KCB Notes - Accounting Policies

Question 1

What does the standard IAS16 provide information on?

Answer 1

IAS 16 - Accounting for plant, property and equipment

Definition: Property, plant and equipment are tangible items that:

• are held for use in the production or supply of goods or services, for rental basis,
  or for administrative purposes;
  and
• are expected to be used for more than one accounting period.

Question 2

What is the objective of IAS16?

Answer 2

The standard IAS 16 deals with the accounting treatment of property, plant and equipment.

It deals with the treatment of :
* recognition and measurement
* determination of carrying amount
* depreciation charges
* any impairment loss
* derecognition
* disclosure

Question 3

What are the exemptions of IAS16?

Answer 3

IAS 16 does not apply to:

• plant, property and equipment held for sale under IFRS 5 (see section 8.5, Chapter 3);
• biological assets related to agricultural activity accounted for under IAS 41 (Agriculture);

and

• exploration and evaluation of mineral assets recognised in accordance with IFRS 6 and mineral rights and mineral reserves such as oil, natural gas
  and similar non-regenerative resources.

Question 4

Detail the initial recognition stated by IAS16.

Answer 4

Initial recognition

Property, plant and equipment shall be measured at its cost or the cash price
equivalent at the recognition date.

Cost includes: * purchase price, including duties and non-refundable purchase taxes, after deducting trade discounts;

Costs directly attributable to bringing the asset to the location and condition necessary for it to operate in the manner intended by management; and

the estimated costs of dismantling and removing the item and restoring
the site on which it is located.

The capitalisation of costs should cease when the asset becomes available for operating use or intended use by the management.

Question 5

Detail the subsequent recognition by IAS16.

Answer 5

• Subsequent recognition and measurement:
• Assets requiring the replacement of some component parts during the useful life (such as the spare parts of a plant or the roof of a building) will recognise the cost of replacement in the carrying amount of the relevant asset if it satisfies the recognition criteria.
• The cost of day-to-day or ongoing repair and maintenance will be charged to the statement of profit or loss and OCI as an expense.
• An asset requiring an inspection after a specified interval as per industry laws (such as in the airline industry) will recognise the cost of such inspection in the carrying amount of the related asset, if its economic benefits are for more than one accounting period.

Question 6

What are the 2 options for subsequent measurements under IAS16?

Answer 6

Subsequent measurement:

After recognition, an entity has two options to choose from for the accounting of property, plant and equipment at each reporting date.

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

Question 7

Under IAS16, where and how are revaluation increases and decreases accounted for?

Answer 7

Revaluation increases
Revaluation increases are recognised under the heading of revaluation surplus in OCI (statement of profit and loss and other comprehensive income) and reported in the statement of changes in equity.

The increase should only be recognised in the statement of profit or loss and OCI to the extent that it reverses a revaluation decrease of the same asset
previously recognised in the statement of profit or loss and OCI.

Revaluation decreases
Revaluation decreases are recognised in the statement of profit or loss and OCI, unless they reverse a previous revaluation increase.
Revaluations should be made with sufficient regularity to ensure that the carrying amount does not differ materially from that which would be determined using fair value at the end of the reporting period.

Question 8

What is depreciation and what are the 2 methods of depreciation?

Answer 8

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

The depreciable amount is the cost of an asset less its residual value.

The depreciation charge for each period should be recognised in the statement of profit or loss and OCI.

The depreciation method used should reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.

The 2 methods of depreciation are:
1. Straight line depreciation
2. Reducing balance method

Question 9

Explain recoverable amount and impairment.

Answer 9

An impairment in accounting is a permanent reduction in the value of an asset to less than its carrying value.

Property, plant and equipment requires impairment testing and, if necessary,
recognition of an impairment loss.

An item of property, plant, or equipment shall not be carried at more than its
recoverable amount.

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

In IAS 36, companies are required to conduct impairment tests where there is an indication of the impairment of an asset. Goodwill and certain intangible assets are an exception to this, as they require an ANNUAL impairment test.

Question 10

What may be indications of impairment?

Answer 10

1. External factors such as a decline in ,market values, negative changes in the economy or in the legal environment.
2. Internal sources such as physical damage or if the asset is idle.
3. Any claim for compensation for impairment or damage of property, plant or equipment from third parities (such as an insurance company( is included in the statement of profit or loss and OCI when the claim becomes receivable.

Question 11

When should derecognition take place and what is the process?

Answer 11

Derecognition (retirements and disposals)

An asset should be removed from the statement of financial position on disposal or when it is withdrawn from use.

The gain or loss on disposal is the difference between the proceeds and the carrying amount at that time and should be recognised in the statement of profit or loss and OCI.

Question 12

What does IAS16 require in terms of disclosures?

Answer 12

IAS 16 requires the following disclosures for each class of property, plant and equipment:

• the basis for measuring carrying amount;
• the depreciation methods to be used or used;
• useful lives or depreciation rates;
• the gross carrying amount (cost or valuation) and accumulated depreciation and impairment losses;
• a reconciliation of the carrying amount at the beginning and the end of the period, showing: –
  additions – disposals – acquisitions through business combinations – revaluation increases or decreases – impairment losses – reversals of impairment losses – depreciation – net foreign exchange differences on
  translation – other movements.

Question 13

What additional disclosures are required when revaluing PPE?

Answer 13

Revalued property, plant and equipment :

• If property, plant and equipment is stated at revalued amounts, certain additional disclosures are required:
• the effective date of the revaluation;
• whether an independent valuer was involved;
• for each revalued class of property, the carrying amount that would have been
  recognised had the assets been carried under the cost model;
  and
• the revaluation surplus, including changes during the period and any restrictions on the distribution of the balance to shareholders.

Question 14

What does IFRS15 provide information on?

Answer 14

IFRS 15 provides information on revenue from contracts with customers.
More than half of the scandals in accounting involve some kind of revenue manipulation. (Satyam Computer Services, Enron, WorldCom & Tesco).

IFRS applies to annual accounting periods commencing on or after 01 January 2018.

IFRS 15 specifies how and when revenue is recognised, as well as requiring entities to provide more informative, relevant disclosures to the users of financial statements.

Under IFRS 15, revenue is recognised when it is PROBABLE that future economic benefits will flow to the entity, and these benefits can be measured reliably.

Question 15

IFRS15 establishes principals that an entity should report useful information to user of financial statements about what?

Answer 15

1. The nature
2. The amount
3. The timings
4. Uncertainty

of revenue and cash flows arising from a contract with a customer.

Under IFRS 15, the transfer of goods and services is based upon the transfer of control (which is described as the ability to direct the use of and obtain substantially all of the remaining benefits from, the asset), rather than the transfer of risks and rewards as in IAS 18. IFRS 15 requires the recognition of revenue to reflect the consideration to which the entity expects to be entitled in exchange for those goods or services.

IFRS 15 may make little impact for straightforward retail transactions, but it has resulted in changes in the amount and timing of revenue recognition for long-term service contracts.

Question 16

What are the exceptions to IFRS15?

Answer 16

The exceptions are contracts dealt with by other standards, such as
lease agreements, insurance contracts and financial instruments.

Question 17

What is the 5 step approach in terms of recognition and measurement of IFRS 15?

Answer 17

Step 1: Identify the contract with the customer under IFRS 15.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price.
Step 5: Recognise revenue as obligations are performed.

Question 19

What is IAS 37 and what is its objective?

Answer 19

IAS37 relates to provisions, contingent liabilities and contingent
assets.

The objective of IAS 37 is to ensure that appropriate recognition
criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets.

It also aims to ensure that sufficient information is disclosed in
the notes to the financial statements to enable users to
understand their nature, timing and amount.

International Accounting Standard 37 excludes obligations and
contingencies arising from:
* a non-onerous executory contract, under which no party has
completed any part of its performance obligation or both parties
have carried on their obligation in part to the same extent; and
* those covered by another standard, such as: – financial
instruments including financial guarantees (IFRS 9); – income tax
(IAS 12); – leases (IFRS 16); and – insurance contracts (IFRS 4)

Question 20

Under IAS37, what is a provision?

Answer 20

A provision is defined as a liability of uncertain timing or
amount.

In IAS 37, a liability is defined as a present obligation of the
entity arising from past events, settlement of which is expected
to result in an outflow of resources.

The provision should be used against the expenditure for which
it was originally made.

This is different to the Conceptual Framework definition of a
liability, although the two definitions are similar.

[Definition of a liability in conceptual framework: A liability is a
present obligation of the entity to transfer an economic resource
or provide services to other entities as a result of past events]

Question 21

How should provisions be recognised under IAS 37?

Answer 21

A provision should be recognised when all three of
the following conditions are met:

• there is a present obligation (legal or constructive) as a
  result of a past event;
• it is probable that an outflow of economic resources will be
  required to settle the obligation; and
• the amount of the obligation can be estimated reliably

Question 22

What dies IAS37 provide around measurement?

Answer 22

The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

• Where a large population of items is being measured, the obligation is estimated by weighting all possible outcomes by their associated probabilities.
• When measuring a single obligation or liability, the individual most likely outcome may be the best estimate.
• the use of expert opinion, legal advice or management’s own judgement based on past experience;
• the use of the expected value method that uses the most
  probable outcome and the events which occur frequently
  for the measurement of one-off events;
• the effect of any related risk and uncertainties; and
• consideration of future events likely to occur that may
  affect the amount required to settle an obligation, such as
  future technology likely to reduce the value of provision.
  If there is a material time difference for the settlement of a
  provision, the present value (PV) should be recognised using
  an appropriate pre-tax discount rate

Question 23

What does IAS37 provide around remeasurement?

Answer 23

Remeasurement of provisions:
The entity should review and appropriately adjust all provisions at each reporting date.

A provision should be reversed if circumstances indicate that the outflow of economic resources is no longer probable.

Any change in a provision should be accounted for as a change in accounting estimate and will have prospective application (IAS 8).

Question 24

How does IAS37 define a contingent liability?

Answer 24

A contingent liability is defined as:

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

Question 25

How does IAS37 say you should disclose contingent liabilities?

Answer 25

A contingent liability is not recognised in the financial statements (as an expense or a liability). It is disclosed as a contingent
liability in the notes to financial statements unless the possibility of an outflow of economic benefits or resources is remote.

Question 26

What is IFRS 16 and what does it replace?

Answer 26

IFRS16 overs accounting for leases and replaces IAS16 from 01 January 2019. It prescribes accounting policies for the recognition, measurement, presentation and disclosure of leases to provide relevant information that faithfully represents those
transactions.

Question 27

What is the historic perspective and current view of IFRS16?

Answer 27

Historic view
A lease agreement is a contract between two parties, the lessor and the lessee. The lessor is the legal owner of the asset, whereas the lessee obtains the right to use the asset in return for rental payments.

Historically, assets that were used but not owned were not shown on the statement of financial position; any associated liability was also left out of the statement. This was known as ‘off-balance sheet’ finance and was a way for companies to reduce their liabilities, thus
distorting gearing and other key financial ratios.

This form of accounting did not faithfully represent the transaction. In reality, a company often effectively ‘owned’ these assets and ‘owed a liability’

Current View
Leases present a reporting issue and affect the interpretation of financial statements.

International Financial Reporting Standard 16 aims to ensure proper
reporting of leased assets (formerly operating leases for the lessee) to curb the effect of any disguised loan or ‘off-balance sheet’ items. This is intended to remove one route for creative accounting which could mislead any readers of the accounts

The new standard provides a single lessee accounting model, requiring a lessee to recognise assets (representing its right to use the assets) and liabilities (representing its obligation to make lease
payments) for all leases with a term of more than 12 months, unless
the underlying asset has a low value.
For short-term and low-value leases, the lessee expenses the lease payments on a straight-line basis over the lease term. Lessors continue to classify leases as operating or finance leases (as in IAS 17) and accounts for the two types of leases differently.

Question 28

Explain substance over form and give an example.

Answer 28

• ‘Substance over form’ implies that the transactions
  recorded in the financial statements must reflect their
  economic substance rather than their legal form alone.
• In some cases, the substance can be different from the
  form of the transaction, such as in sale and leaseback
  arrangements.
• Sale and leaseback arrangements involves a company
  selling an asset to another party and getting it back via a
  lease agreement.
• The company must first determine whether the transfer
  qualifies as a sale based on the requirements for
  satisfying a performance obligation in IFRS 15 (Revenue
  from Contracts with Customers).
• If the nature of the transaction is that of a lease, lease
  accounting is applied as per IFRS 16.