Part C1-4: Reporting The Financial Performance Of Entities Flashcards
Criteria for IFRS 15 (Revenue)
- Both parties have enforceable rights / obligations
- contract approved (neither party can unilaterally terminate)
- payment terms agreed
- commercial substance to the contract
- customer can (probably) and intends to pay
IFRS 15 applies to all contracts except for…
- lease contracts
- insurance contracts
- financial instruments and other contractual rights/obligations within the scope of IAS 39/ IFRS 9, IFRS 10, IFRS 11, IAS 27, IAS 28
- non monetary exchanges between entities within the same business to facilitate sales
Revenue recognition- 5 Steps
1- identify the contract with the customer
2- identify the performance obligations in the contract
3- determine the transaction price
4- allocate the transaction price to the performance obligations in the contract
5- recognise revenue when or as the obligations are satisfied
Revenue recognition- Step 1 - Identify the contract with a customer
- must be approved by all
- everyone’s rights can be identified
- it must have commercial substance
- consideration will probably be paid
Revenue recognition- Step 2 - Identify the separate performance obligations in the contract
These will be goods or services promised to the customer
They need to be distinct and create a separately identifiable obligation
Revenue recognition- Step 3 - Determine the transaction price
How much the entity expects, considering past customary business practices
Variable consideration
- if the price may vary then estimated expected amount used
- only used If probable
- for royalties only recognised when usage occurs
Revenue recognition- Step 4 - allocate the transaction price to the separate performance obligations
If multiple performance objectives, split transaction price by using their standalone selling prices
Revenue recognition- Step 5 - recognise revenue when the entity satisfies obligation
Revenue is recognised as control is passed over time or at a point in time
How to estimate selling price?
- Adjusted market assessment approach
- expected cost plus a margin
- residual approach
- if paid in advance, discount down if it’s significant (> 12m)
What is control?
Ability to direct the use of and get almost all of the benefits from the asset
Includes the ability to prevent others from directing the use of and obtaining benefits from the asset
Benefits of Control could be…
Direct or indirect cash flows that may be obtained directly or indirectly
Using the asset to enhance the value of other assets
Pledging the asset to secure a loan
Holding the asset
Factors to consider of recognising revenue at a specific point in time (not exhaustive list)
The entity now has a present right to receive payment for the asset
The customer has legal title to the asset
The entity has transferred physical possession of the asset
The customer has the significant risks and rewards related to the ownership of the asset
Customer has accepted the asset
Contract liability - circumstances and presentation
Paid upfront but not yet performed
Dr cash
Cr contract liability
Contract receivable or contract asset - circumstances and presentation
Paid later but already performed
Dr receivable
Cr Revenue
Contract receivable or asset?!
Contract asset if payment is conditional (on something other than time)
Receivable if the payment is unconditional
Disclosures related to revenue
All qualitative and quantitative info about:
- it’s contracts with customers
- the significant judgements in applying the guidance to those contracts
- any assets recognised from the costs to fulfil a contract with a customer
Costs to fulfil a contract - recognised as an asset when…
+ examples of asset and when to expense
- relate directly to the contract
- generate resources we are going to use when we sell
- are expected to be recovered
Examples for asset: Direct labour and materials Allocations of depreciation or insurance Anything explicitly chargeable to the customer Subcontractor costs
Examples to expense:
General and administrative costs
Wasted materials, labour and other resources
Costs related to satisfied or partially satisfied performance obligations must be expenses also
Sale with right to return - accounting treatment
Reduce revenue by expected value of returns
Instead dr revenue cr refund liability
Assurance warranties treatment
Bundled into revenue for the product and a provision for the warranty costs is made using IAS37 as normal
Indicators of an Agent
+ accounting treatment of revenue for principle vs agent
Another party is primarily responsible for fulfilling the contract
You don’t take inventory risk before or after a customer order
You Don’t set prices
You Receive commission only
You take no credit risk for the amount receivable
Accounting Treatment
Principle - show gross revenue and cos
Agent - show commission only as revenue
3 Tests to determine whether we should bring PPE into the accounts
- When we control the asset
- When it’s probable that we will get future economic benefits
- When the assets cost can be measured reliably
What gets included in the cost of PPE?
- Directly attributable costs to get it to work and where it needs to be (delivery, installation etc)
- Estimated cost of dismantling and removing the asset and restoring the site (at PV)
- Borrowing costs
PPE cost model
Cost less accumulated depreciation and impairment
Depreciation should begin when ready for use not wait until actually used
PPE Revaluation model
Fair value at the date of revaluation less depreciation
Revals should be carried out regularly
I.e. for volatile annually, others between 3-5 years or less
If an item is revalued, it’s entire class should be
Revalued to market value usually
Specialised properties will be revalued to their depreciated replacement cost
Disposal of a revalued asset
Revaluation surplus in equity drops into retained earnings and therefore only shows up in the statement of changes in equity
Recoverable amount
Higher of:
- FV - CTS
- VIU
Value in use definition
The discounted present value of estimated future cash flows expected to arise from:
- the continuing use of an asset, and from
- it’s disposal are the end of its useful life
Fair value less costs to sell - determining value
- if there is a binding sale agreement, use the price under that agreement less costs of disposal
- if there is an active market for that type of asset, use market price (current bid price) less costs of disposal
- if there is no active market, use the beat estimate of the assets selling price less costs of disposal
Value in use criteria
- the future cash flows must be based on reasonable and supportable assumptions
- budgets and forecasts should not go beyond 5 years
- cash flows should relate to the assets current condition
- cash flows should not include cash from financing activities or income tax
- discount rate used should be the pretax rate that reflects current market assessments of the time value of money and the asset specific risks
Indicators of impairment
- Losses/ worse economic performance
- Market value declines
- Obsolescence or physical damage
- Changes in technology, markets, economy or laws
- Increases in market interest rates
- Loss of key employees
- Restructuring/ re-organisation
Which need annual checks for impairment regardless of indicators
An intangible asset with an indefinite useful life
An intangible asset not yet available for use
Goodwill acquired in a business combination
Assets held for sale - accounting treatment
1) calculate the carrying amount
- bring everything up to date when we decide to sell I.e catch up depreciation and revalue (if policy)
2) calculate FV-CTS
3) value the assets held for sale
- the lower of carrying amount in step 1 and FV-CTS in step 2
4) check for impairment
Held for sale - increase in FV?
At year end of asset still not sold
Gain is recognised in p&l up to amount of all previous impairment losses
When is an asset recognised as held for sale?
- management is committed to a plan to sell
- the asset is available for immediate sale
- an active programme to locate buyer is initiated
- sale is highly probable within 12 months
- actively marketed for sale at a reasonable sales price
Rule for a disposal group with reversal of impairment losses
Can take advantage of some assets within the group using up the unused impairment losses on other assets
What if the asset or disposal group is not sold within 12 months?
- normally returns to PPE at the amount it would have been at had it not gone to held for sale
- check for impairment
- or, keep in HfS if delay is caused by circumstances outside the entity’s control
Investment property is..
A building not used, just makes cash by either FV going up (capital appreciation) or from rental income
Accounting treatment for rental income
Add it to income statement
Investment property- Accounting treatment for FV increase
Difference in FV each year goes to IS
Examples of investment property
Land held for long term capital appreciation
Land held for a currently undetermined future use
Building owned but leased to a third party under an operating lease
Building which is vacant but is held to be leased under an operating lease
Property being constructed or developed for future use as an IP
Can it still be an IAS 40 investment property if we are involved in the building still by giving services to it ?
Yes, if the supply is small and insignificant
Investment property- what if used by sub?
IP in individual accounts but not in the group accounts
An investment property should be recognised when…
It is probable that the future economic benefits will flow
And
The cost of the IP can be measured reliably
(Initially at cost - purchase price + directly attributable costs)
Investment property- if held under a lease, amount recognised at is…
Lower of
Fair value
And
PV of the minimum lease payments
Intangible asset definition
According to IAS 38, it’s an identifiable non-monetary asset without physical substance, such as a licence, patent or trademark
Three critical attributes of an intangible asset are
- identifiability
- control
- future economic benefits
When can you recognise an IA and for how much?
- When it is probable that future economic benefits attributable to the asset will flow to the entity
- the cost of the asset can be measured reliably
- brought in at cost (purchase price + directly attributable costs)
How to treat IA acquired as part of a business combination?
The IA should be initially recognised at FV
If FV cannot be ascertained then it is not reliably measurable and so cannot be shown in the accounts
As a result (by not showing it), goodwill becomes higher
When are development costs capitalised?
Only after technical and commercial feasibility of the asset for sale or use have been established
Must be able to demonstrate how the asset will generate future economic benefits
How to treat research and development acquired in a business combination
Recognise as an asset at cost, even if a component is research
Subsequent expenditure on that project is accounted for as any other research and development cost
How to treat internally generated brands, mastheads, titles, lists
Should not be recognised as assets and should be expensed
How to treat computer software..
If purchased
- capitalise as IA
- operating system for hardware include in hardware cost
If internally developed
- charge to expense until technological feasibility, probably future benefits,
intent and ability to use or sell the software,
Resources to complete the software, and
Ability to measure cost
Always expense the following (in relation to IA)
Internally generated goodwill
Startup, preopening, and preoperating costs
Training costs
Advertising and promotional costs
Relocation costs
Intangible assets - future measurement
Can either use historic cost and amortise, or revaluation
Intangible assets - historic cost
1 - if have a useful economic life
Amortise over UEL
Residual values should be assumed to be nil, except rare circumstances where an active market exists or commitment by a third party to purchase
2 - indefinite UEL
Check for impairment every year
Annual review to see if indefinite life assessment is still appropriate
Intangible assets - revaluation (and amortise)
Can only be adopted if an active market exists for that type of asset
Must be an active market
Item must be unique
Criteria an intangible asset must demonstrate under IAS38 in order to be deemed Development
- Probable future economic benefits
- Intention to complete and use or sell the asset
- Resources are adequate and available to complete and use the asset
- Ability to use or sell the asset
- Technical feasibility of completing the intangible asset
- Expenditure can be measured reliably
Amortisation double entry
Dr amortisation expense (I/S)
Cr accumulated amortisation (SFP)
Using current borrowings to finance an asset - steps
1 - calculate the total amount of borrowings
2 - calculate the interest payable on these in total
3 - weighted average of borrowing costs = divide interest by the borrowing
4 - then multiple borrowing costs by expenditure on asset
Getting a specific loan to fund an asset - steps
Actual borrowing costs less investment income on any temporary investment of the funds
1 - calculate the interest paid on the specific loan
2 - calculate any interest received on loan proceeds not used
3 - add the net of these 2 to the cost of the asset
You don’t have to add interest to the cost of the following assets..
- assets measured at fair value
- inventories that are manufactured or produced in large quantities on a repetitive basis even if they take a substantial period of time to get ready for use or sale
When should we start adding interest to cost of an asset ?
When all three of the following conditions are met
- expenditure begins for the asset
- borrowing costs begin on the loan
- activities begin on building the asset e.g plans drawn up, getting planning etc
Borrowing costs for an asset include
Interest expense calculated using the effective interest method
Finance charges in respect of finance leases
Financial instrument definition
Must be a contract
Must create a financial asset in one entity and a financial liability or equity instrument in another
Contracts that state “will NOT be delivered” or “can be settled net” are almost always what?
Financial instruments
Key features of a financial liability
- The issuer is obliged to deliver either cash or another financial asset to the holder
- An obligation may arise from a requirement to repay principal or interest or dividends
Key features of an equity
Has a residual interest in the entity’s assets after deducting all of its liabilities.
- an equity instrument includes no obligation to deliver cash or another financial asset to another entity
- contract which will be settled by receiving or delivering a fixed number of its own equity instruments is an equity instrument
- if there is any variability in the amount of cash or own equity instruments to be delivered or received, it is a financial asset or liability
The two categories of financial liability
- FVTPL
- this includes a financial liabilities incurred for trading purposes and also derivatives - Amortised cost
Accounting treatment for FVTPL financial liabilities (initially, at YE, any gain/loss)
Initially - at FV
At YE - at FV
Any gain/loss - to the income statement
Accounting treatment for Amortised cost financial liabilities (initially, at YE, any gain/loss)
Initially - FV
At YE - at amortised cost
How to measure the FV of a loan
1 - take all you actual future cash payments
2 - discount them down at the market rate
IFRS 9 requires FVTPL gains and losses in financial liabilities to be split into:
- The gain/loss attributable to changes in the credit risk of the liability (to be placed in OCI)
- The remaining amount of change in the fair value of the liability which shall be presented in profit or loss
Features of a convertible loan
- Better interest rate compared to normal loans
- Higher fair value of loan
- Lower loan figure in SFP
How to calculate the FV of a convertible loan
- Take what is actually paid (cash flows) and discount them at the market rate for normal loans.
Dr cash (capital) Cr loan (PV of cash flows from step 1) Cr equity (the difference)
- Perform amortised cost on the loan
- at the end of the loan, bank decides whether to take the shares or cash.
Option 1: take shares
Dr loan (full capital)
Dr equity
Cr share capital
Cr share premium (balancing figure)
Option 2: take cash
Dr loan
Cr cash
Dr equity
Cr I/S
Transaction costs with a convertible loan
Split the transaction costs pro-rata and reduce the balances by the amounts
Financial assets - 3 categories measurement (initial, YE, gain/loss)
FVTPL
- initial at FV
- YE at FV
- difference to P&L
FVTOCI
- initial at FV
- YE at FV
- difference to OCI
Amortised cost
- initial at FV
- YE at amortised cost
A financial asset that meets the following 2 conditions can be measured at amortised cost
- Business model test
- do we normally keep our receivable loans until the end rather than sell them on? - Cash flows test
- are the only cash flows coming in from capital and interest?
Financial assets FVTPL examples
Equity items held for trading purposes
Equity items not held for trading
Receivable Lon where capital and interest aren’t the only cash flows
FVTPL accounting treatment
- revalue you FV
- difference to I/S
FVTOCI accounting treatment
- revalue to FV
- difference to OCI
Amortised cost accounting treatment
- recalculate using the amortised cost table
- any expected credit losses and forex gains/losses all go to I/S
Transaction costs effect on financial instruments
For FVTPL - go to income statement
For all else:
Asset - increase the opening balance
Liability - decrease the opening balance
Accounting treatment for Treasury shares
- deduct from equity
- no gain or loss shown, even on subsequent sale
- consideration paid or received goes to equity
When to reclassify financial assets between FVTPL, FVTOCI and amortised cost
- Only if financial assets business objective changes
- Do not restate any previously recognised gains/losses
Reclassify prospectively from the reclassification date
Never reclassify FVTOCI equity investments
When to reclassify FVTOCI equity investments?
Never!
Equity FVTOCI de-recognised
No gain/ loss as FV will be up to date and gains/losses will already be in OCI
Not reclassified to I/S
Debt FVTOCI de-recognised
No gain/ loss as FV will be up to date and gains/losses will already be in OCI
The cumulative revaluation gain or loss previously recognised in OCI is reclassified to profit or loss
2 elements of embedded derivatives
1) a host contract
2) an embedded derivative
Embedded derivative- accounting treatment (generally)
Take out the embedded derivative and treat it as a FVTPL
When do we not separate out the embedded derivative
- the embedded derivatives risks are closely related to those of the host contract
- the combined instrument is measured at FVTPL anyway so no need to split
- the host contract is a financial asset anyway so no need to split
- the embedded derivative significantly modified the cash flows of the contract (whole instrument should then be measured at FVTPL)
Embedded derivative definition
A seemingly normal contract that has terms which make the cash flows act like a derivative
Hedging objective
To manage risk
Basic idea is to represent the effect of an entity’s risk management activities
Changes to IFRS 9 (Financial instruments)
- made hedge accounting more principles based to allow for effective risk management to be better shown in the accounts
- allowed more to be hedged incl non-financial items
- allowed more things to be hedging items (options and forwards)
- no longer need to test for hedge effectiveness annually
3 types of hedge
FV hedge I.e loan interest changes
Cash flow hedge
Hedges of a net investment in a foreign operation
A hedged item can be…
A recognised asset or liability
An unrecognised commitment
A highly probable forecast transaction
A net investment in a foreign operation
And must all be separately identifiable, reliably measurable and the forecast transaction must be highly probable
Hedge accounting criteria
- economic relationship exists between the hedged time and the hedging instrument
- credit risk doesn’t dominate the fair value changes
Fair value hedged accounting treatment
- Gains and losses of both the hedged and hedging item are recognised in the current period in the income statement
Cashflow hedges accounting treatment
Effective changes in fair value of the hedging instrument are deferred in reserves.
Deferred gains/losses are then taken to the income statement when the hedged item eventually makes a gain or loss
Hedges of a net investment in a foreign entity
Same as cash flow hedge. Changes in fair value of the hedging instrument are deferred in the OCI
Special cases of hedging items which reduce p&l volatility
- Options - time value were meant when intrinsic value of option is the designated hedging item
- Forward points - when the spot element of a forward contract is the designated hedging item
- Currency basis risk - the spread can be eliminated from the hedge and either be valued as FVTPL or FVTOCI
Impairment of financial instruments- expected credit loss model
- Initially show 12m expected losses
Dr expense
Cr loss allowance (shown next to the financial asset - reduces it)
- Then look to see if there’s significant increase in credit risk. If so, switch from 12m to lifetime expected credit losses
How to calculate the expected credit loss
Use
- a probability weighted outcome
- time value of money
- the best available forward-looking info
Expected credit loss - assets with evidence of impairment
Lifetime expected credit losses recognised
Interest revenue is calculated on the net carrying amount (net of credit allowance)
Expected credit loss- simplified approach
Just recognise a loss allowance based on lifetime expected credit losses at each reporting date
For trade receivables, contract assets with no significant financing component or contracts with a maturity of 12m or less
Purchased or originated credit impaired financial assets
Credit impaired immediately
E.g.
- significant financial difficulty of the borrower
- A default
- probable that the borrower will enter bankruptcy
- disappearance of an active market for the financial asset
Show lifetime expected losses immediately
Lease - definition
A contract that gives the right to use an asset for a period of time in exchange for consideration
3 tests to see if the contract is a lease
Must be identifiable
Customer must be able to get substantially all the benefits while it uses it
Customer must be able to direct how and for what the asset is used
How to value the lease liability
PV of the lease payments:
- fixed payments
- variable payments (if they depend on an index or rate)
- residual value guarantees
- probable purchase options
- termination penalties
How to value the lease right to use asset
- the lease liability
- any lease payments made before the lease started
- any restoration costs (Dr asset Cr provision)
- all initial direct costs
How is the lease term calculated?
Period which can’t be cancelled
Any option to extend period if reasonably certain to take
Period covered by option to terminate if reasonably certain not to take up
What does reasonably certain mean?
- market conditions mean it’s favourable to do
- significant leasehold improvements made
- high costs to terminate the lease
- asset is very important to the lessee
Exemptions to leases treatment
- Short term leases
- expense to IS on a straight line basis
- same treatment for same class of asset
- exemption only for lessees - Low value assets
- expense to IS
- choose is made lease by lease
- exemption only for lessees
Indicators of a financial lease
- majority of the risks and rewards are transferred to the lessee
- ownership transferred at the end
- option to buy at end at less than FV
- lease term is for the majority of the assets UEL
- PV of the future lease payments is close to the actual FV of the asset
- asset is specialised and customised for the lessee
Financial lease accounting treatment
Dr lease receivable
Cr asset
What makes up the lease receivable for lessor?
- PV of lease payments
- unguaranteed residual value
Lessor accounting - opening lease receivable
Dr lease receivable
Cr PPE
Lessor accounting - effective interest received
Dr lease receivable
Cr interest receivable
Lessor accounting - amounts received
Dr cash
Cr lease receivable
Lessor accounting- if operating lease
Keep the asset in SFP
Show lease receipts in the income statement on straight line basis
Lessor accounting operating lease - negotiating costs
Any initial direct costs incurred by lessors should be added to the carrying amount of the asset on the SFP and expenses over the lease term
Lessor accounting operating lease - incentives
Lessor should reduce the rental income over the lease term on a straight line basis
Sale and leaseback
Option 1 - sold under IFRS 15
Step 1 - take the asset out
Dr cash
Cr asset
Cr initial gain in sale
Step 2 - bring in the right to use asset
Dr right to use asset
Cr finance lease/liability
Dr/Cr gain in sale
Option 2 - not a sale under IFRS 15
Seller/lessee leaves the asset in their accounts and accounts cash received as a financial liability
Buyer/lessor accounts for the cash paid as a financial asset (receivable)
How much to show the right to use asset at?
The proportion of our old carrying amount
(PV of lease payments DIVIDE FV of the asset) MULTIPLY carrying amount before sale
How much do we show the financial liability at?
PV of lease payments
