FAC2602 - Generally Accepted Accounting Stds Valuation of Financial Instruments

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Assignment 1 is compulsory and due 5th March 2010 – study topic A (study units 1 to 5)
- counts 5% towards final module mark of 10%
Assignment 2 is compulsory and due 1st April 2010 – study topics A (study units 1 to 9) & B (study
unit 1)
- counts 5% towards final module mark of 10%
Assignment 3 is NOT compulsory and doesn't count towards final mark (study topics A to F)
Exam = 2 hours.
GENERALLY ACCEPTED ACCOUNTING STANDARDS

& THE VALUATION OF FINANCIAL INSTRUMENTS
TOPIC A - STUDY UNIT 1

PROVISIONS OF THE COMPANIES ACT, 1973 (COMPANIES IN GROUP CONTEXT)
Study guide pg 4
Business combination defined as bringing together of separate entities into one reporting entity – regulated by IFRS 3
Business combinations.
Parent company holds more then half of the issued equity share capital and more then half of the voting rights of the
subsidiary.
When parent linked with subsidiary to form larger economic unit then entity is a group.
Simple groups – only one subsidiary
Complex groups – more then one subsidiary
Business combination – transaction or other event in which acquirer obtains control of one or more business
Parent – member of the subsidiary and holds majority of the voting rights in the subsidiary and has the right to control
the composition of the board of directors of the subsidiary
Subsidiary – entity which is controlled by another entity (parent entity)
Sub-subsidiary – subsidiary of a subsidiary.
Companies Act says that equity shares are issued shares which don’t have any rights (except dividends or capital) to
participate beyond a specified amount in a distribution – so NOT preference shares.
Therefore parent can only obtain control over a subsidiary if the parent holds a majority of the equity shares (ordinary
shares) of the subsidiary – so even if owns 80% of the preferential shares of another company is not parent.
Although parent shows the investments in subsidiaries on the Statement of Financial Position, doesn’t account for any
increase in the value of the investment and so no accurate reflection on the activities of the group. Parent company
must draw up single set of financials for the group so shareholders have idea of the earnings per share and the assets
and liabilities of the group. Called consolidated statements or group statements and are combination of all the
statements of the companies in the group. The investment in the parent’s statements is replaced by the assets and
liabilities of the subsidiary which represents these investments in the consolidated statements.
Companies Act says that company that is not a wholly owned subsidiary of another company must submit group
financials to the AGM at the end of the financial year. Should be presented as consolidated annual financials unless
director’s of the parent think that the required information could be more effectively and meaningfully shown in an
alternative form.
Group financials don’t need to deal with subsidiary if directors think that :
 would be impractical or of no real use to members (if sums were insignificant) or the cost of delay would be out
of proportion to the usefulness of members
Need  results would be misleading or prejudicial to the affairs of the parent or other subsidiaries
Registrar’s
permission
 operations of the parent and subsidiary are so different that they could not reasonably be treated as a singe
enterprise
Group annual financials aren’t required when the parent is also a wholly-owned subsidiary of another company.
General provisions of the Companies Act :

 group statements should be fair reflection of the state of affairs of the parent and its subsidiaries as at the
accounting date
 profits / losses that have arisen as a result of transactions in the group must be eliminated if they have not been
realised outside the group
 all intercompany balances must be eliminated by determining total assets and liabilities of the group
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 dividends declared by subsidiary out of pre-acquisition profits don’t form part of the parent’s profits that are available
for distribution
 elimination of the carrying amount of the parent’s investment in the subsidiary
 provisions of the Companies Act must be complied with.
STUDY UNIT 2
CONSOLIDATION OF WHOLLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION
Study guide pg 10
Parent company and subsidiary company draft their financials and then these individual statements are adjusted with
consolidation adjustments and then the consolidated statements are compiled.
Basic consolidation techniques :
 elimination of common items
 elimination of intercompany items
 consolidation of remaining items
Elimination of common items

Need to eliminate the investment in the parent’s books and the shareholder’s equity section in the subsidiary books as
at the date when the investment was made by :
dr share capital of subsidiary out of parent’s books and cr investment in subsidiary
see examples pgs 12/3 of study guide
Share capital in the consolidated Statement of Financial Position is always only the parent’s share capital.
Profits made by the subsidiary after the date of acquisition become part of the retained earnings of the group and are
shown as retained earnings in the consolidated statements.
Profits made by the subsidiary before the date of acquisition cannot form part of the retained earnings of the group – the
parent pays for the profits
If the parent obtained its interest in the subsidiary at the date of incorporation then there can't be any retained earnings
in the books of the subsidiary.
Elimination of intercompany items

Companies in the same group often sell inventories or assets to each other, but the only actual profit made by the group
will be from the sales to the public as all other sales are within the group. These intercompany sales have to be
eliminated during consolidation. Also eliminate any loans or lent assets to subsidiaries.
Consolidation of remaining items

Once all common items and intercompany items have been eliminated will draw up :
 consolidated Statement of Financial Position
 consolidated Statement of Comprehensive Income
 consolidated Statement of Changes in Equity
 consolidated statement of cash flows
If parent obtains an interest in a subsidiary then either price paid by the parent for the interest / investment in the
subsidiary is :
 equivalent to the value of the net assets acquire – called acquisition at net asset value.
see example pgs 15/6 of study guide
 higher then the net asset value – called acquisition at a premium (treated as goodwill and recognised as an asset
at cost. Must not be amortised, but is subjected to impairment test at least once a year.
 lower then the net asset value – called acquisition of a subsidiary at a discount or negative goodwill and if the
fair value of identifiable assets and liabilities exceeds the cost of the business combination then must :
 reassess the identity and measurement of these items
 recognise in profit or loss any excess after reassessment
negative goodwill can arise from errors in measuring fair values of identifiable items
see question 1 & 2 on pgs 19 to 22 of study guide
STUDY UNIT 3
CONSOLIDATION OF PARTLY-OWNED SUBSIDIARY AT DATE OF ACQUISITION
Study guide pg 23
Sometime parent doesn’t take up all the shares in the subsidiary and then the other shareholders are known as non-
controlling shareholders or outside shareholders. Can be either ordinary or preference shareholders.
Before doing the consolidation we have to make provision for the non-controlling shareholder’s interest in the profit of
the subsidiary.
Remember that if shares are valued over R1 per share then have to work out how many shares were issued before
calculating the parent’s interest in the subsidiary.
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see pgs 27 to 30 of study guide for examples of partly-owned subsidiaries consolidated financials
see question 1 & 2 on pgs 31 to 36 of study guide
Note :
 Companies Act says cannot offset cr and dr bank balances during consolidation, so have to show overdraft and
favourable balances separately, UNLESS company with favourable balance has guaranteed the overdrawn account
and they are both at the same bank.
 debentures are treated as intercompany item and must be journalled as such (along with loans)
 revaluation reserve / revaluation of land & buildings held in subsidiary books must be proportioned by the
percentage interest to the parent and non-controlling interest shareholders and not shown in the Balance Sheet.
STUDY UNIT 4
CONSOLIDATION OF WHOLLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION
Study guide pg 37
Any equity (share capital and reserves) of a subsidiary that stands at the acquisition of the subsidiary is eliminated
against the investment in the subsidiary in the consolidated financials, and doesn’t form part of the shareholder’s equity
of the group.
But any profits made after the date of acquisition become profits for the group and are included in the consolidated
statements. All reserves (distributable and non-distributable) of the subsidiary that were formed after the date of
acquisition form part of the total reserves of the group.
Dividends from pre-acquisition profits

All post-acquisition profits form part of the total reserves of the group, but if the subsidiary pays a dividend from pre-
acquisition profit then the payment of the dividend is capital receipt by the parent.
The distributable reserves existed at the date of acquisition and form part of the total shareholder’s equity of the
subsidiary which was paid for by the parent when it bought the shares of the subsidiary.
So when a dividend is declared from distributable reserves that existed at the date of acquisition, then is just a refunding
of a portion of the purchase price.
Consolidation of wholly-owned subsidiary after date of acquisition

Still follow the same procedure of eliminating the common and intercompany items and then consolidating the remaining
items, but now have to divide the analysis of shareholder’s equity into different periods (at acquisition, since acquisition
to the beginning of the current year and then the actual current year).
see examples pgs 41 to 47 of study guide
Note :
 when drawing up consolidate Statement of Changes in Equity for the year the opening balance won’t include the
subsidiary’s balance if it hadn’t been bought by then.
 do journal entry first to eliminate loans, intercompany etc and then draw up Statement of Comprehensive Income to
get the total comprehensive income for the year and then use that figure in the consolidated Statement of Changes
in Equity for the year. Then draw up the consolidated Statement of Financial Position.
see exercises pgs 48 to 58 of study guide

Note :
 must divide the shareholder’s equity into 3 parts so that can get the opening balance for the Statement of Changes
in Equity
 when asked only for a consolidated Statement of Financial Position then don’t have to do consolidated Statement of
Comprehensive Income and consolidated Statement of Changes in Equity, so will combine the “since acquisition”
and “current year” sections of the analysis of shareholder’s equity to deduct all the expenses, tax paid & dividends
paid to get a total for retained earnings for the subsidiary
STUDY UNIT 5
CONSOLIDATION OF PARTLY-OWNED SUBSIDIARY AFTER DATE OF ACQUISITION
Study guide pg 59
Have to make provision for the non-controlling interest in the profit.
Profit attributable to non-controlling shareholders is shown separately in the consolidated Statement of Comprehensive
Income and the consolidated Statement of Changes in Equity.
see example pgs 60 to 63 of study guide
Intercompany transactions
If there has been a transaction within the group (purchase or sale between the subsidiary and the parent) then have to
exclude that profit when determining the total group profit (cos in consolidated statements it would be the same
company).
If subsidiary sells part of their inventory to a person outside the group then that profit is realised.
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If the parent sells inventories to a subsidiary at a profit and the inventory is still in the possession of the subsidiary at the
end of the year – then the profit hasn’t been realised, and the inventory will be shown at the original amount for which
the inventories were manufactured or purchased by a member of the group in the consolidated Statement of Financial
Position.
see exercises pgs 64 to 72 of study guide (go through question 3 – different format!)
STUDY UNIT 6
ACQUISITION OF AN INTEREST IN A SUBSIDIARY DURING THE YEAR
Study guide pg 73
Interim acquisition of a subsidiary – purchase of an interest in a subsidiary at a date other then the accounting date.
Need to allocate the Statement of Comprehensive Income items so that can determine the amount of retained earnings
at the effective date and then the goodwill at date of acquisition.
Apportioning items in the Statement of Comprehensive Income

If it is not practicable to apportion the profit or loss for any financial year then it can be treated as if it accrued from day
to day during the year and be apportioned like that.
Income and expense have to be examined individually to decide how to apportion each item (between the period before
acquisition and the period since acquisition.)
Apportioning items in the Statement of Changes in Equity

Any preference dividends from issued preference shares of the subsidiary have to be accounted for on a time basis
(has to be accounted for even if it hasn’t been declared).
Ordinary dividends declared are year-end items and so fall into the after-acquisition period.
When preparing the consolidated Statement of Comprehensive Income and changes in equity then need to :
 apportion the income and expenditure of the current year between pre and post acquisition periods
 draw up the 2 consolidated statements by including only the post-acquisition profits in the operating profit.
Date of acquisition
The effective date of acquisition is when control of the net assets and operations of the subsidiary is transferred to the
parent (and date when the results of the subsidiary will be include in the group annual financial statements).
Can be date :
 when substantial agreement is reached
 when control over the assets and activities of the subsidiary is transferred to parent
 of signing of the agreement
 date specified in the agreement
 date of payment of the purchase price.
see exercise pgs 83 to 88 of study guide
STUDY UNIT 7
ELIMINATION OF INTERCOMPANY TRANSACTIONS
Study guide pg 91
Intercompany transactions have to be eliminated for consolidation purposes, such as :
 bills of exchange
 discounting of bills of exchange
 property, plant and equipment
 trading inventories
Intercompany bills of exchange

Bill of exchange = negotiable document (written instruction directed to one person to instruct another person to pay
upon demand a certain some of money to the person name in the bill of exchange.)
H Ltd will should it as a bill payable

S Ltd will show it as bill receivable
When consolidating the subsidiary’s bill receivable will be off-set against the bill payable in the parent’s books
Or bill could have been converted to cash before the due date of 30/11/1998 by S Ltd selling it to a financial institution -
called discounting.
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Intercompany bank overdrafts
Overdraft of one company in the group can only be off-set against favourable bank balance of another company when
consolidating the accounts if :
 both companies have their accounts at the same bank and
 the company with the favourable balance has guaranteed the overdraft of the other company or
 the bank itself would off-set the two amounts against each other in terms of an agreement between the two
companies and the bank.
Revaluation of property, plant and equipment

Assets of the subsidiary can be revalued at the date of acquisition if there is a difference between the carrying amounts
and market values of the assets.
Can either be :
 subsidiary’s assets are revalued only for the purposes of determining the purchase price but no journal is done in
the subsidiary’s books or
 subsidiary’s assets are revalued in determine the purchase price and then an adjustment is made in the subsidiary’s
books.
Unrealised profit in trading inventories

Any profit or losses that didn’t take place with a company or person outside the group MUST be eliminated.
H Ltd sells to S Ltd @ cost price of R 1000 plus 20% profit and then sells to X Ltd at R 1 500
(parent) (subsidiary) (external company)
So then following applies :
 if all inventory is sold to X Ltd at the end of the year then there are no adjustments to the consolidated financials
 if none of the inventory has been sold to X Ltd, then the full unrealised profit of R 200 must be eliminated in H
Ltd’s books and the inventory on S Ltd’s books must be adjusted
 if only half the inventory has been sold then just R 100 must be eliminated and S Ltd’s inventory adjusted
If parent company selling to subsidiary company then the profit is with the parent and so there is no need to make any
adjustment to the non-controlling shareholders of the subsidiary company.
If the subsidiary is selling to the parent and so the profit is made by the subsidiary then the non-controlling shareholder’s
interest must be adjusted by their percentage in the profit or loss (made in the analysis of shareholder’s equity).
see example of parent selling inventories to subsidiary pgs 97 to 99 of study guide
Note :
 if sales and costs of sales figures are not given in the question then need to make the adjustments in profit before
tax section of Statement of Comprehensive Income
 so if profit is for the parent then there are no adjustments in the analysis of shareholder’s equity, but only in the
Statement of Comprehensive Income.
see example of subsidiary selling inventory to parent pgs 100 to 103 of study guide
Note :
 as subsidiary has sold the inventories need to make an adjustment for the unrealised profit in the analysis of
shareholder’s equity
 to ensure that the analysis of shareholder’s equity balances can total up the at acquisition amount, since acquisition
amount and non-controlling interest amount to ensure balances to the total column and if calculations are correct
then take that total and multiply by the percentage the that non-controlling interest controls and that will give you a
total that should be equal to your non-controlling interest total in the end column.
Property, plant and equipment held by companies in the group

If one company sells an asset to another company in the group then any profit made must be eliminated and the
depreciation in the books of the company that bought the asset will be too high as the cost price of the asset in those
books will include the profit, so have to write back that portion of the asset when doing the consolidated financials.
The unrealised profit on assets will also be realised by the sale of the asset to an outsider as well as through
depreciation (annual depreciation includes a portion of the unrealised profit which is realised through the use of the
asset.)
see example of parent selling non-depreciable assets to the subsidiary pgs 105 to 108 of study guide
see example of subsidiary selling non-depreciable asset to the parent pgs 108 to 111 of study guide
see example of parent selling depreciable asset to subsidiary pgs 111 to 115 of study guide
see example of subsidiary selling depreciable asset to parent pgs 116 to 119 of study guide

Very important comprehensive examples!
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STUDY UNIT 8
DIVIDENDS DURING CONSOLIDATION

Study guide pg 130
Dividends that are paid or declared in the consolidated statement of changed in equity can only be dividends payable to
the shareholders of the parent so all dividends paid or declared by the subsidiary MUST be eliminated as part of the
intercompany transactions.
The non-controlling shareholders share in the subsidiary’s profit before the payment of dividends (so if a dividend is paid
by a subsidiary then it means that the non-controlling shareholders have realised part of their interest in the profit in the
form of a dividend, and there is a reduction in the balance of the non-controlling interest in the consolidated Statement
of Financial Position).
see example of no dividends paid or declared by the subsidiary pgs 131 to 134 of study guide
see example of dividends paid by the subsidiary pgs 135 to 138 of study guide
see example of parent made provision for dividend declared by subsidiary pgs 138 to 141 of study guide
see example of no provision for dividend by the parent pgs 142 to 145 of study guide
see example of no provision for dividend by subsidiary pgs 146 to 149 of study guide
Dividends distributed by subsidiary from pre-acquisition or post-acquisition profits

Allocation method used by the subsidiary to declare the dividends doesn’t make any difference to the consolidated
annual financial statements (either FIFO or LIFO), but if subsidiary doesn’t have enough post-acquisition profits when
the dividend is declared then the parent should treat it as a capital receipt and reduce the cost of investment.
(see section 4.2 of study unit 4)
STUDY UNIT 9
PREFERENCE SHARES DURING CONSOLIDATION

Study guide pg 159
Preference shares bear a fixed dividend percentage and also a preferential right to dividends if there are sufficient
profits available.
Cumulative preference shares accumulate if they are not paid out annually (so fixed preferential dividend
accumulates) and company must pay arrears as soon as there are sufficient funds.
Participating preference shares share in the profits of the company after the payment of the preference dividend.
Convertible preference shares are converted to ordinary shares at a specific date in the future.
Redeemable preference shares are bought back by they company after a specific period at a predetermined price.
Preference shares of a subsidiary form part of the subsidiary’s shareholder’s equity but they only participate in the profit
or capital up to a fixed amount.
e.g. if is 12% preference share of R 2 000 then will receive dividend of R 240 (R 2 000 x 12%) per annum. If subsidiary
is liquidated then preference shareholder will received maximum of R 2 000.
Preference shares in a subsidiary effects the calculation of the non-controlling interest in the consolidated Statement of
Comprehensive Income and Statement of Financial Position.
Consolidation procedure if subsidiary’s capital includes preference shares

Need to draw up two separate analyses of shareholder’s equities (ordinary share capital and preference share capital)
cos the parent’s percentage interest in the ordinary share capital of the subsidiary is not always the same as it’s
percentage in the preference share capital.
Note :
 if parent pays more for the investment in the subsidiary’s preference shares then the par value of the shares then
this is “goodwill”
Treatment of preference dividends of subsidiary

Can either be :
 preference dividends outstanding at the accounting date – so the subsidiary has declared the dividend but it is
to be paid out at a later date. Only effect on the consolidation statements is that the non-controlling interest has to
be raised by the portion of the dividend or profit which shareholder’s haven’t yet received
 accumulated preference dividends at acquisition of subsidiary – so amount in respect of accumulated
preference dividends is included in the calculation of the purchase price of the preference share investment and
payment is made for the preference share dividend that will be declared later in the year (so when dividend is
declared the investment will reduced by that amount)
 arrear preference dividends – if cumulative preference shares then necessary to make provision for any arrear
preference dividends that must be paid before an ordinary dividend can be paid.
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see example of preference dividend outstanding at accounting date pgs 167 to 170 of study guide
see example of accrued preference dividend on acquisition of subsidiary pgs 171 to 173 of study guide
see example of accrued preference dividend on acquisition of subsidiary (still in arrears) pgs 174 to 179
see example of arrear dividend on acquisition (since paid) pgs 180 to 185 of study guide
Allocation of Statement of Comprehensive Income items :
Date of prev yr-end Acquisition date

Total to acquisition date to year-end date
R R R
Sales XXXXXX
Cost of sales (XXXXX)
Gross profit XXXXXX
Administrative expenses (XXX)
Depreciation (XXX)
Profit from operations XXXXXX
Finance costs (XXX)
Income on investment XXX
Profit before tax XXXXXX
Income tax (XXXX)
Profit for the year XXXX
Analysis of shareholder's equity of …..
Non-
….. 75% controlling
@ since interest at
Total acquisition acquisition 25%
R R R R
@ acquisition
Share capital XXXXX XXXXX XXXXX
Retained earnings
(date of prev yr-end) XXXXX XXXXX XXXXX
Retained earnings
(as calculated to date of acquisition) XXXXX XXXXX XXXXX
Investment in …… XXXXX
Goodwill XXX
Current year
Profit for the year XXXXX XXXXX XXXXX
Dividends (XXX) (XXX) (XXX)
XXXXX XXXXX XXXXX
Non-
Journals controlling
Dr Cr Interest
Share capital XXXX
Retained earnings XXXX
Goodwill XXXX
Investment in ……. XXXXX
Non-controlling interest XXXXX XXXXX
(elimination of shareholder's equity of ….. at acquisition)
Dr Cr Non-
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controlling
Interest
Non-controlling interest (SCI) XXXXX

Non-controlling interest (SFP) XXXXX XXXXX
(recording of non-controlling interest in profit after tax)
Dividends received …….. XXXXX

Non-controlling interest (SFP) XXXXX
Dividends paid ……. XXXXX XXXXX
(elimination of intercompany dividend and recording of
non-controlling interest in dividend)
Cost of sales - subsidiary XXXXX

Inventories - parent XXXXX
(elimination of unrealised profit on closing inventory)
Profit on sale of property - parent XXXXX

Property - subsidiary XXXXX
(elimination of unrealised profit in parent's property)
Bank - subsidiary (cash in transit) XXXXX

Loan parent to subsidiary XXXXX
(recording of cash in transit from parent to subsidiary)
Loan - subsidiary to parent XXXXX

Loan - parent from subsidiary XXXXX
(elimination of intercompany loan accounts)
Share capital - preference shares XXXXX

Retained earnings XXXXX
Goodwill XXXXX
Investment in subsidiary XXXXX
(elimination of shareholder's equity of subsidiary at
acquisition - preference shares)
Retained earnings - preference shares XXXXX

(recording of non-controlling interest in preference
dividends)
Dividends received - parent XXXXX

Non-controlling interest (SFP) XXXXX (XXXXX)
Ordinary dividends paid - subsidiary XXXXX
(elimination of intercompany dividends & recording
of non-controlling interest in ordinary dividends)
Debentures - parent XXXXX

Debentures - subsidiary XXXXX
(elimination of intercompany debentures)
Interest on debentures received - parent XXXXX

Interest on debentures paid - subsidiary XXXXX
(elimination of intercompany interest on debentures)
XXXXX
…….. AND ITS SUBSIDIARY

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Consolidated Statement of Changes in Equity for the year ended …..
Attributable to owners of the parent Non-
Share Preference Retained controlling Total
Capital Share Cap Earnings Total Interest Equity
R R R R R R
Balance at …… (previous year-end) XXXXX XXXX XXXXX XXXXX XXXXX
Equity at date of acquisition XXXXX XXXXX
Total comprehensive income for the
year XXXXX XXXXX XXXX XXXXX
Dividends declared (XXX) (XXX) XXXXX
Dividends paid (XXX) (XXX) (XXXX) XXXXX
Balance at …… (this year-end) XXXXX XXXXX XXXXX XXXXX XXXXX XXXXX

Consolidated Statement of Comprehensive Income for the year ended …..
Notes R
Revenue XXXXXXXXX
Cost of Sales (XXXXXXX)
Gross profit XXXXXXX
Other income XXXX
Other expenses (XXXXXX)
Finance charges (XXXXX)
Profit before tax 1 XXXXXX
Income tax expense (XXXXX)
Profit for the year XXXXXXX
Other comprehensive income
Total comprehensive income for the year XXXXXXX
Profit attributable to :
Owners of the parent XXXXXXX
Non-controlling interest XXXXX
XXXXXXX
Total comprehensive income attributable to :
Owners of the parent XXXXXXX
XXXXXXX

Consolidated Statement of Financial Position for the year ended …..
R
ASSETS
Non-current assets XXXXXX
Plant, property & Equipment XXXXXX
Goodwill XXXX
Investment XXXXX
Current assets XXXXXX

Trade & other receivables XXXXXX
Cash and cash equivalents XXXX
TOTAL ASSETS XXXXXXX

Consolidated Statement of Financial Position for the year ended …..
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R
EQUITY AND LIABILITIES
Total equity XXXXXX
Equity attributable to owners of the parent XXXXXX
Share capital XXXX
Retained earnings XXXXX
Total liabilities XXXXXX
Non-current liabilities XXXXXX

Debentures XXXX
Long-term loan XXXXX
Current liabilities XXXXXX

Trade & other receivables XXXX
Dividends payable XXXXX
Bank overdraft XXXXX
TOTAL EQUITY AND LIABILITIES XXXXXXX
TOPIC B
STATEMENT OF CASH FLOWS
Study guide pg 208
Statements of Generally Accepted Accounting Practice are being formulated by SAICA and will be approved by the
Accounting Practices Board
Companies Act 61 of 1973 says that company’s annual financials have to be drawn up in accordance with GAAP and
with specific requirements of schedule 4
When compiling statement of cash flows then any transactions that have nothing to do with cash flow are omitted.
Aim is to furnish information to the various users of financials regarding the cash flow from operations, investments and
financing.
Normally presented as net cash flow :
 from operating activities :
 cash receipts from customers
 cash paid to suppliers and employees
 investment income
 interest paid
 tax paid
 dividends paid
 from investing activities
 from financing activities
 net change in cash and cash equivalents
Elements of cash flow :

 operating activities – amount of cash arising from operating activities is key indicator of whether the entity has
generated sufficient cash to repay loans, maintain the operating capability of the entity, pay dividends and make
new investments without needing external financing.
Cash flows from operating activities are derived from main revenue producing activities of the entity and so come
from transactions that are used to determine profit or loss, such as :
 cash receipts from sale of goods and rendering services
 cash payments to suppliers for good and services
 cash payments to and on behalf of employees
 cash payments and refunds of income taxes
 investing activities – disclosure is important as the cash flows represent the extent to which payments have been
made for resources intended to generate future receipts and cash flows, such as :
 cash payments to acquire property, plant and equipment and other non-current assets
 cash receipts from sales of property, plant and equipment and other non-current assets
 financing activities – important as useful in predicting claims on future cash flows by providers of capital to the
entity, such as :
 cash proceeds form issuing shares
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 cash payments to owners to acquire or redeems entity’s shares
 cash proceeds from issuing debentures, loans, mortgage bonds and current or non-current borrowings
 cash repayments of amounts borrowed
Can report cash flow by either direct or indirect method :
 direct – principal categories of gross cash proceeds and gross cash payments are disclosed
 indirect method – profit or loss is adjusted for the effect of non-cash transactions and any deferrals or accruals of
previous or future operating cash receipts or payments and income or expenditure items that are related to
investment or financing cash flow.
Only difference is the presentation of the cash flow from operating activities – investing activities and financing activities
sections are the same no matter which method is used.
Schematic representation of Cash FLOW from operating activities

Statement of Cash Flows : minus
Cash APPLIED in investing activities

plus / minus
Cash INFLOW / OUTFLOW from financing activities
is represented by or is equal to
Net increase / decrease in CASH and CASH EQUIVALENTS
INDIRECT METHOD :
No calculation for cash from customers and cash payments to suppliers and employees – must calculate cash
generated by operations by adjusting profit or loss for all non-cash transactions, deferrals or accruals of
previous or future operation cash receipts or payments and income or expenditure items which are related to
investments or financed cash flow.
R
Cash flow from operating activities
Profit before tax XXX
Adjustments for :
Depreciation XXX
Loss on sale of non-current assets XXX
Profit on sale of non-current assets (XXX)
Investment income (XXX)
Interest expense XXX
Operating profit before changes in working capital XXX
Changes in working capital XXX
Decrease /(increase) in inventory
XXX
(previous year less current year) = negative or positive amount
XXX
Decrease / (increase) in trade and other receivables
(XXX)
Decrease / (increase) in trade and other payables

Cash generated by operations XXX
Interest received XX
Interest paid (XX)

Dividends received XXX
Dividends paid (XXX)
Unpaid amount at beginning of the year (previous yrs balance)
Amount debited against income (total dividends declared for current year)
less : Unpaid amount at end of year (current year dividends payable)
Normal tax paid (XXX)
Amount debited against income (provision for income tax current year)
less : Unpaid amount at end of year (current year tax payable)
Net cash inflow from operating activities XXX
DIRECT METHOD :
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Cash receipts from customers XXX
Must reconstruct : trade and other receivables account :
Balance b/d (prev yr trade & other receive) Bank (balancing fig to be used)
Sales (sales figure for the current yr) Balance c/d (current yr trade & other receive)
Cash paid to suppliers and employees (XX)
Must compare the figures given for inventory and trade and other payables from one year to another :
 if inventory has increased from previous to current year then cash flow is negative cash flow
 if trade and other payables has increased from previous to current year then less cash flowed out
and it is positive cash flow
Must also include all inventory and expenses paid in cash like this :
cash paid to suppliers and employees
Balances : Balance :
Inventory b/d (prev yr inventory) Trade & other payables b/d (prev yr trade & other pay)
Prepaid expenses b/d Cost of sales
(prev yr prepaid exps) (cos figure for current yr)
Trade & payables c/d Admin expenses
(current yr trade & other pay) (current yr admin exps)
Selling expenses (current yr selling exps)
Bank (balancing fig to be used) Balances :
Inventory c/d (current yr inventory)
Prepaid expenses c/d (current yr prepaid exps)
Net cash generated by operations XXX
Subtract the cash paid to suppliers and employees from the cash receipts from customers
Current year’s interest received less previous years interest received
Interest paid (XX)
Amount debited against income (total dividends declared for current year)
less : Unpaid amount at end of year (current year dividends payable)
Amount debited against income (provision for income tax current year)
less : Unpaid amount at end of year (current year tax payable)
Note :
 amounts not in brackets are an INFLOW of cash and amounts in brackets are OUTFLOW of cash
 depreciation is not a cash flow (so not included!)
DIRECT & INDIRECT METHOD :

Cash flow from investing activities
Investment to maintain production capacity (XXX)
Replacement of non-current assets (land, vehicles etc) XXX .
Investment to expand production capacity (XXX)

Additions to non-current assets (property) XXX .
Proceeds from the sale of non-current assets XXX

Sale of asset less the accumulated depreciation
Net cash outflow from investing activities XXX
Outflow of cash is purchase of assets and investments and inflow of cash includes proceeds from sale
of non-current assets, such as :
Assets purchased :
 if increase in balance of accumulated depreciation equals the depreciation in income statement,
then no assets were sold or written off during the year and so any increase in the asset accounts
(@ cost price) will be purchases of a new asset.
Revaluation of property :
 increase in value of property as result of revaluation is ignored as is not cash flow
 increase in non-distributable reserve represents the increase in the value of property.
If depreciation is included in administration expenses then it must be ignored (NOT cash flow)
13
Purchase and sale of assets – must reconstruct the ledger accounts :
Land and buildings
Balance b/d (prev yr asset value) Proceeds on sale of property (current yr figure)
Revaluation (inc in bal of surplus on revaluation account) Balance c/d (current yr asset value)
Replacement (balancing fig to be used)
Motor Vehicles (@ cost)

Balance b/d (prev yr vehicle value) Cost of trade-in (current yr figure)
Replacement (given amount) Balance c/d (current yr vehicle value)
Addition (balancing fig to be used)
Accumulated Depreciation - Motor Vehicles

Sales (balancing fig to be used) Balance b/d (prev yr vehicle value)
Balance c/d (current yr vehicle value) Depreciation (current yr dep)
Machinery (@ cost)
Balance b/d (prev yr machinery value) Sales (current yr figure)
Addition (balancing fig to be used) Balance c/d (current yr machinery value)
Accumulated Depreciation - Machinery

Sales (balancing fig to be used) Balance b/d (prev yr acc dep value)
Balance c/d (current mach acc dep value) Depreciation (current yr dep)
Realisation account
Cost price of trade-in (given amount) Acc Deprec on trade-in (given amount)
Profit on trade-in (given amount) Proceeds (given amount)
acc balance acc balance
DIRECT & INDIRECT METHOD :

Entity must report separately on all main classes of gross cash receipts and gross cash payment that result
from financing activities.
New loans, redemption of existing loans and the issue of shares derived from Statement of Financial Position –
must just calculate the change between current year and previous year.
Then must reconcile
Share premium account :
Share issue expenses written off (given value) Balance b/d (current yr figure)
Balance c/d (current yr value) Replacement (balancing fig to be used)
Cash flow from financing activities

Proceeds from the issue of shares XXX
Any increase in ordinary share capital from previous year to current year
Proceeds from long-term loans XXX
Repayment of any loans (last year balance less current balance)
Redemption of redeemable preference shares (XXX)
Net cash inflow from financing activities XXX
Net increase in cash and cash equivalents XXX
Use the figures from above net cash inflow from operating, investing & financing activities
Cash and cash equivalents at beginning of period XXX
Any cash in bank from previous year
Cash and cash equivalents at end of period XXX
Difference between these two – if only given the bank amount for the current year then that is the
amount “at end of period” and the balancing amount will be the amount “at beginning of period”
DIRECT METHOD :
14
R
Cash receipts from customers XXX
Cash paid to suppliers and employees (XX)
Net cash generated by operations XXX
Interest paid (XX)

Replacement of non-current assets XXX .

Additions to non-current assets XXX .


Proceeds form long-term loans XXX
INDIRECT METHOD :
R
Profit before tax XXX
Adjustments for :
Depreciation XXX
Loss on sale of non-current assets XXX
Profit on sale of non-current assets (XXX)
Investment income (XXX)
Interest expense XXX
Operating profit before changes in working capital XXX
Changes in working capital XXX
Decrease /(increase) in inventory XXX

Decrease / (increase) in trade and other receivables XXX
Decrease / (increase) in trade and other payables (XX)
Cash generated by operations XXX
Interest paid (XX)

Replacement of non-current assets XXX .

Additions to non-current assets XXX .

15
Proceeds form long-term loans XXX
TOPIC C
EARNINGS PER SHARE
Study guide pg 236
Earnings per share and dividends per share very widely used ratios by investors to evaluate the profitability of a
company.
Must therefore have guidelines for the calculation and disclosure of earnings and dividends per share as well as fully
diluted earnings per share so can compare the ratios.
IAS 33/AC is applicable to :

 companies listed on the JSE
 companies whose shares are openly traded (unlisted public companies)
 any other company that prefers to disclose earnings and dividends per share (e.g. private company).
Equity shares = company’s issued share capital and shares, excluding any shares that have no voting or other rights
apart from right to dividends or capital (so preference shares that don’t share in asset surplus or dividends except for
their fixed preference right are NOT equity share capital)
Ordinary share = equity instrument that is lowest of all other classes of equity instruments. Only participate in the profit
after other types of shares such as preference shares have received their portion.
Potential ordinary shares = financial instrument or other contract that might entitle the holder to ordinary shares such
as :
 debt or equity instruments (including preference shares) that are convertible into ordinary shares
 share warrants and options (financial instruments that give the holder the right to purchase ordinary shares)
 shares that will be issued when certain conditions are satisfied resulting from contractual arrangements such as the
purchase of a business or other assets.
Basic earnings = profit or loss for the period that is attributable to ordinary shareholders after deducting preference
dividends. All transactions of income and expense (including tax and non-controlling interests) are included in the
determination of the profit or loss for the period.
Amount of preference dividends deducted from the profit for the period will be :
 cumulative preference dividends – taken into account irrespective if they are paid or declared. Excludes any
dividend paid or declared to cumulative preference shares in respect of previous periods
 non-cumulative preference dividends – only taken into account if dividend is declared during the period.
When loss is incurred then do same calculation as for earnings per share.
How to calculate basic earnings :

R
Profit for the year (without interest) XXX
- less tax (XX)
- after fixed preference dividends (XX)
- before transfers to and from reserves XXX
- add attributable profit after tax of associates XXX
& non-controlling subsidiaries accounted for XXX
by the equity method
Earnings XXX
R
or profit for the year XXX
- less preference dividends (XX)
Earnings XXX
R
16
or retained earnings at end of year XXX
- less retained earnings at start of year (XX)
- add transfer to reserve XXX
- add ordinary dividends XXX
Earnings XXX
Weighted average number of shares

Number of ordinary shares outstanding at the beginning of the period, adjusted by the number of ordinary shares
brought back or issued during the period, multiplied by the time-weight factor (number of days the specific shares were
outstanding in proportion to the total number of days in the period).
Normally shares are included in the weighted average number of shares from the date that they are receivable (on date
that they are issued).
So to calculate the weighted average number of shares will take the opening balance of shares at the beginning of the
year, add any shares issued during the year by multiplying the number of shares by the amount of months in the year
that the new shareholders are entitled to share in the profits.
see example pg 239 of study guide
Basic earnings per share

Calculated by dividing the profit or loss for the period for ordinary shareholders by the weighted average number of
ordinary shares outstanding during the period.
profit or loss for the period attributable to ordinary shareholders
i.e. weighted average number of ordinary shares outstanding
Presentation
Entity should present basic earnings per share (including a loss per share) on the face of the Statement of
Comprehensive Income for each class of ordinary shares with equal prominence for all the periods presented.
Disclosure
Entity should disclose the following per basic earnings per share :
 earnings :
 the earning amount used in the calculation and
 a reconciliation of the amounts used in the calculation to the profit or loss for the period in the Statement of
Comprehensive Income
 per share :
 the weighted average number of ordinary shares used and
 a reconciliation between the number of shares used for basic earnings per share.
If entity also discloses (in addition to basic earnings per share) the per share amounts using a reported component of
profit that is different to profit or loss for the period attributable to ordinary shareholders, then that amount must be
calculated using the weighted average number of ordinary shares.
If use component that is not reported as a line item in the Statement of Comprehensive Income then must give a recon
between the component that was used and the component that is reported as a line item in the Statement of
Comprehensive Income.
Different classes of shares

Participating preference shares
Shares where the holder is entitled to a fixed preference dividend and ALSO to share the remainder of the distributable
profit with the ordinary shareholders, either pro-rata or after ordinary shareholders have received a certain maximum
dividend.
Must note the conditions of issue and the capital structure.
(if given that the participating preference shares are paid at 1c per share for every 4c per share for ordinary
shareholders, then must calculate the percentage participation for each shareholders group given the number of
participating shares)
If participating shareholders will receive extra share of profits after the ordinary shareholders have received a minimum
dividend, then the earnings are distributed between the ordinary shareholders and the participating preference
shareholders AFTER have deducted the minimum dividend that the ordinary shareholders earned.
17
Changes in capital structure
Shares issued for consideration
Shares are included in the weighted average number of shares from the date that they are receivable (if that is different
from the date that they were issued then the issue date is not important).
When calculating earnings per share the new shares that have been issued must be weighted according to the date that
the consideration was receivable, BUT number of shares in issue in the previous year must not be weighted, cos only
received in current year so doesn’t affect the number of shares in previous year.
Consideration received for share issue Date of inclusion in calculation of earnings per share
Cash When cash is receivable
Voluntary reinvestment of dividends on ordinary or Dividend payment date

preference shares
Conversation of a debt instrument to ordinary Date interest ceases to accrue

shares
Interest on other financial instrument Date interest ceases to accrue
Settlement of a liability Settlement date
Acquisition of an asset other then cash Date on which the acquisition is recognised
Rendering of services Date or period for which the services are rendered
Ordinary shares issued as part of the purchase From the date of acquisition because the acquirer incorporates
consideration of a business combination that is an the results of the operations of the acquiree into its Statement of
acquisition Comprehensive Income as from the date of acquisition
DOES NOT INFLUENCE THE CALCULATION OF NUMBER OF SHARES IN THE PREVIOUS YEAR!
Contingently issuable shares = ordinary shares that are issuable upon the satisfaction of certain conditions are
considered outstanding and included in the computation of basic earnings per share from the date when all the
necessary conditions have been satisfied.
(Will only be taken into account for weighted number of shares from the date that the company has the extra money
because of the new shares. So when the earnings capacity of the company will increase because of the additional
cash that is available to the company)
Shares issued in exchange for the acquisition of an asset or shares issued in exchange for shares in another
company are essentially on the same basis.
The equity shares for the purposes of calculating earnings per share are regarded as having been issued on the date on
which the income from the investment in shares was included in earnings.
If the income of a company whose shares have been acquired is included with that of the company which issued the
shares from a date other then the date on which the shares were issued as remuneration, then the shares are
considered to have been issued on the same date as the date on which the income was included (so that the earnings
per share are calculated for the time that the income was included corresponds to the period for which the shares are
weighted).
If preference shares or debentures are issued in part of full payment for shares acquired in another company and the
date on which the preference dividends or debentures begin to accumulate differs from the date on which income from
the investment in shares is included in earnings, then the problem is that the cost of acquiring the asset is not matched
with the income generated by the investment (the matching concept).
Rights issue at fair value

Rights issue is an issue to existing shareholders of the company for payment
Shares issued for no consideration

If non-distributable reserves are capitalised by issuing equity shares for no consideration, then the earnings and
dividend per share must be based on the increased weighted average number of issued shares after the capitalisation
issue.
When there is a capitalisation issue then no additional capital is acquired and the company only makes a book entry so
the reserves that were capitalised and the number of shares issued as a capitalisation issue are NOT weighted for the
period of issue. Must also adjust the comparative figures (earnings and dividends per share) by the increase in the
number of shares if they are comparable.
18
In the same way if shares are split or where shares are consolidated and no repayment of capital takes place then that
works on the same principle. Ordinary shares may be issued or the number of shares reduced without there being a
change in corresponding changes in resources – so even through the number of shares changed during the year there
was no consideration received and so the earnings capacity of the company didn’t change.
Will happen in cases like :
 capitalisation or bonus issue
 bonus element in a rights issue
 share split
 reverse share split (consolidation of shares)
So then the number of shares is NOT weighted when calculating the basic earnings per share. The number of ordinary
shares outstanding before the event is adjusted for the proportionate exchange in the number of ordinary shares
outstanding as if the even had occurred at the beginning of the earliest reported period (so the beginning of the prior
year).
The number of shares are only weighted if the capitalisation issue (or any of the other cases) follows a rights issue in
the same year – and then the capitalisation issue is only weighted with regard to the rights issue.
Rights issue at less then fair value

If the company raises capital by means of a rights issue and the issue price is less then the fair value of the company’s
shares when issued then a bonus element arises.
The number of ordinary shares to be used in calculating basic earnings per share for all periods prior to the rights issue
is the number of ordinary shares outstanding prior to the issue multiplied by :
fair value per share immediately prior to the exercise of rights
theoretical ex-rights fair value per share
Theoretical ex-rights fair value per share calculated by either :

total fair value of shares prior to the exercise of the rights + proceeds from the exercise of the rights
number of shares outstanding after the exercise of the rights
or
. fair value of outstanding shares + amount received from rights issue .
number of shares outstanding prior to rights issue + number of shares issued with rights issue
Reduction in equity share capital

Can either be :
 reverse share split – number of shares are reduced in which case the basic earnings per share are based on the
reduced number of the equity shares after the consolidation of shares. Basic earnings per share for the preceding
year are adjusted proportionately
 number of shares remains unchanged and only the nominal value per share is affected – so no adjustment is
necessary to calculate basic earnings per share.
Share split or reverse share spilt is the change in the nominal value of the shares leading to a change in the number of
shares
Headline earnings
All trading profits or losses of the company (including those items that are of such a nature and size that their disclosure
is relevant to explain the performance of the enterprise) after tax, non-controlling interest and preference dividends, but
excluding separately identifiable remeasurements.
Measurement is an amount recognised in the Statement of Comprehensive Income relating to any change (realised or
unrealised) in the carrying amount of an asset or liability that arose after the initial recognition of such asset or liability.
Disclosure in the financials must be :
 earnings per share
 headline earnings per share
 itemised reconciliation between headline earnings and earnings in accordance with IAS33/AC (must detail the
nature and amount of each reconciling item)
Dividends per share

Calculated by :
. dividends declared for the period .
number of issued shares on the date when the dividends were declared
19
So calculation of dividends per share is based on the number of issued shares and NOT the weighed average number
of issued shares.
Comparative figures for dividends per share only adjusted for :
 capitalisation issues
 bonus issues
 share split
 share consolidation
 reduction in equity share capital
If dividends are declared more then once during the period under review then a separate dividends per share must be
calculated for each dividend payment, and the sun of these separate dividends per share calculations will be disclosed
in the Statement of Comprehensive Income or the dividends per share for each declaration can be disclosed.
Adjusted dividend per share must be calculated if the company issued capitalisation shares, bonus issues or a share
split or consolidation in the current year. Result of these shares transactions is that the number of shares increased or
decreased but the rand value of the issued share capital remains the same. Number of issued shares of the previous
year must are therefore adjusted and this requires that the dividend per share calculation is also adjusted.
Disclosure requirement
Must disclose dividends per share in cents for each class of equity shares for the period under review and the
corresponding prior period in the Statement of Changes in Equity or in the notes.
see exercises on pgs 269 to 274 of the study guide – VIP (similar to exam questions)
TOPIC D
TIME VALUE OF MONEY
Study guide pg 278
When money is borrowed price to be paid for use of the money is interest rate which is the return on the lender’s
money.
Interest rate determined by :
 time value of money (cos money is used to earn more money)
 risk that capital can’t be repaid
 inflation (determined by the spending power of money)
Interest rate is the rate of return on the capital payable at the end of a certain period (expressed as a percentage)
Time value of money very important and must be part of the calculations in capital budgeting and capital investments,
and also to manage the cash flow.
Term represents the number of periods involved.
Discounted rate is used when the return on the capital is payable in the beginning of the period (paid in advance). Is
also a percentage.
Fundamental Aspects of Financial Management pg 85

Time value of money
Amount of money receivable today is worth more then the same amount at a future time because of :
 inflation
 loss of interest receivable
 loss of investment opportunities
 potential risk of default on the capital which is repayable
Future and present values

Accumulation or calculation of future value – what is amount receivable today worth at a specific time in the future ?
Discounting or calculation of present value – what is amount receivable at a specific time in the future worth today?
Money increases over time by earning interest or yielding profits (process of accumulation) and is the concept of moving
money forward to determine a future value (FV).
Discounting is the process where people accept a smaller amount of money now in settlement of a larger amount due in
the future. Involves moving money backward to determine a present value (PV).
Simple interest – when interest is payable on capital only

Compound interest – when interest is payable on both capital and accumulated interest.
Annuity is a periodic payment of equal amounts at equal intervals

Ordinary annuity = annuity where the periodic payment is made at the end of each period
Annuity due = annuity where the periodic payment is made at the beginning of each period.
20
Interest tables
4 major tables published :
 future value of R1 investment of a single amount
 present value of R1
 future value of R1 pa (of an annuity)
 present value of R1 pa (of an annuity)
Simple interest
Interest is payable on the capital only – so no interest is re-invested to earn more interest.
S = P ( 1 + rt )
future value = principal ( 1 + interest rate x number of periods / time)
i =S- P
interest = sum (future value) - principal
Compound interest
Interest is payable on capital and also the accumulated interest (so interest earned on re-invested interest)
n
S=P(1+i)
future value = principal ( 1 + interest rate ) to power of number of periods
see example pg 92 of text book for example with Sharp calculator
Future value of an annuity

n
FV = PMT (1+i) - 1 Calculates the future value of R1
i
see example pg 97of text book for example with Sharp calculator
Present value of an amount

1 -n
P= S
. .
n or S=P(1+i) Calculates the present value of R1

(1+i)
Present value of an annuity

-n
an =1-(1+i) Calculates the present value of R1 per period
i
Future value of an annuity

n
sn =(1+i)-1 Calculates the future value of R1 per period
i
Perpetuity
Annuity that continues forever
present value of an perpetuity = P

i (interest must be as a decimal)
Note that the present value of the perpetuity is determined at the beginning of the first year, but that the
first payment will only be at the end of the first year.
Effective interest rate

Interest that is payable once annually (so effective interest rate of 12% per annum means that 12% interest is payable
after 1 year)
Nominal interest rate

Interest which is payable more then once per annum (e.g. nominal interest rate of 12% compounded monthly means
that 1% interest will be added at the end of each month – but that at the end of the year will have earned more then
12% interest cos interest of the 1% per month will be compounded).
see questions pg 112 of text book and also questions with answers pgs 113 to 126
21
TOPIC E
LEASES (ONLY LESSEES) IAS 17
Study guide pg 286
Lease = agreement whereby lessor giving the lease conveys the right to use of an asset to lessee for an agreed period
of time in return for payment or series of payments.
Finance lease = lease that transfers substantially all risks and rewards of ownership of an asset (where title may or
may not eventually be transferred)
Operating lease = when lessee hires the use of the asset for the specified period, but all the risks and rewards of
ownership stay with the lessor
Non-cancellable lease only cancelable if :
 occurrence of some remote contingency
 has permission of lessor
 lessee enters into new lease for the same or equivalent asset with same lessor
 lessee pays an additional amount so that continuation of the lease is reasonably certain.
Inception of lease = earlier of either date of lease agreement or commitment by parties to the provisions of the lease.
From the inception the lease is classified as either operating or finance lease and (if finance lease) then the amounts to
be recognised at the commencement of the lease term are determined.
Commencement of the lease term = date from which lessee can exercise right to use the leased asset (i.e. date of
initial recognition of assets, liabilities, income or expenses resulting from the lease)
Lease term = non-cancellable period for which lessee has the use of the asset (also includes any option that the lessee
may have to extend the lease with or without payment if reasonably certain that the lessee will do so)
Minimum lease payments = payments over the lease term that lessee required to make, excluding contingent rent,
costs for services and taxed to be paid and reimbursed to the lessor. Includes any amounts guaranteed by the lessee
or the third party related to the lessee. If lessee has option to purchase the asset at end of lease at price lower then fair
value (and expected that lessee will exercise this right) then minimum lease payment become payment payable over
the lease term and also the payment required to exercise the purchase option
Fair value = amount for which the asset can be exchanged or liability settled between knowledgeable willing parties in
an arm’s length transaction
Economic life = either period of time over which asset expected to be economically usable or number of production
units expected to be obtained from the asset
Useful life = estimated remaining period over which the economic benefits embodies in the assets are expected to be
available to the entity (not just to the end of the lease!)
Guaranteed residual value = maximum amount that is payable by the lessee at end of lease or that is guaranteed by a
party related to the lessee
Unguaranteed residual value = portion on residual value of the leased asset that the lessor is not assured of getting or
if it is guaranteed solely by a party related to the lessor
Interest rate implicit in the lease = discount rate (at beginning of lease) that means that the total present value of the
minimum lease payments and the unguarenteed residual value is equal to the fair value of the leased asset plus any
initial direct costs
Lessee’s incremental borrowing rate of interest = rate of interest lessee would have to pay on a similar lease or the
rate at the start of the lease that the lessee would have to borrow over similar time and with similar security to buy the
asset
Contingent rent = portion of the lease payments that isn’t fixed but is based on factor’s other then the passage of time
(e.g. percentage of sales, amount of usage, price indicators, market rates of interest)
Initial direct costs = increment costs that are directly part of negotiating and arranging the lease, but not costs for
manufacturer or dealer costs.
Hire purchase contract = contract for hire of asset that has provision the hirer can acquire title to the asset when the
agreed conditions are fulfilled (also type of lease)
If entity has bought an asset then has the legal title to the asset and also the risks and rewards of ownership, so will dr
assets and either cr liability or bank.
If entity has right to use an asset but not the legal title (cos lease agreement and installment sale agreements split the
benefits of ownership from legal title) then need to know who has right to record the asset.
NOT applicable for lease agreements to explore or for natural recourses like oil, gas, timber, metals and mineral rights
or for rights for movies, videos, plays, manuscripts, patents and copyrights.
Also NOT for property that is investment property, investment property under an operating lease or biological assets
held by finance or operating lease.
Classification of lease
If lease is finance or operating lease depends on what the transaction is for and NOT what the contract says.
Finance lease – transfers substantially all the risks and rewards of ownership
Operating lease – doesn’t transfer risks and rewards of ownership.
So classification of lease based on extent to which risks and rewards of ownership belong to either lessor or lessee.
22
Risks include possibility of losses from idle capacity, technological obsolescence or variations in return due to changing
economic conditions
Rewards can be represented by expectation of profitable operation over asset’s economical life and of gain from
appreciation in value or realisation of residual value.
WILL be finance lease if :
 lease transfers ownership of the assets to the lessee at the end of the lease term
 lessee has option to purchase the asset at a price expected to be sufficiently lower then the fair value when option
is exercisable (so reasonable certainly that the option will be exercised at the inception of the lease)
 lease term is for the major part of the economic life of the leased asset even if title is not transferred
 at inception of the lease present value of the minimum lease payments amount to at least substantially all of the fair
value of the leased asset
 leased assets are of a specialised nature that only the lessee can use them without major modifications being made
COULD be finance lease if :
 if lessor’s losses associated with the cancellation of the lease are paid by the lessee if he cancels that lease
 gains or losses from the fluctuations in the fair value of the residual value fall to the lessee (e.g. rent rebate equaling
most of the sales process at the end of the lease)
 lessee has the ability to continue the lease for a secondary period at rent that is substantially lower then market
rent.
Lease classification is made at the start of the lease – if the lessee and lessor change the provision of the lease
(except when renewing the lease) and so different classification of lease, then considered that the revised agreement is
a new agreement over its term.
But not if just change in estimates (of the economic life or the residual value of the leased property) or changes in
circumstances (default by the lessee) are NOT new classification of a lease for accounting purposes.
Leases of land and buildings are operating or finance leases the same as other assets, but land normally has
indefinitely economic life and so if title doesn’t pass to the lessee at the end of the lessee term then the lessee doesn’t
receive all the risks and rewards of ownership and so land is an operating lease.
Premium paid for leasehold represents prepaid lease payments that are amortised over the lease term in accordance
with the patters of benefits provided.
Land and buildings are considered separately for the purpose of lease classification. If title to both are expected to pass
to the lessee by end of the lease term then both elements are classified as a finance lease(whether one or two leases)
unless it is clear that the lease doesn’t transfer substantially all risks and rewards of ownership of one or both elements.
If land has indefinite economic life then normally classified as operating lease if title not expected to pass to the lessee
by end of lease term, while buildings classified as either finance or operating lease.
Might be necessary to classify the minimum lease payments (including lump-sum upfront payments) of lease of land
and buildings between land and buildings in proportion to the relative fair values land and buildings at the inception of
the lease. If can’t be allocated then the entire lease is classified as an operating lease.
Don’t need to split if lessee’s interest is classified as an investment property and is carried at fair value.
Finance leases in the financial statements of lessees

Must be recognised in Statement of Financial Position as assets and liabilities at amounts equal to the fair value of the
leased asset at the inception of the lease or if LOWER at the present value of the minimum lease payments.
When calculating the present value of the minimum lease payments then the discount factor will be the interest rate
stated in the lease if it can be determined – if not, then will use the lessee’s incremental borrowing rate.
Any initial direct cost of the lessee are added to the amount recognised as an asset.
Transactions must be accounted for and presented in accordance with their substance and financial reality and not
merely their legal form. So although legal form of lease agreement is that lessee doesn’t acquire any legal title to the
leased asset for finance lease – the substance and financial reality is that the lessee acquires the economic benefits of
the use of the leased asset for the major part of its economic life. In return lessee enters into obligation to pay an
amount approximating to the fair value of the asset and finance charge for that right.
Accounting implication for finance lease :

 asset recognised separately in the Statement of Financial Position as a leased asset and is depreciated over the
shorter of the lease term or the asset’s useful life, if NO reasonable certainly that the lessee will obtain ownership at
the end of the lease term
 liability is recognised in the Statement of Financial Position as a secured interest bearing finance lease liability
 interest paid or finance charges on the liability and the depreciation on the asset are separately disclosed in the
Statement of Comprehensive Income.
CANNOT disclose liabilities for leased assets as a deduction from the leased assets in the financials.
23
Costs directly attributable to lessee’s activities for a finance lease (e.g. legal fees and commission) included as part of
the amount recognised as an asset under lease. (Initial indirect costs incurred in connection with specific leasing
activities – i.e. in negotiating and securing leasing agreements.)
Finance charges
Lease payments should be apportioned between finance charge and the reduction of the outstanding liability. Finance
charge should be allocated to periods during the lease term so as to produce constant periodic rate of interest on the
remaining balance of the liability for each period.
Must prepare amortisation table to calculate this split – using the effective interest rate method to calculate the
apportionment.
When calculating the interest must take the following into account :
 nominal interest rate is used to calculate the finance charges included in the lease payment if the lease payment are
payable more then once a year
 if lease payments are annual then nominal interest rate equals the effective interest rate
 effective interest rate is disclosed in the note in respect of liabilities relating to capitalised leased assets
 flat rate is the interest rate that is calculated every year of the repayment term on the full original outstanding capital
amount before taking into account any interim repayments and added to the capital amount to determine the total
amount to be repaid.
In leasing transactions normally quote a flat rate of interest per annum based on the cash price of the asset in question.
see examples of effective interest rate method pgs 291 to 293 of study guide
Depreciation
Finance lease gives rise to depreciation for the asset as well as the finance expense for each accounting period.
Depreciation is calculated the same way and at the same rate as with fully owned assets.
If no reasonable certainly that the lessee will own the asset at the end of the lease term then the asset must be fully
depreciated over the SHORTER of the lease term or its useful life.
The initial direct costs are added to the cash price of the asset and are therefore depreciated over the same time and at
the same rate as the cash price of the asset
Cos sum of deprecation expense and finance expense for the asset won’t be the same as the lease payment for the
same period CANNOT just code the lease payments as an expense in the Statement of Comprehensive Income. Also
the asset and the liability won’t be the same after the inception of the lease.
Disclosure
Must make following disclosures for finance leases :
 net carrying amount at Statement of Financial Position date for each class of asset
 reconciliation between total of future minimum lease payments at the end of the reporting period and their present
value as well as the total of future minimum lease payments at the end of the reporting period and their present
value for the following :
 not later then 1 year
 later then 1 year and not later then 5 years
 later then 5 years
 contingent rents recognised as expense for the year
 total of future minimum sublease payments expected to be received under non-cancellable subleases at the
Statement of Financial Position date
 general description of the lessee’s significant leasing arrangement including :
 basis on which contingent rent payments are determined
 existence and terms of renewal or purchase options and escalation clauses
 restrictions imposed by lease arrangements (such as dividends, additional debt and further leasing)
see examples pgs 295 to 301 of study guide
Note :
 depreciation on capitalised leased assets is included as part of the normal depreciation charge for the year in the
same class of fixed assets and the finance charges are included as part of the total interest charged in the
Statement of Comprehensive Income
 depreciation calc’d as ;
(cost of asset + initial direct costs) x (100% divided by years expected life of asset)
 installments are worked out using cost of asset x flat interest rate x time of lease divided by number of payments
 use nominal interest rate for the amortisation table :
cost of asset x (nominal interest rate %
number of payments per year)
Operating leases in the financial statement of lessees

When risks and rewards of ownership are not transferred to the lessee but stay with the lessor.
Can only be classified as operating lease if NONE of the following are applicable :
 lease transfers ownership of the assets to the lessee at the end of the lease term
24
 leased assets are of a specialised nature that only the lessee can use them without major modifications being made
 lessee has option to purchase the asset a price expected to be sufficiently lower then the fair value when option is
exercisable (and reasonable certainly that the option will be exercised at the inception of the lease)
 lease term is for the major part of the economic life of the leased asset even if title is not transferred
 at inception of the lease present value of the minimum lease payments amount to at least substantially all of the fair
value of the leased asset
 if lessor’s losses associated with the cancellation of the lease are paid by the lessee if he cancels that lease
 gains or losses from the fluctuations in the fair value of the residual value fall to the lessee (e.g. rent rebate equaling
most of the sales process at the end of the lease)
 lessee has the ability to continue the lease for a secondary period at rent that is substantially lower then market
rate.
In operating lease the obligation of the lessee is limited to the lease payment, and lease payments and initial direct
costs (e.g. legal fees and commission) are recognised as an expense in the Statement of Comprehensive Income on a
straight-line basis over the lease term (or another systematic basis of time pattern of user’s benefit).
Normally just allocate the lease payments to the expense account, but if the payments are not equal to the period in
which the benefit is received, then must correct it by deferring or providing for the future payments - if payment won’t
reflect the consumption of economic benefits (matching of costs with income earned) then deferred portion will be in
current assets of Statement of Financial Position in account ‘Deferred Lease Payments’. If provision is made for lease
payments then shown as current liability in the Statement of Financial Position in account ‘Provision for Lease
Payments’, when :
 lease payment aren’t spread equally over the lease term
 lease payments made prior to bringing the leased asset into use
 initial term of the lease is significantly less then the period over which benefit will be derived and the lease is likely to
be renewed at payments significantly less or more then the initial lease payments
Disclosure
Must make the following disclosures for operating leases :
 total of future minimum lease payments under non-cancellable operating leases for each of the following periods :
 not later then 1 year
 later then 1 year and not later then 5 years
 later then 5 years
 total of future minimum sublease payments expected to be received under non-cancellable subleases at the
Statement of Financial Position date
 lease and sublease payments for the period with separate amounts for lease payments, contingent rents and
sublease payments
 general description of the lessee’s significant leasing arrangements including :
 basis on which contingent rent payments are determined
 existence and terms of renewal or purchase options and escalation clauses
 restrictions imposed by leases arrangements (such as dividends, additional debt and further leasing).
Lessees – schematic summary :
LEASE
PAYMENTS
Nature
Finance lease Operating lease
Capitalise asset Payments charged

and record against profit on a
the liability systematic basis
25
TOPIC F
VALUATION OF FINANCIAL INSTRUMENTS
Study guide pg 312
If accountant has to act as appraiser or valuator then must know when there are special directions on how to do
valuation or if there are special valuation methods that have to be applied.
Must also be very clear in the report as to what the purpose of the valuation is and what method was used to determine
the value, as well as if there were any limitations (presumptions or prescribed valuation methods) that might result in a
qualification on the report.

Valuation is procedure for arriving at an informed opinion about the value of an asset in monetary terms.
Market value of an undertaking is the HIGHER of :
 revenue from sale to a 3rd party
 liquidation value
 going concern value
Real assets and financial assets Financial assets

Real assets  ordinary shares
 land  preference shares
 buildings  members’ interests (CC)
 knowledge / intellectual capital  capital accounts (partners / sole prop)
 machines  debentures
 workers  loans
Financial assets show how the wealth or earnings generated by entity is distributed between holders of the financial
assets (equity) and so financial assets are claims to the earnings generated by real assets
Financial assets can be either asset or liability in Statement of Financial Position, but real asset only shown as asset.
see examples of valuation of person’s shares in company pgs 136/7 of text book
Shareholder’s equity – ordinary shares

Ordinary shares have :
 residual claim – so ordinary shareholders last in line to claim against assets or income of company if it is in
liquidation
 limited liability
so are therefore have the highest risks of provider of funds to company, but are entitled to wealth created by company
(i.e. profit of the company after taxes, interest and preference dividends have been paid).
Market value HIGHER of :

 sale to 3rd party
 liquidation value – amount that can be realised if assets of undertaking are sold separately from the business that
is in operation
 going concern value – worth of entity when operated “as is” by the current management, but divided into either :
 company that has a normal, average return on investment compared to the sector it is trading in and
 company where the return on investment is above the average of the sector it is trading in (will have higher
value and excess value over the average value of the concern is the goodwill – so goodwill linked to ability of
entity to perform better then average)
Goodwill is difference between the net asset value (book value) and the market value of assets.
Intrinsic value method (asset based method – ignores potential income or profit expectations)
Either individual or entity’s value of its assets less the value of the liabilities – normally used when assets are valued
individually and are dissimilar groups of assets i.e. when :
 valuation of a majority share in a property or investment company
 recently incorporated company with little or no financial history
 enterprise has non-income producing assets such as vacant land
 business where the market value of the assets is much higher then the present value of future profits (poor business
operating on valuable premises)
Value determinants are :

 going concern value of all assets
 value of all liabilities and preference shares of the entity to be valued.
26
Remember : intrinsic value of asset is different to the book value or carrying value in accounting records (e.g. older
asset that has been depreciated to R 1 value might still have value using intrinsic value method.
Intrinsic valuation method :

 determine value of assets on going concern basis
 calculate value of liabilities and preference shares on going concern basis
 deduct the value of the liabilities and preference shares from the value of the assets
see example pgs 148 to 150 of text book
Note :
 must use the revalued amount for an asset as this will be the ‘actual’ value of the asset
 if shares bought have increased in value then this is used as it is the ‘going concern’ value
 if any of the trade receivables are irrecoverable (bad debts) then must reduce the debtors by this amount as that will
be the ‘going concern’ value
CAN ONLY USE THIS METHOD WHEN ENTITY HASN’T GENERATED PROFITS!
Divided yield method (used when calculating minority share holding valuations)
Capitalisation of future dividends at a fair dividend yield (ratio between dividends declared and the share price). Fair
dividend yield is the ratio between next expected dividend and the share price and needs :
 forecast of the next expected dividend
 estimate of fair dividend yield (also called interest rate commensurate with the risk of share)
 capitalisation of the expected future dividends using the dividend yield.
INCOME BASED VALUATION METHOD

Calculates minority share-holding valuations – minority shareholders don’t have much influence on the company’s
operations and only entitled to dividends if they are declared by the majority shareholders.
Dividend yield formula :

Po = D1
k
price at present = next or expected future (divided by number of shares)
dividend yield or risk adjusted interest rate (as a decimal)
then multiply by percent that person wants to value or purchase x number of shares
Earnings yield method (used when valuing ordinary shares for majority shareholder)
Done by capitalising future earnings at a fair earnings yield (ratio between the expected earnings for the next year and
the share price).
INCOME BASED VALUATION METHOD, but doesn’t make any provision for growth in future earnings.
Procedure :
 forecast the expected earnings for the next year
 estimate of fair earnings yield
 capitalise the expected future earnings using the earnings yield
Earnings yield formula :

Po = E1
k
price at present = next year’s expected future earnings
earnings yield or risk adjusted interest rate(as a decimal)
If use earnings yield method then normally higher then dividend yield method cos formula includes the retained earnings
as well as dividends as calculating for majority shareholder (person who determines company and dividend policy and
also the entity’s future business direction).
Dividend yields and earnings yield for all listed companies are available from daily financial papers.
Price earnings is the inverse of earnings yield and gives the value of the ordinary shares against the expected earnings
at the end of the year, or how many years it will take to recover the current market price from earnings.
Price earnings = P0
E1
see questions and answers pgs 159 to 165 of text book

27
Deciding on which method of valuation to use :
GOING
CONCERN
Income or
asset based?
Asset based Income based
Intrinsic value Payments charged

method against profit on a
systematic basis
Value of assets
less value of
liabilities +
preference Minority Majority
shares
Dividend yield Earnings yield

method method
Po = D1 Po = E1
k k
Shareholder’s equity – preference shares

Receive preference dividends which are normally fixed percentage of the nominal value of the preference share and are
contractually payable. But if preference shares are not paid to their holders (they are passed) then preference
shareholders can’t force the company into liquidation.
Preference shareholders have rights and claims against assets and income of company ahead of ordinary shares, but
behind outside funding like debentures and loans. Have limited liability if company is liquidated.
Valued by discounted cash flows like ordinary shares.
Cash flows (or dividend streams) of preference shares that are not redeemable or convertible are a perpetuity.
Valuation formula :
Po = Dps
Kps
price of preferential share = dividends of the preference share
fair dividend yield of preference shares
Advantages of preference shares Disadvantages of preference shares

Investor : Investor :
 provide a reasonably steady dividend flow  substantial portion of ownership risk borne for
 preference for the repayment of capital before ordinary limited return
shareholders in case of liquidation of the issuing company  right to dividends is not legally enforceable
 preference dividends are not taxable in the hands of the recipient
Issuing company : Issuing company :

 obligation to make committed dividend payments avoided  preference shares will have to be issued at
 equal participation in profit after tax avoided (not possible if higher yield then interest rates of outside
ordinary shares had been issued) funding
 company avoids participation in voting and delusion of control  preference dividends are an after tax expense
 more financial flexibility (redeemable preference shares have no for the company
fixed date of maturity)
 mortgageable assets are conserved (not like with secured loans
and debentures)
28
Types of preference shares :
 cumulative preference shares (non-redeemable)
 redeemable preference shares
 convertible preference shares
 participating preference shares
Cumulative preference shares

Preference shares are normally cumulative and non-redeemable unless stated otherwise. If company hasn’t enough
cash to pay dividends then dividends passed in one year will be payable in future years.
Cumulative preference dividends passed are accumulated until they are paid and no dividends may be paid to ordinary
shares holders until cumulative preference shareholders have been fully paid for accumulated arrear preference
dividends as well as current preference dividends.
Use formula :
Po = Dps
Kps
Redeemable preference shares

Preference shares don’t normally have a fixed maturity date, but if the shares are issued with a redemption date then
the value of the shares is based on the discounted cash flows at a fair dividend yield.
find year of cash flow and use discounting rate on the dividend payable to find the present value of
dividend in cents. Also discount the capital amount to present value and add to the discounted rate of the
dividends payable to get the current day value.
Convertible preference shares

Preference shares can be converted to another financial asset such as ordinary share or debenture.
When converting preference shares must remember ;
 preference dividends are received until the conversation takes place
 ordinary shares issued in replacement of the existing preference shares must also be valued.
find the value of an ordinary share and calculate the value of the preference dividend to be received, by
calculating the present value at the fair dividend yield for the number of periods.
see example pgs 175/6 of text book
Participating preference shares

Carry the normal preference dividend, but also have the right to participate in ordinary dividends, bonuses or rights
associated with ordinary shares (usually means sharing in ordinary dividends if and when the ordinary dividend per
share exceeds a certain amount).
calculate the value of 1 participating preference share and then convert it to the present value in cents
before using formula
Po = Dps
Kps
Outside funding (debt)

Either :
 short term debt – repayable in under a year
 medium term debt – repayable in between 1 to 3 years
 long term debt – repayable in over 3 years.
Can also be classified into fixed interest debt or variable interest debt, or unsecured or secured debt (where some or all
assets are pledged to the lender as security in case the borrower defaults on repayment or interest on the debt).
If lending or borrowing normally done by way of written contract that specifies :
 period of loan
 interest – rate percentage and either fixed or variable and dates of repayment of interest
 amount of loan
 secured or unsecured
 capital – once off or periodic repayments and dates of repayment of capital
When valuing debt the terms of the debt contract must be known and mustn’t take monetary amount at face value.
Must take following into account :
 risk of possible default of repayment of the debt
 changes in interest rates and
 time span before repayment of debt
29
Specific types of debt :
 debentures – debt arising from contract between entity and investor (borrower and lender) where the terms are set
out in a debenture contract. Normally issued at fixed interest rate, secured by assets and of a long-term nature
 loans
 payables – credit provided by suppliers of merchandise. Short term and normally no interest charged
Valuation procedure
Debt valued on discounted cash flows – value of any debt should equal the present value of future cash flows
discounted at a fair rate of return.
Must :
 determine the future cash flows consisting of :
 interest payments
 capital repayments
 calculate the fair rate of return which is the risk-adjusted interest rate
 capitalise the future cash flows using the fair rate of return.
As with most financial assets, actual value of the debt is different from the face value (carrying amount) of the debt.
Important variables include :
 risk – debt is worth nothing to the supplier unless the borrower can repay the loan, so risk is either :
 risk free e.g. government guaranteed bonds
 medium risk e.g. mortgage bond on property
 high risk e.g. debt without any guarantees or security such as trade receivables
 interest rate – normally the prime overdraft rate determined by the SA Reserve Bank which is adjusted when
necessary
 time factor
 fair rate of return – irrespective of the actual interest rate charged on the debt (is the risk-adjusted interest rate that
will be used as discount rate of future cash flows.)
Financial instruments
Financial instrument is contract that gives rise to both financial asset in one entity and a financial liability or equity
instrument in another entity.
Involves 3 major categories :
 currency
 debt and
 equity claims.
Financial asset = any asset that is :

 cash
 contractual right to receive cash or another financial asset from another entity
 contractual right to exchange financial instruments with another enterprise under conditions that are potentially
favourable
 any equity instrument of another enterprise
Financial liability :
 contractual obligation to deliver cash or another financial asset to another enterprise or
 contractual obligation to exchange financial instruments with another enterprise under conditions that might be
potentially unfavourable.
Equity instrument = any contract that results in a residual interest in the assets of an entity after deducting all its
liabilities
Derivative instrument = financial instrument :

 of which the value changes in response to the change in a specified interest rate, security price, commodity price,
foreign exchange rate, index of process or rates, credit rating or index or similar variable
 that requires little or no initial net investment
 that is settled at a future date
Use of financial instruments exposes entity to different financial risks :

 credit risk – risk that one party to a financial instrument will fail to honour his obligation and the other party will
suffer a financial loss
30
 cash flow risk – risk that future cash flows associated with financial instrument will fluctuate in amount
 liquidity risk – that entity will find it difficult to raise funds to meet commitments associated with financial
instruments
 price risk – risk that value of financial instrument will change or fluctuate as a result of changes in market factors
resulting in potential gains or losses due to changes in :
 foreign exchange rates
 interest rates
 market prices
Management must strive to implement programs to reduce the above mentioned risks to an acceptable level.
Initial measurement – recognised initially at cost (fair value at time of transaction)

Subsequent measurement – recognition of any further costs after transaction date with regard to specific financial
instrument
Trade date accounting – date on which the enterprise commits to the purchases or sale of an asset
Settlement date accounting – date on which the asset is delivered to or by the entity
Transaction costs – costs directly attributable to the acquisition or disposal of a financial asset or liability
Fair value – amount for which an asset can be exchanged / liability settled between knowledgeable willing parties in an
arm’s length transaction
Amortised cost – amount at which the financial asset or liability was measured at initial recognition, minus principal
repayments, plus or minus the cumulative amortisation of any difference between that initial amount and the maturity
amount and minus the write-down for impairment or uncollectibility
Effective interest rate – rate that discounts the expected stream of future cash payments through maturity date to the
current net carrying amount of the financial asset or liability
Effective interest rate method – calculating amortisation using the effective interest rate of a financial asset or liability
see examples of above on pgs 204 to 207 of text book
Financial assets
Financial assets held for trading – shares purchased for the purpose of speculating to generate a profit.
Accounting treatment :
 initial recognition at cost (fair value plus transaction costs)
 subsequent measurement at fair value as at year-end
 any profit or loss resulting from the subsequent measurement is immediately recognised in Statement of
Comprehensive Income.
Held-to-maturity investments – financial assets (like debentures) where :

 payments are fixed and determinable
 maturity date is fixed
 intent is to hold the investment to maturity
 subsequent measurement at amortised cost, calculated by the effective interest rate method
Amortised cost consists of :
amount at which was measured at initial recognition
minus principal repayments
plus / minus cumulative amortisation of any difference between the initial amount and the maturity amount
(called premiums and discounts)
minus any write down for impairment or uncollectibility
Debentures normally issued and redeemed as follows :

 issued at par and redeemed at par / premium or discount
 issued at premium and redeemed at par / premium or discount
 issued at discount and redeemed at par / premium or discount
So either :
 par – interest rate on specific debenture that is issued is the same as the current market related rates on similar
instruments, so investor will be willing to pay an amount equal to the face value of the debenture / par
 premium – interest rate on specific debenture is higher then the current market related rates on similar instruments,
so investor will therefore be willing to pay more (premium) then the face value of the debenture cos he can earn
more interest on that debenture then he can with a similar one on the market
 discount – interest rate on debenture is lower then the current market related rates on similar instrument so
investor will pay less (discount) then the face value of the debenture cos he will earn less interest then he could on
a similar debenture in the market.
see example pg 210/1 of text book
Loans and receivables originated by the entity – financial asset held at fair value through profit or loss
31
Held for trading = financial assets created by the entity by providing money, goods or services directly to debtor that is
not with the intention of selling immediately or in the short term
 initial recognition at cost (fair value plus transaction cost)
 subsequent measurement at amortised cost, calculated by using the effective interest rate method
Available for sale assets – any financial asset NOT classified as :

 held for trading
 held to maturity investments or
 loans and receivables originated by the entity
Normally investment in shares obtained not for speculation purposes, but which are also not going to be held until
maturity.
 subsequent measurement at fair value
 any differences resulting from subsequent measurement can immediately be recognised in :
 Statement of Comprehensive Income or
 Statement of Changes in Equity and accumulate over the period of investment.
If all fair value adjustments are recognised in equity and the fair value decreases below the initial cost price then the
adjustment is treated as follows :
 if there is evidence of the impairment with a specific asset – recognise the decrease as an expense in the
Statement of Comprehensive Income or
 if there is no evidence of impairment – recognise the decrease as a negative reserve in equity.
Derecognition of financial asset

Enterprise should derecognise financial asset (remove it from the balance sheet) if the enterprise loses control of the
contractual rights that consist of the asset e.g. will lose control if :
 realises the right to benefits specified in the contract
 rights expire
 enterprise surrenders those rights
On derecognition the difference between :

 carrying amount of an asset transferred to another party AND
 sum of :
 proceeds received or receivable and
 any prior adjustments to reflect the fair value of that asset that have been reported in equity
must be included in the net profit or loss for the period.
Financial liabilities
Financial liabilities held at fair value through profit or loss (for trading) – liabilities incurred principally for the
purpose of generating a profit from short-term fluctuations in price.
 initial recognition at cost (fair value of the consideration received including transaction costs)
 subsequent measurement at fair value
Financial liabilities held at fair value through profit or loss (NOT for trading)
 initial recognition at cost (fair value of the consideration received including transaction costs)
 subsequent measurement at amortised cost
Derecognition of financial liability

Entity must derecognise financial liability (remove it from Statement of Financial Position) when the obligation specified
in the contract is discharged, cancelled or expires.
At derecognition the difference between :
 carrying amount of the liability extinguished or transferred to another party (including related unamortized costs)
and
 amount paid for asset
must be included in profit or loss for the period.
Summary
Value of security is influenced by risk and return.
Value of security is the present value of future cash flows discounted at the fair rate of return.
32
Investors must chose between risk and expected return as security with low risk provide lower returns then security with
high risk.

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1

GENERALLY ACCEPTED ACCOUNTING STANDARDS

TOPIC A - STUDY UNIT 1

General provisions of the Companies Act :

Elimination of common items

Elimination of intercompany items

Consolidation of remaining items

Dividends from pre-acquisition profits

Consolidation of wholly-owned subsidiary after date of acquisition

see exercises pgs 48 to 58 of study guide

Apportioning items in the Statement of Comprehensive Income

Apportioning items in the Statement of Changes in Equity

Intercompany bills of exchange

H Ltd will should it as a bill payable

Revaluation of property, plant and equipment

Unrealised profit in trading inventories

Property, plant and equipment held by companies in the group

see exercise pgs 119 to 129 of study guide

DIVIDENDS DURING CONSOLIDATION

Dividends distributed by subsidiary from pre-acquisition or post-acquisition profits

see exercise pgs 149 to 158 of study guide

PREFERENCE SHARES DURING CONSOLIDATION

Consolidation procedure if subsidiary’s capital includes preference shares

Treatment of preference dividends of subsidiary

see exercise pgs 186 to 203 of study guide

Allocation of Statement of Comprehensive Income items :

Date of prev yr-end Acquisition date

Analysis of shareholder's equity of …..

Non-controlling interest (SCI) XXXXX

Dividends received …….. XXXXX

Cost of sales - subsidiary XXXXX

Profit on sale of property - parent XXXXX

Bank - subsidiary (cash in transit) XXXXX

Loan - subsidiary to parent XXXXX

Share capital - preference shares XXXXX

Retained earnings - preference shares XXXXX

Dividends received - parent XXXXX

Debentures - parent XXXXX

Interest on debentures received - parent XXXXX

…….. AND ITS SUBSIDIARY

…….. AND ITS SUBSIDIARY

…….. AND ITS SUBSIDIARY

Current assets XXXXXX

TOTAL ASSETS XXXXXXX

Total liabilities XXXXXX

Non-current liabilities XXXXXX

Current liabilities XXXXXX

TOTAL EQUITY AND LIABILITIES XXXXXXX

Elements of cash flow :

Schematic representation of Cash FLOW from operating activities

Cash APPLIED in investing activities

(previous year less current year) = negative or positive amount

(previous year less current year) = negative or positive amount

DIRECT & INDIRECT METHOD :

Investment to expand production capacity (XXX)

Proceeds from the sale of non-current assets XXX

Motor Vehicles (@ cost)

Accumulated Depreciation - Motor Vehicles

Accumulated Depreciation - Machinery

DIRECT & INDIRECT METHOD :

Cash flow from financing activities

Cash flow from investing activities

Investment to expand production capacity (XXX)