the sale of goods is separate from the performance obligation to provide services in future.
It seems clear that there are separate components, and that the components are capable of being measured by reference to the price of the goods. The service component should therefore be treated as a contract liability (deferred revenue), to be recognised in the future in the period(s) in which the service is carried out and therefore the performance obligation is satisfied.
The value of the service element to be deferred is £750,000.
The journal entry required is:
DR Revenue 750,000
CR Contract Liability 750,000
This transaction affects profit before tax, and therefore the opening item in the reconciliation of profit before tax to cash generated from operations. Because no costs have been incurred in respect of the service revenue, no adjustment is required to cost of sales.
Convertible Bond Instrument:
On 31 October 20X1, Chelle issued a £10 million 5% convertible bond for proceeds of £10 million.
The bond is repayable at par on 31 October 20X9, but can instead be converted at that date, at the choice of the bondholders, into one new ordinary share for every £10 unit held. At the date of issue the market interest rate for similar debt without conversion rights was 6.5%. Interest was paid on 31 October 20X7 and recorded in finance costs, but I have not made any other accounting entries in respect of the convertible bond in the year ended 31 October 20X7.
What are the tax implications of this? -
Convertible Bond Instrument:
On 31 October 20X1, Chelle issued a £10 million 5% convertible bond for proceeds of £10 million.
The bond is repayable at par on 31 October 20X9, but can instead be converted at that date, at the choice of the bondholders, into one new ordinary share for every £10 unit held. At the date of issue the market interest rate for similar debt without conversion rights was 6.5%. Interest was paid on 31 October 20X7 and recorded in finance costs, but I have not made any other accounting entries in respect of the convertible bond in the year ended 31 October 20X7.
(2) Investment in equity instruments
Several years ago, Chelle paid £1 million for 100,000 of the 1,500,000 £1 ordinary shares of Spence
plc, its main supplier of refrigeration equipment. On initial recognition, an irrevocable election was
made to record gains and losses in other comprehensive income. Of the other components of
equity, amounts relating to the accumulated gains and losses on this investment were £776,000 in
20X5 and £503,000 in 20X6. I have not recorded any entry in respect of the financial asset since the
31 October 20X6 year end. The price of one ordinary share in Spence plc at 31 October 20X7 was
£18.50.
If you have generated a loss in the year, what happens to the tax payment?
This becomes a tax asset in the SOFP under “Current Assets”
When must a diluted earnings/(loss) per share be calculated?
Where there are bonds which are convertible into ordinary shares at a future date, a diluted earnings/(loss) per share must be calculated. If the effect of the additional shares would be dilutive, diluted earnings per share must be disclosed.
What does a worsening cash position mean?
“If the company’s cash position worses then its status as a going concern could ultimately be threatened. However, if the gearing is relatively low, it may not be too difficult to obtain further bonds to finance continuing operations”
Evaluate the appropriateness and completeness of SSD’s accounting policy
