IAS 1 Presentation of Financial Statements

XYZ plc
Statement of Comprehensive Income for the year ended 31 December 20X9

IAS 1 allows Comprehensive Income to be presented in two ways: [IAS 1: 81]

i. A single Statement of Comprehensive Income
ii. Two separate statements as shown above

IFRS do not specify whether revenue can be presented only as a single line item in the statement of
comprehensive income, or whether an entity also may include the individual components of
revenue (for example: various sub-totals for banks).

Expenses can be classified by: [IAS 1: 99]

Function: more common in practice (as the above statement)
Nature (e.g. purchase of materials, depreciation, wages and salaries, transport costs)

Finance income cannot be netted against finance costs; it is included in Other income or show
separately in the income statement.
Where finance income is an incidental income, it is acceptable to present finance income
immediately before finance costs and include a sub-total of Net finance costs in the income
statement.
Where earning interest income is one of the entitys main line of business, it is presented as
revenue.

Entities must prominently display: [IAS 1: 51]

name of the reporting entity
whether the statements are for a single entity or a group of entities
date of the end of the reporting period, or the period covered
presentation currency

the level of rounding used in the preparation of the statements

XYZ plc Statement of Changes in Equity for the year ended 31 December 20X9

IAS 16 (PPE) permits and it is best practice to make a transfer between reserves of the excess
depreciation arising as a result of revaluation. [IAS 1: 41]

When an asset carrying using revaluation model is disposed, any remaining revaluation reserve
relating to that asset is transferred directly to retained earnings. [IAS 1: 41]

An entity can present components of changes in equity either in the Statement of Changes in
Equity or in the notes to the financial statements. [IAS 1: 106]

XYZ plc Statement of Financial Position as at 31 December 20X9

Reserves other than share capital and retained earnings may be grouped as other components
of equity.

Entities must present a set of previous years statements for comparison purposes.

An entity shall classify an asset as current when: [IAS 1: 66]

a) It expects to realise the asset, or intends to sell or consume it, in its normal operating
cycle;
b) It holds the asset primarily for the purpose of trading;
c) It expects to realise the asset within twelve months after the reporting period; or
d) The asset is cash or cash equivalents unless the asset is restricted from being exchanged
or used to settle a liability for at least twelve months after the reporting period.

An entity shall classify a liability as current when: [IAS 1: 69]

a) It expects to settle the liability in its normal operating cycle;
b) It holds the liability primarily for the purpose of trading;
c) The liability is due to be settled within twelve months after the reporting period; or

d) It does not have unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

IAS 16 Property, plant and equipment

An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected flow to the entity.

Property, plant and equipment are tangible assets that:

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

Initial recognition:
PPE should initially be recognised in an entity's statement of financial position at cost.
Cost is the amount of cash and cash equivalents paid to acquire the asset at the time of its
acquisition or construction PLUS the fair value of any other consideration given.

Elements of Cost: Cost can include:

Purchase price less any trade discount (not prompt payment discount) or rebate
Import duties and non-refundable purchase taxes
Directly attributable costs of bringing the asset to working condition for its intended use.
Examples:
Where these costs are incurred over a
Costs of site preparation
period of time, the period for which the
Initial delivery and handling costs
costs can be included in the cost of PPE
Installation and assembly costs
ends when the asset is ready for use,
even if not brought into use.
Professional fees such as legal fees, architects fees
Initial costs of testing that asset is functioning correctly
(after deducting the net proceeds from selling any items produced)

The initial estimate of dismantling and removing the item and restoring the site where it is
located if the entity is obliged to do so (to the extent it is recognised as a provision per IAS 37).
Gains from the expected disposal of assets should not be taken into account in measuring a
provision.

In case of a land, if initial estimation of restoration cost is capitalised then this capitalised
restoration cost shall be depreciated.

Borrowing costs incurred in the construction of qualifying assets if in accordance with IAS 23
Borrowing costs.

Any abnormal costs incurred by the entity, for example those arising from design errors,
wastage or industrial disputes, should be expensed as they are incurred and do not form
part of the capitalised cost of the PPE asset.

Estimated economic life and residual value of asset should be reviewed at the end of
each reporting period. If either changes significantly, the change should be accounted for
over the useful economic life remaining.

The residual value of an asset is the estimated amount that an entity would currently
obtain from disposal of the asset, after deducting the estimated costs of disposal, if the
asset were already of the age and in the condition expected at the end of its useful life. [IAS
16: 6]

Subsequent expenditure only to be capitalised if enhances the life of the asset, or improves
quality or quantity of output, or reduces the cost. If not capitalised then recognise as
expense in I/S.

Examples of subsequent expenditure to be capitalised can include:

Modification of an item of plant to extend its useful life
Upgrade of machine parts to improve the quality of output
Adoption of a new production process, leading to large reductions in operating costs
Where an asset is made up of many distinct (i.e. significant) parts (examples: aircraft, ship),
these should be separately identified and depreciated.
Major inspections or overhauls should be recognised as part of (i.e. increase) carrying amount
of the item of PPE, assuming that this meets the recognition criteria.
An example is where an aircraft is required to undergo a major inspection after so many
flying hours. Without the inspection the aircraft would not be permitted to continue flying.
As a separate component of PPE, the capitalised overhaul cost shall be depreciated over
the period to next overhaul.

Measurement after initial recognition: After initially recognising an item of property, plant and
equipment in its statement of financial position at cost, an entity has two choices about how it
accounts for that item going forwards.
Cost model:
Carrying asset at cost less accumulated
depreciation and impairment losses

Revaluation model:
Carrying asset at revalued amount less
subsequent accumulated depreciation and
impairment losses

Revaluation model:
An entity can, if it chooses, revalue assets to their fair value (only if the fair value of the item
can be measured reliably)
For land and buildings this is normally determined based on their market values as determined
by an appraisal undertaken by professionally qualified valuers.
If this model is applied to one asset, it must also be applied to all other assets in the same
class.
Note that when the revaluation model is used PPE must still be depreciated. The revalued
amount is depreciated over the asset's remaining useful life.
For a revalued asset, IAS 16 allows (and encourage) a reserve transfer in the statement of
changes in equity (from revaluation reserve to retained earnings) of the 'excess'
depreciation because of an upward revaluation.

Methods of depreciation:
Straight line method
Reducing balance method
Machine hour method
Sum-of-the-digits method

Sum of the years of assets expected life = N X (N+1)/2 where N is the

assets expected life
Cost of a lorry was $15,000 and expected to last for five years. No scrap
value.
Sum of the years of assets expected life = N X (N+1)/2 = 5 X (5+1)/2 = 15
Depreciation in Year
1
2
3
4

$15,000
$15,000
$15,000
$15,000

X
X
X
X

5
4
3
2

/15
/15
/15
/15

= $5,000
=$4,000
= $3,000
= $2,000

Derecognition: Property, plant and equipment shall be derecognised (i.e. removed from the
statement of financial position) either:
On disposal; or
When no future economic benefits are expected from its use or disposal.

The gain or loss arising from de-recognition is included in profit or loss.

This gain or loss is calculated by comparing the sale proceeds to the asset's carrying amount.
The gain or loss is calculated in the same way, regardless of whether the asset is revalued or
not.
Any gain should not be classified as part of the entity's revenue.

If on disposal of a revalued asset there remains a balance on the revaluation surplus relating to the
asset, this balance should be transferred to retained earnings.

IAS 23 Borrowing costs

Borrowing costs are interest and other
costs that an entity incurs in connection
with the borrowing of funds. [IAS 23: 5]

Borrowing costs eligible for

capitalisation are those that would have
been avoided otherwise. [IAS 23: 10]

An entity shall capitalise (i.e. as part of the asset) borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset as part of the costs of that asset.
[IAS 23: 8]
A qualifying asset is an asset that necessarily takes a
substantial period of time to get ready for its intended use
or sale. [IAS 23: 5]

An entity shall cease capitalisation borrowing costs when substantially all the activities necessary
to prepare the qualifying asset for its intended use or sale are complete. [IAS 23: 22]

The commencement date for capitalisation: [IAS 23: 17]

When the following 3 conditions are first met:
Expenditures for the asset are being incurred
Borrowing costs are being incurred, and
Activities that are necessary to prepare the asset for its intended use are being undertaken.

Borrowing cost (i.e. interest expense)

of 3 months (i.e. $25,000) to be
recognised in Income Statement
under Finance Costs

01.01.12 - $1m
loan @10% for
2 years

28.02.12 Purchase order

made to buy the

Borrowing cost of 9
months (i.e. $75,000) to
be capitalised as part of
asset in Statement of
Financial Position

31.03.12 Payment made to

buy the asset

Borrowing cost of
12 months (i.e.
$100,000) to be
recognised in I/S

31.12.12 - Asset is
delivered & ready

31.12.13 - Loan
is matured and
repaid

All three conditions are met at this

point.
Capitalisation is suspended if active development is interrupted for extended periods.
(Temporary delays or technical/administrative work will not cause suspension).
Interest income from deposit during this period is not deductible from capitalised borrowing
cost since cost from this suspended period is not capitalised. [IAS 23: 21]

 Amount of borrowing costs available for capitalisation is actual borrowing costs incurred less any
investment income from temporary investment of those borrowings. [IAS 23: 13]

On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of
which were expected to take a year to build. Work started during 20X6. The loan facility was drawn
down and incurred on 1 January 20X6, and was utilised as follows, with the remaining funds
invested temporarily. Asset A Asset B $'000 $'000 1 January 20X6 250 500 1 July 20X6 250 500
The loan rate was 9% and Stremans Co can invest surplus funds at 7%.
Required: Ignoring compound interest, calculate the borrowing costs which may be capitalised for
each of the assets and consequently the cost of each asset as at 31 December 20X6.

Asset A

Asset B

$
$
Borrowing costs: To 31 December 20X6
45,000
90,000
Less investment income: To 30 June 20X6
(8,750)
(17,500)

($500,000/$1,000,000 9%)
($250,000/$500,000 7% 6/12)

For borrowings obtained generally, apply the capitalisation rate to the expenditure on the asset
(weighted average borrowing cost). [IAS 23: 14]

Acruni Co had the following loans in place at the beginning and end of 20X6.
1 January

31

December
10% Bank loan repayable 20X8
9.5% Bank loan repayable 20X9
8.9% debenture repayable 20X7

20X6
$m
120
80

20X6
$m
120
80
150

The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining
equipment), construction of which began on 1 July 20X6.
On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a
hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $
30m on 1 January 20X6, $20m on 1 October 20X6.
Required: Calculate the borrowing costs that can be capitalised for the hydro-electric plant
machine.

Capitalisation rate = weighted average rate = (10% (120/ (80 + 120))) + (9.5% (80 / (120 +
80))) = 9.8%
Borrowing costs = ($30m 9.8%) + ($20m 9.8% 3/12) = $3.43m

IAS 40 Investment property

Investment property is a property (land or a building or part of a building or both) held (by
the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or
both, rather than for:
Use in the production or supply of goods or services or for administrative purposes; or
Sale in the ordinary course of business. [IAS 40: 5]

IAS 40 lists the following as examples of investment property: [IAS 40: 8]

Land held for long-term capital appreciation rather than short-term sale in the ordinary course
of business
Land held for a currently undetermined future use
A building owned by the entity (or held under a finance lease) and leased to a third party under
operating lease
A building which is vacant but is held to be leased out under an operating lease
Property being constructed or developed for future use as an investment property (property
constructed for sale is not investment property)

Followings are outside the scope of IAS 40: [IAS 40: 9]

Property intended for sale in the ordinary course of business: IAS 2 Inventories
Property being constructed or developed on behalf of third parties: IAS 11 Construction
Contracts
Owner-occupied property, including property held for future use as owner-occupied: IAS 16
Property, Plant and Equipment
Property occupied by employees whether or not the employees pay rent at market rates: IAS
16 PPE
Property leased to another entity under a finance lease: IAS 17 Leases

Points to note:
If a portion of an asset meets investment property criteria and other portion is not, then an
entity accounts for the portions separately (e.g. one portion under IAS 40 and another under
IAS 16) if those portions could be sold separately or leased out separately under finance lease.
[IAS 40: 10]
Where an entity owns property that is leased to, and occupied by, its parent or another
subsidiary, the property is treated as an investment property in the entity's own accounts.
However, the property does not qualify as investment property in the consolidated financial
statements as it is owner-occupied from the group perspective. [IAS 40: 15]

Initial recognition and measurement:

An investment property should be initially measured at cost (IAS 16s initial recognition rules
applies). [IAS 40: 20]

Measurement after recognition: After initial measurement at cost, an entity can choose
between two models: [IAS 40: 30]
The IAS 16 cost model
The fair value model
If the fair value model is adopted, the accounting treatment of investment properties will be as
follows:
All investment properties should be measured at fair value at the end of each reporting
period provided fair value can be measured reliably.
Changes in fair value, whether gains or losses, should be recognised in profit or
loss for the period in which they arise. [IAS 40: 35]

When determining fair value, do not deduct costs to sale from the fair value. [IAS 40: 37]

The policy chosen should be applied consistently to all of the entity's investment property
IAS 40 encourages the assessment of fair value by independent, appropriately qualified and
experienced professionals but does not require it.

IAS 20 Government grants

An entity should not recognise government grants until it has reasonable assurance that: [IAS 20:
7]
The entity will comply with any conditions attached to the grant
The entity will actually receive the grant

Receiving the grant not necessarily prove that the conditions attached to it have been or will
be fulfilled.
The treatment will be same whether the grant is received in cash or given as a reduction in a
liability to government. [IAS 20: 10]

Grants relating to assets: IAS 20 allows two alternatives:

Government grant recognised as Deferred income (Option 1) needs to be amortised

(i.e. recycled in I/S as Income) over the useful life of the asset.

Grants relating to income: Such grants should be recognised in profit or loss as other income or
deducted from the related expense. [IAS 20: 29]
As with grants related to assets, the benefit of the grant should be recognised in profit or loss
over the periods in which the entity recognises as expenses the related costs for which the
grants are intended to compensate.

A non-monetary asset (example: land, building, etc.) may be transferred by government to an

entity as a grant.
The fair value of such an asset is usually assessed and this is used to account for both the
asset and the grant.
Alternatively, both may be valued at a nominal (i.e. insignificant) amount. [IAS 20: 23]

Government grants that cannot reasonably have a value placed on them (for example the
provision of free services by a government department) are excluded from the definition of
government grants.

Repayment of government grant: If a grant must be repaid it should be accounted for as a revision
of an accounting estimate (IAS 8). [IAS 20: 34]
Repayment of grant related to income: apply first against any unamortised deferred income
set up in respect of the grant, any excess should be recognised immediately as an expense.
[IAS 20: 32]
Repayment of a grant related to an asset: increase the carrying amount of the asset or reduce
the deferred income balance by the amount repayable. The cumulative additional depreciation
that would have been recognised to date in the absence of the grant should be immediately
recognised as an expense. [IAS 20: 32]

It is possible that the circumstances surrounding repayment may require a review of the asset
value and an impairment of the new carrying amount of the asset.

IAS 20 does not cover: [IAS 20: 2]

Accounting for government grants in financial statements reflecting the effects of changing
prices
Government assistance given in the form of tax breaks
Government acting as part-owner of the entity

IAS 38 Intangible assets

An intangible asset is an identifiable non-monetary asset without physical substance. [IAS 38: 8]
An asset is identifiable if it either: [IAS 38: 12]
(a) is separable, i.e. is capable of being
separated or divided from the entity
and sold, transferred, licensed, rented
or exchanged, either individually or
together with a related contract,
identifiable asset or liability, regardless
of whether the entity intends to do so;
or
(b) arises from contractual or other legal
rights, regardless of whether those
rights are transferable or separable
IAS
are
-

38 states that an intangible asset is to be recognised if, and only if, the following criteria
met: [IAS 38: 21]
it is probable that future economic benefits from the asset will flow to the entity
the cost of the asset can be reliably measured.

Purchased

An asset is a resource controlled by the

entity as a result of past event(s) and from
which future economic benefits are
expected to flow to the entity. [IAS 38: 8]

At recognition the intangible should be recognised at cost. [IAS 38: 24]

Examples of expenditures that are not part of the cost of an intangible asset
are: [IAS 38: 29]
Costs of advertising and promotional activities) [IAS 38: 69(c)]
Costs of staff training [IAS 38: 67(c), 69(b)]

phaseDevelopment
phaseResearch

Internally generated

Research is original and planned investigation, undertaken with the prospect of

gaining new scientific or technical knowledge and understanding. [IAS 38: 8]
The result of research is unknown and, so, no probable future economic benefit
can be expected
An intangible asset arising from development must be capitalised if an entity can
demonstrate all of the following criteria: [IAS 38: 57]
the technical feasibility of completing the intangible asset (so that it will be
available for use or sale)
intention to complete and use or sell the asset
ability to use or sell the asset

Internally generated goodwill should not be recognised as an asset. [IAS 38: 48]

Internally generated brands, mastheads, publishing titles, customer lists and items similar in
substance shall not be recognised as intangible assets. [IAS 38: 63]

An intangible asset with a finite useful life should be amortised over its expected useful life [IAS 38:
89]

An intangible asset with an indefinite life should not be amortised [IAS 38: 89], but should be
reviewed for impairment on an annual basis [IAS 38: 108]
There must be an annual review of whether the indefinite life assessment is still appropriate. [IAS
38: 109]

Residual values should be assumed to be nil, except if an active market exists or there is a
commitment by a third party to purchase the asset at the end of its useful life [IAS 38: 100]
An active market is a market in which all the following
conditions exist:
(a) The items traded in the market are homogeneous (i.e.
similar)
(b) Willing buyers and sellers can normally be found at any

IAS 36 Impairment of assets

An asset is impaired when its carrying amount is higher than its recoverable amount. [IAS 36: 6]

Impairment loss = Carrying value Recoverable amount [IAS 36: 59]

Higher of

Fair value less costs to sell:

Value in a binding sale agreement less
incremental costs directly attributable to
the assets disposal. [IAS 36: 25]
-

Otherwise, the assets market price

(where there is an active market), or
amount obtainable in an arms length
transaction (i.e. fair value), less costs of
disposal. [IAS 36: 26]

Value in use:
-

Based on cash-flow projections

Cash flows should include expected disposal proceed.
[IAS 36: 31(a)]
Future cash flows shall be estimated for the asset in its
current condition. Estimates of future cash flows shall
not include estimated future cash inflows or outflows
that are expected to arise from improving or enhancing
the assets performance. [IAS 36: 44]
Cash outflows to maintain the level of economic benefits
from the asset in its current condition should be
included (e.g. repair and replacement of parts). [IAS 36:
41]

Recognition of impairment losses in financial statements: [IAS 36: 60, 61]

Asset carried out at historical cost: in profit or loss.
Revalued assets: first against any revaluation surplus relating to the asset and then (if amount
left) in profit or loss.

If no impairment loss then do nothing!

After impairment review: the depreciation/amortisation should be adjusted for future
periods. [IAS 36: 63]
If goodwill is valued at fair value (in full) the non-controlling share of impairment will be
allocated to non-controlling goodwill (i.e. will reduce NCI).

Where it is not possible to estimate the recoverable amount of an individual asset, the entity
estimates the recoverable amount of the cash-generating unit to which it belongs. [IAS 36: 66]
A cash-generating unit is the smallest identifiable group of assets that generates cash inflows
that are largely independent of the cash inflows from other assets or groups of assets. [IAS 36:
68]
If an active market exists for the output produced by an asset or a group of assets, this group
of assets should be identified as a CGU even if some or all of the output is used internally. [IAS
36: 70]
If the cash inflows are affected by internal transfer pricing, managements best estimate of
future price that could be achieved in arms length transactions are used in estimating the
CGUs value in use. [IAS 36: 70]

Impairment loss is allocated among the asset/CGU in the following order: [IAS 36: 104]
1. any individual asset that is specifically impaired
2. goodwill allocated to the CGU
3. other assets pro rata to their carrying amount in the CGU (subject of the carrying amount of an
asset not being reduced below its individual recoverable amount. [IAS 36: 105]

Reversal of past impairment:

I/S:
An impairment loss reversal on property, plant and equipment first reverses the loss recorded in
profit or loss (and any remainder is credited to the revaluation surplus, subject to IAS 16
requirements) [IAS 36: 119]
SFP:
A reversal for a CGU is allocated to the assets of the CGU, except for goodwill, pro rata with the
carrying amounts of those assets [IAS 36: 122]

Once recognised, impairment losses on goodwill are not reversed [IAS 36: 124]
In case of a reversal, the carrying amount of an asset must not increase above the lower of:
Its recoverable amount; and
Its depreciated carrying amount had no impairment loss originally been recognised. [IAS
36: 123]

Impairment indicators:
The entity should look for evidence at the end of each period and conduct an impairment review
on any asset where there is evidence of impairment. [IAS 36: 9]

External indicators: [IAS 36: 12]

Internal indicators: [IAS 36: 12]

Significant decline in market

value of asset
Significant change in
technological, economic or legal
environment
Increased market interest rate;
thus reducing value in use
Carrying amount of net assets
of the entity exceeds market

Evidence of obsolescence or
physical damage
Significant changes with an
adverse effect on the entity
Evidence available that asset
performance will be worse than
expected.

Intangible assets with an indefinite useful life or not yet available for use, and goodwill acquired in
business combination are subject to annual impairment test irrespective of whether there are
indications of impairment. [IAS 36: 10]

IAS 8 Accounting policies, changes in accounting

estimates and errors

Changes in accounting policies

The same accounting policies are usually adopted from period to period, to allow users to
analyse trends over time in profit, cash flows and financial position.
Examples of accounting policies:
Alternative presentation of government grant (IAS 20)
FIFO or Weighted average method of inventory valuation
Fair value model of cost model for investment properties (IAS 40: 31)

A change in accounting policy must be applied retrospectively.

Retrospective application means that the new accounting policy is applied to transactions
and events as if it had always been in use. In other words, at the earliest date such
transactions or events occurred, the policy is applied from that date.
This involves restating opening balances of current year and comparative previous year.

From earliest date of same

transaction
(i.e. retrospective effect)

On future
transactions

Policy change
date
Two types of event which do not constitute changes in accounting policy:
(i)
Adopting an accounting policy for a new type of transaction or event not dealt with
previously by the entity.
(ii)
Adopting a new accounting policy for a transaction or event which has not occurred in
the past or which was not material.

Changes in accounting policy will be very rare and should be made only if:
The change is required by an IFRS, or
The change will result in a more appropriate presentation of events or transactions in the
financial statements of the entity, providing more reliable and relevant information.

Revaluation of non-current assets should not be treated as changes in accounting policy (i.e.
no retrospective effect for revaluation).

Changes in accounting estimates

Management applies judgement based on information available at the time
Examples of accounting estimates:
Useful life or residual value of a non-current asset (IAS 16)
Provision made for future loss or expenses (IAS 37)
A change in accounting estimate must be applied prospectively.

Changes in accounting
estimate

Errors:
Errors discovered during a current period which relate to a prior period may arise through:
Mathematical mistakes
Mistakes in the application of accounting policies
Misinterpretation of facts
Omissions
Fraud

Prior period errors correct retrospectively.

Either restating the comparative amounts for the prior period(s) in which the error
occurred, or

when the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for that period

Error/ fraud
discovered

IAS 17 Leases

Operating lease: Any lease other than a finance lease.

- Treat this as normal rental agreement.

Finance lease: A lease that transfers substantially all the risks and rewards incidental to
ownership of an asset to the lessee (who took the lease). Title may or may not eventually be
transferred.

IAS 17 identifies five situations which would normally lead to a lease being classified as
a finance lease:
i.
ii.
iii.
iv.

Transfer of ownership of the asset to the lessee at the end of the lease term
The lessee has the option to purchase the asset at a price sufficiently below fair value at
the option exercise date, that it is reasonably certain the option will be exercised
The lease term is for a major part of the assets economic life even if title is not transferred
at end of lease term
Present value of minimum lease payment amounts to substantially all of the assets fair
value at inception

Present value of minimum lease payments is the payments over the lease term that the lessee is required to
make discounted applying implicit interest rate.
v.

The leased asset is so specialised that it could only be used by the lessee without major
modifications being made

At commencement of a finance lease, leasee (i.e. user of the asset) recognises a Non-current asset
and a Liability in Statement of financial position.

The amount of non-current asset to be capitalized is lower

of: [IAS 17: 20]
-

Present value of minimum lease payment, and

Fair value of the leased asset

Liability component comprises a current

portion and a non-current portion; and
amortised over the lease term.

In F7 using cash price (fair value) given in the

question should be sufficient.
Non-current asset is subsequently depreciated over shorter of:
- Assets useful life, and
- Lease term including any secondary period

use useful life if reasonable certainty exists that the lessee will obtain
ownership (IAS 17: 27)

Example: Leasee accounting: Payment quarterly in advance

On 1 October 20X3 Evans entered into a non-cancellable agreement whereby Evans would lease a new
rocket booster. The terms of the agreement were that Evans would pay 26 rentals of $3,000 quarterly
in advance commencing on 1 October 20X3, and that after this initial period Evans could continue, at
its option, to use the rocket booster for a nominal rental which is not material. The cash price of this
asset would have been $61,570 and the asset has a useful life of 10 years. Evans has a policy to
charge full years depreciation in the year of purchase of a non-current asset. The rate of interest
implicit in the lease is 2% per quarter.
Required:
Identify whether this is a finance lease and show how these transactions would be reflected in the
financial statements for the year ended 31 December 20X3.
Answer:
Though the lease term is only 6.5 years ((26 quarter X 3)/ 12 months), the lease assumed to be a
finance lease because the present value of the minimum lease payment is similar to the fair value of
the leased asset.
Present value of the minimum lease payment:

1st instalment (in advance, so already at present value)

3,000
Present value 2nd 26th installment ($3,000 X 19.5234) (25 years annuity at 2%)
61,570
And, fair value of the lease asset at commencement of the lease (Cash price)
Leaseee accounting:

58,570

61,570

 Example: Leasee accounting: Payment annually in arrears

Branch acquired an item of plant and equipment on a finance lease on 1 January 20X1. The terms of
the agreement were as follows:
Deposit
Instalments
Cash price

: $1,150 (non-refundable)
: $4,000 per annum for seven years payable in arrears
: $20,000 (Fair value of the lease asset at commencement of the

lease)
The asset has useful life of four years and the interest rate implicit in the lease is 11%.
Required: Prepare extracts from the income statement and statement of the financial position of
Branch for the year ending 31 December 20X1.
Answer:
It is assumed that fair value of the leased asset and present value of minimum lease payments are
same at the commencement of the lease.

 Example: Leasee accounting: Complex

Bowtock has leased an item of plant. Commencement of the lease was 1 January 20X2 and term of the
lease is 5 years. Payments of $12,000 to be made annually in advance. Cash price and fair value of the
asset - $52,000 at 1 January 20X2 equivalent to the present value of the minimum lease payments.
Implicit interest rate within the lease 8% per annum. The companys depreciation policy for this type of
plant is 20% per annum on cost (apportioned on a time basis where relevant).
Required: Prepare extracts of the income statement and statement of financial position for Bowtock
for the year to 30 September 20X3 for the above lease.
Answer:
Leaseee accounting:

IAS 18 Revenue
Income

Revenue

Income is increases in economic benefits during the accounting period in the

form of inflows or enhancements of assets or decreases of liabilities that
result in increases in equity, other than those relating to contributions from
equity participants. [Framework: 4.25(a)]

Revenue is income that arises in the course of ordinary activities of an entity.

From sale of goods should only be recognised

when all of the five criteria are met: [IAS 18: 14]
-

It is probable that future economic benefits will

flow to the entity.
The amount of revenue can be measured
reliably.
The costs incurred in relation to the transaction
can be reliably measured.
The seller no longer has management
involvement or effective control of the goods.
The seller must have transferred to the buyer all
of the significant risks and rewards of

From rendering of services should only be

recognised when all of the four criteria are met: [IAS
18: 20]
-

It is probable that future economic benefits will

flow to the entity.
The amount of revenue can be measured
reliably.
The costs incurred and the costs to complete in
relation to the transaction can be reliably
measured.
The stage of completion can be measured
reliably.

Seller transfer significant risks and

rewards:

In most cases the transfer of

significant risks and rewards of
ownership coincides with the
transfer of legal title or the

Where consideration (e.g. money) from sales is received but above

revenue recognition criteria are not met:
DR Asset: Cash
CR Liability: Deferred income
When revenue recognition criteria are met:
DR Liability: Deferred income
CR I/S: Revenue/Income

Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and
value added taxes are not part of revenue. [IAS 18: 8]

In an agency relationship, for an agent, revenue is only the amount of his commission. [IAS 18: 8]

In certain circumstances, it is necessary to apply the revenue recognition criteria to the

separately identifiable components of a single transaction in order to reflect the substance
of the transaction. For example, when the selling price of a product includes an
identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue
over the period during which the service is performed. [IAS 18: 13]

In some cases two or more transactions are considered together. For example, an entity may sell
goods and, at the same time, enter into a separate agreement to repurchase the goods at a later
date. This sale and repurchase agreement may constitute a secured loan and recognised as loan
liability instead of sales revenue. [IAS 18: 13]

IAS 2 Inventories

Inventories are assets:

held for sale in the ordinary course of business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process or in the
rendering of services.

Inventories needs to be valued lower of:

Cost

Cost of purchase

Suppliers gross price

for raw materials
+
Import duties, etc
+
Costs of transporting
materials to business
premises
Trade discounts

Cost of
+ conversion
Costs directly related
to the units of
production (e.g. direct
materials, direct
labours)
+
Fixed and variable
production overheads
incurred in converting
materials to finished
goods, allocated on a
systematic basis
+
Borrowing costs (if met
IAS 23 criteria)

Net Realisable Value (NRV)

+
Estimated selling price in the ordinary
course of business, when completed
Estimated costs to completion and the
estimated costs necessary to make the sale.

Costs should not include:

Abnormal waste, finished goods storage, unrelated administrative overheads

Write-down to NRV:
If inventories are write-down to their NRV, this will result closing inventory with lower carrying
value, which will have automatic effect on cost of sales (i.e. cost of sales will be increased).

IAS 2 does not apply to inventories covered by other standards, such as:
Work in progress under construction contracts (IAS 11 Construction contracts)

IAS 37 Provisions, contingent liabilities and contingent

assets

Provision: is a liability where there is uncertainty over its timing or the amount at which it will be
settled. A provision should be recognised where:
-

i.e. established
past
An entity has a present obligation (legal or constructive)
as a result
of a past event;
It is probable (i.e. more likely than not) that there will be an outflow of resources in the form of
cash or other assets;
A reliable estimate can be made of the amount [IAS 37: 10]

A provision should not be recognised in respect of future operating losses since there is no present
obligation arising from a past event. [IAS 37: 63]

An entity can be required to recognise a provision and capitalise (DR Non-current asset: Property,
plant & equipment; CR Liability: Provision) initial estimation of future dismantling and restoration
cost if above provision recognition criteria and IAS 16 capitalisation criteria are met. [IAS 16: 16, 18]
Gains from the expected disposal of assets shall not be taken into account in measuring a
provision. [IAS 37: 51]

If an entity sells goods with a warranty, a provision recognition (DR I/S: Expense; CR Liability:
Provision) can be required based on the best estimate of the expenditure required to settle the
present obligation at the end of the reporting period. [IAS 37: 36]
-

When the selling price includes an identifiable (i.e. distinguishable) amount for subsequent
servicing, that amount is deferred (DR Asset: Cash/ Receivable; CR Liability: Deferred income)
and recognised as revenue over the period during which the service is performed (DR Liability:
Deferred income; CR I/S: Revenue). [IAS 18: 13]

Where the provision being measured involves a large population of items, the obligation is
estimated by expected value calculation. [IAS 37: 39]

Restructuring costs: A constructive obligation, requiring a provision, only arises in respect of

restructuring costs where the following criteria are met:
-

A detailed formal plan has been made, identifying the areas of the business and number of
employees affected with an estimate of likely costs an timescales; and
An announcement has been made to those who will e affected by the restructuring.

A restructuring provision does not include costs of retraining or relocating continuing staff,
marketing, or investment in new systems [IAS 37: 81]

Discounting to present value: When there is a significant period of time between the end of
reporting period and settlement of the obligation, the amount of provision should be discounted to
present value. [IAS 37: 45]
Discount factor: (1+r)
The discount rate shall be a pre-tax rate that reflects current market assessment of the time value
of money and the risks specific to the liability.

Example: If a provision of $1,000 is required to settle a liability after 2 years; at 10% discount rate
the provision will be recognised at Year-0 is $827 ($1,000 X 0.827).

Unwinding of discount: When a provision is included in the statement of financial position at a

discount value (i.e. at present value) the amount of the provision will increase over time, to reflect the
passage of time.
-

Unwinding of discount will be included in the finance cost.

Unwinding of discount (i.e. the amount to be charged in finance cost and by the amount the
provision needs to be increased) can be found by applying discount rate on opening balance of
the provision.

At end of Year-1: $83 ($827X10%); DR I/S: Finance cost; CR Liability: Provision (that makes closing
provision liability = $910 ($827+$83))
At end of Year-2: $91 ($910X10%); DR I/S: Finance cost; CR Liability: Provision (that makes closing
Reimbursement: An entity may be entitled to reimbursement from a third party for all or part of the
expenditure required to settle a provision. Such a reimbursement:

Should only be recognised (DR Assets: Receivable; CR I/S: Other income) where receipt is virtually
certain, and
Should be treated as a separate asset in the statement of financial position (i.e. not netted off
against the provision) at an amount no greater than that provision.
The provision and the amount recognised for reimbursement may be netted off in the I/S. [IAS 37:

Contingent liability: is a possible obligation that arises from past events and whose existence will
be confirmed only by occurrence or non-occurrence of one or more uncertain future events not
wholly within the control of the entity.
-

Contingent liability is not recognised in the financial statements because either it is not
probable, or the amount cannot be measured with sufficient reliability.
Contingent liability is only disclosed in the notes of financial statements. [IAS 37: 10, 13]

Contingent asset: is a possible asset that arises from past events and whose existence will be
confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity.
-

A contingent asset should not be recognised in the financial statements

Contingent assets should only be disclosed in the notes of financial statements when the
expected inflow of economic benefits is probable. [IAS 37: 31, 34]

When the realisation of income is virtually certain, then the related receivable is recognised in the
financial statements (DR Asset: Receivable; CR I/S: Other income) [IAS 37: 33]

Disclosure let out: IAS 37 permits reporting entities to avoid disclosure requirements relating to
provisions, contingent liabilities and contingent assets if they would be expected to be seriously prejudicial
(i.e. will cause serious disadvantage) to the position of the entity in dispute with other parties.

IFRS 5 Non-current assets held for sale and discontinued

operations
A group of assets and liabilities that will be
disposed of in a single transaction are referred to
as disposal group.
Held for sale:

An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying
amount will be recovered principally through a sale transaction rather than through continuing use.
[IFRS 5: 6]

To be classified as held for sale, the following conditions must be met:

The asset's current condition
be adequate to be
Available for immediate sale in present condition [IFRS 5:should
7].
Sale is highly probable [IFRS 5: 8].
effectively sold as seen.
For a sale to be highly probable, the following must apply:
-

Management must be committed to a plan to sell the

asset
There must be an active programme to locate a buyer
The asset must be marketed for sale at a price that is
reasonable in relation to its current fair value

The sale should be expected to take place within one year from the date of classification [IFRS
5: 8].

Once an asset or group of assets and related liabilities is classified as held for sale, the following
rules should be followed:
Fair value less cost to sell is equivalent to net
realisable value

Carry at lower of its carrying amount and fair value less cost to sell, which may give rise to an
impairment loss [IFRS 5: 15].

This is an exception to the normal IAS 36 rule.

IAS 36 impairment of assets requires an entity
to recognise an impairment loss only when an
assets recoverable amount is lower than its
carrying amount.
-

. . . can include transport costs and costs to

advertise that the asset is available for sale

Do not depreciate even if still being used by the entity. [IFRS 5: 1]

Present separately in the statement of financial position. [IFRS 5: 1]
Non-current asset held for sale recognise under current asset. [IFRS 5: 3]

Presentation of a non-current asset or a disposal group classified as held for sale: [IFRS
5: 38]
Non-current assets and disposal groups classified as held for sale should be presented separately
from other assets in the statements of financial position. The liabilities of a disposal group should
be presented separately from other liabilities in the statement of financial position.
Assets and liabilities held for sale should not be offset.
The major classes of assets and liabilities held for sale should be separately disclosed either
on the face of the statement of financial position or in the notes.

On ultimate disposal of an asset classified as held for sale, any difference between its carrying
amount and the disposal proceeds is treated as a loss or gain recognised in income statement.

A non-current asset or disposal group that is no longer classified as held for sale (for
example, because the sale has not taken place within one year) is measured at the lower of: [IFRS
5: 27]

Its carrying amount before it was classified as held for sale, adjusted for any depreciation
that would have been charged had the asset not been held for sale.
Its recoverable amount at the date of the decision not to sell.
An asset that is to be abandoned should not be classified as held for sale. [IFRS 5: 13]

Discounted operation:

Discontinued operation is a component of an entity that has either been disposed of, or is
classified as held for sale, and:
represents a separate major line of business or geographical area of operations
is part of a single co-ordinated plan to dispose of a separate major line of business or
geographical area of operations, or
is a subsidiary acquired exclusively with a view to resale. [IFRS 5: 32]

For discontinued operations, an entity should disclose a single amount in the statement of
comprehensive income comprising the total of: [IFRS 5: 33]
-

The post-tax profit or loss from discontinued operations; and

The post-tax gain or loss on the re-measurement to fair value less costs to sell or on the
disposal of the discontinued operation.
An entity should also disclose an analysis of the above single amount either on the face of the
statement of comprehensive income or in the notes.

An entity shall disclose the amount of income from continuing operations and from
discontinuing operations attributable to owners of the parent.
An entity should also disclose the net cash flows attributable to the operating, investing and
financing activities of discontinued operations. These disclosures may be presented either on
the face of the statement of cash flows or in the notes.

Gains and losses on the re-measurement of a non-current asset or disposal group that is not a
discontinued operation but is held for sale should be included in profit or loss from continuing
operations. [IFRS 5: 37]
XYZ plc - Consolidated statement of comprehensive income for the year ended 31 December
20X9
$000

Revenue
X
Cost of sales
(X)
Gross profit
X
Other income
X
Distribution costs
(X)
Administrative expenses
(X)
Other expenses
(X) 11 Construction
IAS

contracts

Revenue and cost: should be recognised according to the stage of completion of the contract at
the end of the reporting period, but only when the outcome of the activity can be estimated
reliably.

Probable that economic benefit of the

contract will flow to the entity.
Costs and revenue can be identified
clearly and be reliably measured.

Either, proportion of total contract costs

incurred for work carried out to date
Or, physical proportion of the contract work
completed

When outcome of the contract cannot be reliably estimated:

Revenue: Only recognise revenue to the extent of contract costs incurred which are expected
to be recoverable
Cost: Recognise contract costs as an expense in the period they are incurred

Contract costs which cannot be recovered should be recognised as an expense straight away.
If a loss is predicted (i.e. the contract value < total contract cost) on a contract then it should be
recognised immediately in I/S.

Costs incurred to date + costs will

Costs that should be EXCLUDED from
contract costs:
beconstruction
incurred
General administration costs (unless reimbursement is specified to the contract)
Selling costs
Research and development (unless reimbursement is specified to the contract)
Depreciation of idle plant and equipment not used on in the contract

Penalty charged by client (may be for delay) will reduce the revenue; will not increase the cost.
Finance costs should be included in contract costs under IAS 23 Borrowing Costs.

Accounting treatments:
Income Statement:
Revenue
X
((Total contract value X % completed) Revenue recognised in previous periods )
Cost of sales
(X)
((Total contract costs X % completed) Costs and losses charged in previous periods)
Foreseeable loss not previously recognised (ALWAYS test for foreseeable loss)

(X)
(((Total contract value Total contract cost) X % yet to complete)
Any of this loss previously recognised)
Profit/(loss) (before non-reimbursable abnormal cost)
X/(X)
Abnormal cost (e.g. rectification cost which is not reimbursed by client)
(X)

Also known as current tax.

This is the tax on taxable profit (NOT on
X/(X)
profit).
(Any rectification cost which will be reimbursed byaccounting
client will increase
Companies prepare profit or loss account
both total contract value and total contract costs)
based on accounting standards; but taxable
profit is calculated based on tax rules.
Statement of financial position:

If taxable profit for the year is $100

Contract costs incurred to date
(accounting profit can be different) and
X
applicable
tax rate isabnormal
30%; then
the
Profits/(losses) recognised to date (before deducting
non-reimbursable
cost)
accounting treatment will be:
X/(X)
Net profit/(loss)

Also known as VAT (value added tax).

DR I/S: Expense: Income tax
X
Seller
collect sales tax at the point of sale
30
Progress
billing
to date
and the
purchaser
pays
sales tax at the point
CR SFP: Current liability: Tax payable
30
(X)
of purchase.
(If
tax
is
paid
as
incurred;
then
CR
SFP:
Cash)
/ (payables)
(current
If 15%Receivables
sales tax applicable
on sales
made asset/liability)
by
X/(X)
Company
T; the accounting for $100 sales

If there is a tax loss for the year is $100; then

will
be: 12 Income taxes
IAS
the accounting treatment will be:

DR SFP: Cash
115
CR I/S: Revenue
100
CR SFP: Current liability: Sales
Sales tax
tax payable

TAX

15

(Because as per IAS 18, revenue cannot be

recognised for the amount ($15) collected on
behalf of others (i.e. sales tax collected on behalf
of government).

DR SFP: Current asset: Tax recoverable

(or, DR SFP: Current liability: Tax payable,
if there is already a tax payable balance)
CR I/S: Income tax (will reduce expenses)

If 15% sales tax applicable on purchases made

by Company T and if the sales taxes paid by
Company T is recoverable; the accounting for
$80 purchase will be:

DR Purchase
80
DR SFP: Current asset: Sales tax recoverable
12
(or, DR SFP: Current liability: Sales tax payable,
if there is already a sales tax payable balance)

30

30

Income
Under-provision
or
over-provision
of tax: The
tax
Deferred
tax
actual tax liability for the year and the tax
charge in the income statement are not
necessarily the same amount. The actual tax
liability for the year is agreed with tax
authorities, may be, in a later year.
-

If tax charge in Year-1 on Year-1 taxable profit

is $100 and in Year-2 the actual tax charge for
Year-1 determined $120; then the tax charge
for Year-2 will be increased by $20 (this is the
under-provision made in Year-1). I.e. if tax
charge in Year-2 on Year-2 taxable profit is
$150, the tax expense amount in Year-2 I/S will
be $150+$20=$170.

An over-provision of tax from year 1 is

Deferred tax: This is an accounting measure rather than a tax levied by government; it
represents tax payable or recoverable in future accounting periods in relation to transactions which
have already taken place.

Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either taxable or
deductible.
-

Taxable temporary differences will result in taxable amounts in determining taxable profit
(loss) of future periods when the carrying amount of the asset or liability is recovered or
settled.

Deferred tax liabilities: are the amounts of income taxes payable in future periods in
respect of taxable temporary differences.
DR Tax charge
CR SFP: Non-current liabilities: Deferred tax liability

Deductible temporary differences will result in amounts that are deductible in determining
taxable profit (tax loss) of future periods when the carrying amount of the asset is recovered or
settled.

Deferred tax assets: are the amounts of income taxes recoverable in future periods in
respect of deductible temporary differences (and in respect of the carry forward of unused
tax losses or tax credits).
DR SFP: Non-current assets: Deferred tax asset
CR Tax charge

Recognise deferred tax (that is the difference between the opening and closing deferred tax
balances in the SFP) normally in profit or loss. But, exceptions are:
-

Deferred tax relating to items dealt with as other comprehensive income (such as revaluation)
should be recognised as tax relating to other comprehensive income within the statement of
comprehensive income

Deferred tax relating to items dealt with directly in equity (such as the correction of an error
or retrospective application of a change in accounting policy) should also be recognised
directly in equity

Steps to follow in determining deferred tax balances:

Step 1: Determine the items carrying amount (i.e. book value; i.e. SFP value) and tax base
value as at year beginning and year end.

Step 2: Calculate the temporary difference (i.e. difference between carrying value and tax
base value) at year beginning and at year end.
Temporary difference will be either taxable temporary difference or deductible temporary
difference. Check the decision tree below.
In the question sometime the temporary differences are given. In that case you dont need
to apply Step 1.

Step 3: Apply tax rate on temporary differences to identify deferred tax asset or liability at
year beginning and at year end.
The deferred tax asset or liability identified from year end balances is the amount to be
shown in Statement of Financial Position.
The movement from year beginning deferred tax asset or liability to year end deferred tax
asset or liability to be shown in I/S (in other comprehensive income if the portion related to
revaluation).

Expense:
Asset

Income:
Asset

- The tax rate to be used in the calculation for determining a deferred tax asset or liability is
the rate that is expected to apply when the asset is realised, or the liability is settled.

The most important temporary difference is that between depreciation charged in the
financial statements and capital allowances in the tax computation. In practice capital
allowances tend to be higher than depreciation charges, resulting in accounting profits being
higher than taxable profits. This means that the actual tax charge (current tax) is too low in
comparison with accounting profits. However, these differences even out over the life of an
asset, and so at some point in the future the accounting profits will be lower than the taxable
profits, resulting in a relatively high current tax charge.
These differences are misleading for investors who value companies on the basis of their
post-tax profits (by using EPS for example). Deferred tax adjusts the reported tax expense for
these differences. As a result the reported tax expense (the current tax plus the deferred tax)
will be comparable to the reported profits, and in the statement of financial position a
provision is built up for the expected increase in the tax charge in the future.
There are different ways that deferred tax could be calculated. IAS 12 states that the balance
sheet liability method should be used. [IAS 12: IN2]

Question:
Company 'T' buys equipment for $50,000 and depreciates it on a straight line basis over its expected
useful life of five years (i.e. @20%). For tax purposes, the equipment is depreciated at 25% per annum
on a straight line basis (i.e. will be fully depreciated at end of Year-4). Accounting profit before tax is
$5,000 for each of Year 1 to 5. The tax rate is 40%. Show current and deferred tax impacts from Year 1
to 5.
Answer:

Determining tax base of assets:

The tax base of an asset is the amount that will be deductible for tax purposes against any
taxable economic benefits that will flow to an entity when it recovers the carrying amount of
the asset. If those economic benefits are not taxable, the tax base of the asset is equal to its
carrying amount. [IAS 12: 7]
Putting above into a formula:
Tax base = Carrying amount Future taxable amounts + Future deductible amounts

Note:
1.
-

Future taxable amount considered as equivalent to the Carrying amount since the economic
benefit (e.g. operations of the business which will generate income) from using the P&E yet to be
taxable.
Future deductible amount is $3,500 since $6,500 already claimed as tax depreciation in taxable
profit calculation. $3,500 will be deductible in the future periods taxable profit calculation.

2.
-

The amount will be taxable on cash basis; i.e. when the cash will be received in the future. So,
the whole $1,000 amount is Future taxable amount.
The amount will never be deductible in taxable profit calculation. So, Nil Future deductible
amount.

3.
-

The amount already been taxed; so will not be taxed further. That is why Future taxable amount
is Nil. - The amount will never be deductible in taxable profit calculation. So, Nil Future
deductible amount.

4.
-

The amount not taxable and not deductible in the future. So, Future taxable amount and Future
deductible amount both are Nil.

5.
-

The amount will not be taxed or deductible in the future. So, both of the values are Nil.

Determining tax base of liabilities:

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods. In the case of revenue which is received
in advance, the tax base of the resulting liability is its carrying amount, less any amount of the
revenue that will not be taxable in future periods. [IAS 12: 8]

Putting this into a formula: Tax base = Carrying amount + Future taxable amount* Future
deductible amount

*Exception applies for unearned revenue (i.e. revenue received in advance) (see following Note-2)

Note:
1.
-

The related expense will be deducted for tax purposes on a cash basis. Since the amount yet to
be paid, the $1,000 will be Future deductible amount.
The amount is an expense, so will not the taxable in the future.

2.
-

The amount is charged for tax on cash basis. Since the cash is already received, the amount is
already taxed and will not be taxed again. That is why Future taxable amount is taken as a
negative figure, instead of positive (as given in the formula). This is exception to the general
formula, but in compliance with IAS 12 requirements.
Alternative way of calculating Tax base of Unearned revenue is: Carrying amount Amount
that will not be taxable in the future. Thus the calculation will be: 10,000 - 10,000 = Nil

3.

The amount will not be deductible, or chargeable for tax purposes.

4.

The amount will not be deductible, or chargeable for tax purposes.

Financial instruments

Four standards on financial instruments:

IAS 32 Financial instruments: Presentation

IAS 32 deals with classification of financial instruments between liabilities and equity, and
presentation of certain compound instruments

IFRS 7 Financial instruments: Disclosures

IFRS 7 revised, simplified and incorporated disclosure requirements previously in IAS 32

IAS 39 Financial instruments: Recognition and measurement

IAS 39 deals with recognition, derecognition and measurement of financial instruments
and hedge accounting

IFRS 9 Financial instruments

IFRS 9 is a work in progress and will replace IAS 39. It will come into force for accounting
periods ending in 2013.

Compound financial instruments:

A compound or hybrid financial instrument is one that contains both a liability component and an
equity component. As an example, an issuer of a convertible bond has:
-

The obligation to pay annual interest and eventually repay the capital the liability component
The possibility of issuing equity, should bondholders choose the conversion option the equity
component.

In substance the issue of such a bond is the same as issuing separately a non-convertible bond and an
option to purchase shares. At the date of issue the components of such instruments should be
classified separately according to their substance. This is often called split accounting.
The amount received on the issue (net of any issue expense) should be allocated between the
separate components as follows:
-

The fair value of the liability component should be measured at the present value of the
periodic interest payments and the eventual capital repayment assuming the bond is
redeemed.

The present value should be discounted at the market rate for an instrument of comparable credit
status and the same cash flows but without the conversion option.
-

The fair value of the equity component should be measured as the remainder of the net
proceeds.

Note that the rate of interest on the convertible will be lower than the rate of interest on the
comparable instrument without the convertibility option, because of the value of the option to
acquire equity.

Consolidated statement of financial position

Different types of investment and required accounting:

INVESTMENT

CRITERIA

Subsidiary

Control (> 50% rule)

Associate

Significant influence (50% >

20% rule)

Joint venture (jointly controlled

entity)

Contractual agreement

Investments which is none of

the above

Asset held for accretion (i.e.

increase) of wealth

Investments held for sale

(IFRS 5: Non-Current Asset Held
for Sale and Discontinued
Operations)

Sale is highly probable + rule

REQUIRED TREATMENT IN
GROUP ACCOUNTS
Full consolidation, i.e. single
entity IAS 27 Consolidated and
Separate Financial Statements
IFRS 3 Business Combinations
IFRS 10 Consolidated Financial
Statements
Equity accounting
IAS 28 Investment in Associates
and Joint Ventures
Proportionate consolidation or
equity accounting IAS 28
Investment in Associates and
Joint Ventures IFRS 11 Joint
Arrangements
As for single company accounts
(IFRS 9: Financial instruments)
Present assets or group of
assets separately in Statement
of Financial Position and results
of discontinued operations to
be presented separately in the
Statement of Comprehensive
Income.

Investments in Subsidiary:
Control achieved by owning more than 50% voting power. But, control can still exist with less
than 50% voting power.

When parent has:

- Power over more than 50% of the voting rights by virtue of agreement with other
investors.
- The power to govern the financial and operating policies of the entity by statue or
under an agreement.
- The power to appoint or remove a majority of members of the board of directors.

Control may be lost even without changing the ownership levels; when subsidiary becomes
subject to control of a government, court administration or regulator.

Exemptions from preparing group accounts: A parent need not present consolidated financial
statements if ALL of the following conditions are satisfied:
It is a wholly-owned subsidiary or a partially-owned subsidiary of another entity and its other
owners have not objected to the parent not presenting consolidated financial statements
Its securities are not publicly traded
It is not in the process of issuing securities in public securities markets

The ultimate or intermediate parent publishes consolidated financial statements that comply
with IFRS

Different reporting dates: If a subsidiarys reporting date is different then parent and bulk of
other subsidiaries in the group:
the subsidiary may prepare another set of financial statements
OR, if it is not possible, the subsidiarys accounts may still be used provided that the gap is
not more than three months and adjustments are made to reflect significant transactions or
other events.

Differing accounting policies: Uniform accounting policies should be used. Adjustments should
be made where accounting policies of subsidiary differ from parent.

1.

GROUP STRUCTURE:
Parent

2.

3.

50% + (control)

20% + (significant influence)

Subsidiary

Associate

NET ASSETS AT FAIR VALUE AT THE DATE OF:

COST OF INVESTMENT:

Do not include costs like professional fees, legal fees in the cost of investment; these must be
recognised in the Profit or Loss account as expense as incurred. Also, in cost of investment do not
include loan issued to subsidiary.

Any contingent consideration payable must be included even at the date of acquisition if it is not
deemed probable that it will be paid

It is possible that the FV of the contingent consideration may change after the acquisition date. If
it is due to additional information obtained that affects the position at acquisition date, goodwill

should be remeasured (one year qualifying period applies). If the change is due to events after the
acquisition date (such as earnings target met) then the goodwill will not be remeasured (gain/loss
from remeasurement will be recognised in I/S)
4.

5.

GOODWILL:
i.

New method: When examiner will require to use the new method, he will mention full,
gross, new, or calculate NCI at fair value. In this case FV of NCI (value of shares not
acquired) at acquisition date will be given.

ii.

Old method: Where an exam question requires use of the old method, it will state that it is
group policy to value the non-controlling interest at its proportionate share of the fair value of
the subsidiarys identifiable net assets.

NON-CONTROLLING INTEREST (NCI) IN SUBSIDIARY:

- NCI is not applicable for associates.

6.

CONSOLIDATED RESERVE:

7.

INVESTMENT IN ASSOCIATE:

Consolidated statement of comprehensive income

* If subsidiary is acquired part way through the year then all income and expenses of subsidiary shall
be time apportioned
X1: Transaction value of inter-company trading (i.e. the total selling price in inter-company trading)
X2: Who is the seller? (only deduct the unrealised profit)

X3: Interest on inter-company loan

IAS 7 Statement of cash flows

****The formats are not comprehensive. All information in the formats may not be required in every
situation. It is very important to understand the underlying concept than mere memorising the format.

Ratio analysis

Liquidity Ratios: Liquidity ratio measures a company's ability to pay short-term obligations
1. Current ratio =

= X:1

Current ratio is mainly used to give an idea of the company's ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
The higher the current ratio, the more capable the company is of paying its obligations.
A current ratio of 1.5:1 to 2:1 can mean sufficient current asset to cover its current liabilities.
A current ratio of above 2:1 may mean over investment in working capital (i.e. in current
assets). Surplus assets can be used to

to expand the business operation or to increase capacity which will earn additional profit,
to repay debt which will save interest expenses,
distribute to shareholders as dividend.

Current Asset
Current Liabilities

A current ratio below 1 suggests that the company would be unable to pay off all of its current
liabilities if they came due at that point.
Current ratio can be improved by

selling of unused non-current assets,

taking long-term loan,
speeding up the receivables collection,
slowing payables payment

A weak current ratio shows that the company is not in good financial health, but it does not
necessarily mean that it will go bankrupt as there are many ways to access financing; but it is
definitely not a good sign.
Companies that have trouble getting paid by its receivables or have long inventory turnover
can run into liquidity problems

2. Quick or Quick asset or Acid test ratio =

Current Asset - Closing Inventory

Current Liabilities

=X:1

The quick ratio measures a company's ability to meet its short-term obligations with its most
liquid assets (as it excludes inventory).
Inventory is excluded because some companies (specially manufacturing companies with high
inventory holding period) have difficulty turning their inventory into cash.
The higher the quick ratio, the better the position of the company.
A quick ratio of 1:1 is normally most appropriate. For companies with a high inventory turnover
ratio (i.e. short inventory holding period) can have a less than 1 quick ratio without suggesting
that the company could be cash flow trouble.
If quick ratio is too low than the current ratio; this could mean that high amount of working
capital is tied up in inventory. High amount of inventory means high inventory holding costs.

Profitibality Ratios:
1.

Return on capital employed (ROCE) = Profit Before Interest and Tax

Capital Employed

100% = X%

Capital employed = Total asset Current liabilities

= Share capital + Reserves + Long-term liabilities

Deferred Tax Liability or Asset normally excluded from Capital Employed.

In that case, Capital employed = Total asset Current liabilities Deferred tax liability or asset
= Share capital + Reserves + Long-term liabilities
Deferred tax liability or asset

Current Liability portion of Long-term liabilities; and a constant amount of Overdraft normally
also considered as Non-current liability for Capital employed calculation

Better to use average Capital Employed (Opening + Closing / 2 ) where possible.

-

If you are required to compare ratios between two different years and cannot calculate
average for both of the years, then take only the SFP value of the year (i.e. do not
average). This is for comparability purpose.

If market value of equity is taken then do not include Reserves.

There is a lot other contexts to define capital employed. This is basically the capital required
for a business to function.

ROCE is the prime measure of operating performance. This ratio indicates how efficiently a
business (i.e. managers) is using the funds invested (equity and long-term debt).

It is the ratio over which operations management has most control.

ROCE increase from previous year or above industry average means a good sign and reflects
the fact that the company (by managers) has managed to increase the sales without a
proportionate increase in costs.

ROCE decrease from previous year or below industry average shows problem with controlling
of costs. Level of dividend may also fall as a consequence.

The value of capital employed is lower where company mainly uses rented assets (i.e.
thorough operating lease) rather owning or finance lease. This is also possible where assets
carrying value is lot less than the cost (remember in that case assets will need replacement).
These may result a higher ROCE.

2.

Asset revaluation (especially land) will result a higher amount of Capital employed, which will
give a lower ROCE without indicating company performance became poorer.

ROCE should always be higher than the rate at which the company borrows; otherwise any
increase in borrowing will reduce shareholders' earnings.

Return on equity (ROE), or Return on Shareholders Capital (ROSC) =

Profit After Tax and Preference Dividend
Ordinary Share Capital and Reserve

X 100% = X%

Profit after tax and preference dividend is the Profit attributable to ordinary shareholders

It is common to use book values rather market value of shares (if market value used then
remember to exclude Reserves)

Better to use average of Shareholders Capital (Opening + Closing Ordinary Share Capital and
Reserves / 2 ) where possible; specially, when closing balance significantly differs from
opening balance.
- If you are required to compare ratios between two different years and cannot calculate
average for both of the years, then take only the SFP value of the year (i.e. do not average).
This is for comparability purpose.

Return on equity (ROE) indicates to ordinary shareholders how well their investments have
performed measuring how much profit the company has generated for them with their money.

A good figure results in a high share price and makes it easy to attract new funds.

With a similar level of ROCE, a fall in ROE may mean increased finance cost because of new
loans.

An improved ROE with a similar ROCE may mean some of the loans are repaid which resulted a
lower finance cost and, so, improved profit attributable to ordinary shareholders.

If new share issued sometime at period end, this may result a declined ROE without indicating
poor performance of the company because company really did not get time to utilise the new
capital.

3. Gross profit margin =

Gross Profit
Sales

X 100% = X%

High gross profit margin may indicate effective purchasing strategy which results a lower
material &/ production cost (i.e. lower cost of sales). A high gross profit margin may also
indicate concentration on low volume-high margin sales.

Low gross profit margin may be an indication of selling products cheaply (i.e. at discount) in
order to generate high volume of sales. This may also indicate increased production cost
(including material and labour cost) without a proportionate increase in selling price.

4. Operating profit margin = Profit before Interest and Tax

Sales

X 100% = X%

Operating profit margin gives analysts an idea of how much profit (before interest and tax) the
company is making from each dollar of sales.

Typically operational management has full control over operating costs (the amount of loan
capital and, so, interest expense normally depends on more higher level of management and
the amount of tax payable depends on government policy). So, operating profit margin
effectively measures performance of operational management.

A poor or declining Operating profit margin may indicate business is struggling in controlling
the costs. This may also happen because of decrease in selling price.

A healthy operating profit margin is required for a company to be able to pay interest on loans.

5. Net profit margin =

Profit After Tax

Sales

X 100% =

X%

Net profit margin sometimes calculated based on Profit before tax (after interest). Check
question for indication.

A higher percentage than last year or industry average indicates costs are being controlled
better. This may also indicate products are sold at higher price.

A weaken Net profit margin may indicate management is struggling in controlling the costs.

Company can sell at a discount to retain market share during economic downturn (and/or
because of intense competition). If costs remain at similar level this will result a lower Net
Profit Margin. Companies trading cheaper products can gain during economic downturn when
customers generally stop buying luxury products and turn to cheaper ones.

In large companies, where higher level of economies of scale can be achieved (i.e. lower level
of per unit cost) the net profit margin can be higher as a result.

Multinational companies can gain or loss from favourable or adverse exchange rate
movements.

6. Asset turnover or Asset utilisation ratio =

Sales
Capital Employed

= X:1

Use of Non-current assets instead of Capital employed is also correct. Check question for
indication. If question says nothing, then use Capital employed.

This shows the sales that is generated from each $1 worth of Capital (or asset) employed. The
higher the sales per $1 invested the more efficient use of the capital was.

If business is selling luxury products or products with higher profit margin that may result a
lower Asset turnover ratio without a weaken ROCE or Net profit margin ratio.

Efficiency Ratios:
1.

Average receivables collection period = Average Trade Receivables

Credit Sales

X 365 = X days

Use only CREDIT SALES. If question gives us only a Sales figure (i.e. does not split between
credit and cash sales) then use the given Sales figure.

We need only TRADE RECEIVABLES (i.e. receivables derived from credit sales). Nontrade
receivables (e.g. advance, damage claim, receivables of government grant) shall not be
included. If question gives us only a Receivables figure, and does not give any other indication
about its components then assume that is the Trade receivables figure.

Better to use average trade receivables (Opening + Closing /2 ) where possible; specially,
when closing balance significantly differs from opening balance.

An alternative of using Average Receivables is using year-end receivables figure where amount
of receivables did not change significantly from year-beginning to year-end.
- If you are required to compare ratios between two different years and cannot calculate
average for both of the years, then take only the SFP value of the year (i.e. do not average).
This is for comparability purpose.

Receivables collection period is an approximate measure of the length of time customers take
to pay what they owe.

A Receivables Collection Period similar to Payables Payment Period may be an indication of

good credit control policy.

Collection Period of less than 30 days may seem normal. Significantly in excess of 30 days
might be representative of poor management of funds of the business. However, some
businesses such as export oriented businesses normally needs to allow generous credit terms
(may be 60 days) to win customers; whereas retailer may sell only or mainly on cash (may be
collection period of not more than 10 days).

A high or increasing collection period may mean poorly managed credit control function, and
increased risk of bad debts. This also may mean over investment in receivables.

However, increase in collection period might be a deliberate policy to increase sales by

offering better credit terms than competitors.

Decreasing or low collection period may mean tighten credit control policy; which may cause
declining customer numbers (i.e. reduction of sales).

Receivables collection days can be improved by offering discount to customers for early
payment.

2. Average payables payment period =

Average Trade Payables

Credit Purchase

X 365 = X days

If Credit purchase or purchase amount cannot be identified from the question, use Cost of sales
as it serves as an approximation.

Use only Trade payables; i.e. payables generated from credit purchase.

Increasing or long payment period may indicate liquidity problem; and also may indicate
loosing opportunity of prompt payment discounts.

A longer payment period may also mean company has succeeded in obtaining very favourable
credit terms from its suppliers; contradictorily, this may also mean unethical business practice.

3.

Long credit term from suppliers is a source of interest free financing. But, some suppliers may
charge interest if payment period exceeds a certain duration.

Declining or short payment period may indicate business has sufficient cash to meet payables.
A short payment period may put companys credit ratings in higher position.

If receivables collection period is longer than the payables payment period then it can cause
cash flow difficulties.

Inventory turnover/ holding period =

Average Inventory
Cost of Sales

X 365 days = X days

or,
Cost of Sales
Average Inventory

= X Times

Better to use Average Inventory figure to take into account the variation between Opening
inventory and Closing inventory. But, instead of Average Inventory the closing inventory figure
can be used where opening inventory level cannot be determined; in that case comparable
figure has to derive from same approach.

This ratio is an estimate of the average time that inventory is held before it is used or sold. If
average inventory holding period is 30 days, this means that the inventory is turned over (i.e.
sold) on average 12.16 times (= 365/30) in a year

A low turnover (i.e. high holding period) implies slow sales and, therefore, excess inventory
and/ or high level of inventory holding costs.

High inventory levels are unhealthy because they represent an investment with a zero rate of
return. It may also put company at a great loss if prices start to decline (think about
technological products).

In F9:
1. Finished goods inventory turnover period =

2. Raw materials inventory turnover period =

3. Average production (WIP) period =

Average FG Inventory
Cost of Sales

X 365 days = X days

Average RM Inventory
Annul Purchases

X 365 days = X days

Average WIP
Cost of Sales

X 365 days = X days

4. Working capital cycle, or, Cash operating cycle (in days) =

Inventory holding period (days) + Receivables collection period Payables payment period
In F9:
Finished goods inventory turnover period
Raw materials inventory turnover period
Average production (WIP) period
Average receivables collection period
Average payables payment period
Operating cycle

Days
X
X
X
X
(X)
X/(X)

This cycle is the length of time between cash payment to suppliers and cash received form
customers. This measured how long a firm will be deprived of cash.

A company could even achieve a negative cycle by collecting from customers before paying
suppliers. This policy of strict collections and delay payments is not always sustainable or
appreciable by customers (because they have to pay early) and suppliers (because they are
being paid late).

Investment Ratios:
1.

Earnings per share (EPS) =

Earnings (i.e. Profit) Attributable le to Ordinary Shareholders

Weighted Avg. Number of Ordinary Shares

= $X
or,
Market Price per Share
Price Earnings Ratio

2.

= $X

EPS is generally considered to be the single most important variable in determining a shares
price. This is a key measure of company performance from ordinary shareholders point of
view.

EPS shows the amount of profit attributable to each ordinary share. But, it does not represent
actual income of the ordinary shareholders.

Increase in EPS generally indicates success; whereas a decrease is not welcomed by

shareholders.

A constant growth in EPS may result in favourable movements (i.e. increase) in share price.

Both right issue and bonus issue of shares result in a fall of EPS. So, care must be taken while
interpreting.

EPS often ignores the amount of capital employed to generate the earnings. Two companies
could generate the same EPS, but one could do so with less investment; this could mean that
this company was more efficient at using its capital.

Dividend per share (DPS) =

Ordinary Dividend Declared and Paid for The Year

Weighted Avg. Number of Ordinary Shares

= X$

DPS is the actual portion of income received by the ordinary shareholders from EPS.

DPS is important for shareholders who are seeking income from shares rather capital gain.

Growth in dividend per share used in share price valuation. So, companies may have a policy
of achieving steady growth in dividend pay-out per share. A steady growth normally creates
positive market reaction (i.e. increase in share price).

3. Dividend pay-out ratio =

Dividend Per Share

Earnings Per Share

X 100% = X%

or,
Ordinary Dividend Declared and Paid for The Year
Earnings (i e Profit) Attributable to Ordinary Shareholders

X 100% =

X%

Dividend pay-out ratio is the percentage of earnings paid to shareholders as dividends. This
shows how well earnings support the dividend payments.

4.

High dividend pay-out ratio may mean company confidence on future earnings. But, where
majority of shares are held by a small number of shareholders, it may also mean that
shareholders are taking out as much profit as they can; and this does not necessarily serve
companys long-term interest.

Low dividend pay-out ratio may mean company is expecting difficulties in the future; so now
interested in retaining earnings. But, it can also mean expansion (by reinvesting the retained
earnings) of business in the future.

Mature companies tend to have a higher pay-out ratio.

Dividend cover =

Earnings Per Share

Dividend Per Share

= X Times

or,
Earnings (i.e. Profit) Attributable to Ordinary Shareholders
Ordinary Dividend for the Year

= X Times

Dividend cover represents how many times dividend could have paid from the profit
attributable to ordinary shareholders.

Dividend cover is a measure of the ability of a company to maintain the level of dividend paid
out. The higher the cover, the better the ability to maintain dividend pay-out if profits drop.

Typically, a ratio of 2 or higher is considered safe in the sense that the company can well afford
the dividend; but dividend cover below 1.5 may seem risky.

If the dividend cover is below 1 then the company is using its retained earnings from previous
years to pay current years dividend

A low level of dividend cover might be acceptable in a company with very stable profits, but
the same level of cover for a company with volatile profits would indicate that company may
not able to maintain the current level of dividend pay-out.

5. Price/Earning (P/E) ratio =

Market Price Per Share

Earnings Per Share

= X Times

or,
Companys Market Capitalisation
Earnings (i.e.Profit) Attributable to Ordinary Shareholders

= X Times

Market capitalisation is the total market value of all the issued ordinary shares of the company.

P/E ratio also knows as Price Multiple or Earnings Multiple ratio

P/E ratio is a measure of company performance from the markets point of view.

P/E ratio shows how much money investors are currently willing to pay for each dollar of
earnings. It gives an indication of the confidence that the investors have in the future success
(i.e. earnings) of the business.

In a very basic term, a P/E ratio of 20 means investors are paying equivalent of 20 years
earnings (at current EPS level) to own a share in the company.

A P/E ratio of 1 means market is currently willing to pay $1 for each dollar of earnings currently
made by the company; this shows very little confidence on the companys future prosperity.
Whereas, a P/E ratio of 20 expresses a great deal of optimism about the future of the company

since investors are currently willing to pay $20 for each dollar of companys earnings. Investors
paying 20 times of current earnings believe that company will do significantly better in coming
years, and this will not take long to get the $20 earnings.

Market can over-value or under-value company shares depending of information available.

6. Dividend yield =

Dividend Per Share

Market Price Per Share

X 100% = X%

Dividend Yield is a financial ratio that shows how much a company pays out in dividends
relative to its share price.

In the absence of any capital gains, the Dividend Yield is the return on investment for a share.

Investors can secure a minimum stream of cash flow from their investment portfolio by
investing in shares which is paying relatively high and stable dividend yields.

Mature and well-established companies tend to have higher dividend yields; while young and
growth oriented companies tend to have lower yield. Many fast growing companies do not
have a dividend yield at all because they do not pay-out any dividend.

Long-Term Solvency Ratios:

1.

2.
a.

Debt ratio =

Total Debt
Total Assets

Total assets consist of non-current and current assets.

Debts consist of all current and non-current liabilities (Deferred tax liabilities can be ignored).

This ratio represents how much money company owes compared to its Total assets.

If Debt ratio is greater than 50%, the business can be considered as a risky company. But, a
high Debt ratio may also mean companys ability to raise debt finance which shows confidence
of debt holders on the company.

Gearing ratios:
Debt to Equity ratio =

Debt Capital
Liabilities
Equity Capital X 100% =
Capital + Reserves X 100% = X%
b.

X 100% = X%

Redeemable Preference Share Capital + Long-term

Ordinary Share Capital Irredeemable Preference Share

Debt to Total capital ratio =

Debt Capital
Total Capital X 100% =

Debt Capital
Equity Capital + Debt Capital

X 100% = X%

3.

Leverage ratio :
Equity Capital
Equity Capital + Debt Capital X 100%

Take current liability portion as well of long-term liabilities in Debt capital calculation.
Normally do not include Deferred tax liability within Debt capital.
In F9 Preference share considered as Debt capital not Equity capital.
Also in F9, values for Gearing ratio can be either book values or market values. If using market
values remember market value of ordinary shares take account of reserves (i.e. do not add
reserve amount with total market value of ordinary shares)

A gearing level of more than 50% (where Debt Capital to Total Capital used) or more than
100% (where Debt Capital to Equity Capital used) or Leverage ratio of less than 50% means
company is highly geared (i.e. risky).

Risk is high for investors in a high geared company because of obligation to pay the interest
and repaying capital on time.

The standard level of gearing depends on industry sector.

A relatively higher gearing may mean company adopted an aggressive strategy to expand its
operation. This has to be justified with sales and profit growth. A higher gearing may also
mean company is having financial difficulties; so may be a going concern issue.

A low or declining gearing may mean company is getting stronger financially and confident on
future earnings.

Where gearing is high, shareholders required rate of return will increase because of high level
of risk involve in the investment.

To lend money in a highly geared company, lenders may impose some covenants on the
company (example: a maximum limit of gearing, a minimum level of interest cover, pledge on
some assets)

4. Interest cover =

Profit before Interest and Tax

Interest Charge

= X Times

Interest cover is a measure of the adequacy of a company's profit relative to interest payment
on its debt.

A high interest cover ratio means that the business is easily able to meet its interest
obligations from profits. Similarly, a low level of interest cover ratio means that the business is
potentially in danger of not being able to meet its interest obligations.

Interest cover of more than 2 is normally considered reasonably safe. But, companies with very
volatile earnings may require an even higher level of Interest cover.

Interest cover of less than 1 means the company did not earn sufficient earning (i.e. profit) to
meet its interest charge. This means company will have to pay some of its interest from
retained profit from previous years. This may also raise question about companys going
concern.

IAS 33 Earnings per share

An entity is required to calculate and present a basic EPS and a diluted EPS amount based on
the profit/ (loss) attributable to the ordinary shareholders (of the parent entity).

Basic and diluted EPS figures should be presented on the face of the statement of
comprehensive income with equal prominence.

Basic EPS = Net profit or (loss) attributable to ordinary shareholders

Shares are usually included in the
weighted average number of ordinary shares
weighted average number of
shares from the date consideration
is receivable.
Weighted average number of shares can be calculated as:

Basic EPS with bonus issue (scrip issue, capitalisation issue) and share split:
increases number of shares without any consideration. As a result, this distorts the comparison
of EPS in the current year with the EPS in the previous year. So, to ensure that the distortion
does not occur:
The EPS of the current year is calculated as if the bonus issue was in existence of the
beginning took place at the start of the year; and,
The corresponding previous years EPS also restated as that bonus issue was in existence
throughout that previous year.

Simple example: Bonus issue

At year beginning (01.01.2011), company A has a share capital of 400,000 ordinary shares, when it
decides to make a bonus issue of 1 for 4 on 01 April 2011. Its profit for the year to 31 December 2010
and 2011 was $60,000 and $65,000 respectively. Calculate the EPS for the year ending 2011 and for
corresponding previous year.

Complex example: Bonus issue after a full market price issue

At year beginning (01.01.2011), company A has a share capital of 400,000 ordinary shares. It made a
full market price issue on 01 March 2011 of 100,000 shares and a bonus issue of 1 for 4 on 01 April
2011. Its profit for the year to 31 December 2010 and 2011 was $60,000 and $65,000 respectively.
Calculate the EPS for the year ending 2011 and for corresponding previous year.

Basic EPS with right issue:

A rights issue offers existing shareholders the right to buy new shares in proportion of their
existing holding at a price slightly below the market price.
To calculate EPS when right issue is made we need to know:

The cum right price: This is the market price of a share just before the right issue
The ex-right price: This is the price of a share after the right issue. In theory the ex-right
price should be the weighted average of the cum right price of the shares and issue price of
corresponding number of share. This price is called the theoretical ex-right price.

In a right issue, shares are sold at a reduced price; so, we need to divide the total number
of shares issued into bonus shares and fully paid shares and treat as such.

Steps to follow in a right issue:

Step 1: Calculate the theoretical ex-rights price
Step 2: Split the number of shares in the rights issue into bonus shares and full price
shares.

Original shares plus bonus shares = Original number of shares

price

Cum right

Theoretical ex right price

The resulted Original shares plus bonus shares will be a higher
number of shares as we are multiplying by a bigger figure and
a smaller
figure.
dividing
Deductby
original
number
of shares from the result of the above formula to get the bonus
shares
From above Theoretical ex-right price example:
i.
ii.

Number of rights share issued: 10,000,000/4 = 2,500,000

Amount received from rights issue: 2,500,000 X $3 = $7,500,000 iii. $7,500,000 can be
raised by issuing ($7,500,000/ $3.5) = 2,142,857 shares at full market price iv. So, we can
say, 2,142,857 shares were issued at full market price and (2,500,000 2,142,857) =
357,143 shares were bonus issue

To verify the formula in Step 2: (Original shares + Bonus shares) X TERP = Original shares X Cum right
price (10,000,000 + 357,143) X $3.4 = 10,000,000 X $3.5 $35,214,286 = $35,000,000
So, there is a mismatch of ($35,214,286 - $35,000,000) = $214,286 (0.6%) if we use above formula!
But, we still need to use formula in Step-2 to identify bonus fraction in a rights issue, as it is required by

PROBLEM!!
when there will be multiple
Step 3: Calculate current years EPS issues
- check the example below
Step 4: Calculate corresponding previous years EPS taking the bonus share effect. We can
use following formula:

Re-stated EPS of the previous year =

Original EPS of the previous year X
Holding ratio to have the bonus share(s)
Share ratio with bonus shares

Use this part of the formula only

if there is a bonus issue in the
current year.
Check the example below.

Theoretical ex right price

Cum right price

The resulted Re-stated EPS will be a

smaller figure as we are multiplying by
a smaller figure and dividing by a
greater

Basic EPS with right and bonus issue:

Fenton had 5,000,000 ordinary shares in issue on 1 January 20X1. On 31 January 20X1, the company
made a rights issue of 1 for 4 at $1.75. The cum rights price was $2 per share. On 30 June 20X1, the
company made an issue at full market price of 125,000 shares. Finally, on 30 November 20X1, the
company made a 1 for 10 bonus issue. Profit for the year was $2,900,000. The reported EPS for year
ended 31 December 20X0 was 46.4c.
Required: What was the earnings per share figure for year ended 31 December 20X1 and
the restated EPS for year ended 31 December 20X0?
Answer: (a quicker, smarter but complex way)

Diluted EPS:
Diluted EPS warns existing shareholders that the EPS may fall in future years because of
potential new ordinary shares that have been issued.

Potential ordinary shares may be issued in the following forms:

-

Convertible bonds (bonds and debentures that can be converted into ordinary shares)
Convertible preference shares (Preference shares that can be converted into ordinary shares)
Options and warrants (Option holders has right, but not obligation, to buy ordinary shares in a future
date at a predetermined price)
Contingently issuable shares (these are ordinary shares will be issued if certain conditions are met)

The diluted EPS is calculated by revising the original earnings (e.g. cancelling interest and
its tax effect in case of convertible bond) and weighted average number of shares as
though the potential ordinary shares had already been issued.

When calculating the revised weighted average number of shares, the convertible instrument (e.g.
convertible bond) is deemed to have been converted into ordinary shares at the beginning of the period
or, if later, the date of the convertible instrument issued.
Example: Diluted EPS with convertible bond
In 2010 Farrah Co had a basic EPS of 105c based on earnings of $105,000 and 100,000 ordinary $1
shares. It also had in issue $40,000 15% convertible bond which is convertible in two years time at the
rate of 4 ordinary shares for every $5 of bond. Tax is 30% of profit before tax. In 2010 gross profit of
$200,000 and expenses of $50,000 were recorded, including interest payable of $6,000. Calculate the
diluted EPS.
Solution:
$
Gross profit
200,000
Expenses
(50,000)
Add-back: Interest (40,000X15%)
6,000
Profit before tax
156,000
Tax expense (30%)
(46,800)
Earnings attributable to ordinary shareholders
109,200
Number of shares issued
100,000
Additional shares from conversation ($40,000X4/$5)
32,000
132,000
Diluted EPS = ($109,000/132,000) = $0.82.6, i.e. 82.6c
Dilution (i.e. decrease) in earnings would be (105c 82.6c) = 22.4c per share

Dilutive or antidilutive:

- Only diluted shares should be included in the diluted EPS calculation.

- Potential new ordinary shares are not dilutive if EPS would have been higher if the potential
shares had been actual shares in the period.

Example:
Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue. The total earnings in 2010 were
$1,750,000. The rate of income tax is 35%. Decide which one of the following will dilute the EPS and
will be included in diluted EPS calculation:
(a) $1,000,000 of 14% convertible loan stock, convertible in three years time at the rate of 2 shares
per $10of stock
(b) $2,000,000 of 10% convertible loan stock, convertible in one years time at the rate of 3 shares per
$5 of stock

Solution:
Basic EPS = $1,750,000/5,000,000 = 35 cents
(a) Earnings increased (i.e. interest expense saves): i X(1 t) = $1,000,000 X 0.14 (1 0.35) =
$91,000
Potential ordinary shares: ($1,000,000 X 2)/ $10 = 200,000 shares
So, incremental EPS = $91,000/200,000 = 45.5c
Incremental EPS is higher than basic EPS; so NOT diluted and do not include in the diluted EPS
calculation.
(b) Earnings increased (i.e. interest expense saves): i X(1 t) = $2,000,000 X 0.10 (1 0.35) =
$130,000
Potential ordinary shares: ($2,000,000 X 3)/ $5 = 1,200,000 shares
So, incremental EPS = $130,000/1,200,000 = 10.8c
Incremental EPS is lower than basic EPS; so diluted (i.e. weakened) and need to include in the
diluted EPS calculation.
-

Adequate to use a simple average of weekly or

monthly prices; or,
Average of closing market prices; or,
Average of high and low prices when prices fluctuate
Diluted EPS with option: widely.
Options and warrants are dilutive
when they would result in the issue of ordinary shares for
less than the average market price of ordinary shares during the period (i.e. when they
are in the money).
The shares that would be issued if the options or warrants are exercised are divided into
full priced shares and free shares. The free fraction is the dilutive.
Example:
Brand Co had net profit of $1,200,000 for the year ending 31 December 2010. Weighted
average number of ordinary shares outstanding during the year was 500,000. Average fair

value of one ordinary share during the year was $20. Brand Co issued share option of 100,000
shares with exercise price applicable of $15. Calculate both basic and diluted EPS.
Solution:
If the options are exercised, the company will raise cash of (100,000 shares X $15) =
$1,500,000. That is ($1,500,000 / $20) = 75,000 shares if issued full price. So, the company is
giving away (100,000 75,000) = 25,000 shares for free. These 25,000 shares will dilute the
basic EPS.
Basic
Dilutive effect

Number of shares
500,000
25,000
525,000

Profit after tax

$1,200,000
No effect
$1,200,000

Basic EPS in 2010 = $1,200,000 / 500,000 = $2.40

Diluted EPS in 2010 = $1,200,000 / 525,000 = $2.29
Contingently issuable shares:
These are ordinary shares issued for little or no cash when another party satisfies
performance related conditions (e.g. profit target is met) rather mere passing of time.
These shares can be a part of consideration for acquisitions or issued to senior staffs.
Such shares need to be included in the diluted EPS calculation if and only if the conditions
are met
If multiple performance related criteria exists then diluted effect exists when all
performance related criteria are met.
This should be included from the beginning of the period, or, if later, from the date of the
contingent agreement.

Employee share option

Vesting conditions:
Dilutive effect exists from:
met

Stay with the company

Grant date

Performance related
When performance criteria are

If shares are partly paid (i.e. less than shares market value is paid):
The equivalent number of fully paid shares must be established to the extent that partly
paid shares are entitled to participate in dividends during the period; and the equivalent
full number is included in the basic EPS calculation.
To the extent that partly paid shares are not entitled to participate in dividends during the
period they are treated as the equivalent of warrants or options in the calculation of diluted
EPS.

Diluted losses: when loss per share would be higher if potential shares were in issue.

Post reporting date issues:

Bonus issue, share splits and share consolidations after the year end but before the
financial statements are authorised for issue, the number of shares in the EPS calculation
is adjusted for the period just ended and prior periods presented.

Receivables factoring
(Relevant accounting standard: IFRS 9 Financial instruments, para 3.2.3-3.2.9)

Receivables factoring: Companies sometimes need cash before customers pay their account
balances. In such situations, the company may choose to sell accounts receivable to another
company that specializes in collections. This process is called factoring, and the company that
purchases accounts receivable is often called a factor.

Factoring with recourse:

The seller retains the risk of any under-collection of receivables by the factor. If the factor
fails to collect any amount of receivables then the seller reimburses that uncollected amount
to the factor.

Accounting:
i.
When the seller receives money from factor, the double entry is: DR SFP: Bank, CR SFP:
Liability
ii.
Interest charged by factor to the seller: DR I/S: Finance cost, CR SFP: Bank
iii.
Amount received by factor from Receivables: DR SFP: Liability, CR: SFP: Receivables
iv.
Any remaining receivables amount reimbursed by the seller: DR SFP: Liability, CR: SFP:
Bank

Factoring without recourse:

-

The seller transfers risk associated with collection of receivables to the factor. If the factor
fails to collect any amount of receivables, the seller does NOT reimburse that amount.

Accounting:
i.
Amount received by the seller from factor: DR SFP: Bank, CR: Receivables
ii.
Any cash commission charged by the factor: DR I/S: Finance cost, CR SFP: Bank
iii.
If factor charge commission by paying a lower amount of Receivables the seller: DR
SFP: Bank, DR I/S: Finance cost: amount under-received by seller, CR SFP: Receivables

Exercise question:

On 1 October 20X0, Jedders signed a receivables factoring agreement with a company Fab Factors.
Jedders trade receivables are to be split into three groups, as follows.
Group A receivables will not be factored or administered by Fab Factors under the agreement, but
instead will be collected as usual by Jedders.
Group B receivables are to be factored and collected by Fab Factors on a with recourse basis.

Fab Factors will charge a 1% per month finance charge on the balance outstanding at the beginning of
the month. Jedders will reimburse in full any individual balance outstanding after three months.
Group C receivables will be factored and collected by Fab Factors without recourse; Fab Factors will
pay Jedders 95% of the book value of the debtors.
Jedders has a policy of making a receivables allowance of 20% of a trade receivables balance when it
becomes three months old.
The receivables groups have been analysed as follows:

Required:
For the accounts of Jedders, calculate the finance costs and receivables allowance for each group of
trade receivables for the period 1 October 31 December 20X0 and show the financial position values
for those trade receivables as at 31 December 20X0.

Solution:
Group A: No factoring
By 31 December 20X0, 80% (30%+30%+20%) of the receivables collected by Jedders. So, Receivables
allowance of 20% to be recognised on remaining 20% receivables balance.

@ 31 October 20X0:
DR SFP: Bank
($1,250,000 X 30%)
CR SFP: Receivables
(30% of receivables collected by Jedders. So, decrease in receivables)

$375,000
$375,000

@ 30 November 20X0:
DR SFP: Bank
($1,250,000 X 30%)
CR SFP: Receivables
(Further 30% of receivables collected by Jedders. So, decrease in receivables)

$375,000
$375,000

@ 31 December 20X0:
DR SFP: Bank
($1,250,000 X 20%)
CR SFP: Receivables
(Further 20% of receivables collected by Jedders. So, decrease in receivables)
DR I/S: Expense: Increase in receivables allowance
(($1,250,000 X 20%) X 20%)
CR SFP: Receivables: Allowance for receivables
(Receivables allowance of 20% recognised on remaining 20% receivables balance.

This is provision for doubtful debts and presented as decrease in receivables in SFP.)

$250,000
$250,000

$50,000
$50,000

So, Group A receivables balance to be presented in SFP as at 31 December 20X0: (($1,250,000 $375,000 - $375,000 - $250,000) - $50,000) = $200,000.

Group B: Factoring with recourse

Risk associated with any under-collection of receivables is retained with Jedders. So, the amount
received by Jedders from Fab Factors in advance shall be treated as a loan in Jedders account.
@ 1 October 20X0:
DR SFP: Bank
$1,500,000
CR SFP: Liability
$1,500,000
($1,500,000 received from Fab Factors by Jedders; so, increase in liability)
@ 31 October 20X0:
DR I/S: Finance cost
($1,500,000 X 1%)
$15,000
CR SFP: Bank
$15,000
(Interest charged by Fab Factors on outstanding balance at month beginning)
DR SFP: Liability
($1,500,000 X 40%)
$600,000
CR SFP: Receivables
$600,000
(40% of receivables collected by Fab Factors. So, decrease in receivables and liability)
@ 30 November 20X0:
DR I/S: Finance cost
($1,500,000-$600,000) X 1%)
$9,000
CR SFP: Bank
$9,000
(Interest charged by Fab Factors on outstanding balance at month beginning)
DR SFP: Liability
($1,500,000 X 30%)
$450,000
CR SFP: Receivables
$450,000
(Further 30% of receivables collected by Fab Factors. So, decrease in receivables and liability)
@ 31 December 20X0:
DR I/S: Finance cost

($1,500,000-$600,000-$450,000) X 1%)

$4,500
CR SFP: Bank
$4,500
(Interest charged by Fab Factors on outstanding balance at month beginning)

DR SFP: Liability
($1,500,000 X 20%)
$300,000
CR SFP: Receivables
$300,000
(Further 20% of receivables collected by Fab Factors. So, decrease in receivables and liability)
DR SFP: Liability
$150,000
DR SFP: Bank
$150,000

($1,500,000-$600,000-$450,000-$300,000)

(Receivables balance uncollected by Fab Factors reimbursed by Jedders to Fab Factors.

So, decrease in liability. Now, Jedders is responsible in collecting the remaining receivables
balance, not Fab Factors.)
DR I/S: Expense: Increase in receivables allowance
(($150,000 X 20%)
$30,000
CR SFP: Receivables: Allowance for receivables
$30,000
(Receivables allowance of 20% recognised on remaining $150,000 receivables balance.
This is provision for doubtful debts and presented as decrease in receivables in SFP.)
So, Group B receivables balance to be presented in SFP as at 31 December 20X0: (($1,500,000 $600,000 - $450,000 - $300,000) - $30,000) = $120,000. And, finance cost charged in I/S: (15,000 +
$9,000 + $4,500 = $28,500.

Group B: Factoring without recourse

Risk associated with any under-collection of receivables is transferred to Fab Factors. So, receivables
balance shall be derecognised (i.e. removed from SFP) at the point of cash received from Fab Factors.
Any commission charged by Fab Factors (may be by under-payment of receivables balance to Jedders
or cash) shall be recognised as Finance cost.
@ 1 October 20X0:
DR SFP: Bank
DR I/S: Finance cost: Factors commission
CR SFP: Receivables (decrease in receivables)

($2,000,000 X 95%)
($2,000,000 X 5%)

$1,900,000
$100,000
$2,000,000

There is no need for recognising any allowance for receivables on 31 December 20X0, since all the
receivables balance derecognised on 1 October 20X0. Jedders transferred the risk of any undercollection to Fab Factors; that is, Jedders has no more right on receivables balance.
(Shortcut answer is in the book! Check Q-55-Jedders of BPP question bank.)

IAS 10 Events after reporting period

Events after the reporting period are split into:

Adjusting events: are events that provide
evidence of conditions that existed at the
reporting date, and the financial statements
should be adjusted to reflect them. Examples
include:
-

Non-adjusting events: are events that are

indicative of conditions that arose after the
reporting date. Disclosure should be made in
the financial statements where the outcome of
a nonadjusting event would influence the
economic decisions made by users of the
financial statements.

Settlement of a court case that confirms

that the entity had an obligation at the
reporting date.
Evidence that an asset was impaired at the
reporting date (e.g. bankruptcy of a
customer).
Finalisations of prices for assets sold or
purchased before year end.
The discovery of fraud or errors that show
that the financial statements are misstated
- An adjustment to the disclosed EPS (as par
IAS 33) for transactions where the number
of shares altered without an increase in
resources (e.g. bonus issue, share split or
share consolidation).

The cut-off date for the consideration of events after

financial statements are authorised for issue.

A major business combination after the

reporting date (IFRS 3 or the disposing of a
major subsidiary).
Announcement of plan to discontinue an
operation
Major purchases and disposals of assets
Classification of assets as held for sale
Destruction of assets, for example by fire or
flood
Major ordinary share transactions (unless
capitalisation or bonus issue)
Decline in market value of investments
the reporting period is the date on which the

Normally the financial statements are authorised by the directors before being issued to the
shareholders for approval.

Where a supervisory board is made up wholly of non-executive directors, the financial

statements will first be authorised by the executive directors for issue to that supervisory

board for its approval. The relevant cut-off date is the date on which the financial statements
are authorised for issue to the supervisory board.
-

The date on which the financial statements were authorised for issue should be disclosed.

If a significant event occurs after the authorisation of the financial statements but before the
annual report is published, then the entity is not required to apply the requirements of IAS 10.
However, if the event was so material that it affects the entitys business and operations in
the future, the entity may wish to discuss the event in the narrative section at the front of the
Annual Review but outside of the financial statements themselves.

Equity dividend (i.e. dividend to ordinary and irredeemable non-cumulative preference shares)
should only be recognised as a liability where they have been declared before the reporting date,
as this is the date on which the entity has an obligation.
Where equity dividends are declared after the reporting date, this fact should be disclosed but
no liability recognised at the reporting date.

Where the going-concern basis is clearly not appropriate, break-up basis should be
adopted.
The break-up measures the assets at their recoverable amount in a non trading environment,
and a provision is recognised for future costs that will be incurred to break-up the business.

Important definitions

Asset:
A resource controlled by an entity as a result of past events and from which future economic
benefits are expected to flow to the entity. [Conceptual Framework: 4.4a]

Liability:
A present obligation of the entity arising from past events, the settlement of which is expected to
result in an outflow from the entity of resources embodying economic benefits. [Conceptual
Framework: 4.4b]

Equity:
The residual interest in the assets of the entity after deducting all its liabilities. [Conceptual
Framework: 4.4c]

Income:
Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decrease of liabilities that result in increases in equity, other than those
relating to contributions from equity participants. [Conceptual Framework: 4.25a]

Expenses:
Decrease in economic benefits during the accounting period in the form of outflow or depletions of
assets or incurrences of liabilities that result in decrease in equity, other than those relating to
distributions to equity participants. [Conceptual Framework: 4.25b]

Liquidity:
The availability of sufficient funds to meet deposit withdrawals and other short-term financial
commitments as they fall due.

Solvency:
The availability of cash over the longer term to meet financial commitments as they fall due.

Underlying assumptions in preparing financial statements:

Accruals basis: The effects of transactions and other events are recognised when they occur
(and not as cash or its equivalent is received or paid) and they are recorded in the accounting

records and reported in the financial statements of the periods to which they relate.
[Conceptual Framework: OB17]
-

Going concern: The entity is normally viewed as a going concern, that is, as continuing in
operation for the foreseeable future. It is assumed that the entity has neither the intention nor
the necessity of liquidation or of curtailing materially the scale of its operations. [Conceptual
Framework: 4.1]

Materiality:
Information is material if its omissions or misstatements could influence the economic decisions of
users taken on the basis of the financial statements. [Conceptual Framework: QC11]

Substance over form:

The principle that transactions and other events are accounted for and presented in accordance
with their substance and economic reality and not merely their legal form.

Qualitative characteristics:
The attributes which make the information provided in financial statements useful to the users.
[Conceptual Framework: QC19]
Comparability
- Timeliness (Relevance)
Verifiability (Reliability)
Understandability