ACCA F7 Course Note by Mezbah Uddin

F7 FINANCIAL REPORTING (INT)
Primary objective of this document is to help students with regular revision. Students are strongly advised to study full text book chapters, regularly attend class lectures and participate in discussion sessions for better understanding.
Course Note
Prepared by:
Mezbah Uddin Ahmed, ACCA
F7 Financial Reporting (INT)
Contents
Exam structure...................................................................................................................................... 2 Examiner................................................................................................................................................ 2 Past question analysis ......................................................................................................................... 3 Course plan ........................................................................................................................................... 5 IAS 1 Presentation of Financial Statements .................................................................................... 7 IAS 16 Property, plant and equipment ............................................................................................ 13 IAS 23 Borrowing costs ..................................................................................................................... 17 IAS 40 Investment property .............................................................................................................. 20 IAS 20 Government grants ............................................................................................................... 23 IAS 38 Intangible assets ................................................................................................................... 26 IAS 36 Impairment of assets ............................................................................................................ 29 IAS 8 Accounting policies, changes in accounting estimates and errors .................................. 32 IAS 17 Leases..................................................................................................................................... 35 IAS 18 Revenue ................................................................................................................................. 40 IAS 2 Inventories ................................................................................................................................ 42 IAS 37 Provisions, contingent liabilities and contingent assets .................................................. 44 IFRS 5 Non-current assets held for sale and discontinued operations ..................................... 48 IAS 11 Construction contracts .......................................................................................................... 51 IAS 12 Income taxes .......................................................................................................................... 53 Financial instruments ......................................................................................................................... 61 Consolidated statement of financial position.................................................................................. 65 Consolidated statement of comprehensive income ...................................................................... 69 IAS 7 Statement of cash flows ......................................................................................................... 71 Ratio analysis ...................................................................................................................................... 77 IAS 33 Earnings per share ................................................................................................................ 87 Receivables factoring ........................................................................................................................ 94 IAS 10 Events after reporting period ............................................................................................... 99 Important definitions......................................................................................................................... 101
mezbah.ahmed@hotmail.co.uk
Page 1
F7 Financial Reporting (INT) Exam structure

5 Questions Question No. 1 2 3 4 5 Topic Consolidated financial statements Single company financial statements Cash flow statement &/ Ratios & interpretation of financial statements IFRS individual topic (one or two) IFRS individual topic (one or two) Marks 25 Marks 25 Marks 25 Marks 15 Marks 10 Marks
Examiner
The examiner is Steve Scott. Steve has many years experience in accounting lecturing at a leading UK university. He qualified as an accountant with Stott and Golland and his background is in Audit and Financial Reporting. He has been an ACCA examiner since 1998.
Page 2
F7 Financial Reporting (INT) Past question analysis
FRMRK Dec '07 Jun '08 Dec '08 Jun '09 Dec '09 Jun '10 Dec '10 Jun '11 Dec '11 Jun '12 Dec '07 Jun '08 Dec '08 Jun '09 Dec '09 Jun '10 Dec '10 Jun '11 Dec '11 Jun '12 5 IAS 16 2 (i) 2 (ii) 2 (i), 5 2 (i) 2 (vi), 3 (i) 2 (ii), 3 (i) 2 (iii), 4 (b-i) 2 (iii) 2 (ii) 2 (a-ii) IAS 37 Dec '07 Jun '08 Dec '08 Jun '09 Dec '09 Jun '10 Dec '10 Jun '11 Dec '11 Jun '12 2 (iii), 5 3 (iv) 2 (iii), 4 4 (a) 4 (a) 4 (a) 4 (a), 5 (a) 4 (a)
IAS 2
IAS 7
Ratios 3
IAS 8 5 (b) 2 (iv)
IAS 10
IAS 11
IAS 12 2 (ii) 2 (v, vi) 2 (v)
4 (b)
3 3 3 3 (a-ii) 3 3 3 (b) 3 3 3 3 3 2 (iii)
2 (ii)
2 (v) 2 (v)
2 (vi) 4 (a), 4 (b-ii) 5 2 (a-iii)
2 (v) 2 (v) 2 (iv), 2 (vi) 2 (a-iv)
IAS 17 4 (b)
IAS 18 2 (i)
IAS 20
IAS 23
IAS 32 2 (iii) 2 (iii), 3 (ii), 5 2 (iv)
IAS 33
IAS 36
2 (ii), 5 2 (vi), 3(ii), 4 (b-iii)
2 (i) 3 (i) 3 (i)
2 (iii) 2 (i) 4 (b) 5
2 (iv) 2 (iii), (iv), 3 (iii) 2 (i) 2 (ii) 2 (ii), (vi) 4 2 (b) 5
2 (i) 2 (a-ii) IAS 38 5 (b) 3 (i) IAS 40 IFRS 5 PASS RATE 40% 33% 42% 30% 1 (i), 3 (ii), 4 (b) 2 (ii) 39% 28% 47% 38% 56% 48%
2 (v) 4
Page 3
The secret of getting ahead is getting started. - Agatha Christie (British Novelist)
Page 4
F7 Financial Reporting (INT) Course plan
Class No.
Date
Syllabus Area Introduction to F7 IAS 1 Presentation of financial statements IAS 16 Property, plant and equipment IAS 16 Property, plant and equipment IAS 16 Property, plant and equipment IAS 23 Borrowing costs IAS 40 Investment properties IAS 20 Government grants IAS 38 Intangible assets (IFRS 3 Business combinations will cover later) IAS 36 Impairment of assets
BPP Text Book Ref.
Questions to Practice
Chapter 3 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 4 Chapter 5 16-Derringdo II, 96-Errsea 23-Dexterity, 24-Darby (except biii), 54-Peterlee II (a), 90-Shiplake (c) 20-Flightline, 25-Advent, 26Wilderness, 24-Derby (b-iii), Jun '12-Q4-Telepath 90-Shiplake (b, d), BPP text Q-8Multiplex 100-Tunshill, 22-Emerald, 30Partway (b-i), 57-Triangle (ii) 60-Branch, 61-Evans, 62-Bowtock, 63-Fino 27-Derringdo III, 30-Partway (b-ii), 57-Triangle (iv), 59-Wardle 17-Broadoak-a, c(i), 19-Dearing 18-Elite Leisure 17-Broadoak-b, c(ii), 55-Jedders (a) 21-Apex
2 3 4 5 6
Chapter 6
9 10
IAS 36 Impairment of assets IAS 8 Accounting policies, changes in accounting estimates and errors IAS 17 Leases IAS 17 Leases IAS 18 Revenue IAS 2 Inventories
Chapter 6 Chapter 7 Chapter 16 Chapter 16 Chapter 15 Chapter 12
11
IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IFRS 5 Non-current assets held for sale and discontinued operations IAS 11 Construction contracts IAS 12 Income taxes
Chapter 13
51-Bodyline (a, b, d), 53-Promoil, 54-Peterlee II (b), 57-Triangle (i, ii, iii), 58-Angelino (iii), 95-Atomic Power, Dec '11-Q4-Borough (a, b-i) 30-Partway (a) 101-Manco 48-Preparation question; 49-Linnet, 50-Beetie, June '11-Q5-Mocca 66-Bowtock II;
Chapter 13 Chapter 7 Chapter 12 Chapter 17
12
13 14
Page 5
15
IAS 12 Income taxes IAS 32 Financial instruments: presentation IAS 39, IFRS 9 Financial instruments: recognition and measurement IFRS 7 Financial instruments: disclosures
Chapter 17
64-Julian; 65-Deferred taxation
Chapter 14
54-Peterlee II, 55-Jedders (c), 56Pingway, Dec '11-Q5-Bertrand
16
17
Preparing single company accountants
6-Winger (IAS 18, 17, 16, 36, 38, 12), 7-Harrington (IAS 12, 16, Fin. Inst), 8-Llama (IAS 12, 16, Fin. Inst), 9-Tadeon (12, 17, Fin. Inst.), 10-Wellmay (IAS 18, 10, 37, 16, 40, 12, Fin. Inst), 11-Dexton (IAS 18, 16, 8, 12, Fin. Inst), 12-Candel (IAS 16, 38, 37, 12, Fin. Inst), 14Sandown (IAS 18, 12, 16, 36, 38, Fin. Inst), 29-Tourmalet (IAS 2, 12, 17, 16, 40, IFRS 5), 88-Tintagel (IAS 17, 16, 40, 18, 37, 12, Fin. Inst), 93-Kala (IAS 2, 12, 16, 40, 17), 98-Cavern (IAS 12, 16, 37, Fin. Inst.), 13-Pricewell (IAS 11, 16, 17, 18, 12, Fin. Inst), 15-Dune (IAS 16, 18, 12, 11, Fin. Inst, IFRS 5)
18 19
20
Consolidated Statement of Financial Position; Consolidated Statement of Comprehensive Income, IFRS 3 Business combinations, IAS 27 Consolidated and separate financial statements, IAS 28 Investment in associates IAS 7 Statement of cash flows
Chapter 5, 8, 9, 10, 11
All questions from Part-8, 9, 10 &11 of the BPP question bank
21 22 23 24 25 26
Chapter 21
All question from BPP question bank Part-21 70-Reactive, 71-Victular, 72Crosswire, 73-Harbin, 74-Breadline, 94-Greenwood, 99-Hardy, J-11Bengal, 67-Fenton, 68-Savoir, 69-Barstead, J-11-Q4-Rebound 55-Jedders (b), 58-Angelino (b-i), 28-Telenorth (note-c)
Ratios
Chapter 19
IAS 33 Earnings per share Receivables factoring IAS 10 Events after reporting period FINAL MOCK - I FINAL MOCK - II
Chapter 18 Chapter 15 Chapter 20
* Financial reporting is a core area of ACCA study. Experience shows that students with poor F7 performance struggle in P2 & P7, and also working as professional accountant. * Cherry picking of the syllabus areas shall never be a study strategy for ACCA. * In most cases overlapping IAS/IFRS knowledge required to solve a problem. So, frequent revision of previously learned IASs/IFRSs is mandatory.
Page 6
Optimism is the faith that leads to achievement. Nothing can be done without hope and confidence. - Helen Keller (author, political activist, lecturer, and first deaf-blind person to earn a Bachelor of Arts degree)
Page 7
F7 Financial Reporting (INT) IAS 1 Presentation of Financial Statements

XYZ plc Statement of Comprehensive Income for the year ended 31 December 20X9 Income Statement for the year ended 31 December 20X9 Revenue Cost of sales Gross profit Other income Distribution costs Administrative expenses Other expenses Profit/ (loss) from operations Finance costs Profit/ (loss) before tax Tax expense: Current + Deferred Profit/ (loss) for the year from continuing operations Profit/ (loss) for the year form discontinued operations Profit/ (loss) for the year Earnings per share: Basic Diluted $000 Profit/ (loss) for the year Other comprehensive income: Changes on revaluation Gain/ (loss) on re-measuring available for sale financial assets Tax relating to components of other comprehensive income Other comprehensive income for the year, net of tax Total comprehensive income for the year $000 X (X) X X (X) (X) (X) X/(X) (X) X (X) X/(X) X/(X) X/(X)
(single amount)
$X $X $000 X/(X)
X/(X) X/(X) X/(X) X/(X) X/(X)
IAS 1 allows Comprehensive Income to be presented in two ways: [IAS 1: 81] i. A single Statement of Comprehensive Income ii. Two separate statements as shown above IFRS do not specify whether revenue can be presented only as a single line item in the statement of comprehensive income, or whether an entity also may include the individual components of revenue (for example: various sub-totals for banks). Expenses can be classified by: [IAS 1: 99] Function: more common in practice (as the above statement) Nature (e.g. purchase of materials, depreciation, wages and salaries, transport costs) Finance income cannot be netted against finance costs; it is included in Other income or show separately in the income statement.
Page 8

Where finance income is an incidental income, it is acceptable to present finance income immediately before finance costs and include a sub-total of Net finance costs in the income statement. Where earning interest income is one of the entitys main line of business, it is presented as revenue.
Entities must prominently display: [IAS 1: 51] name of the reporting entity whether the statements are for a single entity or a group of entities date of the end of the reporting period, or the period covered presentation currency the level of rounding used in the preparation of the statements
XYZ plc Statement of Changes in Equity for the year ended 31 December 20X9 Ordinary share capital Opening balance Right issue or market price issue of ordinary share capital Bonus issue of ordinary share capital (if from SP) Bonus issue of ordinary share capital (if from RE) Dividend Profit/ (loss) after tax for the year Revaluation gain/ (loss) (IAS 16) Transfer of excess depreciation from RR to RE (IAS 16) Gain/(loss) from Y/end re-measurement of financial assets through other comprehensive income Closing balance (in SFP) X X Irredeemable preference share capital X Revaluati on reserve X Surplus from financial assets through OCI X
Share premium X X
Retained earnings X
(X)
(X) (X) X/(X) X/(X)
(X)
X/(X)
X/(X)
X/(X)
IAS 16 (PPE) permits and it is best practice to make a transfer between reserves of the excess depreciation arising as a result of revaluation. [IAS 1: 41] When an asset carrying using revaluation model is disposed, any remaining revaluation reserve relating to that asset is transferred directly to retained earnings. [IAS 1: 41] An entity can present components of changes in equity either in the Statement of Changes in Equity or in the notes to the financial statements. [IAS 1: 106]
Page 9

XYZ plc Statement of Financial Position as at 31 December 20X9 $000 ASSETS Non-current assets Property, plan and equipment Intangibles Deferred tax asset Long-term investments Current assets Inventories Trade and other receivables Short-term investments Current tax asset Cash and cash equivalents Held-for-sale non-current assets Total assets EQUITY AND LIABILITIES Equity attributable to owners of the parent Ordinary share capital Preference share capital (irredeemable) Share premium account Revaluation surplus Retained earnings
$000
X X X X X
X X X X X X X X X
X X X X X X
Non-current liabilities Preference share capital (redeemable) Finance lease liabilities (non-current portion) Deferred tax liability Long-term borrowings Current liabilities Trade and other payables Dividends payable Current tax liability Provisions Short-term borrowings Finance lease liabilities (current portion) Total equity and liabilities
X X X X X X X X X X X X X
Reserves other than share capital and retained earnings may be g rouped as other components of equity. Entities must present a set of previous years statements for comparison purposes.
Page 10

An (a) (b) (c) (d) entity shall classify an asset as current when: [IAS 1: 66] It expects to realise the asset, or intends to sell or consume it, in its normal operating cycle; It holds the asset primarily for the purpose of trading; It expects to realise the asset within twelve months after the reporting period; or The asset is cash or cash equivalents unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.
An (a) (b) (c) (d)
entity shall classify a liability as current when: [IAS 1: 69] It expects to settle the liability in its normal operating cycle; It holds the liability primarily for the purpose of trading; The liability is due to be settled within twelve months after the reporting period; or It does not have unconditional right to defer settlement of the liability for at least twelve months after the reporting period.
Page 11
Believe in yourself! Have faith in your abilities! Without a humble but reasonable confidence in your own powers you cannot be successful or happy. - Norman Vincent Peale (Author)
Page 12
F7 Financial Reporting (INT) IAS 16 Property, plant and equipment
An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected flow to the entity. Property, plant and equipment are tangible assets that: are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and are expected to be used during more than one period. Initial recognition: PPE should initially be recognised in an entity's statement of financial position at cost. Cost is the amount of cash and cash equivalents paid to acquire the asset at the time of its acquisition or construction PLUS the fair value of any other consideration given. Elements of Cost: Cost can include: Purchase price less any trade discount (not prompt payment discount) or rebate Import duties and non-refundable purchase taxes Directly attributable costs of bringing the asset to working condition for its intended use. Examples: Costs of site preparation Where these costs are Initial delivery and handling costs incurred over a period of time, Installation and assembly costs the period for which the costs Professional fees such as legal fees, architects fees can be included in the cost of Initial costs of testing that asset is functioning correctly PPE ends when the asset is (after deducting the net proceeds from selling any items ready for use, even if not produced) brought into use. The initial estimate of dismantling and removing the item and restoring the site where it is located if the entity is obliged to do so (to the extent it is recognised as a provision per IAS 37). Gains from the expected disposal of assets should not be taken into account in measuring a provision. In case of a land, if initial estimation of restoration cost is capitalised then this capitalised restoration cost shall be depreciated. Borrowing costs incurred in the construction of qualifying assets if in accordance with IAS 23 Borrowing costs. Any abnormal costs incurred by the entity, for example those arising from design errors, wastage or industrial disputes, should be expensed as they are incurred and do not form part of the capitalised cost of the PPE asset. Estimated economic life and residual value of asset should be reviewed at the end of each reporting period. If either changes significantly, the change should be accounted for over the useful economic life remaining. The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life. [IAS 16: 6]
Page 13

Subsequent expenditure only to be capitalised if enhances the life of the asset, or improves quality or quantity of output, or reduces the cost. If not capitalised then recognise as expense in I/S. Examples of subsequent expenditure to be capitalised can include: Modification of an item of plant to extend its useful life Upgrade of machine parts to improve the quality of output Adoption of a new production process, leading to large reductions in operating costs Where an asset is made up of many distinct (i.e. significant) parts (examples: aircraft, ship), these should be separately identified and depreciated. Major inspections or overhauls should be recognised as part of (i.e. increase) carrying amount of the item of PPE, assuming that this meets the recognition criteria. An example is where an aircraft is required to undergo a major inspection after so many flying hours. Without the inspection the aircraft would not be permitted to continue flying. As a separate component of PPE, the capitalised overhaul cost shall be depreciated over the period to next overhaul.
Measurement after initial recognition: After initially recognising an item of property, plant and equipment in its statement of financial position at cost, an entity has two choices about how it accounts for that item going forwards.
Cost model: Carrying asset at cost less accumulated depreciation and impairment losses Revaluation model: Carrying asset at revalued amount less subsequent accumulated depreciation and impairment losses
ASSET IS REVALUED
Upwards Has the asset previously suffered a downward valuation?
Downwards Has the asset previously suffered a upward valuation?
No
No
Yes
Recognise the increase as a revaluation surplus. (Other comprehensive income)
Recognise the decrease directly in profit or loss
Yes
Recognise the increase in profit or loss up to the value of the downward valuation. Any excess should be recognised as a revaluation surplus. (Other comprehensive income)
Recognise the decrease against the revaluation surplus up to the value of the upward valuation. Any excess should be recognised directly in profit or loss.
Page 14

Revaluation model: An entity can, if it chooses, revalue assets to their fair value (only if the fair value of the item can be measured reliably) For land and buildings this is normally determined based on their market values as determined by an appraisal undertaken by professionally qualified valuers. If this model is applied to one asset, it must also be applied to all other assets in the same class. Note that when the revaluation model is used PPE must still be depreciated. The revalued amount is depreciated over the asset's remaining useful life. For a revalued asset, IAS 16 allows (and encourage) a reserve transfer in the statement of changes in equity (from revaluation reserve to retained earnings) of the 'excess' depreciation because of an upward revaluation. Methods of depreciation: Straight line method Reducing balance method Machine hour method Sum-of-the-digits method
Sum of the years of assets expected life = N X (N+1)/2 where N is the assets expected life Cost of a lorry was $15,000 and expected to last for five years. No scrap value. Sum of the years of assets expected life = N X (N+1)/2 = 5 X (5+1)/2 = 15 Depreciation in Year 1 $15,000 X 5 /15 = $5,000 2 $15,000 X 4 /15 =$4,000 3 $15,000 X 3 /15 = $3,000 4 $15,000 X 2 /15 = $2,000 5 $15,000 X 1 /15 = $1,000
Derecognition: Property, plant and equipment shall be derecognised (i.e. removed from the statement of financial position) either: On disposal; or When no future economic benefits are expected from its use or disposal. The gain or loss arising from de-recognition is included in profit or loss. This gain or loss is calculated by comparing the sale proceeds to the asset's carrying amount. The gain or loss is calculated in the same way, regardless of whether the asset is revalued or not. Any gain should not be classified as part of the entity's revenue. If on disposal of a revalued asset there remains a balance on the revaluation surplus relating to the asset, this balance should be transferred to retained earnings.
Page 15
Sal (Salman) Khan, founder of Khan Academy, in MIT 2012 commencement address: '. . . Many of you will soon enter the outside world and be somewhat taken aback. It will be far less efficient, far less fair, far less productive, and far more political than what you may have imagined it to be. There will be pessimism and cynicism everywhere. It is easy to succumb to this, to become cynical or negative yourself. If you do, you with the potential that you have, it would be a loss for yourself and for humanity. To fight these forces of negativity, to increase the net positivity in the world, to optimize the happiness of yourself and the people you love, here are some tips and tools that I like to return to. . .
Start every morning with a smile even a forced one it

will make you happier. Replace the words I have to with I get to in your vocabulary. Smile with your mouth, your eyes, your ears, your face, your body at every living thing you see. Be a source of energy and optimism. Surround yourself with people that make you better. Realize or even rationalize that the grass is truly greener on your side of the fence. Just the belief that it is becomes a self-fulfilling prophecy . . . Remember that real success is maximizing your internally derived happiness. It will not come from external status or money or praise. It will come from a feeling of contribution. A feeling that you are using your gifts in the best way possible. . . '
Page 16
F7 Financial Reporting (INT) IAS 23 Borrowing costs
An entity shall capitalise (i.e. as part of the asset) borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the costs of that asset. [IAS 23: 8] Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds. [IAS 23: 5] A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. [IAS 23: 5]
Borrowing costs eligible for capitalisation are those that would have been avoided otherwise. [IAS 23: 10]
An entity shall cease capitalisation borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. [IAS 23: 22]
The commencement date for capitalisation: [IAS 23: 17] When the following three conditions are first met: Expenditures for the asset are being incurred Borrowing costs are being incurred, and Activities that are necessary to prepare the asset for its intended use are being undertaken. Borrowing cost of 9 Borrowing months (i.e. $75,000) cost of 12 Borrowing cost (i.e. interest to be capitalised as months (i.e. expense) of 3 months (i.e. $25,000) part of asset in $100,000) to to be recognised in Income Statement of Financial be recognised Statement under Finance Costs Position in I/S
01.01.12 - $1m loan @10% for 2 years
28.02.12 - Purchase order made to buy the asset
31.03.12 - Payment made to buy the asset
31.12.12 - Asset is delivered & ready to use
31.12.13 - Loan is matured and repaid
All three conditions are met at this point. Capitalisation is suspended if active development is interrupted for extended periods. (Temporary delays or technical/administrative work will not cause suspension). Interest income from deposit during this period is not deductible from capitalised borrowing cost since cost from this suspended period is not capitalised. [IAS 23: 21]
Page 17

Amount of borrowing costs available for capitalisation is actual borrowing costs incurred less any investment income from temporary investment of those borrowings. [IAS 23: 13]
On 1 January 20X6 Stremans Co borrowed $1.5m to finance the production of two assets, both of which were expected to take a year to build. Work started during 20X6. The loan facility was drawn down and incurred on 1 January 20X6, and was utilised as follows, with the remaining funds invested temporarily. Asset A Asset B $'000 $'000 1 January 20X6 250 500 1 July 20X6 250 500 The loan rate was 9% and Stremans Co can invest surplus funds at 7%. Required: Ignoring compound interest, calculate the borrowing costs which may be capitalised for each of the assets and consequently the cost of each asset as at 31 December 20X6. Asset A $ 45,000 (8,750) 36,250 500,000 36,250 536,250 Asset B $ 90,000 (17,500) 72,500 1,000,000 72,500 1,072,500
Borrowing costs: To 31 December 20X6 ($500,000/$1,000,000 9%) Less investment income: To 30 June 20X6 ($250,000/$500,000 7% 6/12) Costs capitalised as part of assets: Expenditure incurred Borrowing costs
For borrowings obtained generally, apply the capitalisation rate to the expenditure on the asset (weighted average borrowing cost). [IAS 23: 14]
Acruni Co had the following loans in place at the beginning and end of 20X6. 1 January 31 December 20X6 20X6 $m $m 10% Bank loan repayable 20X8 120 120 9.5% Bank loan repayable 20X9 80 80 8.9% debenture repayable 20X7 150 The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining equipment), construction of which began on 1 July 20X6. On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on 1 January 20X6, $20m on 1 October 20X6. Required: Calculate the borrowing costs that can be capitalised for the hydro-electric plant machine.
Capitalisation rate = weighted average rate = (10% (120/ (80 + 120))) + (9.5% (80 / (120 + 80))) = 9.8% Borrowing costs = ($30m 9.8%) + ($20m 9.8% 3/12) = $3.43m
Page 18
By failing to prepare, you are preparing to fail. - Benjamin Franklin (one of the Founding Fathers of the United States, author, printer, political theorist, politician, postmaster, scientist, musician, inventor, satirist, civic activist, statesman, and diplomat)
Page 19
F7 Financial Reporting (INT) IAS 40 Investment property

Investment property is a property (land or a building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both, rather than for: Use in the production or supply of goods or services or for administrative purposes; or Sale in the ordinary course of business. [IAS 40: 5] IAS 40 lists the following as examples of investment property: [IAS 40: 8] Land held for long-term capital appreciation rather than short-term sale in the ordinary course of business Land held for a currently undetermined future use A building owned by the entity (or held under a finance lease) and leased to a third party under operating lease A building which is vacant but is held to be leased out under an operating lease Property being constructed or developed for future use as an investment property (property constructed for sale is not investment property) Followings are outside the scope of IAS 40: [IAS 40: 9] Property intended for sale in the ordinary course of business: IAS 2 Inventories Property being constructed or developed on behalf of third parties: IAS 11 Construction Contracts Owner-occupied property, including property held for future use as owner-occupied: IAS 16 Property, Plant and Equipment Property occupied by employees whether or not the employees pay rent at market rates: IAS 16 PPE Property leased to another entity under a finance lease: IAS 17 Leases Points to note: If a portion of an asset meets investment property criteria and other portion is not, then an entity accounts for the portions separately (e.g. one portion under IAS 40 and another under IAS 16) if those portions could be sold separately or leased out separately under finance lease. [IAS 40: 10] Where an entity owns property that is leased to, and occupied by, its parent or another subsidiary, the property is treated as an investment property in the entity's own accounts. However, the property does not qualify as investment property in the consolidated financial statements as it is owner-occupied from the group perspective. [IAS 40: 15] Initial recognition and measurement: An investment property should be initially measured at cost (IAS 16s initial recognition rules applies). [IAS 40: 20]
Page 20

Measurement after recognition: After initial measurement at cost, an entity can choose between two models: [IAS 40: 30] The IAS 16 cost model The fair value model If the fair value model is adopted, the accounting treatment of investment properties will be as follows: All investment properties should be measured at fair value at the end of each reporting period provided fair value can be measured reliably. Changes in fair value, whether gains or losses, should be recognised in profit or loss for the period in which they arise. [IAS 40: 35] When determining fair value, do not deduct costs to sale from the fair value. [IAS 40: 37]
The policy chosen should be applied consistently to all of the entity's investment property IAS 40 encourages the assessment of fair value by independent, appropriately qualified and experienced professionals but does not require it.
Page 21
Laziness is a secret ingredient that goes into failure. But it's only kept a secret from the person who fails. Robert Half
Page 22
F7 Financial Reporting (INT) IAS 20 Government grants
An entity should not recognise government grants until it has reasonable assurance that: [IAS 20: 7] - The entity will comply with any conditions attached to the grant - The entity will actually receive the grant
Receiving the grant not necessarily prove that the conditions attached to it have been or will be fulfilled. The treatment will be same whether the grant is received in cash or given as a reduction in a liability to government. [IAS 20: 10]
Grants relating to assets: IAS 20 allows two alternatives: Option 1: Present the grant in the statement of financial position as deferred income and systematically recognise it in profit or loss over the asset's useful life. [IAS 20: 26] Option 2: Deduct the grant when arriving at the cost of the asset. The asset is included in SFP at cost minus the grant. Depreciate the net amount over the useful life of the asset. [IAS 20: 27]
Example: A company receives a grant from the EU for CU100,000 towards the cost of a new factory. The overall cost of the factory is CU1,000,000. It has a 50 year useful life and NIL residual value. The company's policy is to apply the straight-line method of depreciation. Option 1 At recognition: Statement of financial position Assets: Factory 1,000,000 Liabilities: Deferred income 100,000 At Year 1 end: Statement of financial position Assets: NCA Factory 1,000,000 Accumulated depreciation (20,000) 980,000 Liabilities: Deferred income 100,000 Income released in the year (2,000) 98,000 (Current liabilities 2,000; Non-current liabilities 96,000) Statement of comprehensive income Other income 2,000 Depreciation (20,000) Option 2 At recognition: Statement of financial position Assets: Factory (1,000,000 100,000)
900,000
At Year 1 end: Statement of financial position Assets: NCA Factory 900,000 Accumulated depreciation (18,000) 882,000
Statement of comprehensive income Depreciation (18,000)
Page 23

Government grant recognised as Deferred income (Option 1) needs to be amortised (i.e. recycled in I/S as Income) over the useful life of the asset. Grants relating to income: Such grants should be recognised in profit or loss as other income or deducted from the related expense. [IAS 20: 29] - As with grants related to assets, the benefit of the grant should be recognised in profit or loss over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate. A non-monetary asset (example: land, building, etc.) may be transferred by government to an entity as a grant. - The fair value of such an asset is usually assessed and this is used to account for both the asset and the grant. - Alternatively, both may be valued at a nominal (i.e. insignificant) amount. [IAS 20: 23]
Government grants that cannot reasonably have a value placed on them (for example the provision of free services by a government department) are excluded from the definition of government grants.
Repayment of government grant: If a grant must be repaid it should be accounted for as a revision of an accounting estimate (IAS 8). [IAS 20: 34] - Repayment of grant related to income: apply first against any unamortised deferred income set up in respect of the grant, any excess should be recognised immediately as an expense. [IAS 20: 32] - Repayment of a grant related to an asset: increase the carrying amount of the asset or reduce the deferred income balance by the amount repayable. The cumulative additional depreciation that would have been recognised to date in the absence of the grant should be immediately recognised as an expense. [IAS 20: 32] It is possible that the circumstances surrounding repayment may require a review of the asset value and an impairment of the new carrying amount of the asset. IAS 20 does not cover: [IAS 20: 2] - Accounting for government grants in financial statements reflecting the effects of changing prices - Government assistance given in the form of tax breaks - Government acting as part-owner of the entity
Page 24
Everybody is a genius. But, if you judge a fish by its ability to climb a tree, itll spend its whole life believing that it is stupid. Albert Einstein
Page 25
F7 Financial Reporting (INT) IAS 38 Intangible assets

An intangible asset is an identifiable non-monetary asset without physical substance. [IAS 38: 8] An asset is identifiable if it either: [IAS 38: 12] (a) is separable, i.e. is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or (b) arises from contractual or other legal rights, regardless of whether those rights are transferable or separable form the entity or from other rights and obligations. An asset is a resource controlled by the entity as a result of past event(s) and from which future economic benefits are expected to flow to the entity. [IAS 38: 8]
IAS 38 states that an intangible asset is to be recognised if, and only if, the following criteria are met: [IAS 38: 21] it is probable that future economic benefits from the asset will flow to the entity the cost of the asset can be reliably measured. At recognition the intangible should be recognised at cost. [IAS 38: 24] Examples of expenditures that are not part of the cost of an intangible asset are: [IAS 38: 29] Costs of advertising and promotional activities) [IAS 38: 69(c)] Costs of staff training [IAS 38: 67(c), 69(b)] Administration and other general overhead costs. After initial recognition an entity can choose between: [IAS 38: 72] the cost model, and the revaluation model: if an active market exists for that type of asset [IAS 38: 75] An active market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, because each such asset is unique and transactions are relatively infrequent. The price paid for one asset may not provide sufficient evidence of the fair value of another. Moreover, prices are often not available to the public. [IAS 38: 78] An intangible asset (other than goodwill) acquired as part of business combination should be recognised at fair value. [IAS 38: 33]
Purchased
Page 26

Research phase Research is original and planned investigation, undertaken with the prospect of gaining new scientific or technical knowledge and understanding. [IAS 38: 8] The result of research is unknown and, so, no probable future economic benefit can be expected IAS 38 states that all expenditure incurred at the research stage should be written off to the income statement as an expense when incurred [IAS 38: 54], and will never be capitalised as an intangible asset. [IAS 38: 71]
Internally generated
Development phase
An intangible asset arising from development must be capitalised if an entity can demonstrate all of the following criteria: [IAS 38: 57] the technical feasibility of completing the intangible asset (so that it will be available for use or sale) intention to complete and use or sell the asset ability to use or sell the asset existence of a market or, if to be used internally, the usefulness of the asset availability of adequate technical, financial, and other resources to complete the asset the cost of the asset can be measured reliably If any of the recognition criteria are not met then the expenditure must be charged to the income statement as incurred. If an entity cannot distinguish the research phase from the development phase, treat that as in the research phase. [IAs 38: 53] Each development project must be reviewed at the end of each accounting period to ensure that the recognition criteria are still met.
Internally generated goodwill should not be recognised as an asset. [IAS 38: 48] Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets. [IAS 38: 63] An intangible asset with a finite useful life should be amortised over its expected useful life [IAS 38: 89] An intangible asset with an indefinite life should not be amortised [IAS 38: 89], but should be reviewed for impairment on an annual basis [IAS 38: 108] There must be an annual review of whether the indefinite life assessment is still appropriate. [IAS 38: 109] Residual values should be assumed to be nil, except if an active market exists or there is a commitment by a third party to purchase the asset at the end of its useful life [IAS 38: 100] An active market is a market in which all the following conditions exist: (a) The items traded in the market are homogeneous (i.e. similar) (b) Willing buyers and sellers can normally be found at any time; and (c) Prices are available to the public.
Page 27
Throughout life people will make you mad, disrespect you and treat you bad. Let God deal with the things they do, cause hate in your heart will consume you too. - Will Smith
Page 28
F7 Financial Reporting (INT) IAS 36 Impairment of assets

An asset is impaired when its carrying amount is higher than its recoverable amount. [IAS 36: 6] Impairment loss = Carrying value Recoverable amount [IAS 36: 59] higher of
Fair value less costs to sell: - Value in a binding sale agreement less incremental costs directly attributable to the assets disposal. [IAS 36: 25]
Value in use: Based on cash-flow projections Cash flows should include expected disposal proceed. [IAS 36: 31(a)] Future cash flows shall be estimated for the asset in its current condition. Estimates of future cash flows shall not include estimated future cash inflows or outflows that are expected to arise from improving or enhancing the assets performance. [IAS 36: 44] Cash outflows to maintain the level of economic benefits from the asset in its current condition should be included (e.g. repair and replacement of parts). [IAS 36: 41]
Otherwise, the assets market price (where there is an active market), or amount obtainable in an arms length transaction (i.e. fair value), less costs of disposal. [IAS 36: 26]
Cash flows from financing activities or income tax receipts and payments should be excluded.
Recognition of impairment losses in financial statements: [IAS 36: 60, 61] Asset carried out at historical cost: in profit or loss. Revalued assets: first against any revaluation surplus relating to the asset and then (if amount left) in profit or loss. If no impairment loss then do nothing! After impairment review: the depreciation/amortisation should be adjusted for future periods. [IAS 36: 63] If goodwill is valued at fair value (in full) the non-controlling share of impairment will be allocated to non-controlling goodwill (i.e. will reduce NCI).
Where it is not possible to estimate the recoverable amount of an individual asset, the entity estimates the recoverable amount of the cash-generating unit to which it belongs. [IAS 36: 66] A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. [IAS 36: 68] If an active market exists for the output produced by an asset or a group of assets, this group of assets should be identified as a CGU even if some or all of the output is used internally. [IAS 36: 70] If the cash inflows are affected by internal transfer pricing, manag ements best estimate of future price that could be achieved in arms length transactions are used in estimating the CGUs value in use. [IAS 36: 70]
Impairment loss is allocated among the asset/CGU in the following order: [IAS 36: 104] 1. any individual asset that is specifically impaired 2. goodwill allocated to the CGU 3. other assets pro rata to their carrying amount in the CGU (subject of the carrying amount of an asset not being reduced below its individual recoverable amount. [IAS 36: 105]
Page 29

Reversal of past impairment: I/S: - An impairment loss reversal on property, plant and equipment first reverses the loss recorded in profit or loss (and any remainder is credited to the revaluation surplus, subject to IAS 16 requirements) [IAS 36: 119] SFP: - A reversal for a CGU is allocated to the assets of the CGU, except for goodwill, pro rata with the carrying amounts of those assets [IAS 36: 122]
Once recognised, impairment losses on goodwill are not reversed [IAS 36: 124]
In case of a reversal, the carrying amount of an asset must not increase above the lower of: - Its recoverable amount; and - Its depreciated carrying amount had no impairment loss originally been recognised. [IAS 36: 123]
Impairment indicators: The entity should look for evidence at the end of each period and conduct an impairment review on any asset where there is evidence of impairment. [IAS 36: 9] External indicators: [IAS 36: 12] Significant decline in market value of asset Significant change in technological, economic or legal environment Increased market interest rate; thus reducing value in use Carrying amount of net assets of the entity exceeds market capitalisation Internal indicators: [IAS 36: 12] Evidence of obsolescence or physical damage Significant changes with an adverse effect on the entity Evidence available that asset performance will be worse than expected.
Intangible assets with an indefinite useful life or not yet available for use, and goodwill acquired in business combination are subject to annual impairment test irrespective of whether there are indications of impairment. [IAS 36: 10]
Page 30
Being busy does not always mean real work. The object of all work is production or accomplishment and to either of these ends there must be forethought, system, planning, intelligence, and honest purpose, as well as perspiration. Seeming to do is not doing. - Thomas A. Edison
Page 31
F7 Financial Reporting (INT) IAS 8 Accounting policies, changes in accounting estimates and errors
Changes in accounting policies o o The same accounting policies are usually adopted from period to period, to allow users to analyse trends over time in profit, cash flows and financial position. Examples of accounting policies: o Alternative presentation of government grant (IAS 20) FIFO or Weighted average method of inventory valuation Fair value model of cost model for investment properties (IAS 40: 31)
A change in accounting policy must be applied retrospectively. Retrospective application means that the new accounting policy is applied to transactions and events as if it had always been in use. In other words, at the earliest date such transactions or events occurred, the policy is applied from that date. This involves restating opening balances of current year and comparative previous year.
From earliest date of same transaction (i.e. retrospective effect) - Unless impractical
On future transactions
Policy change date
Two types of event which do not constitute changes in accounting policy: (i) (ii) Adopting an accounting policy for a new type of transaction or event not dealt with previously by the entity. Adopting a new accounting policy for a transaction or event which has not occurred in the past or which was not material.
Changes in accounting policy will be very rare and should be made only if: The change is required by an IFRS, or The change will result in a more appropriate presentation of events or transactions in the financial statements of the entity, providing more reliable and relevant information.
Revaluation of non-current assets should not be treated as changes in accounting policy (i.e. no retrospective effect for revaluation).
Changes in accounting estimates o o Management applies judgement based on information available at the time Examples of accounting estimates: o Useful life or residual value of a non-current asset (IAS 16) Provision made for future loss or expenses (IAS 37)
A change in accounting estimate must be applied prospectively.
Changes in accounting estimate
Page 32

Errors: o Errors discovered during a current period which relate to a prior period may arise through: Mathematical mistakes Mistakes in the application of accounting policies Misinterpretation of facts Omissions Fraud o Prior period errors correct retrospectively. Either restating the comparative amounts for the prior period(s) in which the error occurred, or when the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for that period
Error/ fraud discovered
Page 33
Life is pretty simple: You do some stuff. Most fails. Some works. You do more of what works. If it works big, others quickly copy it. Then you do something else. The trick is the doing something else. - Leonardo da Vinci
Page 34
F7 Financial Reporting (INT) IAS 17 Leases

Operating lease: Any lease other than a finance lease. Treat this as normal rental agreement. Finance lease: A lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee (who took the lease). Title may or may not eventually be transferred. IAS 17 identifies five situations which would normally lead to a lease being classified as a finance lease: i. Transfer of ownership of the asset to the lessee at the end of the lease term ii. The lessee has the option to purchase the asset at a price sufficiently below fair value at the option exercise date, that it is reasonably certain the option will be exercised iii. The lease term is for a major part of the assets economic life even if title is not transferred at end of lease term iv. Present value of minimum lease payment amounts to substantially all of the assets fair value at inception Present value of minimum lease payments is the payments over the lease term that the lessee is required to make discounted applying implicit interest rate. v. The leased asset is so specialised that it could only be used by the lessee without major modifications being made
At commencement of a finance lease, leasee (i.e. user of the asset) recognises a Non-current asset and a Liability in Statement of financial position. The amount of non-current asset to be capitalized is Liability component comprises a current lower of: [IAS 17: 20] portion and a non-current portion; and - Present value of minimum lease payment, and amortised over the lease term. - Fair value of the leased asset In F7 using cash price (fair value) given in the question should be sufficient.
Non-current asset is subsequently depreciated over shorter of: Assets useful life, and Lease term including any secondary period use useful life if reasonable certainty exists that the lessee will obtain ownership (IAS 17: 27)
Example: Leasee accounting: Payment quarterly in advance On 1 October 20X3 Evans entered into a non-cancellable agreement whereby Evans would lease a new rocket booster. The terms of the agreement were that Evans would pay 26 rentals of $3,000 quarterly in advance commencing on 1 October 20X3, and that after this initial period Evans could continue, at its option, to use the rocket booster for a nominal rental which is not material. The cash price of this asset would have been $61,570 and the asset has a useful life of 10 years. Evans has a policy to charge full years depreciation in the year of purchase of a non-current asset. The rate of interest implicit in the lease is 2% per quarter. Required: Identify whether this is a finance lease and show how these transactions would be reflected in the financial statements for the year ended 31 December 20X3.
Page 35

Answer: Though the lease term is only 6.5 years ((26 quarter X 3)/ 12 months), the lease assumed to be a finance lease because the present value of the minimum lease payment is similar to the fair value of the leased asset. Present value of the minimum lease payment: $ st 1 instalment (in advance, so already at present value) 3,000 nd th Present value 2 26 installment ($3,000 X 19.5234) (25 years annuity at 2%) 58,570 61,570 And, fair value of the lease asset at commencement of the lease (Cash price) 61,570 Leaseee accounting: Income statement for the year ending 31 Dec 20X3 Depreciation Finance cost (6,157) (1,171) Statement of financial position as at 31 Dec 20X3 Non-current assets: Leased assets At lease commencement (@01 Oct 20X3) st Accumulated depreciation (1 year) Carrying value Liabilities: Non-current liabilities: Finance lease Current liabilities: Finance lease
61,570 (6,157) 55,413
51,033 8,708
Lease amortization schedule: Y/ending 31 Dec 20X3 Quarter 1 $ Opening liability 61,570 Instalment in (3,000) advance 58,570 Interest @ 2% 1,171 (I/S) Closing liability 59,741 (SFP)
31 Dec 20X4 2 $ 59,741 (3,000) 56,741 1,135 57,876 3 $ 57,876 (3,000) 54,876 1,098 55,974 4 $ 55,974 (3,000) 52,974 1,059 54,033 5 $ 54,033 (3,000) 51,033 1,020 52,053
Current portion of total closing liability will be calculated as: (Total instalment payable within next one year Total interest expense charge before last instalment in the next year) = ($3,000 + $3,000 + $3,000 + $3,000) ($1,135 + $1,098 + $1,059) = $8,708
Non-current portion of total closing liability will be calculated as: Total closing liability Current portion of the liability = $59,741 - $8,708 = $51,033
Page 36

Example: Leasee accounting: Payment annually in arrears Branch acquired an item of plant and equipment on a finance lease on 1 January 20X1. The terms of the agreement were as follows: Deposit : $1,150 (non-refundable) Instalments : $4,000 per annum for seven years payable in arrears Cash price : $20,000 (Fair value of the lease asset at commencement of the lease) The asset has useful life of four years and the interest rate implicit in the lease is 11%. Required: Prepare extracts from the income statement and statement of the financial position of Branch for the year ending 31 December 20X1. Answer: It is assumed that fair value of the leased asset and present value of minimum lease payments are same at the commencement of the lease. Income statement for the year ending 31 Dec 20X1 Depreciation Finance cost (5,000) (2,074) Statement of financial position as at 31 Dec 20X1 Non-current assets: Leased assets At lease commencement (@01 January 20X1) st Accumulated depreciation (1 year) (20,000/4) Carrying value Liabilities: Non-current liabilities: Finance lease Current liabilities: Finance lease
20,000 (5,000) 15,000
14,786 2,138
Lease amortization schedule: Y/ending Opening liability Initial non-refundable deposit Interest @ 11% (I/S) Instalment in arrears Closing liability (SFP)
31 Dec 20X1 $ 20,000 (1,150) 18,850 2,074 (4,000) 16,924
31 Dec 20X2 $ 16,924 1,862 (4,000) 14,786
Current portion of total closing liability will be calculated as: (Total instalment payable within next one year Total interest expense charge before last instalment in the next year) = ($4,000 $1,862) = $2,138
Page 37

Example: Leasee accounting: Complex Bowtock has leased an item of plant. Commencement of the lease was 1 January 20X2 and term of the lease is 5 years. Payments of $12,000 to be made annually in advance. Cash price and fair value of the asset - $52,000 at 1 January 20X2 equivalent to the present value of the minimum lease payments. Implicit interest rate within the lease 8% per annum. The companys depreciation policy for this type of plant is 20% per annum on cost (apportioned on a time basis where relevant). Required: Prepare extracts of the income statement and statement of financial position for Bowtock for the year to 30 September 20X3 for the above lease. Answer: Leaseee accounting: Income statement for the year ending 30 September 20X3 Depreciation Finance cost (800+1,872) (10,400) (2,672) Statement of financial position as at 30 September 20X3 Non-current assets: Leased assets At lease commencement (@01 January 52,000 20X2) Accumulated depreciation: (7,800) st 1 year9 months (52,000X20%)X(9/12) nd 2 year full year (52,000X20%) (10,400) Carrying value 33,800 Liabilities: Non-current liabilities: Finance lease Current liabilities: Finance lease
21,696 1,376
Lease amortization schedule: Point to note: lease year runs from 01 Jan to 31 Dec, but accounting year runs from 01 Oct to 30 Sept. Accounting year ending 30 Sep 20X2 30 Sep 20X3 30 Sep 20X4 $ $ $ Opening liability 52,000 42,400 33,072 Interest @ 8% (I/S) remaining 3 months of the lease year ((40,000X8%)X3/12) 800 ((31,200X8%)X3/12) 624 Instalment in advance (1 Jan) (12,000) (12,000) (12,000) 40,000 31,200 21,696 Interest @ 8% (I/S) 9 months ((40,000X8%)X9/12) 2,400 ((31,200X8%)X9/12) 1,872 ((21,696X8%)X9/12) 1,302 Closing liability (SFP) 42,400 33,072 22,998
Current portion of total closing liability will be calculated as: (Total instalment payable within next one year Total interest expense charge before last instalment in the next year) = ($12,000 $624) = $11,376
Page 38
People who say it cannot be done should not interrupt those who are doing it. - George Bernard Shaw
Page 39
F7 Financial Reporting (INT) IAS 18 Revenue

Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. [Framework: 4.25(a)] Revenue is income that arises in the course of ordinary activities of an entity. [IAS 18: Objectives]
Income
Revenue
From sale of goods should only be recognised when all of the five criteria are met: [IAS 18: 14] It is probable that future economic benefits will flow to the entity. The amount of revenue can be measured reliably. The costs incurred in relation to the transaction can be reliably measured. The seller no longer has management involvement or effective control of the goods. The seller must have transferred to the buyer all of the significant risks and rewards of ownership.
From rendering of services should only be recognised when all of the four criteria are met: [IAS 18: 20] It is probable that future economic benefits will flow to the entity. The amount of revenue can be measured reliably. The costs incurred and the costs to complete in relation to the transaction can be reliably measured. The stage of completion can be measured reliably.
Seller transfer significant risks and rewards: - In most cases the transfer of significant risks and rewards of ownership coincides with the transfer of legal title or the passing of possession to the buyer.
Where consideration (e.g. money) from sales is received but above revenue recognition criteria are not met: DR Asset: Cash CR Liability: Deferred income When revenue recognition criteria are met: DR Liability: Deferred income CR I/S: Revenue/Income
Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value added taxes are not part of revenue. [IAS 18: 8] In an agency relationship, for an agent, revenue is only the amount of his commission. [IAS 18: 8] In certain circumstances, it is necessary to apply the revenue recognition criteria to the separately identifiable components of a single transaction in order to reflect the substance of the transaction. For example, when the selling price of a product includes an identifiable amount for subsequent servicing, that amount is deferred and recognised as revenue over the period during which the service is performed. [IAS 18: 13] In some cases two or more transactions are considered together. For example, an entity may sell goods and, at the same time, enter into a separate agreement to repurchase the goods at a later date. This sale and repurchase agreement may constitute a secured loan and recognised as loan liability instead of sales revenue. [IAS 18: 13]
Page 40
It is no use saying, 'We are doing our best.' You have got to succeed in doing what is necessary. - Winston Churchill
Page 41
F7 Financial Reporting (INT) IAS 2 Inventories

-
Inventories are assets: held for sale in the ordinary course of business; in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Inventories needs to be valued lower of: Cost Net Realisable Value (NRV) Cost of conversion Costs directly related to the units of production (e.g. direct materials, direct labours) + Fixed and variable production overheads incurred in converting materials to finished goods, allocated on a systematic basis + Borrowing costs (if met IAS 23 criteria) Estimated selling price in the ordinary course of business, when completed Estimated costs to completion and the estimated costs necessary to make the sale.
Cost of purchase Suppliers gross price for raw materials + Import duties, etc + Costs of transporting materials to business premises Trade discounts
Costs should not include: Abnormal waste, finished goods storage, unrelated administrative overheads Write-down to NRV: If inventories are write-down to their NRV, this will result closing inventory with lower carrying value, which will have automatic effect on cost of sales (i.e. cost of sales will be increased). IAS 2 does not apply to inventories covered by other standards, such as: Work in progress under construction contracts (IAS 11 Construction contracts)
Page 42
What is success? I think it is a mixture of having a flair for the thing that you are doing; knowing that it is not enough, that you have got to have hard work and a certain sense of purpose. - Margaret Thatcher
Page 43
F7 Financial Reporting (INT) IAS 37 Provisions, contingent liabilities and contingent assets
Provision: is a liability where there is uncertainty over its timing or the amount at which it will be settled. A provision should be recognised where: i.e. established past practice An entity has a present obligation (legal or constructive) as a result of a past event; It is probable (i.e. more likely than not) that there will be an outflow of resources in the form of cash or other assets; and A reliable estimate can be made of the amount [IAS 37: 10]
A provision should not be recognised in respect of future operating losses since there is no present obligation arising from a past event. [IAS 37: 63]
An entity can be required to recognise a provision and capitalise (DR Non-current asset: Property, plant & equipment; CR Liability: Provision) initial estimation of future dismantling and restoration cost if above provision recognition criteria and IAS 16 capitalisation criteria are met. [IAS 16: 16, 18] Gains from the expected disposal of assets shall not be taken into account in measuring a provision. [IAS 37: 51] If an entity sells goods with a warranty, a provision recognition (DR I/S: Expense; CR Liability: Provision) can be required based on the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. [IAS 37: 36] When the selling price includes an identifiable (i.e. distinguishable) amount for subsequent servicing, that amount is deferred (DR Asset: Cash/ Receivable; CR Liability: Deferred income) and recognised as revenue over the period during which the service is performed (DR Liability: Deferred income; CR I/S: Revenue). [IAS 18: 13] Where the provision being measured involves a large population of items, the obligation is estimated by expected value calculation. [IAS 37: 39] Restructuring costs: A constructive obligation, requiring a provision, only arises in respect of restructuring costs where the following criteria are met: A detailed formal plan has been made, identifying the areas of the business and number of employees affected with an estimate of likely costs an timescales; and An announcement has been made to those who will e affected by the restructuring. A restructuring provision does not include costs of retraining or relocating continuing staff, marketing, or investment in new systems [IAS 37: 81]
Page 44

Discounting to present value: When there is a significant period of time between the end of reporting period and settlement of the obligation, the amount of provision should be discounted to present value. [IAS 37: 45] -n Discount factor: (1+r) The discount rate shall be a pre-tax rate that reflects current market assessment of the time value of money and the risks specific to the liability. Example: If a provision of $1,000 is required to settle a liability after 2 years; at 10% discount rate the provision will be recognised at Year-0 is $827 ($1,000 X 0.827). Unwinding of discount: When a provision is included in the statement of financial position at a discount value (i.e. at present value) the amount of the provision will increase over time, to reflect the passage of time. Unwinding of discount will be included in the finance cost. Unwinding of discount (i.e. the amount to be charged in finance cost and by the amount the provision needs to be increased) can be found by applying discount rate on opening balance of the provision. At end of Year-1: $83 ($827X10%); DR I/S: Finance cost; CR Liability: Provision (that makes closing provision liability = $910 ($827+$83)) At end of Year-2: $91 ($910X10%); DR I/S: Finance cost; CR Liability: Provision (that makes closing provision liability = $1,000 ($910+$91)) Reimbursement: An entity may be entitled to reimbursement from a third party for all or part of the expenditure required to settle a provision. Such a reimbursement: Should only be recognised (DR Assets: Receivable; CR I/S: Other income) where receipt is virtually certain, and Should be treated as a separate asset in the statement of financial position (i.e. not netted off against the provision) at an amount no greater than that provision. The provision and the amount recognised for reimbursement may be netted off in the I/S. [IAS 37: 53]
Contingent liability: is a possible obligation that arises from past events and whose existence will be confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Contingent liability is not recognised in the financial statements because either it is not probable, or the amount cannot be measured with sufficient reliability. Contingent liability is only disclosed in the notes of financial statements. [IAS 37: 10, 13]
Page 45

Contingent asset: is a possible asset that arises from past events and whose existence will be confirmed only by occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. A contingent asset should not be recognised in the financial statements Contingent assets should only be disclosed in the notes of financial statements when the expected inflow of economic benefits is probable. [IAS 37: 31, 34] When the realisation of income is virtually certain, then the related receivable is recognised in the financial statements (DR Asset: Receivable; CR I/S: Other income) [IAS 37: 33] Asset or income receivable because of past event
Probable Yes Reliable estimate Yes Disclosure as contingent asset
No No Do nothing (i.e. do not recognise or disclose in the FSs.
Virtually certain Yes Recognise in financial statements (DR Asset: Receivable; CR I/S: Other income
Disclosure let out: IAS 37 permits reporting entities to avoid disclosure requirements relating to provisions, contingent liabilities and contingent assets if they would be expected to be seriously prejudicial (i.e. will cause serious disadvantage) to the position of the entity in dispute with other parties.
Page 46
I have been impressed with the urgency of doing. Knowing is not enough; we must apply. Being willing is not enough; we must do. - Leonardo da Vinci
Page 47
F7 Financial Reporting (INT) IFRS 5 Non-current assets held for sale and discontinued operations
A group of assets and liabilities that will be disposed of in a single transaction are referred to as disposal group. Held for sale: An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. [IFRS 5: 6] To be classified as held for sale, the following conditions must be met: Available for immediate sale in present condition [IFRS 5: 7]. Sale is highly probable [IFRS 5: 8]. The asset's current condition should be adequate to be effectively sold as seen.
For a sale to be highly probable, the following must apply: Management must be committed to a plan to sell the asset There must be an active programme to locate a buyer The asset must be marketed for sale at a price that is reasonable in relation to its current fair value The sale should be expected to take place within one year from the date of classification [IFRS 5: 8].
Once an asset or group of assets and related liabilities is classified as held for sale, the following rules should be followed: Fair value less cost to sell is equivalent to net realisable value Carry at lower of its carrying amount and fair value less cost to sell, which may give rise to an impairment loss [IFRS 5: 15]. . . . can include transport costs and costs to advertise that the asset is This is an exception to the normal IAS 36 rule. IAS 36 available for sale impairment of assets requires an entity to recognise an impairment loss only when an assets recoverable amount is lower than its carrying amount. Do not depreciate even if still being used by the entity. [IFRS 5: 1] Present separately in the statement of financial position. [IFRS 5: 1] Non-current asset held for sale recognise under current asset. [IFRS 5: 3]
Presentation of a non-current asset or a disposal group classified as held for sale: [IFRS 5: 38] Non-current assets and disposal groups classified as held for sale should be presented separately from other assets in the statements of financial position. The liabilities of a disposal group should be presented separately from other liabilities in the statement of financial position. Assets and liabilities held for sale should not be offset. The major classes of assets and liabilities held for sale should be separately disclosed either on the face of the statement of financial position or in the notes. On ultimate disposal of an asset classified as held for sale, any difference between its carrying amount and the disposal proceeds is treated as a loss or gain recognised in income statement. A non-current asset or disposal group that is no longer classified as held for sale (for example, because the sale has not taken place within one year) is measured at the lower of: [IFRS 5: 27] Its carrying amount before it was classified as held for sale, adjusted for any depreciation that would have been charged had the asset not been held for sale. Its recoverable amount at the date of the decision not to sell.
Page 48

An asset that is to be abandoned should not be classified as held for sale. [IFRS 5: 13] operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. [IFRS 5: 31]
Discounted operation:
Discontinued operation is a component of an entity that has either been disposed of, or is classified as held for sale, and: represents a separate major line of business or geographical area of operations is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations, or is a subsidiary acquired exclusively with a view to resale. [IFRS 5: 32] For discontinued operations, an entity should disclose a single amount in the statement of comprehensive income comprising the total of: [IFRS 5: 33] The post-tax profit or loss from discontinued operations; and The post-tax gain or loss on the re-measurement to fair value less costs to sell or on the disposal of the discontinued operation. An entity should also disclose an analysis of the above single amount either on the face of the statement of comprehensive income or in the notes. An entity shall disclose the amount of income from continuing operations and from discontinuing operations attributable to owners of the parent. An entity should also disclose the net cash flows attributable to the operating, investing and financing activities of discontinued operations. These disclosures may be presented either on the face of the statement of cash flows or in the notes.
Gains and losses on the re-measurement of a non-current asset or disposal group that is not a discontinued operation but is held for sale should be included in profit or loss from continuing operations. [IFRS 5: 37] XYZ plc - Consolidated statement of comprehensive income for the year ended 31 December 20X9 $000 Revenue X Cost of sales (X) Gross profit X Other income X Distribution costs (X) Administrative expenses (X) Other expenses (X) Profit/ (loss) from operations X/(X) Finance costs (X) Share of profit/(loss) of associates X/(X) Profit/ (loss) before tax X Income tax expense (X) PROFIT/ (LOSS) FOR THE YEAR FROM CONTINUING OPERATIONS X/(X) PROFIT/ (LOSS) FOR THE YEAR FORM DISCONTINUED OPERATIONS (SINGLE AMOUNT) X/(X) Profit/ (loss) for the year X/(X)
Page 49
I don't pity any man who does hard work worth doing. I admire him. I pity the creature who does not work, at whichever end of the social scale he may regard himself as being. - Theodore Roosevelt
Page 50
F7 Financial Reporting (INT) IAS 11 Construction contracts

Revenue and cost: should be recognised according to the stage of completion of the contract at the end of the reporting period, but only when the outcome of the activity can be estimated reliably. Either, proportion of total contract costs incurred for work carried out to date Or, physical proportion of the contract work completed Probable that economic benefit of the contract will flow to the entity. Costs and revenue can be identified clearly and be reliably measured.
When outcome of the contract cannot be reliably estimated: - Revenue: Only recognise revenue to the extent of contract costs incurred which are expected to be recoverable - Cost: Recognise contract costs as an expense in the period they are incurred Contract costs which cannot be recovered should be recognised as an expense straight away. If a loss is predicted (i.e. the contract value < total contract cost) on a contract then it should be recognised immediately in I/S. Costs incurred to date + costs will be incurred Costs that should be EXCLUDED from construction contract costs: - General administration costs (unless reimbursement is specified to the contract) - Selling costs - Research and development (unless reimbursement is specified to the contract) - Depreciation of idle plant and equipment not used on in the contract Penalty charged by client (may be for delay) will reduce the revenue; will not increase the cost. Finance costs should be included in contract costs under IAS 23 Borrowing Costs.
Accounting treatments: Income Statement: Revenue ((Total contract value X % completed) Revenue recognised in previous periods ) Cost of sales ((Total contract costs X % completed) Costs and losses charged in previous periods) Foreseeable loss not previously recognised (ALWAYS test for foreseeable loss) (((Total contract value Total contract cost) X % yet to complete) Any of this loss previously recognised) Profit/(loss) (before non-reimbursable abnormal cost) Abnormal cost (e.g. rectification cost which is not reimbursed by client) Net profit/(loss)
(X)
(X)
X/(X) (X) X/(X)
(Any rectification cost which will be reimbursed by client will increase both total contract value and total contract costs) Statement of financial position: Contract costs incurred to date Profits/(losses) recognised to date (before deducting non-reimbursable abnormal cost) Progress billing to date Receivables / (payables) (current asset/liability)
X X/(X) X (X) X/(X)
Page 51
Moral excellence comes about as a result of habit. We become just by doing just acts, temperate by doing temperate acts, brave by doing brave acts. - Aristotle
Page 52
F7 Financial Reporting (INT) IAS 12 Income taxes

Tax Income tax If 15% sales tax applicable on sales made by Company T; the accounting for $100 sales will be: DR SFP: Cash 115 CR I/S: Revenue 100 CR SFP: Current liability: Sales tax payable 15 (Because as per IAS 18, revenue cannot be recognised for the amount ($15) collected on behalf of others (i.e. sales tax collected on behalf of government). If 15% sales tax applicable on purchases made by Company T and if the sales taxes paid by Company T is recoverable; the accounting for $80 purchase will be:
DR Purchase 80 DR SFP: Current asset: Sales tax recoverable 12 (or, DR SFP: Current liability: Sales tax payable, if there is already a sales tax payable balance) CR SFP: Cash 92
Sales tax Also known as VAT (value added tax). Seller collect sales tax at the point of sale and the purchaser pays sales tax at the point of purchase.
Deferred tax
Also known as current tax. This is the tax on taxable profit (NOT on accounting profit). Companies prepare profit or loss account based on accounting standards; but taxable profit is calculated based on tax rules. If taxable profit for the year is $100 (accounting profit can be different) and applicable tax rate is 30%; then the accounting treatment will be:
DR I/S: Expense: Income tax CR SFP: Current liability: Tax payable (If tax is paid as incurred; then CR SFP: Cash) 30 30
If there is a tax loss for the year is $100; then the accounting treatment will be:
DR SFP: Current asset: Tax recoverable (or, DR SFP: Current liability: Tax payable, if there is already a tax payable balance) CR I/S: Income tax (will reduce expenses) 30
30
If sales tax paid by Company T on purchase is NOT recoverable; the accounting for $80 purchase will be: DR Purchase CR SFP: Cash 92 92
Under-provision or over-provision of tax: The actual tax liability for the year and the tax charge in the income statement are not necessarily the same amount. The actual tax liability for the year is agreed with tax authorities, may be, in a later year. If tax charge in Year-1 on Year-1 taxable profit is $100 and in Year-2 the actual tax charge for Year-1 determined $120; then the tax charge for Year-2 will be increased by $20 (this is the under-provision made in Year-1). I.e. if tax charge in Year-2 on Year-2 taxable profit is $150, the tax expense amount in Year-2 I/S will be $150+$20=$170. o An over-provision of tax from year 1 is deducted from total tax charge for year 2. o The other side of the double entry is an adjustment to the current tax liability.
Page 53

Deferred tax: This is an accounting measure rather than a tax levied by government; it represents tax payable or recoverable in future accounting periods in relation to transactions which have already taken place. Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either taxable or deductible. Taxable temporary differences will result in taxable amounts in determining taxable profit (loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Deferred tax liabilities: are the amounts of income taxes payable in future periods in respect of taxable temporary differences. DR Tax charge CR SFP: Non-current liabilities: Deferred tax liability Deductible temporary differences will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset is recovered or settled. Deferred tax assets: are the amounts of income taxes recoverable in future periods in respect of deductible temporary differences (and in respect of the carry forward of unused tax losses or tax credits). DR SFP: Non-current assets: Deferred tax asset CR Tax charge Recognise deferred tax (that is the difference between the opening and closing deferred tax balances in the SFP) normally in profit or loss. But, exceptions are: - Deferred tax relating to items dealt with as other comprehensive income (such as revaluation) should be recognised as tax relating to other comprehensive income within the statement of comprehensive income - Deferred tax relating to items dealt with directly in equity (such as the correction of an error or retrospective application of a change in accounting policy) should also be recognised directly in equity Steps to follow in determining deferred tax balances: o Step 1: Determine the items carrying amount (i.e. book value; i.e. SFP value) and tax base value as at year beginning and year end. o Step 2: Calculate the temporary difference (i.e. difference between carrying value and tax base value) at year beginning and at year end. - Temporary difference will be either taxable temporary difference or deductible tempo rary difference. Check the decision tree below. - In the question sometime the temporary differences are given. In that case you dont need to apply Step 1. Step 3: Apply tax rate on temporary differences to identify deferred tax asset or liability at year beginning and at year end. - The deferred tax asset or liability identified from year end balances is the amount to be shown in Statement of Financial Position. - The movement from year beginning deferred tax asset or liability to year end deferred tax asset or liability to be shown in I/S (in other comprehensive income if the portion related to revaluation). Expense: Asset Liability Income: Asset Liability
Page 54
The tax rate to be used in the calculation for determining a deferred tax asset or liability is the rate that is expected to apply when the asset is realised, or the liability is settled.
Temporary differences
For asset: Tax base value < Carrying amount For liability: Tax base > Carrying amount Taxable temporary differences Deferred tax liability
Tax base = Carrying amount
For asset: Tax base value > Carrying amount For liability: Tax base value < Carrying amount
No deferred tax implications
Deductible temporary differences Deferred tax asset
The most important temporary difference is that between depreciation charged in the financial statements and capital allowances in the tax computation. In practice capital allowances tend to be higher than depreciation charges, resulting in accounting profits being higher than taxable profits. This means that the actual tax charge (current tax) is too low in comparison with accounting profits. However, these differences even out over the life of an asset, and so at some point in the future the accounting profits will be lower than the taxable profits, resulting in a relatively high current tax charge. These differences are misleading for investors who value companies on the basis of their post-tax profits (by using EPS for example). Deferred tax adjusts the reported tax expense for these differences. As a result the reported tax expense (the current tax plus the deferred tax) will be comparable to the reported profits, and in the statement of financial position a provision is built up for the expected increase in the tax charge in the future. There are different ways that deferred tax could be calculated. IAS 12 states that the balance sheet liability method should be used. [IAS 12: IN2]
Page 55

Question: Company 'T' buys equipment for $50,000 and depreciates it on a straight line basis over its expected useful life of five years (i.e. @20%). For tax purposes, the equipment is depreciated at 25% per annum on a straight line basis (i.e. will be fully depreciated at end of Year-4). Accounting profit before tax is $5,000 for each of Year 1 to 5. The tax rate is 40%. Show current and deferred tax impacts from Year 1 to 5. Answer: Current tax calculation: (background workings) Year Accounting profit before tax Add-back: Accounting depreciation (since not deductible by tax rules) (50,000X20%) Less: Tax depreciation (50,000X25%) Taxable profit Current tax expense @ 40% on taxable profit (DR I/S: Expense: Current tax)
1 $ 5,000 10,000
2 $ 5,000 10,000
3 $ 5,000 10,000
4 $ 5,000 10,000
5 $ 5,000 10,000
(12,500) 2,500 (1,000)
(12,500) 2,500 (1,000)
(12,500) 2,500 (1,000)
(12,500) 2,500 (1,000)
15,000 (6,000)
Temporary difference: (background workings) Year Asset's carrying value (i.e. book value) (Cost - Accumulated accounting depreciation) Asset's tax base value (Cost - Accumulated tax depreciation) Taxable temporary difference (since asset's carrying value is higher than the tax base value) Deferred tax liability: (background workings) (since taxable temporary difference results deferred tax liability) Year
1 $ 40,000
2 $ 30,000
3 $ 20,000
4 $ 10,000
5 $ 0
37,500
25,000
12,500
2,500
5,000
7,500
10,000
1 $ 0 1,000
2 $ 1,000 2,000
3 $ 2,000 3,000
4 $ 3,000 4,000
5 $ 4,000 -
Opening liability Closing liability (in SFP under Non-current liabilities) (Apply tax rate of 40% on temporary difference) Liability (increase)/decrease Income: Asset Liability
(1,000)
(1,000)
(1,000)
(1,000)
4,000
Expense: Asset Liability
I/S: For the year ending (part of FS presented) Profit before tax Tax expense: Current tax Deferred tax Profit after tax
1 $ 5,000
2 $ 5,000
3 $ 5,000
4 $ 5,000
5 $ 5,000
(1,000) (1,000) 3,000
(1,000) (1,000) 3,000
(1,000) (1,000) 3,000
(1,000) (1,000) 3,000
(6,000) 4,000 3,000
Page 56

Determining tax base of assets: o The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits are not taxable, the tax base of the asset is equal to its carrying amount. [IAS 12: 7] o Putting above into a formula: Tax base = Carrying amount Future taxable amounts + Future deductible amounts For depreciable assets Future taxable amounts are equal to carrying amounts. Carrying amount $ 5,400 Future taxable amounts $ (5,400) Future deductible amounts $ 3,500 Tax base $ 3,500 Note
Plant & equipment costing $10,000 has a carrying amount of $5,400; accumulated tax depreciation of $6,500 already deducted. Interest receivable has a carrying amount of $1,000. The related interest revenue will be taxed on a cash basis. Trade receivables have a carrying amount of $1,000. The related revenue has already been included in taxable profit. Dividends receivables have a carrying amount of $1,000. The dividends are not taxable. A loan receivable has a carrying amount of $1,000. The repayment of the loan will have no tax consequences. Note:
1,000
(1,000)
Nil
Nil
1,000
Nil
Nil
1,000
1,000 1,000
Nil Nil
Nil Nil
1,000 1,000
4 5
1. - Future taxable amount considered as equivalent to the Carrying amount since the economic benefit (e.g. operations of the business which will generate income) from using the P&E yet to be taxable. - Future deductible amount is $3,500 since $6,500 already claimed as tax depreciation in taxable profit calculation. $3,500 will be deductible in the future periods taxable profit calculation. 2. - The amount will be taxable on cash basis; i.e. when the cash will be received in the future. So, the whole $1,000 amount is Future taxable amount. - The amount will never be deductible in taxable profit calculation. So, Nil Future deductible amount. 3. - The amount already been taxed; so will not be taxed further. That is why Future taxable amount is Nil. - The amount will never be deductible in taxable profit calculation. So, Nil Future deductible amount. 4. The amount not taxable and not deductible in the future. So, Future taxable amount and Future deductible amount both are Nil. 5. The amount will not be taxed or deductible in the future. So, both of the values are Nil.
Page 57

Determining tax base of liabilities: o The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods. [IAS 12: 8]
Putting this into a formula: Tax base = Carrying amount + Future taxable amount* Future deductible amount *Exception applies for unearned revenue (i.e. revenue received in advance) (see following Note-2) Carrying amount $ 1,000 Future taxable amounts $ Nil Future deductible amounts $ (1,000) Tax base $ Nil Note
Current liabilities include accrued expenses with a carrying amount of $1,000. The related expense will be deducted for tax purposes on a cash basis. Current liabilities include interest revenue received in advance, with a carrying amount of $10,000. The related interest revenue was taxed on a cash basis. Current liabilities include accrued fines and penalties with a carrying amount of $100. Fines and penalties are not deductible for tax purposes. A loan payable has a carrying amount of $1,000. The repayment of the loan will have no tax consequences. Note:
10,000
(10,000)
Nil
Nil
100
Nil
Nil
100
1,000
Nil
Nil
1,000
1. - The related expense will be deducted for tax purposes on a cash basis. Since the amount yet to be paid, the $1,000 will be Future deductible amount. - The amount is an expense, so will not the taxable in the future. 2. - The amount is charged for tax on cash basis. Since the cash is already received, the amount is already taxed and will not be taxed again. That is why Future taxable amount is taken as a negative figure, instead of positive (as given in the formula). This is exception to the general formula, but in compliance with IAS 12 requirements. - Alternative way of calculating Tax base of Unearned revenue is: Carrying amount Amount that will not be taxable in the future. Thus the calculation will be: 10,000 - 10,000 = Nil 3. The amount will not be deductible, or chargeable for tax purposes. 4. The amount will not be deductible, or chargeable for tax purposes.
Page 58
Page 59
You never achieve success unless you like what you are doing. - Dale Carnegie
Page 60
F7 Financial Reporting (INT) Financial instruments

Four standards on financial instruments: o IAS 32 Financial instruments: Presentation IAS 32 deals with classification of financial instruments between liabilities and equity, and presentation of certain compound instruments o IFRS 7 Financial instruments: Disclosures IFRS 7 revised, simplified and incorporated disclosure requirements previously in IAS 32 o IAS 39 Financial instruments: Recognition and measurement IAS 39 deals with recognition, derecognition and measurement of financial instruments and hedge accounting o IFRS 9 Financial instruments IFRS 9 is a work in progress and will replace IAS 39. It will come into force for accounting periods ending in 2013. Financial instruments A financial instrument is any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. A financial asset is any asset that is: (a) cash (b) an equity instrument of another entity; or (c) a contractual right to receive cash or another financial asset from another entity; .... Examples: Companys equity share A financial liability is any liability that is: (a) a contractual obligation: (i) to deliver cash or another financial asset to another entity, .... An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.
Examples: - Cash and timed deposits - Trade and loan receivables - Investments in shares issued by other entities (typically below 20%)
Examples: Trade payables Loans and redeemable preference shares Bank overdraft
own
Example 1: Accounting for a liability using amortised cost Giles issues a debt instrument at discount of $500 and is redeemed at a premium of $1,075 (i.e. total of $11,075). Nominal value of the instrument is $10,000 and redeemable in two years. Coupon rate is 2% and effective rate is 10%. Opening balance Year 1 9,500 (10,000-500) Year 2 10,250 Charge in I/S @ 10% 950 (9,500X10%) 1,025 Cash flow (200) (10,000X2%) (200) Y/end balance (SFP) 10,250 11,075
If there was a issue cost of $500, instead of initial $500 discount, the result would have been same.
Page 61

Compound financial instruments: A compound or hybrid financial instrument is one that contains both a liability component and an equity component. As an example, an issuer of a convertible bond has: The obligation to pay annual interest and eventually repay the capital the liability component The possibility of issuing equity, should bondholders choose the conversion option the equity component. In substance the issue of such a bond is the same as issuing separately a non-convertible bond and an option to purchase shares. At the date of issue the components of such instruments should be classified separately according to their substance. This is often called split accounting. The amount received on the issue (net of any issue expense) should be allocated between the separate components as follows: The fair value of the liability component should be measured at the present value of the periodic interest payments and the eventual capital repayment assuming the bond is redeemed. The present value should be discounted at the market rate for an instrument of comparable credit status and the same cash flows but without the conversion option. The fair value of the equity component should be measured as the remainder of the net proceeds.
On 1 January 20X7 an entity issued 10,000 6% convertible bonds at a par value of 100. Each bond is redeemable at par or convertible into four shares on 31 December 20X8. Interest is payable annually in arrears. The market rate of interest for similar debt without the conversion option is 8%. Year 20X7 20X8 Total liability component Total proceeds (10,000 100) Equity element Cash flow 60,000 1,060,000 Discount factor 0.9259 0.8573 Will be given in Q Present value 55,554 908,738 964,292 1,000,000 35,708
The subsequent accounting for the liability component should be as follows: Year 20X7 20X8 Opening balance 964,292 981,435 Interest expense (8%) 77,143 78,515 Closing balance 981,435 Amount 999,950 will be in SFP: The amount should have been Liabilities 1,000,000. The mismatch is
due to decimal places of the Discount factor used. (not incorrect in exam!)
Interest paid (60,000) (60,000)
Will be charged in I/S as Finance cost
The actual interest payment; will reduce cash in SFP
If on 31 December 20X8 all the bond holders elect to convert into equity, then the 1 million liability should be reclassified to equity, making 1,035,708 in total. The double entry should be: DR Financial liability 1 million CR Equity 1 million If none of the bonds are of converted to equity, the liability 1 million will be rate extinguished by the Note that the rate interest on the convertible will of be lower than the of interest on the cash repayment. However, the amount already included in equity of 35,708 should remain there. comparable instrument without the convertibility option, because of the value of the option to acquire The double entry should be: equity. DR Financial liability 1 million CR Cash 1 million Note that the rate of interest on the convertible will be lower than the rate of interest on the comparable instrument without the convertibility option, because of the value of the option to acquire equity.
Page 62

Equity Share capital Ordinary share capital - This represents the face value of total issued share. - To identify number shares in issue, divide total share capital by face value per share. Irredeemable preference share Treat this preference share as equity, and recognise dividend paid to irredeemable preference shareholders in Statement of changes in Equity as distribution of retained earnings. Preference share Share premium - This represents the additional amount than the face value collected on issue of ordinary share. - If face value is $1 of per ordinary share and $1.2 collected on issue of per 1,000 share: DR Cash 1,200 CR Share capital 1,000 CR Share premium 200 Reserves Retained earnings - Generally, this is amount accumulated from year-onyear undistributed (i.e. retained) profit after tax. - Profit after tax can be distributed to ordinary shareholders and irredeemable preference shareholders. Revaluation reserves - This is the amount derived from IAS 16 Property, plant and equipment revaluation.
Redeemable preference share - Treat this preference share as liability in SFP. - Recognise dividend paid to Redeemable preference shareholders as Finance cost in I/S (i.e. do not recognise in Statement of changes in equity).
Convertible preference share - This is also known as compound or hybrid financial instrument. - It has liability component and equity component. (see compound instrument note)
Non-cumulative - Dividend will be due only when it is declared. But, ordinary shareholders typically cannot get dividend before preference shareholders. - Ordinary shares and, generally, Irredeemable preference shares are non-cumulative.
Cumulative - Dividend will be due irrespective of declaration during the year. - Typically redeemable and convertible preference shares are cumulative.
Page 63
Half of the harm that is done in this world is due to people who want to feel important. They don't mean to do harm. But the harm does not interest them. - T. S. Eliot
Page 64
F7 Financial Reporting (INT) Consolidated statement of financial position

Different types of investment and required accounting: CRITERIA Control (> 50% rule) REQUIRED TREATMENT IN GROUP ACCOUNTS Full consolidation, i.e. single entity IAS 27 Consolidated and Separate Financial Statements IFRS 3 Business Combinations IFRS 10 Consolidated Financial Statements Equity accounting IAS 28 Investment in Associates and Joint Ventures Proportionate consolidation or equity accounting IAS 28 Investment in Associates and Joint Ventures IFRS 11 Joint Arrangements As for single company accounts (IFRS 9: Financial instruments) Present assets or group of assets separately in Statement of Financial Position and results of discontinued operations to be presented separately in the Statement of Comprehensive Income.
INVESTMENT Subsidiary
Associate
Significant influence (50% > 20% rule) Contractual agreement
Joint venture (jointly controlled entity)
Investments which is none of the above Investments held for sale (IFRS 5: NonCurrent Asset Held for Sale and Discontinued Operations)
Asset held for accretion (i.e. increase) of wealth Sale is highly probable + rule
Investments in Subsidiary: Control achieved by owning more than 50% voting power. But, control can still exist with less than 50% voting power. When parent has: Power over more than 50% of the voting rights by virtue of agreement with other investors. The power to govern the financial and operating policies of the entity by statue or under an agreement. - The power to appoint or remove a majority of members of the board of directors. - The power to cast a majority of votes at meetings of the board of directors. Parent should cease to consolidate an entity which was a subsidiary when control is lost. Control may be lost even without changing the ownership levels; when subsidiary becomes subject to control of a government, court administration or regulator. -
Exemptions from preparing group accounts: A parent need not present consolidated financial statements if ALL of the following conditions are satisfied: It is a wholly-owned subsidiary or a partially-owned subsidiary of another entity and its other owners have not objected to the parent not presenting consolidated financial statements Its securities are not publicly traded It is not in the process of issuing securities in public securities markets The ultimate or intermediate parent publishes consolidated financial statements that comply with IFRS Different reporting dates: If a subsidiarys reporting date is different then parent and bulk of other subsidiaries in the group: the subsidiary may prepare another set of financial statements OR, if it is not possible, the subsidiarys accounts may still be used provided that the gap is not more than three months and adjustments are made to reflect significant transactions or other events. Differing accounting policies: Uniform accounting policies should be used. Adjustments should be made where accounting policies of subsidiary differ from parent.
Page 65

1) GROUP STRUCTURE: Parent 50% + (control) Subsidiary 2) NET ASSETS AT FAIR VALUE AT THE DATE OF: Subsidiary Acq. Y/end $ $ X X X / (X) X X X / (X) X X X / (X) X X (X) X / (X) (X) / X X Associate Acq. Y/end $ $ X X X / (X) X X X / (X) X X X / (X) X X X / (X) (X) / X X 20% + (significant influence) Associate
Share capital Reserves: Retained earnings: credit/(debit) balance Share premium Other reserves (e.g. revaluation) Unrealised profit when subsidiary sales to parent Fair value adjustments FV adj. Post-acquisition depreciation (cumulative effect from acq. to y/e) Total Post-acquisition reserve (difference between Acq. & Y/end) 3) COST OF INVESTMENT:
Cash consideration Acquisition date fair value of other consideration (e.g. acquisition date market value of shares given by parent to subsidiary) Contingent and deferred consideration (converted into PV n applying (1+r) )
Subsidiary $ X X X X
Associate $ X X X X
Do not include costs like professional fees, legal fees in the cost of investment; these must be recognised in the Profit or Loss account as expense as incurred. Also, in cost of investment do not include loan issued to subsidiary. Any contingent consideration payable must be included even at the date of acquisition if it is not deemed probable that it will be paid It is possible that the FV of the contingent consideration may change after the acquisition date. If it is due to additional information obtained that affects the position at acquisition date, goodwill should be remeasured (one year qualifying period applies). If the change is due to events after the acquisition date (such as earnings target met) then the goodwill will not be remeasured (gain/loss from remeasurement will be recognised in I/S)
4) GOODWILL: i) New method: When examiner will require to use the new method, he will mention full, gross, new, or calculate NCI at fair value. In this case FV of NCI (value of shares not acquired) at acquisition date will be given. ii) Old method: Where an exam question requires use of the old method, it will state that it is group policy to value the non-controlling interest at its proportionate share of the fair value of the subsidiarys identifiable net assets.
Page 66

New method Cost of investment (W-3) FV of NCI at acquisition (value of share not purchased)(given in question) Less: FV of net assets of subsidiary at acquisition date (W-2) Goodwill at acquisition Impairment of goodwill to year end (acquisition date to year-end) Goodwill at year end in SFP Old method Cost of investment (W-3) Non-controlling share of net asset at aqc. (NCI% X NA @ FV @ Acq.) (W-2) Less: Total net assets of subsidiary at acquisition date (W-2) Goodwill at acquisition Impairment of goodwill to year end (acquisition date to year-end) Goodwill at year end in SFP Subsidiary $ $ X X (X) X (X) X Subsidiary $ $ X X (X) X (X) X
5) NON-CONTROLLING INTEREST (NCI) IN SUBSIDIARY: New method FV of NCI at acquisition (value of share not purchased) (given in question) NC% X Post-acquisition reserve (W-2) NC% of Goodwill impairment to date NCI at Y/end in SFP Subsidiary $ X X (X) X
Old method Non-controlling share of net asset at aqc. (NCI% X NA @ FV @ Acq.) (W-2) NC% X Post-acquisition reserve (W-2) NCI at Y/end in SFP NCI is not applicable for associates.
Subsidiary $ X X X
6) CONSOLIDATED RESERVE: Parents reserves (Share premium, Retained earnings, Revaluation reserve) at reporting date (100%) Group share of post-acquisition reserve of: Subsidiary: Acquisition % X Post-acquisition reserve (W2) Associate: Acquisition % X Post-acquisition reserve (W2) Unrealised profit - when parent sales to subsidiary Unrealised profit when there is a transaction with associate (Group % X Unrealised profit) Unwinding of discounting of deferred/ contingent consideration (W-3) Goodwill impairment to date (Acq. to Y/end): Subsidiary: take only the G% of impairment if goodwill is calculated applying new method Associate Reserve in SFP $ X / (X)
X / (X) X / (X) (X) (X) (X)
(X) (X) X
Page 67

7) INVESTMENT IN ASSOCIATE: $ X X / (X) (X) (X) X
Cost of investment in Associate (W-3) Group share of post-acquisition reserve of Associate (G% X Post-acquisition reserve) (W2) Unrealised profit - when Parent or Subsidiary sales to Associate (G% X Unrealised profit) Impairment of Associate to date Investment in Associate in SFP
P Group Consolidated statement of financial position as at 31.XX.XXXX $ ASSETS Non-current assets Property, plant and equipments (Parent + Sub +/- FV adj. (W2)) Intangible assets (Parent + Sub +/-FV adj. (W-2) Goodwill (W-4) Investment in Associate (W-7) Other investments (excluding investment in Sub & Asso) Current assets Cash & bank (Parent + Sub) Receivables (Parent + Sub - Inter-company receivables) Closing inventory (Parent + Sub - Unrealised profit from transaction with Sub - G% of Unrealised profit if Associate sales to Parent/Sub) (W-2/W-6) Total assets EQUITY AND LIABILITIES Equity Share capital (only parent's) Reserves (W-6) Non-controlling interest (W-5) Non-current liabilities (Parent + Sub - Inter-company loan) Current liabilities Bank overdraft (Parent + Sub) Payables (Parent + Sub - Inter-company payables) Deferred/contingent consideration after unwinding (W-3) Total equity and liabilities X X X X X X X X X X X X X X X X X X X X X $
Page 68
F7 Financial Reporting (INT) Consolidated statement of comprehensive income

P Group Consolidated statement of comprehensive income for the year ending 31.XX.XX Subsidiar Associat Parent y e $ $ $ Revenue Cost of sales Unrealised profit in closing inventory Gross profit Operating expenses Dep. from FV adj. Goodwill impairment during the year (sub) Investment income Dividend from subsidiary (parent's portion) Profit before interest & tax Finance cost (e.g. Interest expense) Profit before tax Tax Group share of Associate's profit after tax Impairment of Associate during the year Consolidated net profit X Other comprehensive income Total comprehensive income X Net profit attributable to: Non-controlling interests (Total of sub's column X NC%) (X ) Parent (balancing figure) Net profit Total comprehensive income attributable to: 5 Non-controlling interests (Total of sub's column X NC%) (X ) Parent (balancing figure) Total comprehensive income
4 5 4 Group share
Adj. $ (X) X
1 1
Total $ X (X) (X) X (X) (X)/X (X)
X (X) (X) (X) (X) X (X) (X) (X)

Old 2
X (X) (X) (X) (X)/X (X) X

New 2
(X)
X (X) X
(X) (X) X (X)
(X) X (X) X X (X) X
X X
X X X
X X X
* If subsidiary is acquired part way through the year then all income and expenses of subsidiary shall be time apportioned X : Transaction value of inter-company trading (i.e. the total selling price in inter-company trading) 2 X : Who is the seller? (only deduct the unrealised profit) 3 X : Interest on inter-company loan
1
Page 69
Our greatest weakness lies in giving up. The most certain way to succeed is always to try just one more time. - Thomas A. Edison (Inventor)
Page 70
F7 Financial Reporting (INT) IAS 7 Statement of cash flows

XYZ Co. Statement of cash flows for the year ending 31.XX.XXXX $ NET CASH FLOW FROM OPERATING ACTIVITIES Indirect method Profit before tax (after interest) Adjustments for: Finance cost (Interest expense) for the year (amount charged in I/S ) Depreciation and amortisation for the year (amount charged in I/S) (W-4/5) (Gain)/loss on disposal of non-current asset (amount recognised in I/S) (W-7) (Gain)/loss on revaluation of investment properties (IAS 40) (amount recognised in I/S) Income from investment properties (amount recognised in I/S) Investment income (e.g. interest/ dividend income) (amount recognised in I/S) Operating cash flow before working capital changes (Increase)/decrease in receivables (from last year to current year's SFP balance) (Increase)/decrease in inventories (from last year to current year's SFP balance) Increase/(decrease) in payables (from last year to current year's SFP balance) Cash generated from operations Interest paid (W-1) Income tax paid (W-2) Dividend paid* (W-11) Net cash generated/ (used) from / (for) operating activities Direct method Cash receipts from customers (W-13) Operating cash outflows (e.g. payment to suppliers & employees) (W-14) Cash generated from operations Interest paid (W-1) Income tax paid (W-2) Net cash generated/ (used) from / (for) operating activities CASH FLOWS FROM INVESTING ACTIVITIES Purchase of Non-current assets (W-3/5) Development expenditure during the year (W-8) Proceeds from sale of Non-current assets (W-7) Income from investment properties (excluding revaluation gain & non-cash income) Interest received Divided received Net cash generated/ (used) from/ (in) investing activities CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from issue of shares (W-12) Proceeds from issue of loan-notes (increase from last year to current years SFP balance) Repayment of loan-notes (decrease from last year to current years SFP balance) Payment of finance lease liabilities (W-9) Dividend paid* (W-11) X X (X) (X) (X) (X) (X) X X X X X/(X) X (X) X (X) (X) X/(X) X X (X)/X (X)/X (X) (X) X (X)/X (X)/X X/(X) X (X) (X) (X) X/(X) X $
Page 71

Net cash generated/ (used) from/ (in) financing activities Net increase/ (decrease) in cash and cash equivalents **Cash and cash equivalents at beginning of the period (from last year's SFP) (including bank overdraft & short-term investments) **Cash and cash equivalents at end of the period (agrees with current year's SFP) (including bank overdraft & short-term investments) *Dividend payment can be either in Operating Activities or in Financing Activities. **Cash and cash equivalents includes Banks asset balance and overdraft balance and short -term deposits (short-term deposits are normally for less than 3 months). Workings-1 Interest payable Payment during the year (balancing figure) C/f (from current year's SFP) X X X Workings-2 Tax payable B/f - Asset (from last year's SFP): Current Deferred Credit (similar to income) for the year (I/S): Current Deferred Payment during the year (balancing figure) C/f - Liability (from current year's SFP): Current Deferred X X X Workings-3 Property, plant and equipment: Cost B/f (from last year's SFP or other information) Revaluation gain during the year Finance lease: Asset Purchase (i.e. addition during the year) X X X X X Disposal Revaluation loss during the year Accumulated dep. with revalued NCA on revaluation C/f (from current year's SFP or other information) X X X X X X X X X X B/f - Liability (from last year's SFP): Current Deferred Charge for the year (I/S): Current Deferred Received during the year (balancing figure) C/f - Asset (from current year's SFP): Current Deferred X X X B/f (from last year's SFP) Charge for the year (I/S) X X X X/(X) X/(X) X/(X) X/(X)
X X
X X X
Page 72

Workings-4 Property, plant and equipment: Accumulated depreciation Acc. Dep. with disposed NCA on disposal Acc. Dep. with revalued NCA on revaluation c/f (from current year's SFP or other information) X X X X Workings-5 Property, plant and equipment: Net book value B/f (from last year's SFP) Revaluation gain during the year Finance lease: Asset Purchase (i.e. addition during the year) X X X X X Workings-7 Profit/ (loss) on disposal of PPE = Disposal proceed Carrying value at disposal date Carrying value at disposal date = Cost Accumulated depreciation at disposal date Workings-8 Development expenditure: NBV B/f (from last year's SFP) Expenditure incurred during the year X X X Workings-9 Finance lease: Liability B/f - Liability (from last year's SFP): Payment during the year (balancing figure) X Current Non-current C/f - Liability (from current year's SFP): Current Non-current X X X X New finance lease X Amortisation charge for the year (I/S) C/f (from current year's SFP) X X X Disposal (NBV at disposal date) Revaluation loss during the year Depreciation charge (I/S) C/f (from current year's SFP) X X X X Depreciation charge for the year X X b/f (from last years SFP or other information) X
X X
Page 73

Workings-10 Government grant B/f - Liability (from last year's SFP): X Current Non-current C/f - Liability (from current year's SFP): Current Non-current X X X Workings-11 Retained earnings Bonus share issue from retained earnings X B/f (from last year's SFP) Profit for the year (I/S) Dividend paid C/f (from current year's SFP) X X X Extra depreciation transfer from revaluation reserve (IAS 16) C/f (from current year's SFP) X X X X New grant in the year X
Grant released during the year (I/S)
X X
Opening retained earnings Profit for the year Extra depreciation transfer from revaluation reserve (IAS 16) Bonus share issue from retained earnings Dividend payment (balancing figure) Closing retained earnings
X X X (X) (X) (X)
Workings-12 Share capital and share premium account B/f (from last year's SFP): Bonus share issue from share premium C/f (from current year's SFP): Share capital Share premium X Share capital Share premium Bonus issue X X X Share issue for cash X X X X X
Page 74

Workings-13 Receivables B/f (from last year's SFP) Sales revenue for the year X X X Cash received from customers C/f (from current year's SFP) X X X
Workings-14 Payables Cash payment during the year X B/f (from last year's SFP) Purchase during the year (W15) Other operating expenses for the year excluding depreciation, profit/loss on disposal, investment income, interest expense & tax X X
C/f (from current year's SFP)
X Workings-15 Inventory B/f (from last year's SFP) Purchase during the year X X X Cost of sales: Inventory C/f (from current year's SFP)
X X X
****The formats are not comprehensive. All information in the formats may not be required in every situation. It is very important to understand the underlying concept than mere memorising the format.
Page 75
The keys to life are running and reading. When you're running, there's a little person that talks to you and says, Oh I'm tired. My lung's about to pop. I'm so hurt. There's no way I can possibly continue. You want to quit. If you learn how to defeat that person when you're running, you will know how to not quit when things get hard in your life. For reading: there
have been gazillions of people that have lived before all of us.
There's no new problem you could have . . . There's no new problem that someone hasn't already had and written about it in a book. Will Smith
Page 76
F7 Financial Reporting (INT) Ratio analysis

Income Statement for the year ending X.X.X: Sales/Revenue/Turnover X Less: Cost of Sales (X) Gross profit X Less: Expenses (X) Operating profit X Less: Finance cost/Interest expense (X) Profit before tax (PBT) X Less: Tax (X) Profit after tax (PAT)/Profit for the year/Net profit X Less: Preference (irredeemable) dividend (X) Profit attributable to ordinary shareholders X Less: Ordinary dividend (X) Retained profit for the year X Balance Sheet/Statement of Financial Position as at X.X.X: Assets: Non-current assets X Current assets: Cash X Receivables X Closing Inventory X X Total assets X of Statement In Changes in Equity Shareholders capital: Ordinary share capital Reserves Preference share capital* Long-term liabilities Current liabilities
X X X X X X X
*Redeemable preference share capital will be treated as a long-term liability. In that case its dividend will be treated as interest (Finance cost in Income Statement).
LIQUIDITY RATIOS: Liquidity ratio measures a company's ability to pay short-term obligations 1. Current ratio = o o o o
Current Asset Current Lia ilities
X:1
o o
Current ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A current ratio of 1.5:1 to 2:1 can mean sufficient current asset to cover its current liabilities. A current ratio of above 2:1 may mean over investment in working capital (i.e. in current assets). Surplus assets can be used to - to expand the business operation or to increase capacity which will earn additional profit, - to repay debt which will save interest expenses, - distribute to shareholders as dividend. A current ratio below 1 suggests that the company would be unable to pay off all of its current liabilities if they came due at that point. Current ratio can be improved by - selling of unused non-current assets, - taking long-term loan, - speeding up the receivables collection, - slowing payables payment A weak current ratio shows that the company is not in good financial health, but it does not necessarily mean that it will go bankrupt as there are many ways to access financing; but it is definitely not a good sign. Companies that have trouble getting paid by its receivables or have long inventory turnover can run into liquidity problems
Page 77

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

Profit EFORE Interest and Tax Capital Employed
X 100% = X%
o o
Capital employed = Total asset Current liabilities = Share capital + Reserves + Long-term liabilities Deferred Tax Liability or Asset normally excluded from Capital Employed. In that case, Capital employed = Total asset Current liabilities Deferred tax liability or asset = Share capital + Reserves + Long-term liabilities Deferred tax liability or asset Current Liability portion of Long-term liabilities; and a constant amount of Overdraft normally also considered as Non-current liability for Capital employed calculation (Opening + Closing Better to use average Capital Employed 2 where possible. If you are required to compare ratios between two different years and cannot calculate average for both of the years, then take only the SFP value of the year (i.e. do not average). This is for comparability purpose. If market value of equity is taken then do not include Reserves. There is a lot other contexts to define capital employed. This is basically the capital required for a business to function.
o o o
o o
o o
ROCE is the prime measure of operating performance. This ratio indicates how efficiently a business (i.e. managers) is using the funds invested (equity and long-term debt). It is the ratio over which operations management has most control. ROCE increase from previous year or above industry average means a good sign and reflects the fact that the company (by managers) has managed to increase the sales without a proportionate increase in costs. ROCE decrease from previous year or below industry average shows problem with controlling of costs. Level of dividend may also fall as a consequence. The value of capital employed is lower where company mainly uses rented assets (i.e. thorough operating lease) rather owning or finance lease. This is also possible where assets carrying value is lot less than the cost (remember in that case assets will need replacement). These may result a higher ROCE. Asset revaluation (especially land) will result a higher amount of Capital employed, which will give a lower ROCE without indicating company performance became poorer. ROCE should always be higher than the rate at which the company borrows; otherwise any increase in borrowing will reduce shareholders' earnings.
Page 78

2. Return on equity (ROE), or Return on Shareholders Capital (ROSC)
Profit AFTER Tax and Preference Dividend Ordinary Share Capital and Reserve
X 100% = X%
o o o
Profit after tax and preference dividend is the Profit attributable to ordinary shareholders It is common to use book values rather market value of shares (if market value used then remember to exclude Reserves) Better to use average of Shareholders Capital (Opening + Closing Ordinary Share Capital and Reserves 2 where possible; specially, when closing balance significantly differs from opening balance. - If you are required to compare ratios between two different years and cannot calculate average for both of the years, then take only the SFP value of the year (i.e. do not average). This is for comparability purpose.
o o o o o
Return on equity (ROE) indicates to ordinary shareholders how well their investments have performed measuring how much profit the company has generated for them with their money. A good figure results in a high share price and makes it easy to attract new funds. With a similar level of ROCE, a fall in ROE may mean increased finance cost because of new loans. An improved ROE with a similar ROCE may mean some of the loans are repaid which resulted a lower finance cost and, so, improved profit attributable to ordinary shareholders. If new share issued sometime at period end, this may result a declined ROE without indicating poor performance of the company because company really did not get time to utilise the new capital.
3. Gross profit margin = o
Gross Profit Sales
X 100% = X%
High gross profit margin may indicate effective purchasing strategy which results a lower material &/ production cost (i.e. lower cost of sales). A high gross profit margin may also indicate concentration on low volume-high margin sales. Low gross profit margin may be an indication of selling products cheaply (i.e. at discount) in order to generate high volume of sales. This may also indicate increased production cost (including material and labour cost) without a proportionate increase in selling price.
4. Operating profit margin = o o
Profit efore Interest and Tax Sales
X 100% = X%
o o
Operating profit margin gives analysts an idea of how much profit (before interest and tax) the company is making from each dollar of sales. Typically operational management has full control over operating costs (the amount of loan capital and, so, interest expense normally depends on more higher level of management and the amount of tax payable depends on government policy). So, operating profit margin effectively measures performance of operational management. A poor or declining Operating profit margin may indicate business is struggling in controlling the costs. This may also happen because of decrease in selling price. A healthy operating profit margin is required for a company to be able to pay interest on loans.
Page 79

5. Net profit margin = o
Profit After Tax Sales
X 100% = X%
Net profit margin sometimes calculated based on Profit before tax (after interest). Check question for indication. A higher percentage than last year or industry average indicates costs are being controlled better. This may also indicate products are sold at higher price. A weaken Net profit margin may indicate management is struggling in controlling the costs. Company can sell at a discount to retain market share during economic downturn (and/or because of intense competition). If costs remain at similar level this will result a lower Net Profit Margin. Companies trading cheaper products can gain during economic downturn when customers generally stop buying luxury products and turn to cheaper ones. In large companies, where higher level of economies of scale can be achieved (i.e. lower level of per unit cost) the net profit margin can be higher as a result. Multinational companies can gain or loss from favourable or adverse exchange rate movements.
Sales Capital Employed
o o o
o o
6. Asset turnover or Asset utilisation ratio = o
= X:1
Use of Non-current assets instead of Capital employed is also correct. Check question for indication. If question says nothing, then use Capital employed. This shows the sales that is generated from each $1 worth of Capital (or asset) employed. The higher the sales per $1 invested the more efficient use of the capital was. If business is selling luxury products or products with higher profit margin that may result a lower Asset turnover ratio without a weaken ROCE or Net profit margin ratio.
o o
EFFICIENCY RATIOS: 1. Average receivables collection period = o o

Average Trade Receiva les Credit Sales
X 365 = X days
o o
o o o o
Use only CREDIT SALES. If question gives us only a Sales figure (i.e. does not split between credit and cash sales) then use the given Sales figure. We need only TRADE RECEIVABLES (i.e. receivables derived from credit sales). Nontrade receivables (e.g. advance, damage claim, receivables of government grant) shall not be included. If question gives us only a Receivables figure, and does not give any other indication about its components then assume that is the Trade receivables figure. (Opening + Closing Better to use average trade receivables 2 where possible; specially, when closing balance significantly differs from opening balance. An alternative of using Average Receivables is using year-end receivables figure where amount of receivables did not change significantly from year-beginning to year-end. - If you are required to compare ratios between two different years and cannot calculate average for both of the years, then take only the SFP value of the year (i.e. do not average). This is for comparability purpose. Irrecoverable debts and provision for doubtful debts normally not deducted from Trade Receivables collection period is an approximate measure of the length of time customers take to pay what they owe. A Receivables Collection Period similar to Payables Payment Period may be an indication of good credit control policy. Collection Period of less than 30 days may seem normal. Significantly in excess of 30 days might be representative of poor management of funds of the business. However, some businesses such as export oriented businesses normally needs to allow generous credit terms
Page 80

(may be 60 days) to win customers; whereas retailer may sell only or mainly on cash (may be collection period of not more than 10 days). A high or increasing collection period may mean poorly managed credit control function, and increased risk of bad debts. This also may mean over investment in receivables. However, increase in collection period might be a deliberate policy to increase sales by offering better credit terms than competitors. Decreasing or low collection period may mean tighten credit control policy; which may cause declining customer numbers (i.e. reduction of sales). Receivables collection days can be improved by offering discount to customers for early payment.
o o o o
2. Average payables payment period = o o o o o o o
Average Trade Paya les Credit Purchase
X 365 = X days
If Credit purchase or purchase amount cannot be identified from the question, use Cost of sales as it serves as an approximation. Use only Trade payables; i.e. payables generated from credit purchase. Increasing or long payment period may indicate liquidity problem; and also may indicate loosing opportunity of prompt payment discounts. A longer payment period may also mean company has succeeded in obtaining very favourable credit terms from its suppliers; contradictorily, this may also mean unethical business practice. Long credit term from suppliers is a source of interest free financing. But, some suppliers may charge interest if payment period exceeds a certain duration. Declining or short payment period may indicate business has sufficient cash to meet payables. A short payment period may put companys credit ratings in higher position. If receivables collection period is longer than the payables payment period then it can cause cash flow difficulties.
3. Inventory turnover/ holding period =
Average Inventory Cost of Sales Cost of Sales Average Inventory
X 365 days = X days
or, o
= X Times
Better to use Average Inventory figure to take into account the variation between Opening inventory and Closing inventory. But, instead of Average Inventory the closing inventory figure can be used where opening inventory level cannot be determined; in that case comparable figure has to derive from same approach. This ratio is an estimate of the average time that inventory is held before it is used or sold. If average inventory holding period is 30 days, this means that the inventory is turned over (i.e. sold) on average 12.16 times (= 365/30) in a year A low turnover (i.e. high holding period) implies slow sales and, therefore, excess inventory and/ or high level of inventory holding costs. High inventory levels are unhealthy because they represent an investment with a zero rate of return. It may also put company at a great loss if prices start to decline (think about technological products).
o o
Page 81
In F9: 1. Finished goods inventory turnover period = 2. 3.

Average FG Inventory X 365 days = X days Cost of Sales Average R Inventory Raw materials inventory turnover period = X 365 days = X days Annul Purchases Average IP Average production (WIP) period = X 365 days = X days Cost of Sales
4. Working capital cycle, or, Cash operating cycle (in days) = Inventory holding period (days) + Receivables collection period Payables payment period In F9: Finished goods inventory turnover period Raw materials inventory turnover period Average production (WIP) period Average receivables collection period Average payables payment period Operating cycle o o Days X X X X (X) X/(X)
This cycle is the length of time between cash payment to suppliers and cash received form customers. This measured how long a firm will be deprived of cash. A company could even achieve a negative cycle by collecting from customers before paying suppliers. This policy of strict collections and delay payments is not always sustainable or appreciable by customers (because they have to pay early) and suppliers (because they are being paid late).
INVESTMENT RATIOS: 1. Earnings per share (EPS) =

Earnings (i e Profit) Attri uta le to Ordinary Shareholders eighted Avg Num er of Ordinary Shares ar et Price per Share Price Earnings Ratio
= $X
or,
= $X
o o o o o o
EPS is generally considered to be the single most important variable in determining a shares price. This is a key measure of company performance from ordinary shareholders point of view. EPS shows the amount of profit attributable to each ordinary share. But, it does not represent actual income of the ordinary shareholders. Increase in EPS generally indicates success; whereas a decrease is not welcomed by shareholders. A constant growth in EPS may result in favourable movements (i.e. increase) in share price. Both right issue and bonus issue of shares result in a fall of EPS. So, care must be taken while interpreting. EPS often ignores the amount of capital employed to generate the earnings. Two companies could generate the same EPS, but one could do so with less investment; this could mean that this company was more efficient at using its capital.
Page 82

2. Dividend per share (DPS) =
Ordinary Dividend Declared and Paid for The ear eighted Avg Num er of Ordinary Shares
= X$
o DPS is the actual portion of income received by the ordinary shareholders from EPS. o DPS is important for shareholders who are seeking income from shares rather capital gain. o Growth in dividend per share used in share price valuation. So, companies may have a policy of achieving steady growth in dividend pay-out per share. A steady growth normally creates positive market reaction (i.e. increase in share price).
3. Dividend pay-out ratio =
Dividend Per Share Earnings Per Share
X 100% = X%
or, o o
Ordinary Dividend Declared and Paid for The ear Earnings (i e Profit) Attri uta le to Ordinary Shareholders
X 100% = X%
Dividend pay-out ratio is the percentage of earnings paid to shareholders as dividends. This shows how well earnings support the dividend payments. High dividend pay-out ratio may mean company confidence on future earnings. But, where majority of shares are held by a small number of shareholders, it may also mean that shareholders are taking out as much profit as they can; and this does not necessarily serve co mpanys long-term interest. Low dividend pay-out ratio may mean company is expecting difficulties in the future; so now interested in retaining earnings. But, it can also mean expansion (by reinvesting the retained earnings) of business in the future. Mature companies tend to have a higher pay-out ratio.
4. Dividend cover =
Earnings Per Share Dividend Per Share
= X Times
or, o o o o o
Earnings (i e Profit) Attri uta le to Ordinary Shareholders Ordinary Dividend for the ear
= X Times
Dividend cover represents how many times dividend could have paid from the profit attributable to ordinary shareholders. Dividend cover is a measure of the ability of a company to maintain the level of dividend paid out. The higher the cover, the better the ability to maintain dividend pay-out if profits drop. Typically, a ratio of 2 or higher is considered safe in the sense that the company can well afford the dividend; but dividend cover below 1.5 may seem risky. If the dividend cover is below 1 then the company is using its retained earnings from previous years to pay current years dividend A low level of dividend cover might be acceptable in a company with very stable profits, but the same level of cover for a company with volatile profits would indicate that company may not able to maintain the current level of dividend pay-out.
Page 83

5. Price/Earning (P/E) ratio =
ar et Price Per Share Earnings Per Share
= X Times
or, o o
Company s ar et Capitalisation Earnings (i e Profit) Attri uta le to Ordinary Shareholders
= X Times
Market capitalisation is the total market value of all the issued ordinary shares of the company. P/E ratio also knows as Price Multiple or Earnings Multiple ratio
o o
o o
P/E ratio is a measure of company performance from the markets point of view. P/E ratio shows how much money investors are currently willing to pay for each dollar of earnings. It gives an indication of the confidence that the investors have in the future success (i.e. earnings) of the business. In a very basic term, a P/E ratio of 20 means investors are paying equivalent of 20 years earnings (at current EPS level) to own a share in the company. A P/E ratio of 1 means market is currently willing to pay $1 for each dollar of earnings currently made by the company; this shows very little confidence on the companys future prosperity. Whereas, a P/E ratio of 20 expresses a great deal of optimism about the future of the company since investors are currently willing to pay $20 for each dollar of companys earnings. Investors paying 20 times of current earnings believe that company will do significantly better in coming years, and this will not take long to get the $20 earnings. Market can over-value or under-value company shares depending of information available.
6. Dividend yield = o o o o
Dividend Per Share ar et Price Per Share
X 100% = X%
Dividend Yield is a financial ratio that shows how much a company pays out in dividends relative to its share price. In the absence of any capital gains, the Dividend Yield is the return on investment for a share. Investors can secure a minimum stream of cash flow from their investment portfolio by investing in shares which is paying relatively high and stable dividend yields. Mature and well-established companies tend to have higher dividend yields; while young and growth oriented companies tend to have lower yield. Many fast growing companies do not have a dividend yield at all because they do not pay-out any dividend.
LONG-TERM SOLVENCY RATIOS:

1.
Debt ratio = o o
Total De t Total Assets
X 100% = X%
Total assets consist of non-current and current assets. Debts consist of all current and non-current liabilities (Deferred tax liabilities can be ignored). This ratio represents how much money company owes compared to its Total assets. If Debt ratio is greater than 50%, the business can be considered as a risky company. But, a high Debt ratio may also mean companys ability to raise debt finance which shows confidence of debt holders on the company.
o o
Page 84

2. Gearing ratios: a. Debt to Equity ratio =
De t Capital Redeema le Preference Share Capital Long-term Lia ilities X100% = X 100% = X% Equity Capital Ordinary Share Capital Irredeema le Preference Share Capital Reserves
b. Debt to Total capital ratio =

De t Capital Total Capital
X100% = Equity Capital
De t Capital De t Capital
X 100% = X% X100%
3. Leverage ratio =
Equity Capital Equity Capital De t Capital
o o o o
Take current liability portion as well of long-term liabilities in Debt capital calculation. Normally do not include Deferred tax liability within Debt capital. In F9 Preference share considered as Debt capital not Equity capital. Also in F9, values for Gearing ratio can be either book values or market values. If using market values remember market value of ordinary shares take account of reserves (i.e. do not add reserve amount with total market value of ordinary shares)
o o o
o o o
A gearing level of more than 50% (where Debt Capital to Total Capital used) or more than 100% (where Debt Capital to Equity Capital used) or Leverage ratio of less than 50% means company is highly geared (i.e. risky). Risk is high for investors in a high geared company because of obligation to pay the interest and repaying capital on time. The standard level of gearing depends on industry sector. A relatively higher gearing may mean company adopted an aggressive strategy to expand its operation. This has to be justified with sales and profit growth. A higher gearing may also mean company is having financial difficulties; so may be a going concern issue. A low or declining gearing may mean company is getting stronger financially and confident on future earnings. Where gearing is high, shareholders required rate of return will increase because of high level of risk involve in the investment. To lend money in a highly geared company, lenders may impose some covenants on the company (example: a maximum limit of gearing, a minimum level of interest cover, pledge on some assets)
4. Interest cover = o o
Profit efore Interest and Tax Interest Charge
= X Times
o o
Interest cover is a measure of the adequacy of a company's profit relative to interest payment on its debt. A high interest cover ratio means that the business is easily able to meet its interest obligations from profits. Similarly, a low level of interest cover ratio means that the business is potentially in danger of not being able to meet its interest obligations. Interest cover of more than 2 is normally considered reasonably safe. But, companies with very volatile earnings may require an even higher level of Interest cover. Interest cover of less than 1 means the company did not earn sufficient earning (i.e. profit) to meet its interest charge. This means company will have to pay some of its interest from retained profit from previous years. This may also raise question about companys going concern.
Page 85
Steve Jobs at Stanford Commencement Speech (2005): 'Stay Hungry. Stay Foolish.' ' . . . Sometimes life hits you in the head with a brick. Don't lose faith. I'm convinced that the only thing that kept me going was
that I loved what I did. You've got to find what you love. And
that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle. . .
Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary. . .'
Page 86
F7 Financial Reporting (INT) IAS 33 Earnings per share

An entity is required to calculate and present a basic EPS and a diluted EPS amount based on the profit/ (loss) attributable to the ordinary shareholders (of the parent entity). Basic and diluted EPS figures should be presented on the face of the statement of comprehensive income with equal prominence. Shares are usually included in the weighted average number of shares from the date consideration is receivable.
Basic EPS =
Net profit or (loss attri uta le to ordinary shareholders eighted average num er of ordinary shares
Weighted average number of shares can be calculated as: Number of shares at year beginning Number of shares issued with full market price X (Number of months remaining after the issue / 12) Weighted average number of shares X Number of shares at year beginning X (Number of months to new issue at full price / 12) X Total number of shares after new issue at full Price X (Number of months remaining / 12) Weighted average number of shares X X
X X
Example: Number of shares at year beginning (at 01.01.11) New issue of shares at full market price (at 31.05.11) Number of share at year end
170,000 80,000 250,000
170,000 + (80,000 X 7/12) = 216,666
(170,000 X 5/12) + (250,000 X 7/12) = 216,666
Basic EPS with bonus issue (scrip issue, capitalisation issue) and share split: increases number of shares without any consideration. As a result, this distorts the comparison of EPS in the current year with the EPS in the previous year. So, to ensure that the distortion does not occur: The EPS of the current year is calculated as if the bonus issue was in existence of the beginning took place at the start of the year; and, The corresponding previous years EPS also restated as that bonus issue was in existence throughout that previous year.
Simple example: Bonus issue At year beginning (01.01.2011), company A has a share capital of 400,000 ordinary shares, when it decides to make a bonus issue of 1 for 4 on 01 April 2011. Its profit for the year to 31 December 2010 and 2011 was $60,000 and $65,000 respectively. Calculate the EPS for the year ending 2011 and for corresponding previous year. 2011 $65,000 400,000 100,000 500,000 $0.13, i.e. 13c 2010 $60,000 400,000 100,000 500,000 As shares were in existence at the beginning of both years!
Earnings Number of shares before bonus issue Bonus issue
EPS
$0.12, i.e. 12c (restated)
$0.12 is the restated EPS of 2010 in 2011 financial statements for comparison. Originally, in 2010, the EPS was reported as ($60,000/400,000) = $0.15 Calculating corresponding previous years restated EPS using a formula = Original EPS X
Original num er of shares Num er of shares after onus issue 400,000 500,000
Original EPS X
Holding ratio to have the onus share(s Share ratio with onus shares 4 4+1
= $0.15 X
= $0.12
= $0.15 X
= $0.12
Page 87

Complex example: Bonus issue after a full market price issue At year beginning (01.01.2011), company A has a share capital of 400,000 ordinary shares. It made a full market price issue on 01 March 2011 of 100,000 shares and a bonus issue of 1 for 4 on 01 April 2011. Its profit for the year to 31 December 2010 and 2011 was $60,000 and $65,000 respectively. Calculate the EPS for the year ending 2011 and for corresponding previous year. Date 01.01.11 01.03.11 01.04.11 Description Opening balance Full market price issue Total N. of shares Bonus issue: 400,000/4 = 100,000/4 = Total N. of shares N. of shares 400,000 X 100,000 X 500,000 100,000 X 25,000 X 625,000 Month weight 12/12 10/12 Weighted avg. N. of shares 400,000 83,333
= =
12/12 10/12
= =
100,000 20,833 604,166
Alternative way: Date 01.01.11 01.03.11 Description Opening balance Full market price issue Total N. of shares after full market price issue Bonus issue (1 for 4 held) (500,000/4) Total N. of shares after bonus issue Number shares 400,000 100,000 500,000 of Bonus effect 5/4 5/4 issue Month weight 2/12 1/12 Weighted avg. number of shares 83,333 52,083
01.04.11
125,000
625,000
9/12
468,750 604,166
EPS for year ending 2011: $65,000/604,166 = $0.108, i.e. 10.8c Corresponding previous years (2010) restated EPS: Original EPS X = o
$60,000 4 4 4+1
Holding ratio to have the onus share(s Share ratio with onus shares
= $0.12, i.e. 12c
Basic EPS with right issue: A rights issue offers existing shareholders the right to buy new shares in proportion of their existing holding at a price slightly below the market price. To calculate EPS when right issue is made we need to know: The cum right price: This is the market price of a share just before the right issue The ex-right price: This is the price of a share after the right issue. In theory the ex-right price should be the weighted average of the cum right price of the shares and issue price of corresponding number of share. This price is called the theoretical ex-right price. Example: A company has 10,000,000 shares in issue. It is now proposes to make a 1 for 4 rights issue at a price of $3 per share. The market value of existing shares on the final day before the issue is made is $3.50. What is the theoretical ex-rights price per share? Solution: $ Before right issue: 4 shares @ $3.50 14 Right issue: 1 share @ $3 3 Theoretical value of 5 shares 17 So, theoretical ex-rights price per share is ($17/5) = $3.40 In a right issue, shares are sold at a reduced price; so, we need to divide the total number of shares issued into bonus shares and fully paid shares and treat as such.
Page 88

Steps to follow in a right issue: Step 1: Calculate the theoretical ex-rights price Step 2: Split the number of shares in the rights issue into bonus shares and full price shares. Original shares plus bonus shares = Original number of shares X
Cum right price Theoretical ex right price
The resulted Original shares plus bonus shares will be a higher number of shares as we are multiplying by a bigger figure and dividing by a smaller figure. Deduct original number of shares from the result of the above formula to get the bonus shares
From above Theoretical ex-right price example: i. Number of rights share issued: 10,000,000/4 = 2,500,000 ii. Amount received from rights issue: 2,500,000 X $3 = $7,500,000 iii. $7,500,000 can be raised by issuing ($7,500,000/ $3.5) = 2,142,857 shares at full market price iv. So, we can say, 2,142,857 shares were issued at full market price and (2,500,000 2,142,857) = 357,143 shares were bonus issue To verify the formula in Step 2: (Original shares + Bonus shares) X TERP = Original shares X Cum right price (10,000,000 + 357,143) X $3.4 = 10,000,000 X $3.5 $35,214,286 = $35,000,000 So, there is a mismatch of ($35,214,286 - $35,000,000) = $214,286 (0.6%) if we use above formula! But, we still need to use formula in Step-2 to identify bonus fraction in a rights issue, as it is required by IAS 33 (Para A2). Step 3: Calculate current years EPS PROBLEM!! when there will be multiple issues check the example below
Step 4: Calculate corresponding previous years EPS taking the bonus share effect. We can use following formula: Re-stated EPS of the previous year = Original EPS of the previous year X
Holding ratio to have the onus share(s) Theoretical ex right price X Share ratio with onus shares Cum right price
Use this part of the formula only if there is a bonus issue in the current year. Check the example below.
The resulted Re-stated EPS will be a smaller figure as we are multiplying by a smaller figure and dividing by a greater figure.
Page 89

Basic EPS with right and bonus issue: Fenton had 5,000,000 ordinary shares in issue on 1 January 20X1. On 31 January 20X1, the company made a rights issue of 1 for 4 at $1.75. The cum rights price was $2 per share. On 30 June 20X1, the company made an issue at full market price of 125,000 shares. Finally, on 30 November 20X1, the company made a 1 for 10 bonus issue. Profit for the year was $2,900,000. The reported EPS for year ended 31 December 20X0 was 46.4c. Required: What was the earnings per share figure for year ended 31 December 20X1 and the restated EPS for year ended 31 December 20X0? Answer: (a quicker, smarter but complex way) Theoretical ex-right price: ((4X$2) + $1.75)/5 = $1.95 Date Narrative Shares Time weight
1 12 5 12 5 12 1 12
Bonus in right Bonus issue

2 1.95
Weighted avg. 470,085 2,864,583 2,921,875 584,375 6,840,918
1.1.X1 b/d 31.1.X1 Rights issue
5,000,000 X 1,250,000 6,250,000 X 30.6.X1 Full-market price125,000 6,375,000 X 30.11.X1 Bonus issue 637,500 7,012,500 X EPS for y/e 31.12.X1 =
$2,900,000 6,840,918
X X X X
X X X X
11 10 11 10 11 10
= = =
- =
= $0.424, i.e. 42.4c

10 11
Restated EPS for y/e 31.12.X0 = 46.4c X
1.95 2
= 41.1c
Diluted EPS: Diluted EPS warns existing shareholders that the EPS may fall in future years because of potential new ordinary shares that have been issued. Potential ordinary shares may be issued in the following forms: - Convertible bonds (bonds and debentures that can be converted into ordinary shares) - Convertible preference shares (Preference shares that can be converted into ordinary shares) - Options and warrants (Option holders has right, but not obligation, to buy ordinary shares in a future date at a predetermined price) - Contingently issuable shares (these are ordinary shares will be issued if certain conditions are met) The diluted EPS is calculated by revising the original earnings (e.g. cancelling interest and its tax effect in case of convertible bond) and weighted average number of shares as though the potential ordinary shares had already been issued.
When calculating the revised weighted average number of shares, the convertible instrument (e.g. convertible bond) is deemed to have been converted into ordinary shares at the beginning of the period or, if later, the date of the convertible instrument issued.
Page 90
Example: Diluted EPS with convertible bond In 2010 Farrah Co had a basic EPS of 105c based on earnings of $105,000 and 100,000 ordinary $1 shares. It also had in issue $40,000 15% convertible bond which is convertible in two years time at the rate of 4 ordinary shares for every $5 of bond. Tax is 30% of profit before tax. In 2010 gross profit of $200,000 and expenses of $50,000 were recorded, including interest payable of $6,000. Calculate the diluted EPS. Solution: Gross profit Expenses Add-back: Interest (40,000X15%) Profit before tax Tax expense (30%) Earnings attributable to ordinary shareholders $ 200,000 (50,000) 6,000 156,000 (46,800) 109,200
Number of shares issued 100,000 Additional shares from conversation ($40,000X4/$5) 32,000 When more than one basis of conversion exists, the conversion assumes 132,000 the most advantageous conversion rate or exercise price from the standpoint of the holder of the potential ordinary shares. Diluted EPS = ($109,000/132,000) = $0.82.6, i.e. 82.6c Dilution (i.e. decrease) in earnings would be (105c 82.6c) = 22.4c per share
o -
Dilutive or antidilutive: Only diluted shares should be included in the diluted EPS calculation. Potential new ordinary shares are not dilutive if EPS would have been higher if the potential shares had been actual shares in the period. Example: Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue. The total earnings in 2010 were $1,750,000. The rate of income tax is 35%. Decide which one of the following will dilute the EPS and will be included in diluted EPS calculation: (a) $1,000,000 of 14% convertible loan stock, convertible in three years time at the rate of 2 shares per $10of stock (b) $2,000,000 of 10% convertible loan stock, convertible in one years time at the rate of 3 shares per $5 of stock Solution: Basic EPS = $1,750,000/5,000,000 = 35 cents (a) Earnings increased (i.e. interest expense saves): i X(1 t) = $1,000,000 X 0.14 (1 0.35) = $91,000 Potential ordinary shares: ($1,000,000 X 2)/ $10 = 200,000 shares So, incremental EPS = $91,000/200,000 = 45.5c Incremental EPS is higher than basic EPS; so NOT diluted and do not include in the diluted EPS calculation. (b) Earnings increased (i.e. interest expense saves): i X(1 t) = $2,000,000 X 0.10 (1 0.35) = $130,000 Potential ordinary shares: ($2,000,000 X 3)/ $5 = 1,200,000 shares So, incremental EPS = $130,000/1,200,000 = 10.8c Incremental EPS is lower than basic EPS; so diluted (i.e. weakened) and need to include in the diluted EPS calculation.
Page 91
o -
Adequate to use a simple average of weekly or monthly prices; or, Average of closing market prices; or, Average of high and low prices when prices fluctuate widely. Whichever method used, must be applied consistently
Diluted EPS with option: Options and warrants are dilutive when they would result in the issue of ordinary shares for less than the average market price of ordinary shares during the period (i.e. when they are in the money). The shares that would be issued if the options or warrants are exercised are divided into full priced shares and free shares. The free fraction is the dilutive.
Example: Brand Co had net profit of $1,200,000 for the year ending 31 December 2010. Weighted average number of ordinary shares outstanding during the year was 500,000. Average fair value of one ordinary share during the year was $20. Brand Co issued share option of 100,000 shares with exercise price applicable of $15. Calculate both basic and diluted EPS. Solution: If the options are exercised, the company will raise cash of (100,000 shares X $15) = $1,500,000. That is ($1,500,000 / $20) = 75,000 shares if issued full price. So, the company is giving away (100,000 75,000) = 25,000 shares for free. These 25,000 shares will dilute the basic EPS. Number of shares Profit after tax Basic 500,000 $1,200,000 Dilutive effect 25,000 No effect 525,000 $1,200,000 Basic EPS in 2010 = $1,200,000 / 500,000 = $2.40 Diluted EPS in 2010 = $1,200,000 / 525,000 = $2.29 o Contingently issuable shares: These are ordinary shares issued for little or no cash when another party satisfies performance related conditions (e.g. profit target is met) rather mere passing of time. These shares can be a part of consideration for acquisitions or issued to senior staffs. Such shares need to be included in the diluted EPS calculation if and only if the conditions are met If multiple performance related criteria exists then diluted effect exists when all performance related criteria are met. This should be included from the beginning of the period, or, if later, from the date of the contingent agreement. Employee share option Vesting conditions: Dilutive effect exists from: Stay with the company Grant date Performance related When performance criteria are met
If shares are partly paid (i.e. less than shares market value is paid): The equivalent number of fully paid shares must be established to the extent that partly paid shares are entitled to participate in dividends during the period; and the equivalent full number is included in the basic EPS calculation. To the extent that partly paid shares are not entitled to participate in dividends during the period they are treated as the equivalent of warrants or options in the calculation of diluted EPS. Diluted losses: when loss per share would be higher if potential shares were in issue. Post reporting date issues: Bonus issue, share splits and share consolidations after the year end but before the financial statements are authorised for issue, the number of shares in the EPS calculation is adjusted for the period just ended and prior periods presented.
o o
Page 92
The value of a man should be seen in what he gives and not in what he is able to receive. - Albert Einstein
Page 93
F7 Financial Reporting (INT) Receivables factoring

(Relevant accounting standard: IFRS 9 Financial instruments, para 3.2.3-3.2.9) Receivables factoring: Companies sometimes need cash before customers pay their account balances. In such situations, the company may choose to sell accounts receivable to another company that specializes in collections. This process is called factoring, and the company that purchases accounts receivable is often called a factor. Factoring with recourse: - The seller retains the risk of any under-collection of receivables by the factor. If the factor fails to collect any amount of receivables then the seller reimburses that uncollected amount to the factor. - Accounting: i. When the seller receives money from factor, the double entry is: DR SFP: Bank, CR SFP: Liability ii. Interest charged by factor to the seller: DR I/S: Finance cost, CR SFP: Bank iii. Amount received by factor from Receivables: DR SFP: Liability, CR: SFP: Receivables iv. Any remaining receivables amount reimbursed by the seller: DR SFP: Liability, CR: SFP: Bank Factoring without recourse: - The seller transfers risk associated with collection of receivables to the factor. If the factor fails to collect any amount of receivables, the seller does NOT reimburse that amount. - Accounting: i. Amount received by the seller from factor: DR SFP: Bank, CR: Receivables ii. Any cash commission charged by the factor: DR I/S: Finance cost, CR SFP: Bank iii. If factor charge commission by paying a lower amount of Receivables the seller: DR SFP: Bank, DR I/S: Finance cost: amount under-received by seller, CR SFP: Receivables
Page 94

Exercise question: On 1 October 20X0, Jedders signed a receivables factoring agreement with a company Fab Factors. Jedders trade receivables are to be split into three groups, as follows. Group A receivables will not be factored or administered by Fab Factors under the agreement, but instead will be collected as usual by Jedders. Group B receivables are to be factored and collected by Fab Factors on a with recourse basis. Fab Factors will charge a 1% per month finance charge on the balance outstanding at the beginning of the month. Jedders will reimburse in full any individual balance outstanding after three months. Group C receivables will be factored and collected by Fab Factors without recourse; Fab Factors will pay Jedders 95% of the book value of the debtors. Jedders has a policy of making a receivables allowance of 20% of a trade receivables balance when it becomes three months old. The receivables groups have been analysed as follows: % of 1 October 20X0 balance collected in: October November December $000 $000 $000 30% 30% 20% 40% 30% 20% 50% 25% 22%
Group A Group B Group C
Balance @ 1 October 20X0 $000 1,250 1,500 2,000
Required: For the accounts of Jedders, calculate the finance costs and receivables allowance for each group of trade receivables for the period 1 October 31 December 20X0 and show the financial position values for those trade receivables as at 31 December 20X0.
Solution: Group A: No factoring By 31 December 20X0, 80% (30%+30%+20%) of the receivables collected by Jedders. So, Receivables allowance of 20% to be recognised on remaining 20% receivables balance. @ 31 October 20X0: DR SFP: Bank ($1,250,000 X 30%) CR SFP: Receivables (30% of receivables collected by Jedders. So, decrease in receivables)
$375,000 $375,000
@ 30 November 20X0: DR SFP: Bank ($1,250,000 X 30%) $375,000 CR SFP: Receivables $375,000 (Further 30% of receivables collected by Jedders. So, decrease in receivables)
Page 95

@ 31 December 20X0: DR SFP: Bank ($1,250,000 X 20%) $250,000 CR SFP: Receivables $250,000 (Further 20% of receivables collected by Jedders. So, decrease in receivables) DR I/S: Expense: Increase in receivables allowance (($1,250,000 X 20%) X 20%) $50,000 CR SFP: Receivables: Allowance for receivables $50,000 (Receivables allowance of 20% recognised on remaining 20% receivables balance. This is provision for doubtful debts and presented as decrease in receivables in SFP.) So, Group A receivables balance to be presented in SFP as at 31 December 20X0: (($1,250,000 - $375,000 - $375,000 - $250,000) - $50,000) = $200,000.
Group B: Factoring with recourse Risk associated with any under-collection of receivables is retained with Jedders. So, the amount received by Jedders from Fab Factors in advance shall be treated as a loan in Jedders account. @ 1 October 20X0: DR SFP: Bank $1,500,000 CR SFP: Liability $1,500,000 ($1,500,000 received from Fab Factors by Jedders; so, increase in liability) @ 31 October 20X0: DR I/S: Finance cost ($1,500,000 X 1%) $15,000 CR SFP: Bank $15,000 (Interest charged by Fab Factors on outstanding balance at month beginning) DR SFP: Liability ($1,500,000 X 40%) $600,000 CR SFP: Receivables $600,000 (40% of receivables collected by Fab Factors. So, decrease in receivables and liability) @ 30 November 20X0: DR I/S: Finance cost ($1,500,000-$600,000) X 1%) $9,000 CR SFP: Bank $9,000 (Interest charged by Fab Factors on outstanding balance at month beginning) DR SFP: Liability ($1,500,000 X 30%) $450,000 CR SFP: Receivables $450,000 (Further 30% of receivables collected by Fab Factors. So, decrease in receivables and liability)
Page 96

@ 31 December 20X0: DR I/S: Finance cost ($1,500,000-$600,000-$450,000) X 1%) $4,500 CR SFP: Bank $4,500 (Interest charged by Fab Factors on outstanding balance at month beginning) DR SFP: Liability ($1,500,000 X 20%) $300,000 CR SFP: Receivables $300,000 (Further 20% of receivables collected by Fab Factors. So, decrease in receivables and liability) DR SFP: Liability ($1,500,000-$600,000-$450,000-$300,000) $150,000 DR SFP: Bank $150,000 (Receivables balance uncollected by Fab Factors reimbursed by Jedders to Fab Factors. So, decrease in liability. Now, Jedders is responsible in collecting the remaining receivables balance, not Fab Factors.) DR I/S: Expense: Increase in receivables allowance (($150,000 X 20%) $30,000 CR SFP: Receivables: Allowance for receivables $30,000 (Receivables allowance of 20% recognised on remaining $150,000 receivables balance. This is provision for doubtful debts and presented as decrease in receivables in SFP.) So, Group B receivables balance to be presented in SFP as at 31 December 20X0: (($1,500,000 - $600,000 - $450,000 - $300,000) - $30,000) = $120,000. And, finance cost charged in I/S: (15,000 + $9,000 + $4,500 = $28,500.
Group B: Factoring without recourse Risk associated with any under-collection of receivables is transferred to Fab Factors. So, receivables balance shall be derecognised (i.e. removed from SFP) at the point of cash received from Fab Factors. Any commission charged by Fab Factors (may be by under-payment of receivables balance to Jedders or cash) shall be recognised as Finance cost. @ 1 October 20X0: DR SFP: Bank ($2,000,000 X 95%) DR I/S: Finance cost: Factors commission ($2,000,000 X 5%) CR SFP: Receivables (decrease in receivables)
$1,900,000 $100,000 $2,000,000
There is no need for recognising any allowance for receivables on 31 December 20X0, since all the receivables balance derecognised on 1 October 20X0. Jedders transferred the risk of any under-collection to Fab Factors; that is, Jedders has no more right on receivables balance. (Shortcut answer is in the book! Check Q-55-Jedders of BPP question bank.)
Page 97
Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all. - Dale Carnegie
Page 98
F7 Financial Reporting (INT) IAS 10 Events after reporting period

Events after the reporting period are split into: Adjusting events: are events that provide evidence of conditions that existed at the reporting date, and the financial statements should be adjusted to reflect them. Examples include: Settlement of a court case that confirms that the entity had an obligation at the reporting date. Evidence that an asset was impaired at the reporting date (e.g. bankruptcy of a customer). Finalisations of prices for assets sold or purchased before year end. The discovery of fraud or errors that show that the financial statements are misstated An adjustment to the disclosed EPS (as par IAS 33) for transactions where the number of shares altered without an increase in resources (e.g. bonus issue, share split or share consolidation). Non-adjusting events: are events that are indicative of conditions that arose after the reporting date. Disclosure should be made in the financial statements where the outcome of a nonadjusting event would influence the economic decisions made by users of the financial statements. A major business combination after the reporting date (IFRS 3 or the disposing of a major subsidiary). Announcement of plan to discontinue an operation Major purchases and disposals of assets Classification of assets as held for sale Destruction of assets, for example by fire or flood Major ordinary share transactions (unless capitalisation or bonus issue) Decline in market value of investments
The cut-off date for the consideration of events after the reporting period is the date on which the financial statements are authorised for issue. Normally the financial statements are authorised by the directors before being issued to the shareholders for approval. Where a supervisory board is made up wholly of non-executive directors, the financial statements will first be authorised by the executive directors for issue to that supervisory board for its approval. The relevant cut-off date is the date on which the financial statements are authorised for issue to the supervisory board. The date on which the financial statements were authorised for issue should be disclosed. If a significant event occurs after the authorisation of the financial statements but before the annual report is published, then the entity is not required to apply the requirements of IAS 10. However, if the event was so material that it affects the entitys business and operations in the future, the entity may wish to discuss the event in the narrative section at the front of the Annual Review but outside of the financial statements themselves. Equity dividend (i.e. dividend to ordinary and irredeemable non-cumulative preference shares) should only be recognised as a liability where they have been declared before the reporting date, as this is the date on which the entity has an obligation. Where equity dividends are declared after the reporting date, this fact should be disclosed but no liability recognised at the reporting date. Where the going-concern basis is clearly not appropriate, break-up basis should be adopted. The break-up measures the assets at their recoverable amount in a non trading environment, and a provision is recognised for future costs that will be incurred to break -up the business.
Page 99
'Whatever you do will be insignificant, but it is very important that you do it'. - Mohandas Karamchand Gandhi
Page 100
F7 Financial Reporting (INT) Important definitions
Asset: A resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. [Conceptual Framework: 4.4a] Liability: A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. [Conceptual Framework: 4.4b] Equity: The residual interest in the assets of the entity after deducting all its liabilities. [Conceptual Framework: 4.4c] Income: Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decrease of liabilities that result in increases in equity, other than those relating to contributions from equity participants. [Conceptual Framework: 4.25a] Expenses: Decrease in economic benefits during the accounting period in the form of outflow or depletions of assets or incurrences of liabilities that result in decrease in equity, other than those relating to distributions to equity participants. [Conceptual Framework: 4.25b] Liquidity: The availability of sufficient funds to meet deposit withdrawals and other short-term financial commitments as they fall due. Solvency: The availability of cash over the longer term to meet financial commitments as they fall due. Underlying assumptions in preparing financial statements: Accruals basis: The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate. [Conceptual Framework: OB17] Going concern: The entity is normally viewed as a going concern, that is, as continuing in operation for the foreseeable future. It is assumed that the entity has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations. [Conceptual Framework: 4.1]
Materiality: Information is material if its omissions or misstatements could influence the economic decisions of users taken on the basis of the financial statements. [Conceptual Framework: QC11] Substance over form: The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form. Qualitative characteristics: The attributes which make the information provided in financial statements useful to the users. [Conceptual Framework: QC19] Comparability Verifiability (Reliability) Timeliness (Relevance) Understandability
Page 101
'As is a tale, so is life: not how long it is, but how good it is, is what matters.' - J. K. Rowling Speaks at Harvard Commencement 08
Page 102
* * * End * * *
This document is prepared based on experience as a student and as a lecturer. Most of the lines in this document copied from relevant IASs/IFRSs or ACCA books. It took more than 100 hours in planning, writing, rewriting, organising and reorganising this 26,000 word document.
Wish you the very best with your study. Mezbah
Page 103

ACCA F7 Course Note by Mezbah Uddin

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

ACCA F7 Course Note by Mezbah Uddin

Uploaded by

Copyright:

Available Formats

F7 FINANCIAL REPORTING (INT)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) Exam structure

F7 Financial Reporting (INT) Past question analysis

IAS 8 5 (b) 2 (iv)

IAS 12 2 (ii) 2 (v, vi) 2 (v)

3 3 3 3 (a-ii) 3 3 3 (b) 3 3 3 3 3 2 (iii)

2 (vi) 4 (a), 4 (b-ii) 5 2 (a-iii)

2 (v) 2 (v) 2 (iv), 2 (vi) 2 (a-iv)

IAS 32 2 (iii) 2 (iii), 3 (ii), 5 2 (iv)

2 (ii), 5 2 (vi), 3(ii), 4 (b-iii)

2 (i) 3 (i) 3 (i)

2 (iii) 2 (i) 4 (b) 5

2 (iv) 2 (iii), (iv), 3 (iii) 2 (i) 2 (ii) 2 (ii), (vi) 4 2 (b) 5

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) Course plan

BPP Text Book Ref.

Chapter 6 Chapter 7 Chapter 16 Chapter 16 Chapter 15 Chapter 12

Chapter 13 Chapter 7 Chapter 12 Chapter 17

F7 Financial Reporting (INT)

64-Julian; 65-Deferred taxation

54-Peterlee II, 55-Jedders (c), 56Pingway, Dec '11-Q5-Bertrand

Preparing single company accountants

All questions from Part-8, 9, 10 &11 of the BPP question bank

Chapter 18 Chapter 15 Chapter 20

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 1 Presentation of Financial Statements

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

F7 Financial Reporting (INT)

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

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

An (a) (b) (c) (d)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 16 Property, plant and equipment

F7 Financial Reporting (INT)

Upwards Has the asset previously suffered a downward valuation?

Downwards Has the asset previously suffered a upward valuation?

Recognise the increase as a revaluation surplus. (Other comprehensive income)

Recognise the decrease directly in profit or loss

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

Start every morning with a smile even a forced one it

F7 Financial Reporting (INT) IAS 23 Borrowing costs

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

28.02.12 - Purchase order made to buy the asset

31.03.12 - Payment made to buy the asset

31.12.12 - Asset is delivered & ready to use

31.12.13 - Loan is matured and repaid

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 40 Investment property

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 20 Government grants

Statement of comprehensive income Depreciation (18,000)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 38 Intangible assets

F7 Financial Reporting (INT)

F7 Financial Reporting (INT)

F7 Financial Reporting (INT) IAS 36 Impairment of assets

F7 Financial Reporting (INT)