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FINANCIAL REPORTING

STANDARDS
(FOR LEVEL 2 ICA-GH CANDIDATES)

Compiled by; Michael (0547186610)


Lets chat @ Darlingmickymike@outlook.com
HIGHLIGHTS OF THIS MANUAL;
This manual has been complied to help candidates preparing for ICA-GH professional exams on financial
reporting at level 2 and also level 3 Corporate reporting. Many students have problem when they meet
any question on International Accounting Standards (IAS) and in view of that, I thought it as much to
gather some pieces on Financial Reporting Standards to help anyone in need of a solution to grab
reporting standards.

WHAT TO LOOK OUT FOR IN THE BOOK?


I have summarized the standards by tackling on the main issues.
Each solution to a particular question comes along with an explanation to explain the reason behind the
figures.
Disclosures to each of the standards were not attached. Kindly check that in your other F.R books.

WHY DO WE FAIL FINANCIAL REPORTING AND SEE IT AS A ROCK TO CRACK?


In order to pass reporting, you have to sit down and read through the standards very well. Many students
think, accounting is just double entry so once I got the question, I must set the ball rolling but remember
that there is a particular framework governing Accounting and that’s the standards. Not until you read
thoroughly what each standard says, you won’t be able to solve just a single question on it. Remember
also that about 40% to 50% of the examiners questions always test Standards, meaning before you can
pass Financial Reporting, you need to grab your IAS and IFRS well.

I WILL PLEAD WITH YOU NOT JUST TO LOOK AT THE QUESTIONS IN THE BOOK BUT
READ THROUGH ALL THE NOTES ON STANDARDS FOR YOUR OWN GOOD.

GOD BLESS YOU


NOT FOR SALE
IAS 16, PROPERTY, PLANT AND EQUIPMENT

IAS 16 is the standard that governs all aspects of accounting for property, plant and equipment.
These are properties acquired by an entity purposely for its own use for more than one accounting year.
The carrying amount of a P.P.E is the amount at which an asset is shown in the statement of financial
position after all accumulated depreciation and accumulated impairment losses have been deducted.
The fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. (Summarized)

What goes into the price/cost of an asset?


For the purpose of defining the total component cost of an asset, IAS 16 list any of the following to
include as part of the cost of an asset;

 Purchase price less any trade discount given,


 Import duties
 The initial estimate of dismantling and restoration cost/ decontamination cost
 Directly Attributable cost of bringing the asset to working condition for its intended use.
These include any of the following;
 Professional fees
 Delivery costs
 Site preparation costs
 Testing costs

AT RECOGNITION;
(a) it is probable that economic benefits associated with the asset will flow to the entity.
(b) The cost of the asset to the entitiy can be measured reliably.

INITIAL MEASUREMENT
At initial measurement, an asset should be measured at the cost.

MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION;


After an asset has been recorded initially at cost, an entity has the choice or option to subsequently record
the asset either at the cost model or revaluation model.
At cost, we carry the asset at its original cost less depreciation and any accumulated impairment loss.
At revaluation model, we carry the asset at a revalued amount being its fair value and at the date of
revaluation less any subsequent accumulated depreciation and or subsequent accumulated impairment
losses.
Somebody might ask, why do we still have to depreciate an asset after it has been revalued.
The answer is simple; it’s all because the assets in question are used by the entity for its operations hence
it has to be depreciated. Now bear this in mind, anytime a revaluation happens, it leads to an increase in
the carrying amount of the asset, and if it’s a loss that would be impairment (we will talk about this later
on). Let’s look at this simple example; I have a car registered for business. At the commencement of the
accounting year, the car had a carrying amount of GHc10,000 but at the end of the accounting year, the
car is now revalued at an amount of GHC 15000.
Obviously, the significance of this is that, there is a gain or increment in the value of the asset, so my
question is, what then becomes the treatment?
Always remember that in accounting, every transaction affects the income statement and the balance
sheet and as such this is of no exception. Now the car`s new value is GHc15,000 so it must be debited to
the car asset account (non-current asset) and credit GHc5000 to the capital surplus account under equity.
At the same time, GHc5,000 must be shown under “other comprehensive income.”
The same goes for a decrease in value on revaluation. Any decrease should be recognized as an expense,
except where it offsets a previous increase taken as a capital surplus in the owner`s equity.

COMPLEX ASSETS;
These are assets that are sophisticated in nature and are heavy. Examples are aircrafts, ships and other
similar heavy machines. The rule is that, each component under a complex asset is depreciated over their
useful life. Let’s look at this example below.
Baby Jet Airlines has the following components.

Undercarriage 2000 500 standings


Engines 8000 1600 flying hours.
What will be the depreciation charge if the airline traveled for 400 hours totaling 150 flights?

SOLUTION;

The undercarriage has a cost of GHc2,000 and a useful life of 500 standings.
In the normal way, we would have just divided the useful life (500 landings) by the cost but it travelled
for only 150 flights hence it would be 2000 x 150/500 giving us GHC600.

For the engine, bear in mind that, the strength of an engine is measured by the number of hours it travels
hence we have GHc8, 000 x 400/1600 giving GH2,000.
The total of the two (GH2,600) gives the depreciation charge for the airline.

EXAMINATION SCENARIO QUESTION (ICA-GHANA, F.R, QUESTION BANK);


At this moment, let’s take a close look at how examiners frame a question based on IAS 16, P.P.E…

On 1 October 2015 DR acquired a machine under the following terms.

HOURS GHS

Manufacturer`s base price 1050000


Trade Discount (applying to base price only) 20%
Early settlement discount taken (on the payable amount of the base cost only) 5%
Freight Charges
30000
Electrical installation cost 28000
Staff training in use of machine 40000
Purchase of a three-year maintenance contract 60000
Pre-production testing 22000
Estimated residual value 20000
Estimated life in machine hours 6000
Hours used
--year ended 30th Sept 2016 1200
–year ended 30th Sept 2017 1800
–year ended 30th Sept 2018 850

On 1st October 2017 DR decided to upgrade the machine by adding new components at a cost of
GHc200000. This upgrade let to a reduction in the production time per unit of the goods being
manufactured using the machine. The upgrade also increased the estimated remaining life of the machine
at 1st October 2017 to 4500 machine hours and its estimated residual value was revised to GHc40000.

REQUIRED;
Prepare extracts from the statement of profit or loss and statement of financial position for the above
machine for each of the three years to 30th September 2018.

SOLUTION WITH EXPLANATION

What the question demands from you is just two main issues.

1. Is to identity the total component of the cost of the machine in accordance with IAS 16
2. Is to determine the depreciation charges for each of the period in order to arrive at the net
book value (carrying amount) of the asset.

Straight to the question, per IAS 16 the following qualifies to form the component cost of the machinery.

Manufacturer’s base price 1,050,000


Trade Discount [20% of 1,050,000] (210,000)
Freight charges(just like Import duties) 30,000
Electrical Installation (necessary to bring the asset in its present location) 28,000
Pre-Production testing 22,000
Total Component of Cost 920,000

The following do not qualify to form part of the cost and the reasons are;
Early settlement discount, this must only be treated as an expense in the Profit or loss account. [5% of
840,000).
Staff training in the use of machine, you can’t capitalize the cost of training your staff, IAS 38 (Intangible
assets) prohibits such. It must be treated as an expense in the Profit or loss account. GHC40,000.
Maintenance cost must be spread over the three years and charged as an expense for each period.

DEPRECIATION CHARGE FOR THE PERIODS;


looking at the question critically, you would observe clearly that the straight line method comes to play
considering the facts given. First of all, Straight line method is Cost-Scrap value/ useful life.
From the question, we have 920000-20000= 900000 (being the cost of the asset, taking out the scrap
value).

Year ended September 2016, Depreciation Charge


1200
6000
∗ 900,000 = 𝐺𝐻𝐶180,000
Year ended September 2017, Depreciation Charge
1800
6000
∗ 900,000 = 270,000
Year ended September 2018,Depreciation charge.
For the last year, remember that, it was clearly stated in the question that the useful life of the machine
was reassessed to be 4500 hours and only 850 hours had been used as at the period. Hence we have;
850
670,000 − 40,000 ∗ 4500 = 119,000

A reader may argue, from where the (GHC670,000-GHC40,000), Remember also that, on 1st October,
there was an upgrade of GHC200,000 to the machine and that must be capitalized as part of the cost after
charging depreciation (2 years) on the asset. After charging 2 years depreciation, the carrying amount of
the machine would be GHC470,000 hence an addition of GHC200,000 as an upgrade will eventually give
the machinery a new carrying amount of GHC670,000.

STATEMENT OF PROFIT OR LOSS (EXTRACT)

Year Ended 30th Sept 2016 30th Sept 2017 30th Sept 2018
Statement of Profit or loss: GHC GHC GHC
Depreciation (workings 3) 180,000 270,000 119,000
Maintenance (60000/3) 20,000 20,000 20,000
Discount received (5% * 840,000) (42,000) - -
Staff training 40,000 - -

As at; 30th Sept 2016 30th Sept 2017 30th Sept 2018

Statement of financial position GHC GHC GHC


Cost/Valuation (Workings 1 and 2) 920,000 920,000 670,000
Accumulated Depreciation (180,000) (450,000) (119,000)
Carrying Amount 740,000 470,000 551,000

After solving the question, examiners expect you to present your solution in a table form as you can see
above, with that you are trying to illustrate the effect of each transaction on the financial statements.

READ ON DEPRECIATION ACCOUNTING WITH RESPECT TO A CHANGE IN USEFUL


LIFE, DEPRECIATION POLICY TO APPLY.
EXAMINATION SCENARIO QUESTION (ACCA F.R JUNE 2014)

The following details relate to two items of property, plant and equipment (A and B) owned by Delta
which are depreciated on a straight-line basis with no estimated residual value:
Item A Item B
Estimated useful life at acquisition 8 years 6 years
$’000 $’000
Cost on 1 April 2010 240,000 120,000
Accumulated depreciation (two years) (60,000) (40,000)
–––––––– ––––––––
Carrying amount at 31 March 2012 180,000 80,000
–––––––– ––––––––
Revaluation on 1 April 2012:
Revalued amount 160,000 112,000
Revised estimated remaining useful life 5 years 5 years
Subsequent expenditure capitalized on 1 April 2013 nil 14,400

At 31 March 2014 item A was still in use, but item B was sold (on that date) for $70 million.
Note: Delta makes an annual transfer from its revaluation surplus to retained earnings in respect of excess
depreciation.
Required:
Prepare extracts from:
(i) Delta’s statements of profit or loss for the years ended 31 March 2013 and 2014 in respect of
charges (expenses) related to property, plant and equipment;
(ii) Delta’s statements of financial position as at 31 March 2013 and 2014 for the carrying amount
of property, plant and equipment and the revaluation surplus.

SOLUTION

Item A Item B
GHC000 GHC000
Carrying amounts at 31 March 2012 180,000 80,000
Balance = loss to statement of profit or loss (20,000)
––––––––
Balance = gain to revaluation surplus 32,000
––––––––
Revaluation on 1 April 2012 160,000 112,000
Depreciation year ended 31 March 2013 (160,000/5 years) (32,000) (22,400) (112,000/5 years)
–––––––– ––––––––
Carrying amount at 31 March 2013 128,000 89,600
Subsequent expenditure capitalized on 1 April 2013 nil 14,400
–––––––– ––––––––
104,000
Depreciation year ended 31 March 2014 (unchanged) (32,000) (26,000) (104,000/4 years)
–––––––– ––––––––
78,000
Sale proceeds on 31 March 2014 (70,000)
––––––––
Loss on sale (8,000)
––––––––
Carrying amount at 31 March 2014 96,000 nil
–––––––– –––––––

EXPLANATION TO THE ABOVE SOLUTION;

Don’t be scared at all at the question you have seen. In actual fact, that is how a P.P.E schedule is
prepared. Before I proceed, critically study the question again and match my explanations to the solutions
clearly.

For Item A and B, after two charging two years depreciation, their carrying amounts become Item A
180,000 and Item B 80,000. The asset was revalued on 1st April, 2012, and Item A now had a revalued
amount of 160,000 and Item B 112,000.
Meaning Item A has now suffered an impairment loss of GHC20,000 (i.e 180,000-160,000). Now Item B
however has a revaluation gain of GHC32,000 after the asset was revalued to GHC112,000.
We then charged a current year depreciation on both item of assets (160000/5 and 112000/5) leaving a
carrying amount of 128000 and 89600 as you can see from the solution.
After the depreciation charge, Item A had a carrying amount of GHC128,000 and Item B had an amount
of GH89,600.
From the question, there was a subsequent expenditure capitalized on 1st April, hence GHC14,400 was
added to the cost of item B.
We then charged depreciation for the accounting year ended March 2014. Then again, from the question,
Item B was disposed off at GHC70,000 but remember that after charging the last year depreciation
(March, 2014), it had a carrying amount of GHC78,000 so the difference of GHC8,000 is a loss.
INVESTMENT PROPERTY

Investment property is guided by IAS 40. This is one of the easiest standards, any candidate preparing for
F.R can grab. Let’s look at the clue below and once you understand the story line, then trust me, your
problem is almost half solved.

When Rashida turned 22 years old, her boyfriend, Noel, bought for her a piece of land costing GHc
10,000 as a token of love to her. Due to lack of immediate funds available to Rashida, she couldn’t build
anything on the land and it’s been three years since Noel acquired the land for her. The fair value of the
plot is now GHC 15,000.
Now the key emphasis on this scenario is that, there has been an appreciation in the value of the land
and that is equally an investment.

Before Lizzy`s grandmother died, she willed in her name a 22 unit compound house and now her granny
is no more. Lizzy lives in one of the rooms and has rented out the remaining 21 rooms to others.
CLUE; Since Lizzy lives in one of the room, her own room would be classified as an owner occupied
property (IAS16) and Lizzy shall treat the remaining 21 rooms as an investment property all because it
fetches her with rental income.

Quite simply IAS 40 defines Investment Property as any property which is held for capital appreciation or
for rentals.
Note however that, the following does not qualify to be recognized as investment properties;

 Property intended for sale in the ordinary course of business (IAS 2, Inventories)
 Property constructed or developed on behalf of third parties (IAS 11 Construction Contracts)
 Owner-occupied property (IAS 16, Property, Plant and Equipment)

MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION


After a firm has initially recognized its investment properties, IAS 40 requires that an entity can choose
between the Fair Value model and the Cost Model.

FAIR VALUE:
After initial recognition, an entity that chooses the fair value model should measure all of its investment
properties at fair value except in extremely rare cases where this cannot be measured. A gain or loss
arising from a change in the fair value of an investment property should be recognized in net profit oe loss
for the period in which it arises.

COST MODEL:
This should be in line with the cost model of IAS 16.
TRANSFERS

Transfers to or from investment property should be only made when there is a change in use. When an
owner-occupied property becomes an investment property, an entity should apply IAS16, Cost model up
to the date of change of use.

EXAMPLE;
BendiSweet Limited owns a building which serves as the central stores of the company since its
inception. In order to boost profit, it moved its central stores to one of their branches on 30th June 2009
and has now let out the office. It is the policy of the company to use the fair value model for its
investment property. The original cost of the building on 1st January 2000 was GHc 250000 with a useful
life of 50 years. At 31st December 2009, the fair value was assessed to be GHc 350,000.
How would Mr. Payo, the accountant of BendiSweet Ltd treat this in his books?

SOLUTION;

Before the building was let out for rent, it was used by the company as its central stores.
The significance of this is that, the building should be depreciated from initial cost to the time it was
converted as an investment property.
Original Cost 250,000
Depreciation (1st Jan, 2000- 1st Jan 2009) [250/50 x 9] (45,000)
Current Depreciation up to 30th June 2009 (250/50 x 6/12) (2500)
th
Carrying Amount as at 30 June 2009 202500
Capital Surplus 147500
Fair Value at 30th June 2009 350,000

As at 30th June 2009 when the building was let out, it had a book value or carrying amount of GHC
202,500 and the fair value of the building was assessed to be GHC350,000. The difference between the
two which is GHC147,500 will go to the capital surplus account.

EXAMINATION SCENARIO QUESTION (ACCA F.R, JUNE 2013, PAST QUESTION)


(a) Speculate owns the following properties at 1 April 2012:

Property A: An office building used by Speculate for administrative purposes with a depreciated
historical cost of $2 million. At 1 April 2012 it had a remaining life of 20 years. After reorganization on 1
October 2012, the property was let to a third party and reclassified as an investment property applying
Speculate’s policy of the fair value model. An independent valuer assessed the property to have a fair
value of $2·3 million at 1 October 2012, which had risen to $2·34 million at 31 March 2013.

Property B: Another office building sub-let to a subsidiary of Speculate. At 1 April 2012, it had a fair
value of $1·5 million which had risen to $1·65 million at 31 March 2013.
Required:
Prepare extracts from Speculate’s entity statement of profit or loss and other comprehensive income and
statement of financial position for the year ended 31 March 2013 in respect of the above properties. In the
case of property B only, state how it would be classified in Speculate’s consolidated statement of
financial position. Note: Ignore deferred tax
SOLUTION WITH EXPLANATION;
This question is also another example of an owner occupied property being transferred to an investment
property.
For property A, it has a historical depreciated cost of $2million with a useful life of 20 years.
Bear in mind that, the transfer to investment property occurred on the 1st October and the company’s
accounting year commences on 1st April. The significance of this is that, we shall charge half year
2000 6
depreciation. ( 20
∗ 12 = $50 𝑎𝑠 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑐ℎ𝑎𝑟𝑔𝑒).
Now, from the question, you would also realize that after the building was initially assessed to have a fair
value of $2.3m, another assessment placed its value at $2.34m as at the year end, 31st March 2013.
This means there has being a gain of $40. The same thing goes for property B. There has being a gain of
$150.
(Please consider your date very well, in F.R, dates lead to apportionments)

Let’s look at the presentation below and see its effect on the financial statement.

Extracts from Speculate’s financial statements for the year ended 31 March 2013
(workings in brackets in $’000)
$’000
Statement of profit or loss and other comprehensive income
Depreciation of office building (A) (2,000/20 years x 6/12) (50)
Gain on investment properties: A (2,340 – 2,300) 40
B (1,650 – 1,500) 150
Other comprehensive income (A see below) 350
Statement of financial position
Non-current assets
Investment properties (A and B) (2,340 + 1,650) 3,990
Equity
Revaluation reserve (A) [2,300 – (2,000 – 50)] 350

In Speculate’s consolidated financial statements property B would be accounted for under IAS 16
Property, Plant and Equipment and be classified as owner-occupied. Further information is required to
determine the depreciation charge.

EXAMINATION SCENARIO QUESTION (ICA-GH, NOVEMBER 2016 SITTING)


Tanoso owns the following properties as at 31 December 2015:
Property: Fair value (GH¢million)
Land with future use undetermined 3.2
Factory rented to Tanoso's subsidiary under an operating lease 2.4
10 floor office building (fair value is equal per floor)
with 3 floors used as the subsidiary's head office and seven floors
rented to third parties under an operating lease. 15.0
Empty building held for capital appreciation, but not leased out. 4.1

Tanoso's accounting policy is to hold its investment properties under the fair value model and its land and
buildings under the revaluation model.
Required:
In accordance with IAS 40 Investment Property calculate the carrying amount to be recognised as
investment property in Tanoso's consolidated financial statements as at 31 December 2015. (3 marks)
SOLUTION WITH EXPLANATION;
For this particular question, any candidate who has read on the principles of consolidation will understand
my explanation so simply but to those who have still not yet covered there, don’t be scared, just read
through thoroughly and compare with what the question gave, you will understand it.
First of all, if Tanoso was preparing her own separate financial statement, the amount to be recognized as
investment properties in her financial statement would be [3.2 + 2.4 + 15.0 + 4.1= GHC24.7] but under
consolidated accounts, the principle of intra group trading does not permit us to consolidate
transactions that a parent company had with her subsidiary hence we have this.
Land with future use undetermined meets the criteria for recognition, so does the empty building also
meets.
We can’t consolidate the amount rented out to the subsidiary under operating lease and also we have to
take out the 3 floors used by the subsidiary for its operations, hence we end up having 7 floors x 1.5 =
GHC10.5 (each floor cost 1.5m)

The solution has been clearly presented below (as to how it should appear in Group Tanoso Financial
Statements)
. GHm
Land with future undetermined use 3.2
10 floor office building (proportional) 10.5
Empty building held for capital appreciation 4.1
Total 17.8
BORROWING COST

IAS 23 is the standard that governs borrowing cost. Borrowing cost is also one of the easiest standards a
student can score good marks when a question appears from there. Don’t be scared when you here the
term borrowing cost. All that it means is that interests on loans taking to put up any qualifying asset must
be capitalized as part of the cost of the asset all because had the loan not been taken, the interest cost
would not have been incurred. However, let’s look at the scenario below to throw much light into
borrowing cost before we step further down in details.

Mubarick, a fresh graduate accountant prepared his final accounts for consideration. In his report P.P.E
was recognized as GHc 15,000 but upon investigations by the external auditors, they realized that
Mubarick`s entity took a loan amount of GHc15, 000 to put up their new head office at an interest rate of
10%. The auditors argued that IAS 23 entreats all entities to capitalize as part of the cost of an asset any
interest accrued on loans taken to construct any qualifying asset.
Hence Mubarick readjusted his P.P.E as GHc 16,500 (10% 0F 15000) added to the cost of the asset.

Now that the above scenario has thrown some lights unto borrowing cost, let us look at the following.
A qualifying asset is any asset that takes a substantial period of time before it becomes ready for its
intended use or sale.
The standard list the following as part of a qualifying asset;

 Inventories
 Manufacturing plants
 Power generation facilities
 Intangible assets
 Investment properties

Borrowing cost is any cost incurred in connection of borrowing of funds for the construction of qualifying
assets.
The following qualifies to be included in borrowing cost;

 Interest on bank overdrafts and short term and complex borrowings.


 Finance charges in respect of finance leases recognized with IAS 17.
 Exchange differences arising from foreign currency borrowings to the extent that they are
regarded as an adjustment to internet cost.
 Refer to other reading manuals for the rest.

Borrowing Cost eligible for capitalization;

1. Those borrowing costs directly attributable to the acquisition, construction or production of a


qualifying asset are capitalized.
2. The amount of borrowing costs available for capitalization will be the actual borrowing costs
incurred less any investment income on the temporary investment.
EXAMPLE;
On 1st Jan, 2016, Akimoda Co borrowed GHC 1.5m to finance the production of two assets, both of
which were expected to take a year to build. Work started during 2016. The loan facility was drawn down
and incurred on 1st Jan 2016, and was utilized as follows, with the remaining funds invested temporarily.
. ASSET A ASSET B
. GH000 GH000
st
1 January 2016 250 500
1st July 2016 250 500
The loan rate was 9% and Akimoda Co can invest surplus funds at 7%.
Required:
ignoring compound interest, calculate the borrowing costs which may be capitalized for each of the assets
and consequently the cost of each asset as at 31st December 2016.

SOLUTION WITH EXPLANATION;


What the question seeks to achieve is how much should be capitalized as borrowing cost as part of the
cost of the building.
When you study the question clearly, you would realize that Akimoda Co borrowed GHC1.5m to finance
two different assets with each asset costing GHC500 and GHC1000. But because construction was done
in stages, they invested half of the money into investments to yield them returns to reduce their interest
cost on the loan taken.
We shall look at this question in two folds.
Firstly; 1. Borrowing cost;
For Asset A, borrowing cost is GHC500,000 X 9% = GHC 45000.
6
But because we invested half of this amount as investment, we therefore have 𝐺𝐻𝐶250,000 ∗ 7% ∗ =
12
𝐺𝐻𝐶8750 𝑎𝑠 𝑝𝑟𝑜𝑐𝑒𝑒𝑑𝑠 𝑓𝑟𝑜𝑚 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

So therefore, amount to capitalize is GHC45000- GHC8750 = GH36250.00.

The standard states that any interest gain from investment income should be used to offset the
interest cost to be capitalized.

Don’t be confused as to why I calculated the borrowing cost on GHC500000 but rather calculated the
interest gain on the GHC250,000. The reason is simple, GHC500,000 is the actual cost of putting up asset
A but as the question said earlier on, construction was in stages hence you can’t use all the money
instantly, that’s why Akimoda Co. invested half of the money to yield her returns.
But if you want to know the true cost of the asset for capitalization, it is therefore the GHC500,000.

YOUR ASSIGNMENT; Find the borrowing cost for Asset B after studying the solution for Asset A.
Now in some particular cases, an entity can borrow funds generally but apply the funds in part to put up a
qualifying asset. In this case, we can only find the amount of borrowing cost by working out for a
capitalization rate.
The capitalization rate is simply the weighted average of the borrowing cost applicable to the entity`s
borrowing excluding any borrowings made specifically or purposely for any qualifying asset.

EXAMPLE (ICA-GHANA, FINANCIAL REPORTING, READING MANUAL)


Acruni Co had the following loans in place at the beginning and end of 2016.
. 1st Jan, 2016 31st Dec, 2016
. GHcm GHcm
10% Bank loan repayable 2018 120 120
9.5% Bank loan repayable 2019 80 80
8.9% debenture repayable 2017 - 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 1st July 2016.
On 1st Jan, 2016, Acruni Co began construction of a qualifying asset, a piece of machinery for a hydro-
electric plant, using existing borrowings.
Expenditure drawn down for the construction was; GHC 30m on 1st Jan 2016, GHC 20m on 1st October,
2016.
Required:
Calculate the borrowing costs that can be capitalized for the hydro-electric plant machine.

SOLUTION WITH EXPLANATION

This question illustrates a situation where borrowings are obtained from many sources and hence to find
the capitalization rate, you have to use the weighted average method.
The question made it clear that the 8.9% debenture was acquired to fund the construction of a certain
qualifying asset hence, this is straightforward and it has no effect with the problem at hand. I
intentionally highlighted that in the question to draw your attention to it, it won’t be part of our
calculation for borrowing cost.
The problem with this question lies with the remaining loans taken.
I believe that you will agree with me that we can’t capitalize our cost at 10% leaving out the 9.5% bank
loan. Hence to solve this, we simply look for the weighted average to arrive at a capitalization rate.
Follow the steps below.
120 80
Capitalization rate= 10% ∗ + 9.5% ∗ = 9.8%
120+80 120+80

Good, now that we have a single capitalization rate, we can go ahead to calculate our borrowing cost.
𝟑
Borrowing cost = (GHC30m x 9.8%) + (GHC20m x 9.8% x𝟏𝟐 = 𝑮𝑯𝑪𝟑. 𝟒𝟑𝒎)

Someone may argue, why we multiplied the capitalization rate by GHC30m and 20m instead.
Remember that from the question, the cost of the two assets was given as GHC30m and GHC20m.
We only took a grand loan of GHC120m and GHC80m to finance two different assets.
Bear this in mind, we don’t capitalize an amount of loan taken, we rather capitalize the portion of loan
taken to construct an asset.

Example, if we took a loan of 10,000 cedis to construct an asset which cost 10,000 cedis, then we shall
capitalize the cost based on the 10,000 cedis but if we took 10,000 cedis but the cost of the building in
question is 5000 cedis, we shall capitalize our cost based on the GHC5000. Kindly bear this in mind.

EXAMINATION SCENARIO QUESTION


(ICA-GHANA, CORPORATE REPORTING, LEVEL 3, PAST QUESTION)

(a) You have been recently appointed as the technical manager of Quality Consultancy Service (QCS).
QCS provides training and consultancy advice to companies which prepare financial statements using
International Financial Reporting Standards (IFRSs). The managing partner of QCS has asked you to
prepare the advice to be given to several clients in respect of the accounting requirements of non-current
assets and financial instruments for the year ended 31 December 2011.

(i) ABC Ltd had the following loan liability in place during 2011:
i. GHC2, 000,000 at 20% per annum
ii. GHC6, 000,000 at 24% per annum

The company installed a new bottling plant costing GHC1, 800,000 in 2011, the project of which was
financed from the pool of funds. The project commenced in the first week of January 2011 and was
completed on 30 September 2011. Payments to the contractor were scheduled as follows:
GHC
1 January 2011 600,000
1 April 2011 1,000,000
30 September 2011 200,000
The plant was commissioned and put to use in 1 November 2011.

Required:
Describe and justify the correct accounting treatment and presentation of the bottling plant indicating
clearly the amount of borrowing costs that can be capitalized as part of the cost of the bottling line.

SOLUTION WITH EXPLANATION;

When you study this question carefully, you would then again realize that, we have to find a
capitalization rate since ABC Ltd had two loans as at 2011. Just like how we solved the question above,
lets follow same steps for this question;
2000000 6000000
Capitalization rate = 20% ∗ + 24% ∗ = 23%
2000000+6000000 2000000+6000000
Now that we know our borrowing cost rate, let us find the amounts (costs) to be capitalized.
Remember that, from the question, the new bottling plant cost was GHC1,800,000 and a breakdown of its
component cost was GHC600,000, GHC1,000,000 and GHC200,000. Now we have;
9
23% x 600000 x = 𝐺𝐻𝐶103,500
12

6
23% x 1000000 x = GHC 115,000
12

0
23% x 200000 x = NIL (ZERO)
12

Do you know why I did the apportionment as 9/12, 6/12 and 0/12?
This is the reason;
Read the question again, you will realize that the completion date for the project was 30th September and
the projects started each on 1st January (9months till September) 1st April (6months till September) and
30th September (nil because the project ends that very same day).

Total Amount to Capitalize is GHC218500. The cost of the asset is GHC1800000 hence the total cost of
the asset is (218,500 + 1,800,000) given GHC2,018,500

Commencement of Capitalization;
For capitalization of borrowing cost to commence, the following conditions must be fulfilled;
1. Expenditure on the asset is being incurred.
2. Borrowing cost are being incurred.
3. Activities are in progress that is necessary to prepare the asset for its intended use or sale.

Suspension of Capitalization;
When active development is interrupted for any extended periods, capitalization of borrowing cost should
be suspended for those periods. However suspension of borrowing cost is not necessary for temporary
delays or for periods when substantial technical or administrative work is taking place.

Cessation of capitalization;
When all the activities necessary to prepare the qualifying assets for its intended use or sale are complete,
then capitalization of borrowing cost should cease. Some assets may be completed in parts or stages,
where each part can be used while construction is still taking place on the other parts.
Capitalization should cease for parts that are completed.
INTANGIBLE ASSETS

IAS 38 governs the recognition and disclosure of intangible assets.


In a layman`s understanding of an intangible asset, it is any asset that cannot be touched or felt.

IAS 38 defines an intangible asset as an identifiable non-monetary asset without physical substance.
For an asset to be recognized as an intangible asset;

 It must be controlled by the entity as a result of events in the past


 It must be capable of generating future economic benefits.

Examples of intangible assets are computer software, patents, copyrights, goodwill.


Under this standard, we would specifically be looking at what goes into research and development cost
and Goodwill (IFRS3).

RESEARCH AND DEVELOPMENT COST;


Intangible assets are developed with time, it certainly passes through a lot of stages before it finally
achieves it purpose for being invented or created. Study carefully the scenario below as it throws light
into what goes into research and development cost.

Hadi Mukaila is a software entrepreneur, he intends developing accounting software that can out-rightly
signal the management of a company that, they are at risk of collapse. The projected cost of this software
is GHc100, 000 and Hadi started the process by inquiring knowledge from existing ones available, and
testing new ones to experiment his trial process. After four months of thorough research and testing, Hadi
is certain that his new software can stand market trial.

From the scenario above, we can clearly see that Hadi intends to research about the new software by
gathering facts and info before developing it into a standard type. Later on, Hadi was certain that the
software can stand market trial. (That’s development)

Quite simply, research stage is aimed at obtaining new knowledge about the process, formulation, design
and selection of possible alternatives. Research costs should be treated as an expense in the profit or loss
account and written off.

At Development;

 Its technical feasibility of the process being a success is high.


 Management is committed to the course
 Its ability to use or sell the intangible asset.
All cost incurred at this stage are capitalized.
GOODWILL (IFRS3)

Right from our elementary studies in accounting, we have been told and made to understand that goodwill
is an asset. Yes that is very true but let’s figures out something about goodwill and to cut the story short,
not all goodwill can be capitalized as an asset.
Lets look at the scenario below

Diana Aidoo is the C.E.O of Lady Diana Kiddy Care School. She has experienced a rapid increase of
about 500 new kids in the school and has asked her accountant Mr Payo to value the school`s goodwill.
Is that acceptable?
CLUE; Internally generated goodwill cannot be capitalized and treated as an asset all because it is
subjective in nature.

Goodwill can only be capitalized when a business takes over another business. Hence in that case, we call
it purchased goodwill. Goodwill is the excess amount paid over the net worth of a business in a purchase
consideration exercise.

In the case of Lady Diana Kiddy Care school, supposing management wants to sell the school at a price of
GHc1m but the school is worth GH800000, the excess of GHc200,000 is attributed to goodwill and hence
the acquirers can capitalize that amount.

However, at the end of every accounting year, goodwill must be tested for impairment to see if its value
has fallen or impaired over the period of time.

EXAMINATION SCENARIO QUESTIONS (ICA-GHANA, F.R, QUESTION BANK)

D.E is a public listed company. It has been considering the accounting treatment of its intangible assets
and has asked for your opinion on how the matters below should be treated in its financial statements for
the year to 31st March 2014.

1. On 1st October 2013, DE acquired TE, a small company that specializes in pharmaceutical drug
research and development. The purchase consideration was by way of a share exchange and valued at
GH35m. the fair value of TEs net assets was GHc15m (excluding any items referred to below). TE owns
a patent for an established successful drug that has a remaining life of eight years. A firm of specialist
advisors, Leadbrand, has estimated the current value of this patent to be GHc10m, however the company
is awaiting the outcome of clinical trials where the drug has been tested to treat a different illness. If the
trials are successful, the value of the drug is then estimated to be GHc15m. also included in the
company’s statement of financial position is GHc2m for medical research that has been conducted on
behalf of a client.
SOLUTION WITH EXPLANATION;

The following assets will be recognized on acquisition;


fair value of sundry net assets 15
Patent at fair value 10
Research carried out for customer 2
Goodwill (balancing figure) 8
Total consideration 35.

The patent is recognized at its fair value at the date of acquisition, even if it hadn’t previously been
recognized by TE. It will be amortized over the remaining 8 years of its useful life with an assumed nil
residual value. The higher value of GHC15m cannot be used because it depends on the successful
outcome of the clinical trials. The extra GHC5m is a contingent asset, and contingent assets are not
recognized in a business combination. (Only assets, liabilities and contingent liabilities are recognized.)
Although research is not capitalized, this research has been carried out for a customer and should be
recognized as work in progress in current assets. It will be valued at the lower of cost and net realizable
value unless it meets the definition of a construction contract. The goodwill is capitalized at cost. It is not
amortized but it will be tested for impairment annually.

2. DE has developed and patented a new drug which has been approved for clinical use. The cost of
developing the drug were GHc12m. based on early assessments of its sales success, Leadbrand has
estimated its market value at GHc20m

SOLUTION; NEW DRUG

Under IAS 38, the GHC12m costs of developing this new drug are capitalized and then amortized over its
commercial life. (The costs of researching a new drug are never capitalized.) Although IAS 38 permits
some intangibles to be held at valuation, it specifically forbids revaluing patents, therefore the GHC20m
valuation is irrelevant.

3. DE’s manufacturing facilities have recently received a favorable inspection by government medical
scientists. As a result of this the company has been granted an exclusive five-year license to manufacture
and distribute a new vaccine. Although the license had no direct cost to DE, its directors feel its granting
is a reflection of the company’s standing and have asked Leadbrand to value the license. Accordingly
they have placed a value of GHc10m on it.

SOLUTION; GOVERNMENT LICENCE

IAS 38 states that assets acquired as a result of a government grant may be capitalized at fair value, along
with a corresponding credit for the value of the grant. Therefore DE may recognize an asset and grant of
GHC10m which are then amortized or released over the five year life of the license. The net effect on
profits and on shareholders’ funds will be nil.
4. In the current accounting period, D.E has spent GHc3m sending its staff on specialist training courses.
Whilst these courses have been expensive, they have led to a marked improvement in production quality
and staff now needs less supervision. This in turn has led to an increase in revenue and cost reductions.
The directors of DE believe these benefits will continue for at least three years and wish to treat the
training costs as an asset.

SOLUTION; TRAINING COST


Although well trained staff adds value to a business, IAS 38 prohibits the capitalization of training costs.
This is because an entity has insufficient control over the expected future economic benefits arising from
staff training; in other words trained staffs are free to leave and work for someone else. Training is part of
the general cost of developing a business as a whole.

EXAMINATION SCENARIO QUESTION (ICA-GHANA, MAY 2016 SITTING)


You are the finance director of ABC Company. ABC is preparing its financial statements for the year
ended 31st December 2015. The following item has been brought to your attention:
ABC acquired the entire share capital of XYZ Ltd during the year. The acquisition was achieved through
a share exchange. The terms of the exchange were based on the relative values of the two companies
obtained by capitalizing the companies’ estimated cash flows. When the fair value of XYZ’s Ltd
identifiable net assets was deducted from the value of the company as a whole, its goodwill was
calculated at GH¢2.5 million. A similar exercise valued the goodwill of ABC at GH¢4 million. The
directors wish to incorporate both goodwill values in the companies’ consolidated financial statements
Required:
Describe how ABC should treat the item in its financial statements for the year ended 31st December
2015 commenting on the directors views, where appropriate.

SOLUTION;

ABC Ltd
Whilst it is acceptable to value the goodwill of GHC2.5 million of XYZ (the subsidiary) on the basis
described in the question and include it in the consolidated balance sheet, the same treatment cannot be
afforded to ABC’s own goodwill. The calculation may indeed give a realistic value of GHC4 million for
ABC goodwill, and there may be no difference in nature between the goodwill of the two companies, but
it must be realized that the goodwill of ABC is internal goodwill and IFRSs prohibit such goodwill
appearing in the financial statements. The main basis of this conclusion is one of reliable measurement.
The value of acquired (purchased) goodwill can be evidenced by the method described in the question
(there are also other acceptable methods), but this method of valuation is not acceptable as a basis for
recognizing internal goodwill.
IMPAIRMENT OF ASSETS

IAS 36 governs the recognition and disclosure of impairment of assets. The word impairment can be
deduced from “pair`` so hence “impair” means the opposite of pairing.
Now, when they say, an asset has suffered from impairment, all that it means is that the carrying amount
of the asset is higher than its recoverable amount. Let’s look at the scenario below.

Mr. Jonas Acquah is the accountant of Home Growth capital, one of their cars with a value of GHc20,000
had an accident and at the end of the accounting year, a revaluation exercise conducted reviewed that the
recoverable amount of the assets is now GH150,000. The carrying amount of the pool of assets before the
accident was 200,000.What comes into your mind, is nothing else than impairment.
Let’s explore this section below in details as impairment is treated in bits.

MEASURING RECOVERABLE AMOUNT

The recoverable amount is the HIGHER of (1) fair value less costs to sell and (2) Value in use.
The higher amount of any of these two would be the recoverable amount.

FAIR VALUE LESS COST TO SELL;

Fair value is normally taken as the market value. If no active market exists, it may be possible to estimate
the amount that the entity could obtain from the disposal. Direct selling cost includes legal costs, stamp
duty and costs necessary to bring the asset in a condition to be sold.

VALUE IN USE;

An asset`s value in use represents the present value of the expected future cash flows from its continuing
use, discounted at a suitable cost of capital or discount rate.

QUESTION (ICA-GH FINANCIAL REPORTING READING MANUAL)

A company that extracts natural gas and oil has built a drilling platform. It is required by legislation to
remove and dismantle the platform at the end of its useful life. Accordingly, the company has included an
amount in its accounts for removal and dismantling costs, and is depreciating this amount over the
platform’s expected life. The company is carrying out an exercise to establish whether there has been an
impairment of the platform.
(a). its carrying amount out an exercise to establish of financial position is GHC3m.
(b). there company has received an offer of GHC2.8m for the platform from another oil company.
The bidder would take over the responsibility (and costs) for dismantling and removing the platform at
the end of its life.
(c). the present value of the estimated cash flows from the platform’s continued use is GH3.3m (before
adjusting for dismantling costs).
(d). the carrying amount in the statement of financial position for the provision for dismantling and
removal is currently GHC0.6m.

What should be value of the drilling platform in the statement of financial position, and what, if
anything is the impairment loss?
SOLUTION WITH EXPLANATION

The question has tasked us to find the carrying amount of the drilling platform and assess if any
impairment loss has occurred. To do so, we first of all find the following.

 The fair value of the drilling platform is 2.8m (being the offer price received from a bidding
company).
 At this moment, even if you don’t know anything, you should get this. There is an impairment
loss of GHC0.2m being GHC3.0m lessGH2.8m.
 Remember that, to find the carrying amount, the standard says that it should be the higher of the
asset’s fair value less cost to dispose or the asset’s value in use.
For now, we know its fair value to be GHC2.8m, so what about its value in use.
The value in use is GHC3.3m – GHC0.6m = GHC2.7m. hence the higher of these two is
GHC2.8m. so therefore, the carrying amount of the asset should be reduced to GHc2.8m.

CASH GENERATING UNIT (C.G.Us)

When the recoverable amount of an asset cannot be determined, that of its cash generating unit is used. A
cash generating unit refers to the smallest identifiable group of assets for which independent cash flows
can be attributed.

GOODWILL; Allocating goodwill to C.G.Us

Goodwill acquired in a business combination does not generate cash flows independently of other assets.
It must therefore be allocated to each of the acquirer’s cash-generating unit (or group of cash generating
unit) that are expected to benefit from the synergies of the combination. Each unit to which the goodwill
is allocated should

 Represent the lowest level within the entity at which the goodwill is monitored for internal
management purposes.
 Not be larger than a reporting segment in accordance with IFRS 8, Operating Segment.
ACCOUNTING TREATMENT OF AN IMPAIRMENT LOSS.
If the recoverable amount of an asset is less than its carrying amount in the statement of financial
position, an impairment loss has occurred. The following treatment must take place;

 The asset’s carrying amount should be reduced to its recoverable amount in the statement of
financial position.
 The impairment loss should be recognized immediately in profit or loss account unless the asset
has been revalued in which case the loss is treated as a revaluation decrease. After the asset has
been reduced to its recoverable amount, the depreciation charge on the asset must be based on its
new carrying amount, and its estimated residual value (if any) and its estimated remaining useful
life.

IMPAIRMENT LOSS TREATMENT FOR A CASH GENERATING UNIT.


When an impairment loss is recognized for a C.G.U, the loss should be allocated between the assets in the
unit in the following order.

 First, to any assets that are obviously damaged or destroyed.


 Next, to the goodwill allocated to the C.G.U
 Then to all other assets in the C.G.U on a pro-rata basis.

EXAMINATION SCENARIO QUESTIONS, (ICA-GHANA, QUESTION BANK)

The assistant financial controller of the WL Group, a public listed company, has identified the matter
below which she believes may indicate impairment to one or more assets;

WL owns and operates an item of plant that cost GHc640000 and has accumulated depreciation of
GHc400000 at 1st October 2014. It is being depreciated at 12.5% on cost. On 1st April 2015 (exactly half
way through the year) the plant was damaged when a factory vehicle collided into it. Due to the
unavailability of replacement parts, it is not possible to repair the plant, but still operates, albeit at a
reduced capacity. Also it is expected that as a result of the damage the remaining life of the plant from the
date of the damage will be only two years. Based on its reduced capacity, the estimated present value of
the plant in use is GHc150000. The plant has a current disposal value of GHc20000 (which will be nil in
two years time), but WL has been offered a trade-in-value of GHc180000 against a replacement machine
which has a cost of GHc1m (there would be no disposal costs for the replaced plant). WL is reluctant to
replace the plant as it is worried about the long-term demand for the product by the plant. The trade-in-
value is only available if the plant is replaced.

REQUIRED;
Prepare extracts from the statement of financial position and statement of profit or loss of WL in respect
of the plant for the year ended 30th September 2015.
SOLUTION WITH EXPLANATION;
Before we prepare extract to show the effect of this on the financial statement, let us do the following
calculations first, based on the information provided to us by the question.
The whole idea about this question is on impairment of an asset that got damaged through car accident.
The asset in question cost GHC640,000 with an accumulated depreciation of GHC400000, leaving it with
a net book value of GHC240,000. But exactly half way through the accounting year, an accident occurred
1 6
so we shall charge just half year depreciation on the asset. (GHC640,000 * 12 % ∗ = (𝐺𝐻𝐶40,000)
2 12

In a presentation, this is all that am trying to say;


Carrying amount as at 1st April 2015 GHS
Cost 640,000
Accumulated depreciation (as stated in the question) (400,000)
Half year current depreciation (40000)
. ________
. 200,000
. ________

From the question, the recoverable amount of the asset was assessed to be GHC150,000. The fair value
less costs to sell is GHC20,000.
WL Ltd has no intention to replace the asset so the trade-in-value of GHC180000 is irrelevant.

Now in comparing our carrying amount of GHC200000 as against our recoverable amount of
GHC150,000 its clear that the asset is impaired by GHC50,000. So now, its new carrying amount should
be GH150,000.
Now that we have a new value for the asset, let us calculate the 2nd six months depreciation charge for
the year end.

Carrying amount as at 30th September 2015, GHS


Recoverable amount or impaired value 150,000
6
Depreciation for the 2nd six months ( GHC150000 * 24) (37,500)
Carrying amount 112,500

The 6/24 means, the asset has a remaining useful life of 2 years but we have spent just six months out
of that.

STATEMENT OF PROFIT OR LOSS (EXTRACT)


. GH
Non-Current asset;
Depreciation;

 First six months 40,000


 Second six months 37,500

Impairment 50,000
Total Charge 127,500
STATEMENT OF FINANCIAL POSITION AT 30TH SEPTEMBER 2015(EXTRACT)
. GHC
Cost 640,000
Accumulated depreciation and Impairment (400+50+37.5) (527,500)
Carrying Amount 112,500

EXAMINATION SCENARIO QUESTION (ACCA F.R, JUNE 2012 SITTING)

Telepath acquired an item of plant at a cost of $800,000 on 1 April 2010 that is used to produce and
package pharmaceutical pills. The plant had an estimated residual value of $50,000 and an estimated life
of five years, neither of which has changed. Telepath uses straight-line depreciation. On 31 March 2012,
Telepath was informed by a major customer (who buys products produced by the plant) that it would no
longer be placing orders with Telepath. Even before this information was known, Telepath had been
having difficulty finding work for this plant. It now estimates that net cash inflows earned from the plant
for the next three years will be;
year ended: $000
31 March 2013 220
31 March 2014 180
31 March 2015 170
On 31 March 2015, the plant is still expected to be sold for its estimated realizable value.
Telepath has confirmed that there is no market in which to sell the plant at 31 March 2012.
Telepath’s cost of capital is 10% and the following values should be used:
value of $1 at: $
End of year 1 0·91
End of year 2 0·83
End of year 3 0·75
(ii) Telepath owned a 100% subsidiary, Tilda that is treated as a cash generating unit. On 31 March 2012,
there was an industrial accident (a gas explosion) that caused damage to some of Tilda’s plant. The assets
of Tilda immediately before the accident were:
$’000
Goodwill 1,800
Patent 1,200
Factory building 4,000
Plant 3,500
Receivables and cash 1,500
–––––––
12,000
–––––––
As a result of the accident, the recoverable amount of Tilda is $6·7 million
The explosion destroyed (to the point of no further use) an item of plant that had a carrying amount of
$500,000.Tilda has an open offer from a competitor of $1 million for its patent. The receivables and cash
are already stated at their fair values less costs to sell (net realizable values).
Required:
Calculate the carrying amounts of the assets in (i) and (ii) above at 31 March 2012 after applying any
impairment losses.

SOLUTION WITH EXPLANATION;

The carrying amount of the plant at 31 March 2012, before the impairment review, is $500,000 (800,000
– (150,000 x 2)) where $150,000 is the annual depreciation charge ((800,000 cost – 50,000 residual
value)/5 years).
This needs to be compared with the recoverable amount of the plant which must be its value in use as it
has no market value at this date.

Value in use:
Cash flow Discount factor Present value
. $’000 at 10% $’000
year ended: 31 March 2013 220 0·91 200
31 March 2014 180 0·83 149
31 March 2015 170 + 50 0·75 165
––––
514
––––
At 31 March 2012, the plant’s value in use of $514,000 is greater than its carrying amount of $500,000.
This means the plant is not impaired and it should continue to be carried at $500,000.
(ii) Per question After plant write off After impairment
$’000 $’000 $’000
Goodwill 1,800 1,800 write off in full nil
Patent 1,200 1,200 at realizable value 1,000
Factory 4,000 4,000 pro rata loss of 40% 2,400
Plant 3,500 3,000 pro rata loss of 40% 1,800
Receivables and cash 1,500 1,500 realizable value 1,500
––––––– ––––––– ––––––
12,000 11,500 value in use 6,700
––––––– ––––––– ––––––
The plant with a carrying amount of $500,000 that has been damaged to the point of no further use should
be written off (it no longer meets the definition of an asset).
The carrying amounts in the second column above are after writing off this plant.
After this, firstly, goodwill is written off in full.
Secondly, any remaining impairment loss should write off the remaining assets pro rata to their carrying
amounts, except that no asset should be written down to less than its fair value less costs to sell (net
realizable value).
After writing off the damaged plant the remaining impairment loss is $4·8 million (11·5m – 6·7m) of
which $1·8 million is applied to the goodwill, $200,000 to the patent (taking it to its realizable value)
and the remaining $2·8 million is apportioned pro rata at 40% (2·8m/(4m + 3m)) to the factory and the
remaining plant.
The carrying amounts of the assets of Tilda, at 31 March 2012 after the accident, are as shown in the third
column
IFRS 5: NON-CURRENT ASSETS HELD FOR SALE AND DISCOUNTED OPERATIONS.

This particular standard looks at the accounting treatment and disclosures relating to assets that are held
for sale and operations that an entity wishes to discontinue.
IFRS 5 requires that assets, any group of assets that are held for sale should be presented separately in the
statement of financial position. This would enable users of the financial statement to critically assess
business performance and make useful projections about the financial state of the entity.

A disposal group is a group of assets to be disposed of, by sale or otherwise, together as a group in a
single transaction and liabilities directly associated with those assets that would be transferred in the
transaction. A disposal group can be a subsidiary company, cash-generating unit or single operation
within an entity.

CLASSIFICATION OF ASSETS HELD FOR SALE

Take this note clearly, an entity can classify its non-current assets as held for sale if and only if the assets
carrying amount will be recovered principally through a sale transaction rather than through continuing
use. So for this assertion to hold, the following criteria must be met;

 The asset must be available for immediate sale in its present condition.
 Its sale must be highly probable (significant to occur)

So for the sale to be highly probable;

 Management must be committed to a plan to sell the asset.


 An active programme must be in place to locate a buyer.
 The asset must be marked at a price reasonable in relation to its current fair value.
 The sale must be expected to take place within one year.

Note this also;


An asset that has been abandoned by management must not be classified as held for sale.
This is because its carrying amount will be recovered principally through continuing use.

However, a disposal group to be abandoned may meet the definition of a discontinued operation and
therefore separate disclosure may be required. Let’s look at the scenario below.

On 1st Dec, 2015, Kuukua Fashions Ltd became committed to a plan to sell its hairdressing facilities and
has already identified a potential buyer. Kuukua Fashions does not intend to discontinue the operations
currently at the workshop. At 31st Dec, 2015, due to the Christmas activities and the high demand for
hairdressing services, there is a large list of customers to be served. The company cannot transfer the
facilities to the buyer until it completes all customer orders. This has been estimated to occur somewhere
May 2016. Mr. Brown, the accountant is contemplating whether the hairdressing facility should be
classified as “held for sale” at 31st Dec, 2015 and as a qualified accountant, he has called for your opinion.
As a qualified accountant, this should be your answer.
The answer is simply NO, he can’t classify the hairdressing facility as “held for sale” and here are the
reasons.
Even though Kuukua fashions Ltd has met some of the criteria, the facility will not be transferred not
until all customers have been served. (This clearly shows that the asset is not available for immediate sale
in its present condition.)
TREATMENT; carry the asset in the books and continue to depreciate it.

MEASUREMENT OF “HELD FOR SALE”

At this juncture, let us look at how an asset that has been “held for sale” should be measured.
Quite simply, it is the lower of carrying amount and its fair value less costs to disposal.
An impairment loss should be recognized where fair value less cost to disposal is lower than the carrying
amount. An impairment loss is charged to profit or loss.
Once a non-current asset has been held for sale, it should no longer be depreciated, even if the entity
still uses the asset but impairment loss should be charged to the profit or loss account.

However, when a non-current asset is no longer classified as held for sale, (all because the sale has not
taken place within a year), the asset is measured at the lower of the carrying amount (before it was
classified as held for sale) adjusted for the depreciation that wasn’t charged and its recoverable amount at
the date of the decision not to sell.

EXAMINATION SCENARIO QUESTION (ACCA, F.R PAST QUESTION)


Radar’s sole activity is the operation of hotels all over the world. After a period of declining profitability,
Radar’s directors made the following decisions during the year ended 31 March 2013:

– it disposed of all of its hotels in country A;


– it refurbished all of its hotels in country B in order to target the holiday and tourism market. The
previous target market in country B had been aimed at business clients.
Required:
Treating the two decisions separately, explain whether they meet the criteria for being classified as
discontinued operations in the financial statements for the year ended 31 March 2013.

SOLUTION
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations has been criticized for the use of
the term ‘a separate major line of business or geographical area of business operations’ to identify a
discontinued operation as it may mean different things to different people and lead to inconsistency (and
thus a lack of comparability). Despite this, the disposal of hotels in country A would seem to represent a
separate geographical location and should be treated as a discontinued operation, even though the group
will continue to operate hotels in other countries. The example of country B is less conclusive.
Some might argue that a change in the target market (to holiday and tourism) does represent a different
‘line of business operations’ that has a different pricing structure, operating costs (such as providing ‘all-
inclusive’ holidays) and profit margins than that of business clients. Also, the refurbishment of the hotels
would seem to indicate catering to a different market. Others may argue that this is simply adapting a
product (as all companies have to do) and does not represent a change to a separate line of business.
EXAMINATION SCENARIO QUESTION (ICA-GHANA, NOVEMBER 2016 SITTING)

Sofoline Ltd has a plant which cost GH¢40,000 and was purchased on 1 January 2013 with a useful life
of 10 years. The plant was being used as part of its business operating capacity. On 30 June 2015,
Sofoline Ltd made a decision to classify the plant as held for sale and an agent was appointed for the sale
of the plant that have started advertising the plant at a selling price of GH¢29,000 which was considered
to be its fair value. The selling expenses are estimated to be GH¢1,500. The asset has not yet been sold by
the year end of 31 December 2015 and it has a fair value less cost to sell of GH¢24,000 on this date.
Required:
Discuss how this will be accounted for in the financial statements of Sofoline Ltd for the year ended 31
December, 2015 in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations.

SOLUTION WITH EXPLANATION;

Cost 40,000
Less Accumulated Dep. (GHS40,000/10 years) (8,000)
×2
Carrying value at 1.1.2015 32,000
Less Current Yr. Dep. (6 months) (GHS4,000 × (2,000)
6/12)
Carrying value at 30.6.2015 30,000
Impairment loss at 30.6.2015 (2,500)
Fair value less cost to sell at 30.6.2015 27,500
(GHS29,000 - GHS1,500)
Further impairment loss at 31.12.2015 (3,500)
Fair value less cost to sell at 31.12.2015 24,000

EXPLANATION;
The question tasked students to account for how the asset will be treated in the books of Sofoline. The
first question we ought to ask ourselves is that, has the plant met the criteria to be classified as a held for
sale and discontinued operation. From the facts given in the question, it is clear that the conditions have
been met. Sofoline acquired the plant on 1st Jan 2013 and used it till 30th June 2015 after which it decided
to classify the plant as held for sale. From that period till 30th June 2015 was 2 and half years so after
charging depreciation, its carrying amount was GHC30,000 as illustrated in the solution. The plant was
held for sale at 29,000 less selling cost of 1,500 with a net balance of 27,500. You would realize that since
the asset’s carrying amount was 30,000, then an impairment loss of 2,500 has occurred. The cplant was
further classified as 24000 on 30th December,2015. This means there has been a further impairment loss
of 3,500 for that six month period.
IAS 10: EVENTS AFTER THE REPORTING PERIOD

Every business just like the natural season has a calendar year. A time to commence operations and a time
to close operations for accountability. The issue here is that, in business, an entity does not stop trading or
conducting business all because its accounting year has ended. There are some events that occur after the
reporting period which can be both favorable and unfavorable between the end of the reporting period
(when accountants compile their final accounts) and the date the financial statements are authorized for
issue (directors accept and sign the financial statements).

These events are (1) Adjusting (2) Non-adjusting.

Adjusting events provide evidence of conditions that existed at the end of the reporting period.
Examples are;

 Sale of inventory after the reporting period for less than its carrying amount at the year end.
 Discovery of error or fraud which shows that the financial statements were incorrect.
 Insolvency of a customer with a balance owing at the year end.
 Evidence of a permanent diminution in property value for the year end.
 Events of a permanent diminution of value of a long-term investment prior to the year end.

Non-adjusting events are those that are indicative of conditions that arose after the reporting period.
Examples are;

 Acquisition of, disposal of a subsidiary after the year ends.


 Announcement of a plan to discontinue an operation.
 Major purchases and disposals of assets.
 Destruction of a production plant by fire after the reporting period.
 Announcement or commencing implementation of a major restructuring.

EXAMINATION SCENARIO QUESTIONS (ICA-GHANA, NOVEMBER 2016 SITTING)


Suame Ltd is a listed telecommunication company which prepares its financial statements for the year
ended 31 October, 2015 in accordance with IFRS. The financial statements are due to be authorized for
issue on 15 January 2016.

i) Suame Ltd holds an investment in the shares of a listed company, Asafo Ltd. During November 2015
there was a material fall in the value of Asafo Ltd’s shares. Analysts attribute the fall in value principally
to a fraud dating back to December 2014 that was discovered by Asafo Ltd's management and announced
publicly in November 2015.

SOLUTION;
i) The fall in value relates to conditions that arose after the end of the reporting period. Therefore, the fall
in value is a non-adjusting event after the reporting period.
Whilst the effect of the fraud may be an adjusting event in Asafo Ltd’s own financial statements, it is not
an adjusting event for the value of the company's shares on the stock market as that market value was
based on all information available at that time (for example investors who purchased shares on 31
December at the market price on that date would not be able to make a claim against the previous owner
when the fraud was discovered).
In accordance with IAS 10, which requires disclosure of material non-adjusting events after the
reporting period, disclosure will be made of:
nature of the event

ii) In December 2015, the directors of Suame Ltd publicly announced a plan to reduce the workforce by
10% as a result of worsening economic conditions.
Required:
Discuss the effects of each of the above items on the financial statements of Suame Ltd for the year ended
31 October 2015 in accordance with IAS 10 Events after the Reporting Period.

SOLUTION;

ii) The announcement of plans to restructure creates a constructive obligation to do a restructuring. As a


result, a restructuring provision will be recognized from that date, providing the IAS 37 criteria are met.
However, no legal or constructive obligation existed to restructure at the 31 October 2015 year end and
this is therefore a non-adjusting event after the reporting period.
In accordance with IAS 10, which requires disclosure of material non-adjusting events after the reporting
period, disclosure will be made of:
IAS 37: PROVISIONS, CONTIGENT LIABILITIES AND CONTIGENT ASSETS

IAS 37 is the standard that prescribes what should be recognized as a provision and what shouldn’t be
recognized. The English word “provision” means to provide. So therefore in this context, what do we
provide for? Let’s look at the scenario below to catch a glimpse of what causes provisions to be made.

Many at times, entities have obligations or responsibilities to fulfill in the near future. These obligations
are legal and or necessary to do so. Hence there is the need to make a provision for such obligation in the
financial statements.

The essence of this standard was to correct the abuses and creative accounting, many companies used to
recognize provisions in their financial statements. Hence IAS 37 was introduced to guide entities in
reporting what entitles as a provision and what does qualify as a provision. IAS 37 sees a provision to be
a liability (take note well).

A provision is a liability of uncertain timing or amount. A liability is a present obligation of an entity


resulting from past activities, the settlement of which is expected to result in an outflow from the
resources embodying economic benefits.

RECOGNITION;

 An entity has a present obligation (legal or constructive as a result of past events)


 It is probable that an outflow of resources embodying economic benefits will be required to settle
the obligations.
 A reliable estimate can be made of the amount of the obligation.

OBLIGATION;
Two types of obligation can lead to or create a provision. We have legal and constructive obligation.
IAS37 defines a constructive obligation as an obligation which arises out of an established pattern of
past practices, published policies or a sufficiently specific current statement of the entity has indicated to
other parties that it will accept certain responsibilities.
This creates a valid expectation on the part of those other parties that it will discharge those
responsibilities. Example, an established pattern by an entity to paint their company premises, once every
five years.

PROBABLE TRANSFER OF RESOURCES.


A transfer of resources embodying economic benefits is regarded as “probable” if the event is more likely
than not to occur. This indicates a probability of 50%. However, the standard makes it clear that where
there are a number of similar obligations, the probability should be based on considering the population as
a whole rather than one sample items.
MEASUREMENT OF PROVISIONS
The amount recognized as a provision should be the best estimate of the expenditure required to settle the
present obligation at the end of the reporting period. The estimates will be determined by the judgment of
the entity’s management supplemented by the experience of similar transactions.
Examples of such

Changes in provisions;
Provisions should be reviewed at the end of each reporting period and adjusted to reflect the current best
estimates. If it is no longer probable that a transfer of resources will be required to settle the obligation,
the provision should be reversed.

Future operating losses;


Provisions should not be recognized for future operating losses.

Examples of possible provisions;

 Warranties
 Major repairs
 Self insurance
 Environmental contamination
 Decommissioning or abandonment cost restricting.

ONEROUS CONTRACT
This is a contract entered into with another party under which the unavoidable costs of fulfilling the terms
of the contract exceed any revenues expected to be received from the goods or services or purchased
directly or indirectly under the contract and where the entity would have to compensate the other party if
it did not fulfill the terms of the contract.

PROVISIONS FOR RESTRUCTURING


IAS 37 defines a restructuring as “a programme that is planned and is controlled by management and
materially changes one of two things”

 The scope of a business undertaken by an entity.


 The manner in which that business is conducted.

Examples of events that may fall under the definition of restructuring are;

 The sale or termination of a line of business


 The closure of business location in a country or the relocation of business activities from one
country to another.
 Changes in management structure.

An entity must have act formal for the restructuring.

 It must have raised a valid expectation in those affected that it will carry out the restructuring by
starting to implement that plan or announcing its main features to those affected by it.

A mere management decision is not normally sufficient.


Where the restructuring involves the sale of an operation, IAS 37 states an obligation only arises when an
entity has entered into a binding sale agreement.

Cost to be included within a restructuring provision;


Only direct expenditures arising from the restructuring are to be included. And they are;

 Necessarily entailed by the restructuring,


 Not associated with the ongoing activities of the entity.

These costs should not be included;


1.Retraining or relocating continuing staff,
2. Marketing cost,
3. Investment in new systems and distribution networks.

EXAMPLE;
on 13th December 2009, the board of Fine Shades Ent decided to close down a division. The accounting
date of the company is 31st December. The decision was not communicated to any of those affected and
no other further steps were taken to implement the decision.
(No provision would be recognized as the decision has not been communicated)

EXAMINATION SCENARIO QUESTION (ACCA, F.R JUNE 2012 SITTING)

At a board meeting on 1 July 2012, Pulsar’s directors made the decision to close down one of its factories
on 31 March 2013. The factory and its related plant would then be sold.

A formal plan was formulated and the factory’s 250 employees were given three months’ notice of
redundancy on 1 January 2013. Customers and suppliers were also informed of the closure at this date.
The directors of Pulsar have provided the following information:
Fifty of the employees would be retrained and deployed to other subsidiaries within the group at a cost of
$125,000; the remainder will accept redundancy and be paid an average of $5,000 each.
Factory plant has a carrying amount of $2·2 million, but is only expected to sell for $500,000 incurring
$50,000 of selling costs; however, the factory itself is expected to sell for a profit of $1·2 million.
The company rents a number of machines under operating leases which have an average of three years to
run after 31 March 2013.
The present value of these future lease payments (rentals) at 31 March 2013 was $1 million; however, the
lessor has said they will accept $850,000 which would be due for payment on 30 April 2013 for their
cancellation as at 31 March 2013.
Penalty payments due to non-completion of supply contracts are estimated at $200,000.
Required:
Explain and quantify how the closure of the factory should be treated in Pulsar’s financial
statements for the year ended 31 March 2013.
Note: The closure of the factory does not meet the criteria of a discontinued operation.
SOLUTION WITH EXPLANATION
On its own, a board decision to close the factory is not sufficient to justify the creation of a provision
under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. However, by formulating a plan
and informing interested parties (employees, customers and suppliers), this is likely to constitute a
constructive obligation for a restructuring provision by raising a valid expectation of the closure.
The amounts that should be provided for at 31 March 2013 are:
(workings in brackets are in $’000)
$’000
– Redundancy (200 employees x 5) 1,000
– Impairment loss on plant (2,200 – (500 – 50)) 1,750
– Onerous contract (lower amount) 850
– Penalty payments 200
––––––
, 3,800
______
The $3·8 million should be charged to the statement of profit or loss for the year ended 31 March 2013
and the same amount reported in the statement of financial position as at 31 March 2013 as a current
liability/plant impairment (assuming all parts of the factory closure will be completed within the next 12
months).
The factory and the plant would be disclosed in the statement of financial position as non-current assets
held for sale at the lower of their carrying amount (the factory) or fair value less cost to sell (the plant).
The $125,000 retraining costs cannot be provided for as they are part of future activities and the
anticipated $1·2 million profits on the disposal of the factory cannot be recognized until it is realized.

CONTINGENT LIABILTIES AND CONTINGENT ASSETS

An entity should not recognize a contingent asset or liability but they should be disclosed. IAS 37 defines
a contingent liability as a possible obligation that arises from past events and whose existence will only be
confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within
the control of the entity.

TREATMENT OF CONTINGENT LIABILTY

They should not be recognized but disclosed.


Disclosures such as brief description of the nature of the contingent liability. Estimate of its financial
effect. An indication of the uncertainties that exist.

Contingent Liability
IAS 37 defines a contingent asset as a possible asset that arises from past events and whose existence will
be confirmed by the occurrence of one or more uncertain future events not wholly within the control of
the entity.
EXAMPLE;
During 2001, Fine boy Co guaranteed certain borrowings of Baaba Co. whose financial conditions at that
time were sound. During 2002, Baaba Co financial conditions sound so bad and as at 30th June 2002,
Baaba Co has filed for protection from its creditors. What should be the accounting treatment of this event
in the books of Fine boy Co as at 30th June 2001 and 30th June 2002?

SOLUTION;
30th June 2001;
as at this date, there was no obligating event to indicate or suggest that Fine boy Co will settle a liability,
hence no provision should be made. Fine boy Co should make a disclosure concerning the event.

30th June 2002;


as at this date, there was reasonable evidence that Fine boy has to settle the liability of Baaba Co as a
result of guarantying on the company’s behalf. This will result in a transfer of economic benefits that will
outflow to the company. A provision should be recognized.

EXAMINATOIN SCENARIO QUESTION (ACCA, F.R, DECEMBER, 2011)

Borough owns the whole of the equity share capital of its subsidiary Hamlet. Hamlet’s statement of
financial position includes a loan of $25 million that is repayable in five years’ time. $15 million of this
loan is secured on Hamlet’s property and the remaining $10 million is guaranteed by Borough in the
event of a default by Hamlet. The economy in which Hamlet operates is currently experiencing a deep
recession, the effects of which are that the current value of its property is estimated at $12 million and
there are concerns over whether Hamlet can survive the recession and therefore repay the loan.

Required:
Describe, and quantify where possible, how the above should be treated in Borough’s statement of
financial position for the year ended 30 September 2011.
Distinguish between Borough’s entity and consolidated financial statements and refer to any
disclosure notes. Your answer should only refer to the treatment of the loan and should not
consider any impairment of Hamlet’s property or Borough’s investment in Hamlet
SOLUTION;
From Borough’s perspective, as a separate entity, the guarantee for Hamlet’s loan is a contingent liability
of $10 million.
As Hamlet is a separate entity, Borough has no liability for the secured amount of $15 million, not even
for the potential shortfall for the security of $3 million. The $10 million contingent liability would
normally be described and disclosed in the notes to Borough’s entity financial statements.
In Borough’s consolidated financial statements, the full liability of $25 million would be included in the
statement of financial position as part of the group’s consolidated non-current liabilities – there would be
no contingent liability disclosed.
The concerns over the potential survival of Hamlet due to the effects of the recession may change the
disclosure in Borough’s entity financial statements. If Borough deems it probable that Hamlet is not a
going concern the $10 million loan, which was previously a contingent liability, would become an actual
liability and should be provided for on Borough’s entity statement of financial position and disclosed as a
current (not a non-current) liability.
EXAMINATION SCENARIO QUESTION (ACCA, F.R, DECEMBER 2014, SITTING)

Skeptic has two potential liabilities to assess.


The first is an outstanding court case concerning a customer claiming damages for losses due to faulty
components supplied by Skeptic.
The second is the provision required for product warranty claims against 200,000 units of retail goods
supplied with a one-year warranty.
The estimated outcomes of the two liabilities are:
Court case Product warranty claims
10% chance of no damages awarded 70% of sales will have no claim
65% chance of damages of $4 million 20% of sales will require a $25 repair
25% chance of damages of $6 million 10% of sales will require a $120 repair

SOLUUTION WITH EXPLANATION;


The two provisions must be calculated on different bases because IAS 37 Provisions, Contingent
Liabilities and Contingent Assets distinguishes between a single obligation (the court case) and a large
population of items (the product warranty claims).

For the court case the most probable single likely outcome is normally considered to be the best estimate
of the liability, i.e. $4 million. This is particularly the case as the possible outcomes are either side of this
amount. The $4 million will be an expense for the year ended 31 March 2014 and recognized as a
provision.
The provision for the product warranty claims should be calculated on an expected value basis at $3·4
million (((75% x nil) + (20% x $25) + (10% x $120)) x 200,000 units).
This will also be an expense for the year ended 31 March 2014 and recognized as a current liability (it is
a one-year warranty scheme) in the statement of financial position as at 31 March 2014.

EXAMINATION SCENARIO QUESTION (ICA-GHANA, F.R, QUESTION BANK)

NA prepares its financial statements to 31st December each year. During the years ended 31st December
2010 and 31st December 2011, the following event occurred.

NA is involved in extracting minerals in a number of different countries. The process typically involves
some contamination of the site from which the minerals are extracted. NA makes good this contamination
only where legally required to do so by legislation passed in the relevant country. The company has been
extracting minerals in Copperland since January 20W8 and expects its site to produce output until 31st
December 2015. On 23rd December 2010, it came to the attention of the directors of NA that the
government of Copperland was virtually certain to pass legislation requiring the making good of mineral
extraction sites. The legislation was duly passed on 15th March 2011. The directors of NA estimate that
the cost of making good the site in Copperland will be GHc2m. This estimate is of the actual cash
expenditure that will be incurred on 31st December 2015.
Required;
Compute the effect of the estimated cost of making good the site on the financial statements of NA for
BOTH of the years ended 31st December 2010 and 2011. The annual discount rate to be used in any
relevant calculations is 10%. The relevant discount factors at 10% are;
Year 4 @ 10% 0.683 Year 5 @ 10% 0.621
SOLUTION WITH EXPLANATION;

NA should recognize a provision for the estimated costs of making good the site because;

1. it has a present obligation to incur the expenditure as a result of a past event. In this case, the
obligating event occurred when it became virtually certain that the legislation would be passed.
Therefore the obligation existed at 31st December 2010.
2. An outflow of resources embodying benefits is probable.
3. It is possible to make a reliable estimate of the account.

For the year ended 31st December 2010;


A provision of GHC1,242,000 (2,000,000 x 0.621) is reported as a liability.
A non-current asset of GHC1,242,000 is also recognized. This is because, the provision results in a
corresponding asset because the expenditure gives the company access to an inflow of resources
embodying future economic benefits, there is no effect on profit or loss for the year.

For the year ended 31st December 2011;


Depreciation of GHC248,000 (1,242,000 x 20%) is charged to profit or loss.
The non-current asset is depreciated over its remaining useful economic life of 5 years from 31st
December 2010. (The site will cease operations on 31st December 2015)
therefore at 31st December 2011, the carrying amount of the non-current asset will be GHC993,600
(1,242,000 – 248,000)

EXAMINATION SCENARIO QUESTION (ACCA, F.R, DECEMBER, 2011)

On 1 October 2010, Borough commenced the extraction of crude oil from a new well on the seabed. The
cost of a 10-year license to extract the oil was $50 million. At the end of the extraction, although not
legally bound to do so, Borough intends to make good the damage the extraction has caused to the seabed
environment. This intention has been communicated to parties external to Borough. The cost of this will
be in two parts: a fixed amount of $20 million and a variable amount of 2 cents per barrel extracted. Both
of these amounts are based on their present values as at 1 October 2010 (discounted at 8%) of the
estimated costs in 10 years’ time. In the year to 30 September 2011 Borough extracted 150 million barrels
of oil.

SOLUTION WITH EXPLANATION;


Although the information in the question says the environmental provision is not a legal obligation, it
implies that it is a constructive obligation (Borough has created an expectation that it will pay the
environmental costs) and therefore these costs should be provided for. The obligation for the fixed
element of the cost arose as soon as the extraction commenced, whereas the variable element accrues in
line with the extraction of oil. The present value of the environmental cost is shown as a non-current
liability (credit) with the debit added to the cost of the license and (effectively) charged to income as part
of the annual amortization charge.
The relevant extracts from Borough’s statement of financial position as at 30 September 2011 are:
$’000
Non-current asset
License for oil extraction (50,000 + 20,000) 70,000
Amortization (10 years) (7,000)
–––––––
Carrying amount 63,000
–––––––
Non-current liability
Environmental provision ((20,000 + (150,000 x 0·02 cents)) x 1·08 finance cost) 24,840
–––––––
FINANCIAL INSTRUMENTS

This is a topic which is governed by several standards.

(a) IAS 32; Financial Instruments: Presentation, which deals with


 The classification of financial instruments between liabilities and equity.
 Presentation of certain compound instruments (instruments combining debt and equity)
 IAS 39; Financial Instruments; Recognition and measurement, which deals with
 Recognition and derecognition
 Measurement of financial instruments
 Hedge accounting
 IFRS 7 Financial Instruments; Disclosures
 IFRS 9; Financial Instruments; IFRS 9 deals with recognition, derecognition and measurement
of financial assets and liabilities.

Many candidates preparing for financial reporting seem to have a mixed feeling towards this topic
perhaps due to some few complex technicalities involved, but trust me, this is one of the coolest standards
to go by. At the end of this section, you shall understand it well in terms of what is expected of level 2
candidates.

Just follow the steps and discussions as we unlock this topic in bits.

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.

Financial Asset;
This is any asset in the form of cash, equity instrument of another entity, a contract to receive cash or
another financial asset from another entity or to exchange financial instruments with another entity under
conditions that are potentially favorable to the entity.

Financial Liability;
Any liability that is a contractual obligation to deliver cash or another financial asset to another entity or
to exchange financial instruments with another entity under conditions that are potentially unfavorable.

EXAMPLES OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES

Financial Assets Financial Liabilities

 Trade receivables Trade Payables


 Options Debenture loan payable
 Shares (when held as an investment) Redeemable preference (non-
equity)
PRESENTATION OF FINANCIAL INSTRUMENTS
The main objective of IAS 32 is to demonstrate to students and practitioners on how financial instruments
may affect an entity`s financial position, financial performance and cash flow.

SCOPE;
IAS 32 applies to all types of financial instruments except items such as subsidiaries, associates and joint
ventures, pensions and insurance contracts.

LIABILITIES AND EQUITY;


IAS 32 states that financial instruments should be presented according to their substance, not merely their
legal form. An entity which issues financial instruments should classify them either as financial liability
or equity. A financial liability can be distinguished from an equity instrument when there is a contractual
obligation on the issuer either to deliver cash or other financial assets to the holder or to exchange another
financial instrument with the holder under potentially unfavorable conditions to the issuer. When the
above criteria are not met, then the financial instrument is an equity instrument.

COMPOUND FINANCIAL INSTRUMENTS;


Some financial instruments contain both a liability and an equity element. In such cases, IAS 32 requires
each component of the instrument to be classified separately, according to the substance of the contractual
arrangement and in line with the definitions of a financial liability and an equity instrument. One of the
most common types of this instrument is a convertible debt. It creates a primary financial liability of the
issuer and grants an option to the holder of the instrument to convert it into an equity instrument (usually
ordinary shares) of the issuer.
IAS 32 requires the following method;

 Calculate the value for the liability component


 Deduct this from the instrument as a whole to leave a residual interest or value for the equity
component.

VALUATION OF A COMPOUND FINANCIAL INSTRUMENT


EXAMPLE, (ICA-GHANA, F.R READING MANUAL)

Rathbone Co. issues 2000 convertible bonds at the start of 2002. The bonds have a 3 year term and are
issued at par with a face value of $1000, giving total proceeds of $2000000. Interest is payable annually
in arrears at a nominal annual interest rate of 6%. Each bond is convertible at any time up to maturity into
250 ordinary shares. When the bonds are issued, the prevailing market interest rate for similar but non-
convertible debt is 9%. What is the value of the equity component in the bond?

SOLUTION WITH EXPLANATION;

Rathbone Co issued 2000 convertible bonds at the start of the year with a face value of $1000, this gives a
total market capitalization of $2,000,000 as stated in the question. There are two interest rates in the
question that is 6% and 9%. The 6% is the actual interest that the company can afford to pay on the bond
and the 9% is the interest rate comparable to a similar but non-convertible bond. We would first of all
calculate our interest based on the rate (6%) the company can afford to pay, then we compute the total
interest to be received using the market rate (9%).
The interest is 6% x 2,000,000 = 120,000.
Now we calculate the true value of interest that will be paid using the market rate for similar but non-
convertible bonds rate of 9%, hence we have
GHC120,000 x 2.5313 = GHC303,755. (*2.5313 was obtained after finding the discount factor of 9% for
three years, accumulated together).
Now, because the loan amount of GHC2,000,000 will be redeemed in the third (3rd) year, we then find
the present value of GHC2,000,000 in three(3) years time using the market rate of 9%.
That is GHC2,000,000 x 0.772 = GHC1,544,367.
Now when you add up GH1,544,367 + GHC303,755 together, that will be GHC1,848,122.
The difference between this amount (GHC1,848,122) and the loan amount of GHC2,000,000 is
GHC151,878. This is the equity component being separated. The solution has been presented formally
below.

P.V of 2,000,000 @ 3 yrs (2m x 0.772) 1,544,367


P.V of interest 120,000 for 3 yrs (120,000 x 2.5313) 303,755
total liability component 1,848,122
Equity component (balancing figure) 151,878
Proceeds of the bond issue 2,000,000

Finance Cost is (9% x 1,848,122) = GHC166,330.98


Loan balance is [1,848,122 + (166,330.98 – 120,000)] = GHC1,894,452.98

Note; the finance cost is charged using the interest rate for similar but non-convertible bond. This is
treated as an expense in the profit or loss account.
The loan balance is calculated as the [loan amount + (Finance Cost – Interest Paid using company
rate, 6%)]
EXAMINATION SCENARIO QUESTION (ICA-GHANA, F.R, MAY 2016 SITTING)
Naniama Ltd issued 3,000 convertible bonds at par. The bonds are redeemable in 4 years’ time at their par
value of GH¢100 per bond. The bonds pay interest annually in arrears at an interest rate (based on
nominal value) of 5%. Each bond can be converted at the maturity date into 5 GH¢1.00 shares. The
prevailing market interest rate for four year bonds that have no right of conversion is 8%.
The present value of 8% of GHC1 receivable at the end of;

Year 1 0.926
Year 2 0.857
Year 3 0.794
Year 4 0.735

SOLUTION;
Kindly follow the same explanation I gave for the first question, the same procedure applies in this
question.

Naniama Ltd
GHC
Non-current liabilities
Financial liability component of convertible bond (W1) 270,180
Equity
Equity component of convertible bond (300,000 – (Wi) 270, 180) 9,820
Working GHC
Fair value of equivalent non-convertible debt
Present value of principal payable at end of 4 years
(3,000 x GHC100 = GHC300,000 x 0.735) = 220,500
Year 1 (5% x 300,000) 15,000 x 0.926 13,890
Year 2 15,000 x 0.857 12,855
Year 3 15,000 x 0.794 11,910
Year 4 15,000 x 0.735 11,025
49,680
270,180
INTEREST, DIVIDENDS, LOSSES AND GAINS

 Interest, dividends, loans and gains relating to a financial instrument classified as a financial
liability should be recognized as an income or expense in profit or loss.
 Distributions to holders of a financial instrument classified as an equity instrument should be
debited directly to equity by the issuer. These are dividends. (Appear under the statement of
changes in equity.)
 Transaction costs of an equity transaction should be accounted for as a deduction from equity
usually debited to the share premium account.

RECOGNITION OF FINANCIAL INSTRUMENT;

INITIAL RECOGNITION;
A financial asset or liability should be recognized in the statement of financial position when the reporting
entity becomes a party to the contractual provisions of the instrument. (This is different from the
recognition criteria in most of the standards)

DERECOGNITION;
This means removing a previously recognized financial instrument from an entity’s statement of financial
position when the contractual rights to the cash flows from the financial asset has expired or it transfers
substantially all the risks and rewards of ownership of the financial asset to another party. An entity must
derecognize a financial liability when the obligation specified in the contract has been canceled or
expired.

On derecognition, the following treatment has occur


Carrying amount or liability transferred xx
less; proceeds received/paid xx
any cumulative gain/loss xx
. (xx)
Difference goes to the net profit or loss x

MEASUREMENT OF FINANCIAL INSTRUMENT;


They should be recorded initially at cost. At initially measurement, it is measured at the fair value of the
consideration given or received.

SUBSEQUENT MEASUREMENT;
After measuring a financial asset at initial recognition, IAS 39 classifies financial asset into four
categories.

 A financial asset or liability at fair value through profit or loss. It is classified as held for
trading; (acquired principally for the purpose of selling or repurchasing it in the near term. Also a
part of a portfolio of identified financial instrument that are managed together for which there is
evidence of a recent actual pattern of short term profit taken.)
 Held-to-maturity investments; non-derivative financial asset with fixed or determinable
payments and fixed maturity that an entity has positive intent and ability to hold for maturity.
 Loans and Receivables; they are also non-derivative financial asset with fixed or determinable
payments and fixed maturity that are not quoted in an active market.
 Available for sale financial asset; these are financial assets other than the first three listed
above.

Loans and receivables and held for maturity investments should be measured at amortized cost using
effective interest method.

IAS 39 defines Amortized cost of a financial asset or liability as an amount at which a financial asset or
financial liability is measured at initial recognition less principal repayments, plus or minus the
cumulative amortization of any difference between that initial amount and the maturity amount, and
minus any write down for impairment or uncollectability. The effective interest method is a method of
calculating the amortized cost of a financial instrument and of allocating the interest income or interest
expense over the relevant period.

The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts
through the expected life of the financial instrument to the net carrying amount.

Subsequent measurement of financial liabilities.


After initial recognition, all financial liabilities should be measured at amortised cost, except financial
liabilities at fair value through profit or loss. They should be measured at fair value but in situation where
its fair value is not capable of being measured reliably, its cost should be used.

Gains and losses;


financial instruments at fair value through profit or loss;
gains and losses are recognized in profit or loss.
Available for sale financial assets; Gains and losses are recognized directly in equity through statement
of comprehensive income.
Financial instruments at amortized cost;
Gains and losses are recognized in profit or loss as a result of the amortization process and when the asset
is derecognized.

Level 3 candidates should further read on impairment of financial instruments.


IAS 17, ACCOUNTING FOR LEASES

A lease is a way of getting a non-current asset such as plant and machinery to use without purchasing it
outright. Sometimes, when an entity does not have enough funds to purchase an asset outright, they can
lease the asset on a number of years.
IAS 17 defines a lease as an agreement whereby the lessor (owner) conveys to the lessee in return for a
payment or series of payments, the right to use an asset for an agreed period of time. Under IAS 17, there
are two types of leases. Each type of lease is accounted for in a different way. The nature of terms of the
lease agreement determines the type of lease.

Finance Lease;
As the name suggests, this type of lease involves the hiring of major assets that can be used for more than
one accounting year. Under finance lease, we look at the concept of substance over form.
Accounting for finance lease is based on this concept all because, transaction and items should be
accounted for according to their economic substance, and not their legal form. Let’s look at the scenario
below.

Suleiman Rentals leased out ten (10) of their heavy duty tracks to Albee Engineering Services for a period
of 15 years. In this scenario, legally the cars belong to Suleiman rentals because they have the title
documents to the cars. But as accountants, we look at the substance of the contract considering Albee
Engineering Services going to use the assets for 15 good years. It becomes like their asset and hence they
add it to their pool of assets and depreciate them just like how they treat other assets.

A finance lease is a lease that transfers substantially all the risks and rewards of ownership to the lessee.
This means the lessee is responsible for risks such as maintaining the assets and also has the rewards in
the form of revenue generation from the asset.

IDENTIFYING A FINANCE LEASE

1. The legal ownership of the asset will be transferred from the lessor to the lessee at the end of the
term of the lease, based on the terms of the lease agreement.
2. The lessee has the option at a future date to purchase the asset from the lessor and the agreed
purchase price is substantially lower than the expected fair value of the asset.
3. The leased asset is of such a specified nature that it can only be used by the lessee.

TREATMENT OF FINANCE LEASE IN THE FINANCIAL STATEMENTS OF THE LESSER


(ENTITY THAT HIRES)
At the commencement of a finance lease, the entity should record the leased asset in his or her account as
a non-current asset ‘’at cost``. This should be the lower of the fair value of the asset and the present value
of the minimum lease payments. (These refer to the minimum payments that the lessee has agreed to pay
under the terms of the lease agreement). The fair value of the asset is the cash price had the asset been
purchased out rightly. The present value of the lease payments would be stated within the question given.

Double Entry Principles;

Debit; Property, plant and Equipment (P.P.E)


Credit; Liabilities; Finance lease obligations.
ACCOUNTING TREATMENT;
During the term of the lease, the leased asset is accounted for as a tangible non-current asset.
It is depreciation over the shorter of its expected useful life and the terms of the lease.
The leased asset is included in the statement of financial position at cost minus accumulated depreciation
and the annual depreciation cost is an expense in profit or loss account.
The rental payments by the lessee to the lessor consist of two elements.

 A finance charge (interest charge) on the liability to the lessor and


 A partial repayment of the liability (the fiancé lease obligations).

The finance charge is treated as finance cost in profit or loss for the period.
The partial repayment of the lease obligation reduces the amount of the liability that remains unpaid.

Lease payments; interest charge and partial repayment of the liability.

Just like a loan sum taken, lease payments at each year is divided into a finance charge and a partial
repayment of all liability for the finance lease obligation.

Total lease payment in the financial period A


Minus; finance charge (interest charge) B
Equals; Partial repayment of the liability for the finance lease obligation A-B

The remaining liability for the finance lease obligation is calculated each year.

Allocating finance charges (Interest);


There are two methods to allocate finance charges and these are
1. Actuarial method

2. Sum of the digits method.

Lease Payments (Arrears and in Advance)

The payment of lease installments can be done in advance or at arrears. This seems to confuse many
students at times when determining when a question is talking at payments made in advance or in arrears.

Payments in arrears; Interest accrues over time and is included in the repayment (if made at the end of
the period.)

Payment in advance; the first instalment repays capital only as no interest has yet accrued. At the end of
each accounting period, the year-end liability will include capital and interest accrued to date but not yet
been paid.
QUESTION (ICA-GHANA, STUDENTS JOURNAL, SEPT/DEC. 2016 EDITION)
Accounting for a finance lease (Payment in arrears)
X limited leased an asset under the following terms;

 Fair value of asset GHC10,0000


 Rentals in arrears 4 years at GHC3,000 p.a
 Implicit rate of interest 7.72%
 Useful life of the asset 4 years

Calculate the interest charge and year end liability each year using the actuarial method, together with the
relevant statement of financial position.

YEAR OPENING INT. REPAYMENT CAPITAL CLOSING


BALANCE CHARGE ELEMENT BALANCE
(7.72%)
1 10,000 772 3,000 2.228 7,772
2 7,772 600 3,000 2,400 5,372
3 5,372 415 3,000 2,585 2,787
4 2,787 215 3,000 2,785 NIL

EXTRACT FROM STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE


INCOME- Year 1
Depreciation GHC2,500
Finance Cost GH772

EXTRACT FROM STATEMENT OF FINANCIAL POSITION- Year 1


Non-Current Asset (GHC10,000-GHC2,500) GHC7,500
Non-Current Liability- Lease GHC5,372
Current Liability
Lease GHC2,400
QUESTION (ICA-GHANA, STUDENTS JOURNAL, SEPT/DEC. 2016 EDITION)
Accounting for a finance lease (Payment in advance)

The terms of a finance lease are as follows;


Cost of asset GHC25,000
Estimated useful life 5 years
Lease term is 5 years at GHC6,500 per annum in advance and the implicit rate of interest is 15.2%

Calculate the interest charge and year end liability each year using the actuarial method, together with the
relevant statement of financial position.

YEAR OPENING LEASE NET FINANCE CLOSING


BALANCE. PAYMENT.GHC BALANCE COST @ BALANCE.
GHC GHC 15.2% GHC
1 25,000 (6,500) 18,500 2,812 21,312
2 21,312 (6,500) 14,812 2,251 17,063
3 17,603 (6,500) 10,563 1,606 12,169
4 12,169 (6,500) 5,669 861 6,530
5 6,530 (6,500) ---- ---- ----

EXTRACT FROM STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE


INCOME- Year 1
Depreciation (GHC25,000/ 5 yrs); GHC5,000
Finance Cost GHC2,812

EXTRACT FROM STATEMENT OF FINANCIAL POSITION-Year 1


Non-current Asset (GHC25,000-GHC5,000) GHC20,000
Non-current liability-Lease GHC14812
Current Liability
Lease (GHC6,500-GHC2,812) GHC3,688
Interest Accrual GHC2812

QUESTION; (ICA-GHANA, STUDENTS JOURNAL, SEPT/DEC. 2016 EDITION)


Using Sum of the digit method;

Smith Limited entered into a six-year finance lease for an item of plant on 1st August 2007. The
agreement requires Smith Limited to pay a deposit of GHC80,000 to be followed by five equal
installments of GHC120,000 on 1st August in each subsequent year. The purchase price of the asset if
purchased outright would be GHC620,000. Smith Limited has just recently paid the insurance bill for the
machine. Smith Limited uses the sum of digits to allocate the finance charge for this lease.

SOLUTION WITH EXPLANATION;


Unlike the actuarial method in which an implicit interest is given, the sum of the digits method uses a
different approach. From the question, Smith Limited is to make five equal annual installment of
GHC120,000. Hence our sum of digits allocation = 5+4+3+2+1 = 15 (lease is payable in advance). But
the problem is, how then do we find our Finance charge to calculate the interest on it.
Remember that Smith Limited made an initial deposit of GHC80,000 and five equal installment of
GHC120,000, hence we have total payment of [GHC80,000 + 5 X GHC120,000]= GHC680,000.
The fair value of the asset is GHC620,000 as stated in the question. Therefore GHC680,000 –
GHC620,000 = GHC60,000 as the amount to calculate finance charge on.
Let’s calculate our interest charges for the five periods. I will solve the first two for you and present the
rest in the table, please do well to continue the rest.
5
Year ended 31st July 2008; ∗ 60,000 = 𝐺𝐻𝐶20,000.
15

4
Year ended 31st July 2009; ∗ 60,000 = 𝐺𝐻𝐶 16000.
15

Calculate the rest for the time period ending 31st July 2010, 2011, 2012 and 2013.

YEAR BALANCE(GHC) PAYMENT(GHC) CAPITAL INTEREST(GHC) CLOSING


ENDED (GHC) BAL.
31ST July 620,000 (80,000) 540,000 20,000 (5/15) 560,000
2008
31st July 560,000 (120,000) 440,000 16,000 (4/15) 456,000
2009
31st July 456,000 (120,000) 336,000 12,000 (3/15) 348,000
2010
31st July 348,000 (120,000) 228,000 8,000 (2/15) 236,000
2011
31st July 236,000 (120,000) 116,000 4,000 (1/15) 120,000
2012
31st July 120,000 (120,000) ----- ----- -----
2013

Total liability at 31st July 2008 = GHC560,000


Non-current liability = GHC440,000
Current liability = GHC 1120,000

EXAMINATION SCENARIO QUESTION (ICA-GHANA NOVEMBER 2016 SITTING)


You are employed as the Financial Accountant for Asokwa Ltd. Asokwa Ltd leased a new piece of
equipment from Amakom Ltd for three years commencing on 30 September 2014. The fair value of the
equipment is GH¢70,000. A deposit of GH¢4,000 was payable on 30 September 2014 followed by six
half-yearly payments of GH¢13,500, payable in arrears, and commencing on 31 March 2015. Asokwa Ltd
allocates finance charges on a sum of the period digits basis.

Required:
Prepare financial statement extracts showing how the lease transaction of Asokwa Ltd should be treated
for the year ended 31 December 2014.
SOLUTION;

Lease
Calculation of finance charge GHS
Deposit 4,000
Lease payments (6 X GHS13,500) 81,000
Fair value of asset (70,000)
Finance charges in total 15,000
Interest calculation
Sum of Digits = n (n +1)
2
= (6 x 7)/2 = 21

Period ended GHS


31 March 2015 6/21 x 15,000 4,286
Of which to 31 December 2014 3/6 2,143
30 September 2015 5/21 x 15,000 3,571
31 March 2016 4/21 x 15,000 2,857
30 September 2016 3/21 x 15,000 2,143

Liability
b/f Interest Payment Capital
31 December 2014 66,000 2,143 0 68,143
31 March 2015 2,143 (13,500) 56,786
30 September 2015 56,786 3,571 (13,500) 46,857
31 December 2015 46,857 1,429 0 48,286
31 March 2016 48,286 1,428 (13,500) 36,214
30 September 2016 36,214 2,143 (13,500) 24,857
Total liability at 31 December 2014 = 68,143
Capital > 1 year = GHS48,286 (due 31 December 2013)
Due < 1year = GHS19,857 (balancing figure)
GHS68,143
Statement of profit or loss and other comprehensive income for the year ended 2014
Depreciation
70,000/3 * 3/14 (GHS5,833)
Finance charge (GHS2,143)
Statement of financial position as at 31 December 2014
Non-current assets
70,000- 5,833 GHS64,167
Current liabilities
Finance lease liabilities GHS19,857
Non-current liabilities
Finance lease liabilities GHS48, 286

ACCOUNTING FOR OPERATING LEASE


This is accounted for in a different way from a finance lease. The leased asset is not owned in substance
by the lease. It is similar to a rental agreement for the hire of the asset.
Treatment; IAS 17 accounting for leases states the total payment made by the lessee under an operating
lease should be recognized, as an expense, and apportioned between financial periods on a straight line
basis.
EARNINGS PER SHARE (IAS 33)

IAS 33 is the standard that governs what goes into EPS.


Many students regard EPS as just a common ratio that can be computed once you have the formula
expressed in a fraction as a/b. Yes that is very true but a lot goes into this expression of fraction more
especially with the denominator ‘b’.
Due to this fact, this standard is a burden for most students and it is the wish of any student that
examiners spare them this area but trust me, after going through this section, the myth surrounding this
topic shall be a thing of the past. Just follow the game well as we unlock the chapter in pieces. Good luck!

Earnings are profits available for equity (ordinary shareholders).


Hence EPS is a measure of the amount of earnings in a financial period for each equity share. EPS = a/b
where a= total earnings, b= no. of ordinary shares. The problem with this standard is not really the A
(total earnings) but rather B (no. of ordinary shares) due to some adjustments that are done at times.
Don’t worry at all, we shall figure out the technicalities involved and adjust them all.

NOTE;
Preference shares are not ordinary shares. The dividends paid to preference shares must be excluded from
the total earnings for the period. Hence earnings are therefore profit after tax less preference dividends
paid.

OBJECTIVES AND SCOPE OF IAS 33;


The objectives of IAS 33 are to set out the principles for; the calculation of EPS and the presentation of
EPS in the financial statements.

SCOPE OF IAS 33;


IAS 33 applies only to publicly traded entities or those which are about to be publicly traded. A publicly
traded entity is an entity whose shares are traded by the investing public, for example on a stock exchange
market.

BASIC AND DILUTED EARNINGS PER SHARE;


IAS 33 requires entities to calculate; the basic EPS on its continuing operations, the diluted EPS on its
continuing operations. Additional requirements to apply to earnings relating to discounted operations.

Basic EPS;

Basic EPS is given as (quote formula)

EXAMPLE;
Sweet Honey ltd made a profit after tax of GHc350, 000. Out of this amount, GHc300000 was from
continuing operations and GHC50000 from discounted operations. It paid ordinary dividends of
GHc180,000 and GHc65,000 to preference dividends. Throughout the year, the company had 1 million
shares in issue. Calculate the basic EPS for Sweet Honey Ltd for the year ended.
SOLUTION;
300,000−𝐶65,000
E.P.S = 1000000
= 0.235𝑜𝑟 23.5𝑝

As explained earlier on, E.P.S is attributable to the common (ordinary) shareholders hence preference
holders profit of GHC65,000 had to be taken off from the profit earned from continuing ooperations.
Discontinued operations are separated from profit earned from continuing operations in calculating E.P.S
for a period.

EXAMPLE;
Elikem Wears has a financial year ending 31st Dec. on 1st Jan, there were 6000000 ordinary shares in
issue. On 1st April, it issued 1000000 new shares at full market price. Total earnings for the period were
GHc2700000. What was the EPS in year 1?

SOLUTION;
There are two methods of solving this question; (in terms of finding the weighted average number of
shares). We all look into all the two methods.
Method 1 Weighted Average
Shares @ 1st Jan 6,000,000
9
Shares issued on 1st April 1000000 * 12 750,000
Total number of shares 6,750,000
𝐶2700000
E.P.S = 6750000
= 0.40𝑝

9
Note that the 12 ∗ 10000000 means the shares was issued in April, 3 months already into the year, hence it
had to be apportioned on the time basis.

Method 2;
With the second method, a time factor is applied to the total number of shares after the issue of new share.
The time factor to apply is either; for the remaining number of months to the year end or for the number
of months to the next share.

DATE DETAILS NO. OF SHARES TIME FACTOR WEIGHTED AVG


1. Jan Balance 6,000,000 x 3/12 1,500,000
1. April Issue @ full mkt 1,000,000
31. Dec Carried forward 7,000,000 x 9/12 5,250,000
2700000
E.P.S = 6750000 = 0.40𝑝
EXAMPLE;
Brown Holdings has a financial year ending Dec 31. On 1st Jan 2013, there were 9000000 ordinary shares
in issue. On 1st May, the entity issued 1200000 new shares at full market price. On 1st Oct, it issued a
further 1800000 shares, also at full market price. Total earnings in year 3 were GHc 3690000. Calculate
the E.P.S for the year

DATE DETAIL NO. OF SHARES TIME FACTOR WEIGHTED AVG


1. Jan Balance 9,000,000 x 4/12 3,000,000
1. April Issue @ full mkt 1,200,000
. Shares after the new 10,200,000 x 5/12 4,250,000
1. Oct Issue @ full mkt price 1,800,000
31st Dec Carried forward 12,000,000 x 3/12 3,000,000
. 10,250,000

EXPLANATION;
From the solution, you can see a table showing the date the various shares were issued and its
corresponding time factor apportioned to arrive at a weighted average.
These are the reasons why the shares have been apportioned as 4/12, 5/12 and 3/12.
4/12; from the question, you will realize that Brown Ltd had 9000000 shares as at 1st January and that
lasted for only four months only for additional shares of 1,200,000 to be issued.
5/12; after the 1,200,000 shares were issued, it gave the company an accumulated total share of
10,200,000 and that also lasted until 1st October when new additional shares of 1,800,000 were issued.
From 1st April to 1st October is 5 months, hence this explains why there is 5/12.
3/12; after the 1800000 shares was issued, Brown Ltd had a total accumulated shares of 12000000
multiplied by the time factor meaning 3/12.

Overall from the calculation, we have a weighted average number of shares to be 10,250,000.

Somebody might argue and contemplate on this; You say that E.P.S = Profit/No. of ordinary shares. So
why do we have to even find weighted average number of shares? So can’t we simply be adding or
consolidating the number of shares that were issued in the year without looking at the time factor.
Relax, the answer is very simple and clear;
You and I know that an accounting calendar runs for 12 months hence profit for that period covers the
whole 12 months. Let’s look at this scenario. If I had 1000 shares in my company as at 1st Jan and on 1st
July, Lizzy wants to join but issued 500 shares, ideally we should have 1500 shares in issue but because
Lizzy didn’t come as at the start of the accounting year, we have to apportion her shares for that period so
that when profit is been shared among we two, the time factor will reflect judging from the fact that she
joined me in July (6months, hence 6/12 x 500).
I hope, this explanation is clear to you now.
BONUS ISSUES OF SHARES:
This is also known as a scrip issue or capitalization issue. It is an issue of new shares to existing
shareholders, in proportion to their existing shareholding for no consideration. This is an issue of free
shares to the shareholders. When shares are issued free (without cash), it has its own implications. The
number of ordinary shares increase but the new shares due to bonus issue does not generate any additional
profit.

When bonus issue is in place?


To ensure that EPS in the year of bonus issue is comparable with the previous year’s EPS, IAS 33
requires that the weighted average number of shares should be calculated as if the bonus shares had
always been in issue. IAS 33 states “the number of ordinary shares outstanding before the (bonus issue) is
adjusted for the proportionate number of shares outstanding as if the (bonus issue) has occurred at the
beginning of the earliest period presented.
The implication is that;

 The current period’s shares are adjusted as if the bonus shares were issued on the 1st day of the
year.
 The comparative E.P.S for the previous year is restated on the same basis.

EXAMPLE;
ABC Ltd made a one for four bonus issue on 1st July, 2005. Its financial year ends on 31st December. The
financial results of ABC Ltd for 2004 and 2005 are as follows;
. 2005 2004
Total Earnings 2,100,000 2,000,000
No. of shares in issue 5,000,000 4,000,000

E.P.S= 0.42p 0.40p

Comparative E.P.S for previous year;


In 2004, the actual E.P.S for the financial year was 2000000/4000000 = 0.50p because only 4 million
shares were in issue. The standard specifies that when bonus issue are in place, we must readjust the E.P.S
of the previous year to make the two years comparable,
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑏𝑜𝑛𝑢𝑠 𝑖𝑠𝑠𝑢𝑒
hence we have E.PS reported last year x 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 𝑎𝑓𝑡𝑒𝑟 𝑏𝑜𝑛𝑢𝑠 𝑖𝑠𝑠𝑢𝑒

So then, we have 0.50p x 4/5 = 0.40p. (There were four shares in issue before I was added due to the
bonus issue.)

When there is a bonus issue in addition to a cash issue;


Example;
Rashman Co ltd had 2000000 ordinary shares in issue on 1st January, 2012. On 1st April 2012, it issued
500,000 ordinary shares, at full market price. On 1st July 2012, there was a 1 for 2 bonus issue. In 2011,
E.P.S had been calculated as 0.25p. In 2012, total earnings were GHC855,000. The financial year ends on
31st December.
SOLUTION;

DATE DETAILS NO. OF SHARES TIME FACTOR BONUS FACTOR WEIGHTED AVG
1.Jan Balance b/f 2,000,000 x 3/2 x3/2 750,000
1.Apr Issue @ mkt 500,000
. 2,500,000 x 3/2 x3/2 937,500
1.July Bonus (1 for 2) 1,250,000
31.Dec Balance c/f 3,750,000 x6/12 --- 1,875,000
Total 3,562,500
855,000
E.P.S for 2012 = = 0.24𝑝
3562,500

To restate the comparative E.P.S for 2011 as the standard says so, we have 0.25p x 2/3 = 0.1667p.

RIGHTS ISSUE OF SHARES;


This is an issue of new shares for cash, where the new shares are offered firstly to current shareholders in
proportion to their existing shareholdings. The new shares are issued at a price below the current market
price. Due to this, there is an element of bonus in the issue, hence an adjustment is needed for E.P.S to
ensure a fair comparison of the current year E.P.S with the previous year E.P.S

Current Year E.P.S;


To adjust for the bonus element in the right issue, the number of shares in the current financial year must
be adjusted. The number of shares in issue is multiplied by the number of shares before by a rights factor.
𝐴𝑐𝑡𝑢𝑎𝑙 𝑐𝑢𝑚−𝑟𝑖𝑔ℎ𝑡𝑠 𝑝𝑟𝑖𝑐𝑒
We have 𝑇ℎ𝑒𝑜𝑟𝑒𝑡𝑖𝑐𝑎𝑙 𝑒𝑥−𝑟𝑖𝑔ℎ𝑡𝑠 𝑝𝑟𝑖𝑐𝑒

Previous Year E.P.S;


To ensure a fair comparison of the current year E.P.S with the previous year’s E.P.S, the comparative
E.P.S for the previous year is obtained by adjusting the E.P.S actually reported last year. The previous
year’s E.P.S is reduced by the following factor.
𝑇ℎ𝑒𝑜𝑟𝑖𝑡𝑖𝑐𝑎𝑙 𝑐𝑢𝑚−𝑟𝑖𝑔ℎ𝑡𝑠 𝑝𝑟𝑖𝑐𝑒
We have; 𝐴𝑐𝑡𝑢𝑎𝑙 𝑐𝑢𝑚 𝑟𝑖𝑔ℎ𝑡𝑠 𝑝𝑟𝑖𝑐𝑒

EXAMPLE;
Honeybees Ltd had 3,000,000 ordinary shares in issue on 1st January 2017. On 1st April 2007, it made a
one for two rights issue of 1,500,000 ordinary shares @ GHC2 per share. The market price of the share
prior to the rights issue was GHC5. An issue of 400,000 shares at full market price was then made on 1st
August 2017. In the year to 31st December, 2017, total earnings were GHC1,746,875. In the year 2016,
E.P.S was reported as 0.35p. Calculate the E.P.S for the year to 31st December 2017 and the adjusted
E.P.S for the 2016 year for comparative purposes.
SOLUTION WITH EXPLANATION;
lets calculate our theoretical ex-rights price. After the rights issue, there will be 1 new share for every 2
shares already in existence.
2 existing shares (2 x GHC5) = 10
1 new share = 2
3 shares after issue = 12
theoretical ex-rights = 12/3 = GHC4.00.

DATE DETAILS NO. OF TIME RIGHTS WEIGHTED


SHARES FACTOR FACTOR AVERAGE
1 January Balance b/f 3,000,000 X 3/12 X 5/4 937,500
1 April Rights issue (1 1,500,000
for 2)
4,500,000 X 4/12 1,500,000
1 August 400,000
4,900,000 X 5/12 2,041,667
4,479,167

𝐺𝐻𝐶𝐶1,746,875
E.P.S for 2017 = 4,479,167
= 0.39𝑝

4
E.P.S for 2016 = 0.35𝑝 ∗ 5
= 0.28𝑝

DILUTED EPS;
EPS shows earnings attributable to each share. In an entity, the class of capital holders includes ordinary
shareholders, preference and bond holders. Some bonds are convertible in nature. Meaning, the holders
can choose to maintain the bond or convert it into ordinary share capital. Now the fact is that, when these
convertible bonds are converted to ordinary shares, there is a possibility that the EPS will be reduced due
to a larger number of ordinary shares in issue. Let’s look at this drama of example.

Ama and Kofi are to share GHc24,000 each. Yaw has the option to join them or not. Should Yaw decide
not to join in the sharing of many, Ama and Kofi will each have GHc12000 but if Yaw should join, each
will have GHc8000. (This is due to dilution)

Regulatory Framework;
IAS 33 requires publicly traded companies to calculate a diluted E.P.S in addition to their basic E.P.S for
the current year. (With a comparative diluted E.P.S for the previous year), allowing for the effects of all
diluted potential ordinary shares.
Diluted E.P.S comes into play when any of the following two issues/conditions occurs;

1. Where convertible preference shares and convertible bonds are issued;


2. Where options and warrants are issued.
 Convertible Preference shares and convertible bonds;
Basic assumption in calculating diluted E.P.S is that if all convertible securities were convertible
into ordinary shares on the 1st day of the financial period and also on the most favourable terms
available to the holders of the bond.

What to adjust?
Total Earnings;
Earnings must be adjusted because based on the assumption that all convertible preference and bonds are
convertible into equity, then that means we don’t have to pay for any interest on bonds or dividends.
Convertible preference share; Add back the dividend paid
Adjusted Earnings; Actual earnings + Convertible preference dividends

Bonds;
Add back interest charge on “bonds” minus the tax relief relating to the bond.
Adjusted Earnings; Actual total earnings + (Convertible bond interest – tax relief on the interest).

EXAMPLE;
Sweet Aroma Ltd has 12,000,000 ordinary shares in issue and GHC4,000,000 of 5% convertible bonds.
As at 31st December, 2012, there was no issue of shares or bonds for several years, the bonds are
convertible into ordinary shares in 2013 04 2014 at the following rates.
31st December 2013; 30 shares for every GHC100 of bonds.
31st December 2014; 25 shares for every GHC100 of bonds.
Total earnings for the year 2012 was GHC3,600,000.
Earnings for the previous years was GHC3,300,000. Tax is payable at a rate of 30% on profits.
Required;
Calculate basic E.P.S and diluted E.P.S for 2012 and comparative years.

SOLUTION WITH EXPLANATION;


𝐺𝐻𝐶𝐶3,600,000
Basic E.P.S for 2012 = 1,200,000
= 0.30𝑝

𝐺𝐻𝐶𝐶3,300,000
Basic E.P.S for 2011 = 1,200,000
= 0.275𝑝
PARTICULARS 2012 2011
Actual earnings 3,600,000 3,300,000
Add back Convertible 200,000 200,000
bond Int (5% x GH4m)
Minus tax @ 30% (60,000) (60,000)
Adjusted total earnings 3,740,000 3,440,000
No of shares 12,000,000 12,000,000
Actual 1,200,000 1,200,000
Potential (4m x 30/100) 13,200,000 13,200,000
By formula 3,740,000/13,200,000 3,440,000/13,200,000
Diluted E.P.S 0.2833 0.2606

OPTIONS AND WARRANTS;


Options and Warrants also cause dilution of E.P.S. When they are exercised, the holders of these
instruments will pay cash to obtain new ordinary shares. When options and warrants are exercised, the
entity will receive cash to invest, thereby increasing earnings. However, since the options and warrants
have not yet been exercised, it is not possible to predict how total earnings will be affected when the cash
is eventually received. The exercise price for the options and warrants is less than the market price for the
share, hence there is a bonus element in the issue.

 Calculate the number of shares that will be issued if all the options or warrants are exercised.
 Reduce this figure by the number of shares that could be purchased at full market price with the
cash received from the exercise of the options or warrants. The market price of the shares should
be the average market price during the period (the financial year).
 The net figure is then added to the existing number of shares in issue, to obtain the total shares for
calculating the diluted E.P.S

EXAMPLE;
Papa Kumasi Co. ltd had total earnings during the year 2013 of GHC1,030,000. It has 5,000,000 ordinary
shares in issue. There are outstanding share options on 400,000 which can be exercised at a future date, at
an exercise price of GHC200 per share. The average market price of shares in Papa Kumasi Co. during
2013 was GHC4. Calculate the diluted E.P.S for 2013.

SOLUTION;
Cash receivable on exercise of all the options = 400,000 x GHc2.50 = GHC1,000,000.
Number of shares this would buy at full market price in 2013 = GHC1,000,000/4 = 250,000 shares.
. SHARES
Options 400,000
Minus number of shares at fair value (250,000)
Net dilution 150,000
Existing shares in issue 5,000,000
Total shares 5,150,000
𝐺𝐻𝐶1,030,000
Diluted E.P.S = 5,150,000
= 0.20𝑝
IAS 18 REVENUE

Revenue is income that arises in the ordinary course of activities and it is referred to by a variety of
different names including sales, fees, interest and dividends. IAS 18 defines revenue as the gross inflow
of economic benefits during the period in the course of the ordinary activities of an entity, when those
inflows result in increases in equity, other than increases relating to contributions from equity
participants.

MEASUREMENT OF IAS 18;


IAS 18 emphasize that revenue must be measured at the “fair value” of the consideration received or
receivable.

SALE OF GOODS; RECOGNITION


IAS 18 states that an entity may recognize revenue from sale of goods when all the following conditions
have been met

 The selling entity has transferred to the buyer the “significant risk and rewards” of ownership of
the goods. (legal title to the goods or possession has been passed to the buyer)
 The entity does not retain effective control over the goods sold or does not have any role to play
in a continual management of the goods.
 The amount of revenue can be measured reliably.
 It is probable that economic benefits associated with the transaction will flow to the entity.
 Cost incurred can be measured reliably.

Examples

1. Becky sold goods to Kuffour for GHC 100. Kuffour has the right to return the goods if they
remain unsold (sale or return basis).
Revenue should not be recognized by Becky because risks and rewards have not been
transferred.
2. Goods have been sold on credit to a customer in a country where there is political instability and
out of that, there has been a ban on payments made overseas.
Revenue should not be recognized yet. It is not probable that economic benefits will flow to the
seller.
3. An entity receives GHC50000 as an advance payment for goods that are yet to be manufactured.
Payment in advance should not be recognized as an income (revenue).
The money received should be included as a current liability in the balance sheet. (Debit Cash
account, Credit Payments received in advance).
RENDERING OF SERVICES; RECOGNITION
When the outcome of a transaction can be measured reliably, estimated revenue should be recognized by
the stage of completion in relation to a service provided to a customer. The recognition of revenue by
reference to the stage of completion of a transaction is referred to as “percentage of completion method.”
IAS 18 states that the outcome of a service can be estimated reliably when the following conditions are
met;

 The amount of revenue can be measured reliably.


 It is probable that the stage of completion of the transaction at the balance sheet date can be
measured reliably.
 The costs already incurred for the transaction and the costs that will be incurred to complete the
transaction can be measured reliably.

When all the above conditions are fully met, revenue should be recognized only to the extent of the
expenses recognized that are recoverable.

EXAMPLE;
Amalina Co is developing an app. Revenue to be incurred is GH50000 but at year one, cost incurred is
GH12000. It is not yet certain as to the completion of the job.
Revenue in the current period is GHC12000, hence no profit or loss is made.

EXAMINATION SCENARIO QUESTION (ACCA, F.R, DEC 2012, EXTRACT)

The following trial balance relates to Quincy as at 30 September 2012:


$’000
Revenue (note (i)) 213,500

The following notes are relevant:


(i) On 1 October 2011, Quincy sold one of its products for $10 million (included in revenue in the trial
balance). As part of the sale agreement, Quincy is committed to the ongoing servicing of this product
until 30 September 2014 (i.e. three years from the date of sale). The value of this service has been
included in the selling price of $10 million. The estimated cost to Quincy of the servicing is $600,000 per
annum and Quincy’s normal gross profit margin on this type of servicing is 25%. Ignore discounting.

SOLUTION.
I took an extract from ACCA question 2 on final account publication, for us to seek the effect of an
ongoing servicing of a product on the financial statements.

Quincy – Statement of comprehensive income for the year ended 30 September 2012
$’000
Revenue (213,500 – 1,600 (w (i))) 211,900

Quincy – Statement of financial position as at 30 September 2012


Non-current liabilities
Deferred revenue (w (i)) 800
Sales made which include revenue for ongoing servicing work must have part of the revenue deferred.
The deferred revenue must include the normal profit margin (25%) for the deferred work. At 30
September 2012, there are two more years of servicing work, thus $1·6 million ((600 x 2) x 100/75) must
be treated as deferred revenue, split equally between current and non-current liabilities.

INTEREST, ROYALTIES AND DIVIDENDS; RECOGNITION

Interest is recognized on a time proportion basis that takes into account the effective yield on the asset.
Royalties are recognized on an accruals basis in accordance with the substance of the relevant agreement.
Dividends are recognized when the shareholder’s right to receive payment is established.

FORMS OF OFF-BALANCE SHEET FINANCE.

1. CONSIGNMENT INVENTORY;
This is an agreement where inventory is held by one party but its owned by another party. This is
similar to goods sold on a sale or return basis. In order to identify the correct treatment, it is
important to indentify at which stage that the distributor acquired the benefits of the goods in
question rather than the point at which legal title was acquired. If the manufacturer of the goods
has the right to seek a return of the goods and that right is likely to occur, then the goods is not an
asset of the dealer or the agent.
Accounting Treatment; when there is enough fact to conclude that the goods are in substance an
asset of the agent,
(a) the inventory should be recognized as such in the agent’s statement of financial position
together with a corresponding liability to the manufacturer (double entry principle)
(b) any deposit should be used to deduct the liability and the difference classified as a trade
payable.
Where the goods is not in substance an asset of the dealer,
(a) the goods should not be included in the agent’s statement of financial position until transfer of
risk and rewards have been made.
(b) any deposits received should be classified under “other receivables.”

EXAMINATION SCENARIO QUESTION (ACCA, F.R, JUNE 2014, EXTRACT)

The following trial balance relates to Xtol at 31 March 2014:


$’000
Revenue (note (i)) 490,000
Trade payables 32,200
The following notes are relevant:
(i) Revenue includes an amount of $20 million for cash sales made through Xtol’s retail outlets during the
year on behalf of Francais. Xtol, acting as agent, is entitled to a commission of 10% of the selling price of
these goods.
By 31 March 2014, Xtol had remitted to Francais $15 million (of the $20 million sales) and recorded this
amount in cost of sales.
SOLUTION;
This is an extract to show you the effect of consignment goods on the effect on financial statements.

Xtol – Statement of profit or loss for the year ended 31 March 2014
$’000
Revenue (490,000 – 20,000 agency sales (w (i))) 470,000
Other operating income – agency sales 2,000

Xtol – Statement of financial position as at 31 March 2014


Current liabilities
Trade payables (32,200 + 3,000 re Francis (w (i))) 35,200

EXPLANATION;
Remember that Xtol is only acting as an agent on behalf of Francis hence he can’t recognize revenue of
20,000. That is why, it was less from revenue [490,000 – 20,000]. However he is entitled to 10% of the
sales and that is 2,000. This should be treated as an other operating income as you can see in the
solution. Also from the footnote, it was stated that Xtol has only remitted an amount of 15,000 to
Francis, meaning he is liable to Francis at a cost of 5,000 but because he paid himself an agency fee of
2,000, the liability outstanding now becomes 3000 which was added to the trade payables of 32,200 as
shown in the solution above.

2. SALE AND REPURCHASE AGREEMENTS;


This is an agreement whereby a company sells an asset to another party but a condition includes
that the company can repurchase the asset under certain circumstances. A typical example is the
sale and repurchase of maturing inventories. The key emphasis is to assess whether the
transaction is in effect a straightforward sale or a secured loan on the goods acquired. If the seller
has the right to the benefits of the use of the asset, and the repurchase is likely to occur, the
transaction should be accounted for as a loan. Accounting Treatment; should the transaction be a
secured loan;
(a) the seller should continue to recognize the original asset and record the proceeds received
from the buyer.
(b) Interest, however designated, should be accrued.
(c) The carrying amount of the asset should be reviewed for impairment and written down if
necessary.

EXAMINATION SCENARIO QUESTION (ACCA, F.R, JUNE 2013, EXTRACT)

The following trial balance relates to Atlas at 31 March 2013:

Revenue (note (i)) 550,000


Inventory at 31 March 2013 43,700

The following notes are relevant:


(i) Revenue includes the sale of $10 million of maturing inventory made to Xpede on 1 October 2012.
The cost of the goods at the date of sale was $7 million and Atlas has an option to repurchase these goods
at any time within three years of the sale at a price of $10 million plus accrued interest from the date of
sale at 10% per annum.
At 31 March 2013 the option had not been exercised, but it is highly likely that it will be before the date it
lapses.

SOLUTION;
This is also another extract to show the effect of a repurchase of maturity goods or inventory on the
financial statement.

Atlas – Statement of profit or loss and other comprehensive income for the year ended 31 March
2013
Revenue (550,000 – 10,000 in substance loan) 540,000

Atlas – Statement of financial position as at 31 March 2013


Assets
Inventory (43,700 + 7,000 re in substance loan) 50,700

Non-current liabilities
In substance loan from Xpede (10,000 + 500 accrued interest) 10,500

3. FACTORING OF RECEIVABLES/DEBTS;
Where debts or receivables are factored, the creditor (company) sells the debts to the factor. The
sales price may be fixed at the onset or could be adjusted later on. At times, some factors would
offer a credit facility that allows the seller to draw upon a proportion of the amounts owed. To
ascertain whether the benefits of the debts have been passed on to the factor, or whether the factor
is, in effect, providing a loan on the security of the receivable balances. If the seller has it a duty
to pay interest on the difference between the amounts advanced to him or her and that the factor
has received, and if the seller bears the risks of non-payment by the debtor, then the indications
would be that the transaction is, in effect, a loan.

EXAMINATION SCENARIO QUESTION (ACCA, F.R, DECEMBER 2013)

On 1 September 2013, Laidlaw factored (sold) $2 million of trade receivables to Finease.


Laidlaw received an immediate payment of $1·8 million and credited this amount to receivables and
charged $200,000 to administrative expenses. Laidlaw will receive further amounts from Finease
depending on how quickly Finease collects the receivables.
Finease will charge a monthly administration fee of $10,000 and 2% per month on its outstanding balance
with Laidlaw. Any receivables not collected after four months would be sold back to Laidlaw; however,
Laidlaw expects all customers to settle in full within this period. None of the receivables were due or had
been collected by 30 September 2013.
SOLUTION
When dealing with the factoring of receivables, probably the most important aspect of the transaction is
which party bears the risk of any non-payment by the customer (irrecoverable receivables). In this case,
that party is Laidlaw as it will have to ‘buy back’ any receivables not settled within four months of their
‘sale’. Thus Finease is acting as an administrator (for a fee of $10,000 per month) and as a provider of
finance (charging 2% interest per month).
Laidlaw should not ‘derecognize’ the receivables as suggested in the question, but instead treat the $1·8
million cash received from Finease as a current liability (a loan or financing arrangement secured on the
receivables). Laidlaw should charge $10,000 as an administration fee and $36,000 ($1·8 million x 2%) as
interest (for the month of September 2013), to profit or loss as administrative expenses and finance costs
respectively. Both these amounts should also be added to the current liability (the amount owed to
Finease) which at 30 September 2013 would amount to $1,846,000.
IAS 12; ACCOUNTING FOR TAX.

This is perhaps another controversial standard that confuses many students at time. Problems arise when
students come across issues of deferred tax and its effect on the financial statement. We shall go through
in bits and by the end of the session, you shall understand this topic well.

CURRENT TAX;
Once profit is made, tax must be paid on it. Current tax is the amount of tax payable in respect of the
taxable profit for a period. All things being equal, the higher the profit, the higher the tax to be paid and
vice versa. Companies will do whatever to pay the minimum of tax, hence in the computation of tax,
distinction must be made between what an accounting profit is and what a taxable profit is because the
two serve different purposes.

ACCOUNTING AND TAXABLE PROFIT.


Accounting profit or loss made for a period, before deducting the tax charge for the period. Accounting is
computed based on the accruals concept, hence we match revenue against expenses for the period in
which it occurred.

Taxable profit is determined by adjusting the accounting profit, according to the rules established by a
country’s tax authorities. We adjust accounting profit to suit tax payment because certain expenses are not
allowable as per a country’s tax law. A common example is a non-cash item like depreciation which is
replaced by capital allowance rate. Some revenue might have been earned but not yet received and this
must be adjusted for tax purposes all because we tax cash earned and at hand. These are some of the
reasons that lead to deferred tax, we shall cover that soon in our studies.

TREATMENT OF CURRENT TAX FOR A PERIOD.


Current tax is quite simple to calculate for, treat it as a/an;

 Expense for the period and


 Liability in the statement of financial position (since it will be paid to the government later).

CURRENT TAX PAID BEFORE THE END OF THE REPORTING PERIOD.


Some countries tax laws permits companies to pay some of their current tax liability for a period before
the year end. In such case, current tax is paid in installments. ABC Ltd has taxable profits of
GHC300,000 and has a current tax of GHC90,000.
The company has already paid GHC40,000 during the year.
What will be their tax liability for the year?
TAX PAYABLE

Tax payable 90
Tax paid (cash) 40
Tax owing (bal) 50
MEASUREMENT;
Current tax liabilities and prior period are measured at the amount expected to be paid to (recovered from)
the tax authorities.

UNDER AND OVER PROVISION OF TAX.


Some tax jurisdiction permit companies to do self assessment. With this system, companies estimate an
amount of tax that they are likely to pay for the financial period. The actual liability is later agreed with
the tax authorities after the end of the financial period. The difference that exist between the tax and the
actual tax to be paid is either an under provision of tax or over provision of tax.
Note that an under-provision of tax in year 1 is added to the total tax charge for year 2.
An over-provision of tax in year 2 is deducted from the total tax charge for year 2.

TAX BASE;
The tax base of an asset or a liability is the amount attributed to that asset or liability for tax purposes. It is
the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to
the entity when it recovers the carrying value of the asset. Where economic benefits are not taxable, the
tax base of the asset is the same as the carrying amount.

Examples are;
1. A machine cost GHC15,000. For the purpose of tax, a depreciation charge of GHC5000 has been
charged for the current and prior periods and the remaining cost will be deductible in future periods.
The tax base of the machine is GHC10,000.
2.Interest receivable has a carrying amount of GHC1000. The related interest revenue will be taxed on a
cash basis. The tax base of the interest receivable is nil.
3.Trade receivables have a carrying amount of GHC10000. The related revenue has already been included
in taxable profit (tax loss). The tax base of the trade receivables is GHC10,000.

IAS 12 requires the following;


Current and deferred tax should be recognized as an expense (or income) and included in the profit or loss
for the period except to the extent that the tax arises from a transaction or event that is recognized either
in other comprehensive income. Current and deferred tax should be recognized outside profit or loss if the
tax related to items that are recognized outside profit or loss.
Either in other comprehensive income or directly in equity.

DEFERRED TAX; IAS 12


It was mentioned earlier on that there are two types of profit and they are accounting profit and taxable
profit.
The differences between these two can be attributed to;

 Permanent differences and


 Temporary differences
PERMANENT DIFFERENCES;
In arriving at net profit of a period, an entity may deduct some expenses but some expenses are not
allowable by a country`s tax laws. (as explained earlier on). Hence, these expenses must be added back to
accounting profit. As a result of this, the entity will have to pay more tax than what was actually reported
in their books.

TEMPORARY DIFFERENCES;
Temporary differences arise from items of income and expenditure that are included in both accounting
and taxable profits but in different periods. An example is, tax relief for capital expenditure on non-
current assets (capital allowances) may be given at a faster rate than depreciation is charged on the non-
current assets in the financial statements. Over the full life of the asset, the total amount allowed as
deduction from taxable profits will be the same as total depreciation charge in the financial statement.
However, in each individual financial year, the amount of “depreciation” allowed for tax purposes and the
depreciation charge in the following period is different.

ACCOUNTING FOR TEMPORARY DIFFERENCES

DEFERRED TAX ACCOUNT;


All taxable temporary differences create a deferred tax liability.
The charge (or credit) for deferred tax should be recognized within the total tax charge for the period.
Increases in deferred tax are added to the total reported tax charge for the year. Reductions in deferred tax
are subtracted from the total reported tax charge for the year. Deferred tax is increased when due to
temporary timing differences, the current tax calculated on taxable profits is less than what the current tax
would have been if calculated on accounting profits.

TAXABLE TEMPORARY DIFFERENCES;


Transactions that affect the statement of Comprehensive Income;

Depreciation; depreciation of an asset is accelerated for tax purposes, when new assets are purchased,
allowances may be available against taxable profits which exceed the amount of depreciation chargeable
on the assets in the final accounts for the year of purchase.

Sale goods (revenue); This is included in accounting profit but only included in taxable profit when cash
is received.

Development Cost; Development cost are capitalized and will be amortized in the statement of other
comprehensive income but they were in actual fact, deducted in full from taxable profit in the period in
which they were incurred.

Interest revenue; Interest revenue received in arrears and included in accounting profit on the basis of
time apportionment. It is included in taxable profit, however on a cash basis. This affects the statement of
financial position.
EXAMPLE;
Sulerash Co. purchased a motor vehicle costing GHC3,000. At the end of the year, the carrying amount
was GHC2,000. The cumulative depreciation for tax purposes is GHC1,800 and the current tax rate is
25%. Calculate the deferred tax liability for the motor vehicle.

SOLUTION;
First of all, let’s identify the tax base of the motor vehicle.
Tax base = GHC3,000 – GHC1,800 = GHC1,200.
To recover the carrying amount of GHC2,000, Sulerash Co. must earn taxable income of GHC2,000 but it
can only deduct GHC1,200 as a taxable expense.
Hence GHC2,000 – GHC1,200 = GHC800. Income tax = 25% x GHC800 = GHC200. (When the asset is
recovered).
Sulerash Co. must recognize a deferred tax liability of 25% x GHC800 = GHC200.
(To recognize the difference between the carrying amount of GHC200 and the tax base of GHC1,200 as a
taxable temporary difference)

TIMING DIFFERENCES;
Most often, some temporary differences are caused by timing differences, when income or expense is
included in accounting profit in one period, but is included in taxable profit in different period. These give
rise to a deferred tax liability. Examples are interest received, development costs capitalized and
amortized.

DEDUCTIBLE TEMPORARY DIFFERENCE;


They give rise to a deferred tax asset.

Transactions that affect the statement of comprehensive income.


Retirement benefit cost (Pension cost); they are deducted from accounting profit as service is provided
by the employee. They are not deducted in determining taxable profit until the entity pays either
retirement benefits or contributions to a few.

Research cost; recognized as an expense for accounting purposes but not deductible against profit until a
later period.

Government grants; included in statement of financial position as deferred income, but it will not be
taxable in future periods.

PRACTICAL ILLUSTRATIONS BEHIND THE RECOGNITION OF DEFERRED TAX ASSETS.

1. When an entity incurs a liability, it is supposed that the liability will be settled in the form of
outflows of economic benefits (gains) from the entity in future periods.
2. When the entity makes payment through an outflow of economic resources, part or all may be
deductible in determining taxable profits of a period later than that in which the liability is
recognized.
3. A temporary tax difference then exists between the carrying amount of the liability and its tax
base.
4. A deferred tax asset therefore arises, representing the income taxes will be recovered in futre
periods when that part of the liability is allowed as a deduction from taxable profit.
5. Also, when the carrying amount of an asset is less than its tax base, the difference gives rise to a
deferred tax asset in respect of the income taxes that will be recoverable in future periods.

HOW TAX IS CALCULATED AND PRESENTED IN THE FINANCIAL STATEMENT

The tax on profit on ordinary activities is calculated by aggregating;

1. Income tax on taxable profits.


2. Transfers to or from deferred taxation.
3. Any under-provision or over-provision of income tax on profits of previous years

Example;
Sulerash Ltd made a profit before tax of GHC110,000. Income tax on the operating profit has been
estimated at GHC45,000. In the previous year (2002) income tax on 2002 profits had been estimated as
GHC38,000 but it was subsequently agreed at GHC40,500. A transfer to the credit of the deferred
taxation account of GHC16,000 will be made in 2003.
Required;
(a) calculate the tax on profits for 2003 for disclosure in the accounts.
(b) Calculate the amount of tax payable.

SOLUTION;
(a) To know the tax expense for the year 2003, it is the total of the following
income tax on profit GHC45,000
Deferred tax GHC16,000
Under-provision of tax (GHC40,500 – GHC38000) GHC1,500
Tax expense GHC63,500

(b) . The tax payable on 2003 (profit) is GHC45,000 (LIABILITY)


EXAMINATION SCENARIO QUESTION (ICA-GHANA, F.R, QUESTION BANK)

B.H recognized a deferred tax liability for the year end 31st December 2013 which related solely to
accelerated tax depreciation on property, plant and equipment at a rate of 30%.
The net book value of the P.P.E at that date was GHC310,000 and the tax written down value was
GHC230,000.
The following data relates to the year ended 31st December 2014.

(i) At the end of the year, the carrying value of P.P.E was GHC460,000 and their tax written down value
was GHC270,000. During the year some items were revalued by GHC90,000. No items had previously
required revaluation. In the tax jurisdiction in which B.H operates, revaluations of assets do not affect the
tax base of an asset or taxable profit. Gains due to revaluations are taxable on sale.

(ii) B.H began development of a new product during the year and capitalized GH60,000 in accordance
with IAS38. The expenditure was deducted for tax purposes as it was incurred. None of the expenditure
had been amortized by the year end.

(iii) B.H’s statement of profit or loss showed interest income receivable of GHC55,000, but only
GHC45,000 of this had been received by the year end. Interest income is taxed on a receipt basis.

(iv) During the year, B.H made a provision of GHC40,000 to cover an obligation to clean up some
damage caused by an environmental accident. None of the provision had been used by the year end.
The expenditure will be tax deductible when paid.

The corporate income tax rate recently enacted for the following year is 30% (unchanged from the
previous year).
The current tax charge was calculated for the year as GHC45,000.
Current tax is settled on a net basis with the national tax authority.

REQUIRED;
(a) Prepare a table showing the carrying values, tax bases and temporary differences for each of the items
above at 31st December 2014.
(b) Prepare the statement of profit or loss and statement of financial position notes to the financial
statements relating to deferred tax for the year ended 31st December, 2014.

SOLUTION WITH EXPLANATION;

Before, I present the solution as an extract to show the effect of the transactions on the P & L account and
statement of financial position, I want us to clarify these few thoughts on the question based on what the
standards says.

Remember that, all taxable temporary differences gives rise to a deferred tax liability.
So now, let us tackle each of the items listed above to see if any temporary difference occurred.
Item 1; P.P.E had a carrying amount of GHC460,000 but its tax base is GHC270,000, this means there is
a taxable temporary difference of GHC190,000.
Item 2; Development expenditure had a carrying amount of GHC60,000 and this is taxable hence, there
would be a taxable temporary difference of GHC60,000.
Item 3; B.H’s profit or loss account showed income receivable of GH55,000 but only GHC45,000 had
been received, the difference of GHC10,000 is yet to be received hence, it is a taxable temporary
difference.
Item 4; B.H made a provision of GHC40,000 and it is taxable. It has not been used as at the year end.
This creates a taxable temporary difference.
In a nutshell, this is the presentation of the above explanation for question (a).
. Carrying Amt Tax base Temporary Diff
Property, plant and equipment 460 270 190
Development expenditure 60 60
Interest receivable (55-45) 10 10
Provision (40) (40)
Total 220

*Provision (40) means, it has not yet been utilized so it must be deducted from the current year charges
for temporary differences.

(b) Lets calculate the deferred tax liability on the temporary differences
. GHC000
Accelerated depreciation for tax purposes (190-90) x 30% 30
Development expenditure deducted from taxable profit (60 x 30%) 18
Interest income taxable when received (10 x 30%) 3
Provision for environmental cost deductible when paid (40 x 30%) (12)
Revaluations (90 x 30%) 27
Total 66

At 1 January 2014 [ 310 -230 x 30%] 24


Amount charged to P & L (balancing figure) 15
Amount charged to equity (90 x 30%) 27
At 31st December 2014 66

Statement of profit or loss account;


Income tax expense for the year;
. GHC
Current tax 45
Deferred tax (balancing figure) 15
Total charge 60

Question 1
Trial balance extract at 31 March, 2007
Deferred tax liability 12,500
The provision for income tax for the year to 31 March, 2007 has been estimated at $28.3 million. The
deferred tax provision at 31 March, 2007 is to be adjusted to a credit balance of $14.1 million.

Answer 1
Dr CT 1,600
Cr DT 1,600
Dr P or L 29,900
Cr CT 29,900

Question 2
Trial balance extract at 30 September, 2008
Income tax (credit balance) 400
Deferred tax liability 11,200
The balance of income tax in the trial balance represents the under/over provision of the previous year’s
estimate. The estimated income tax liability for the year ended 30 September 2008 is $18.7 million. At 30
September 2008 there were $40 million of taxable temporary differences. The income tax rate is 25%.
Note: you may assume that the movement in deferred tax should be taken to the Statement of Profit or
Loss.

Answer 2
Dr DT 1,200
Cr CT 1,200
Dr P or L 17,100
Cr CT 17,100
REFERENCES;

1. Institute of Chartered Accountants Ghana, Financial Reporting, Reading Manual, 2015 edition.
2. Emile Woolf, Financial Reporting, ACCA, 2010 edition.
3. Institute of Chartered Accountants Ghana, Student Journal, September/December, 2016.
4. Institute of Chartered Accountants Ghana, Financial Reporting Past Questions (2010 to 2016)
5. Institute of Chartered Accountants Ghana, Financial Reporting Questions Bank, 2015 edition.
6. Association of Chartered Certified Accountants, Past Questions (2010 to 2014).
7. International Accounting Standards Publication.
8. ACCA Students preparation questions on Financial Reporting/Open tuition.

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