You are on page 1of 102

F7 FINANCIAL

REPORTING (INT)
Primary objective of this document is to help students with
regular revision. Students are strongly advised to study full
text book chapters, regularly attend class lectures and
participate in discussion sessions for better understanding.

Course Note

Prepared by:
Mezbah Uddin Ahmed,
ACCA

F7 Financial Reporting (INT)

Contents
Exam structure...................................................................................................................................... 2
Examiner................................................................................................................................................ 2
Past question analysis ......................................................................................................................... 3
Course plan ........................................................................................................................................... 6
IAS 1 Presentation of Financial Statements .................................................................................... 8
IAS 16 Property, plant and equipment ............................................................................................ 14
IAS 23 Borrowing costs ..................................................................................................................... 18
IAS 40 Investment property .............................................................................................................. 21
IAS 20 Government grants ............................................................................................................... 24
IAS 38 Intangible assets ................................................................................................................... 27
IAS 36 Impairment of assets ............................................................................................................ 30
IAS 8 Accounting policies, changes in accounting estimates and errors .................................. 33
IAS 17 Leases..................................................................................................................................... 36
IAS 18 Revenue ................................................................................................................................. 39
IAS 2 Inventories ................................................................................................................................ 41
IAS 37 Provisions, contingent liabilities and contingent assets .................................................. 43
IFRS 5 Non-current assets held for sale and discontinued operations ..................................... 48
IAS 11 Construction contracts .......................................................................................................... 51
IAS 12 Income taxes .......................................................................................................................... 53
Financial instruments ......................................................................................................................... 58
Consolidated statement of financial position.................................................................................. 62
Consolidated statement of comprehensive income ...................................................................... 66
IAS 7 Statement of cash flows ......................................................................................................... 68
Ratio analysis ...................................................................................................................................... 74
IAS 33 Earnings per share ................................................................................................................ 84
Receivables factoring ........................................................................................................................ 91
IAS 10 Events after reporting period ............................................................................................... 96
Important definitions........................................................................................................................... 98

mezbah.ahmed@hotmail.co.uk

Page 1

F7 Financial Reporting (INT)


Exam structure
5 Questions
Question No.
1
2
3
4
5

Topic
Consolidated financial statements
Single company financial statements
Cash flow statement &/ Ratios & interpretation of financial
statements
IFRS individual topic (one or two)
IFRS individual topic (one or two)

Marks
25 Marks
25 Marks
25 Marks
15 Marks
10 Marks

Examiner

The examiner is Steve Scott. Steve has many years experience in accounting lecturing at a leading
UK university. He qualified as an accountant with Stott and Golland and his background is in Audit
and Financial Reporting. He has been an ACCA examiner since 1998.

mezbah.ahmed@hotmail.co.uk

Page 2

F7 Financial Reporting (INT)


Past question analysis
FRMRK
Dec '07

4 (a), 5
(a)

Jun '08

4 (a)

IAS 2

IAS 7

4 (b)

Ratios

IAS 8

3
3

Jun '09

Dec '09

4 (a)

3 (a-ii)

3 (b)

Jun '10

4 (a)

3
3

Dec '10
4 (a)

IAS 12

IAS 16

5 (b)

2 (ii)

2 (i)

2 (iv)

2 (v, vi)

2 (ii)

2 (v)

2 (i), 5

2 (v)

2 (i)

2 (v)

2 (vi), 3
(i)

2 (v)

2 (ii), 3
(i)
2 (iii), 4
(b-i)

Jun '12

Dec '12

4 (a)

4 (a), 4
(b-ii)

2 (a-iii)

3 (a)

3 (b)

IAS 20

IAS 23

4 (b)

IAS 32

2 (iii)

2 (iv)

Dec '09

3 (i)

2 (i)

2 (iii),
(iv), 3
(iii)

Jun '10

3 (i)

4 (b)

2 (ii)

Jun '11

2 (ii),
(vi)
2 (v)

June '13

2 (ii)

2 (a-iv)

2 (a-ii)

2 (vi)

2 (iv)

2 (iv),

2 (ii)

IAS 37

IAS 38

2 (i)

2 (i)

mezbah.ahmed@hotmail.co.uk

5 (a)

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

1 (i), 3
(ii), 4 (b)

2 (iii), 5
4

2 (b)
2 (i)

2 (iii), 4

2 (i)

Dec '10

1 (c)

2 (vi)

3 (iv)
2 (ii),

2 (i)

Dec '12

2 (iii)

5 (b)

2 (iv)

Jun '09

2 (a-ii)

IAS 36

2 (iii), 3
(ii), 5

Dec '08

Jun '12

IAS 33

2 (iv),

2 (iii)
2 (i)

Dec '11

2 (v)

2 (iii)

4 (b)

Jun '08

2 (vi)

IAS 18

2 (ii)

June '13

IAS 17

Dec '11

Dec '07

IAS 11

Dec '08

Jun '11

IAS 10

2 (ii)

4
2 (i), 5
(a, b)

2 (b)

2 (iii), 4
(b)

Page 3

F7 Financial Reporting (INT)

IAS 40

IFRS 5

PASS
RATE

Dec '07
Jun '08

40%
3 (i)

33%

Dec '08

42%

Jun '09

30%

Dec '09

39%

2 (ii)

Jun '10

28%

Dec '10

47%

Jun '11

38%

Dec '11

56%

Jun '12

48%

Dec '12

53%

June '13

2 (ii), 4

mezbah.ahmed@hotmail.co.uk

Page 4

F7 Financial Reporting (INT)

The secret of getting ahead is getting started. - Agatha


Christie (British Novelist)

mezbah.ahmed@hotmail.co.uk

Page 5

F7 Financial Reporting (INT)


Course plan

Class
No.

2
3
4
5

Date

Syllabus Area
Introduction to F7
IAS 1 Presentation of financial
statements
IAS 16 Property, plant and
equipment
IAS 16 Property, plant and
equipment
IAS 16 Property, plant and
equipment

BPP Text
Book Ref.

Chapter 3
Chapter 4

17-Broadoak-a, c(i), 19-Dearing

Chapter 4

18-Elite Leisure

Chapter 4

17-Broadoak-b, c(ii), 55-Jedders (a)

IAS 23 Borrowing costs

Chapter 4

21-Apex

IAS 40 Investment properties

Chapter 4

IAS 20 Government grants

Chapter 4

16-Derringdo II, 96-Errsea


23-Dexterity, 24-Darby (except biii), 54-Peterlee II (a), 90-Shiplake
(c)

IAS 38 Intangible assets


6

(IFRS 3 Business combinations


will cover later)

Chapter 5

IAS 36 Impairment of assets

Chapter 6

IAS 36 Impairment of assets


IAS 8 Accounting policies,
changes in accounting estimates
and errors
IAS 17 Leases

Chapter 6

9
10

11

12

Questions to Practice

20-Flightline, 25-Advent, 26Wilderness, 24-Derby (b-iii), Jun


'12-Q4-Telepath
90-Shiplake (b, d), BPP text Q-8Multiplex

Chapter 7

100-Tunshill, 22-Emerald, 30Partway (b-i), 57-Triangle (ii)

Chapter 16

60-Branch, 61-Evans,

IAS 17 Leases

Chapter 16

62-Bowtock, 63-Fino

IAS 18 Revenue

Chapter 15

27-Derringdo III, 30-Partway (b-ii),


57-Triangle (iv), 59-Wardle

IAS 2 Inventories

Chapter 12

IAS 37 Provisions, Contingent


Liabilities and Contingent Assets

Chapter 13

IAS 37 Provisions, Contingent


Liabilities and Contingent Assets
IFRS 5 Non-current assets held
for sale and discontinued
operations

51-Bodyline (a, b, d), 53-Promoil,


54-Peterlee II (b), 57-Triangle (i, ii,
iii), 58-Angelino (iii), 95-Atomic
Power, Dec '11-Q4-Borough (a, b-i)

Chapter 13

30-Partway (a)

Chapter 7

101-Manco

13

IAS 11 Construction contracts

Chapter 12

48-Preparation question; 49-Linnet,


50-Beetie, June '11-Q5-Mocca

14

IAS 12 Income taxes

Chapter 17

66-Bowtock II;

mezbah.ahmed@hotmail.co.uk

Page 6

F7 Financial Reporting (INT)

15

IAS 12 Income taxes


IAS 32 Financial instruments:
presentation
IAS 39, IFRS 9 Financial
instruments: recognition and
measurement
IFRS 7 Financial instruments:
disclosures

Chapter 17

64-Julian; 65-Deferred taxation

Chapter 14

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

6-Winger (IAS 18, 17, 16, 36, 38,


12), 7-Harrington (IAS 12, 16, Fin.
Inst), 8-Llama (IAS 12, 16, Fin.
Inst), 9-Tadeon (12, 17, Fin. Inst.),
10-Wellmay (IAS 18, 10, 37, 16, 40,
12, Fin. Inst), 11-Dexton (IAS 18,
16, 8, 12, Fin. Inst), 12-Candel (IAS
16, 38, 37, 12, Fin. Inst), 14Sandown (IAS 18, 12, 16, 36, 38,
Fin. Inst), 29-Tourmalet (IAS 2, 12,
17, 16, 40, IFRS 5), 88-Tintagel
(IAS 17, 16, 40, 18, 37, 12, Fin.
Inst), 93-Kala (IAS 2, 12, 16, 40,
17), 98-Cavern (IAS 12, 16, 37, Fin.
Inst.), 13-Pricewell (IAS 11, 16, 17,
18, 12, Fin. Inst), 15-Dune (IAS 16,
18, 12, 11, Fin. Inst, IFRS 5)

16

17

18
19

20

21
22
23
24
25
26

Preparing single company


accountants

Consolidated Statement of
Financial Position; Consolidated
Statement of Comprehensive
Income, IFRS 3 Business
combinations, IAS 27
Consolidated and separate
financial statements, IAS 28
Investment in associates

Chapter 5,
8, 9, 10, 11

All questions from Part-8, 9, 10 &11


of the BPP question bank

IAS 7 Statement of cash flows

Chapter 21

All question from BPP question


bank Part-21

Ratios

Chapter 19

70-Reactive, 71-Victular, 72Crosswire, 73-Harbin, 74-Breadline,


94-Greenwood, 99-Hardy, J-11Bengal,

IAS 33 Earnings per share

Chapter 18

67-Fenton, 68-Savoir, 69-Barstead,


J-11-Q4-Rebound

Receivables factoring

Chapter 15

55-Jedders (b), 58-Angelino (b-i),


28-Telenorth (note-c)

IAS 10 Events after reporting


period

Chapter 20

MOCK EXAMS

* Financial reporting is a core area of ACCA study. Experience shows that students with poor F7
performance struggle in P2 & P7, and also working as professional accountant.
* Cherry picking of the syllabus areas shall never be a study strategy for ACCA.
* In most cases overlapping IAS/IFRS knowledge required to solve a problem. So, frequent revision of
previously learned IASs/IFRSs is mandatory.

mezbah.ahmed@hotmail.co.uk

Page 7

F7 Financial Reporting (INT)

Optimism is the faith that leads to achievement. Nothing


can be done without hope and confidence. - Helen
Keller (author, political activist, lecturer, and first deaf-blind
person to earn a Bachelor of Arts degree)

mezbah.ahmed@hotmail.co.uk

Page 8

F7 Financial Reporting (INT)


IAS 1 Presentation of Financial Statements
XYZ plc
Statement of profit or loss and other comprehensive income for the year ended 31 December
20X9
$000
Revenue
X
Cost of sales
(X)
Gross profit
X
Other income
X
Distribution costs
(X)
Administrative expenses
(X)
Other expenses
(X)
Profit/ (loss) from operations
X/(X)
Finance costs
(X)
Profit/ (loss) before tax
X
Tax expense: Current + Deferred
(X)
Profit/ (loss) for the year from continuing operations
X/(X)
Profit/ (loss) for the year form discontinued operations (single amount)
X/(X)
Profit/ (loss) for the year
X/(X)
Earnings per share:
Basic
Diluted

$X
$X
$000

Profit/ (loss) for the year


Other comprehensive income:
Changes on revaluation
Gain/ (loss) on re-measuring available for sale financial assets
Tax relating to components of other comprehensive income
Other comprehensive income for the year, net of tax
Total comprehensive income for the year

$000
X/(X)

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

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

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


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

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

mezbah.ahmed@hotmail.co.uk

Page 9

F7 Financial Reporting (INT)

Entities must prominently display: [IAS 1: 51]


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

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

Irredeemable
preference
share capital

Share
premium

Retained
earnings

Revaluati
on
reserve

Opening balance
Right issue or market
price issue of ordinary
share capital

Bonus issue of ordinary


share capital (if from SP)
Bonus issue of ordinary
share capital (if from
RE)

(X)

(X)
(X)

Dividend
Profit/ (loss) after tax for
the year
Revaluation gain/ (loss)
(IAS 16)
Transfer of excess
depreciation from RR to
RE (IAS 16)
Gain/(loss) from Y/end
re-measurement of
financial assets through
other comprehensive
income
Closing balance (in
SFP)

Surplus from
financial
assets
through OCI
X

X/(X)
X/(X)

(X)

X/(X)

X/(X)

X/(X)

IAS 16 (PPE) permits and it is best practice to make a transfer between reserves of the excess
depreciation arising as a result of revaluation. [IAS 1: 41]
When an asset carrying using revaluation model is disposed, any remaining revaluation reserve
relating to that asset is transferred directly to retained earnings. [IAS 1: 41]
An entity can present components of changes in equity either in the Statement of Changes in
Equity or in the notes to the financial statements. [IAS 1: 106]

mezbah.ahmed@hotmail.co.uk

Page 10

F7 Financial Reporting (INT)


XYZ plc Statement of Financial Position as at 31 December 20X9
$000
ASSETS
Non-current assets
Property, plan and equipment
Intangibles
Deferred tax asset
Long-term investments
Current assets
Inventories
Trade and other receivables
Short-term investments
Current tax asset
Cash and cash equivalents
Held-for-sale non-current assets

X
X
X
X
X

X
X
X
X
X
X
X
X
X

Total assets
EQUITY AND LIABILITIES
Equity attributable to owners of the parent
Ordinary share capital
Preference share capital (irredeemable)
Share premium account
Revaluation surplus
Retained earnings

Non-current liabilities
Preference share capital (redeemable)
Finance lease liabilities (non-current portion)
Deferred tax liability
Long-term borrowings

$000

X
X
X
X
X
X

X
X
X
X
X

Current liabilities
Trade and other payables
Dividends payable
Current tax liability
Provisions
Short-term borrowings
Finance lease liabilities (current portion)
Total equity and liabilities

X
X
X
X
X
X
X
X

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

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

mezbah.ahmed@hotmail.co.uk

Page 11

F7 Financial Reporting (INT)

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

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


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

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

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


It expects to settle the liability in its normal operating cycle;
It holds the liability primarily for the purpose of trading;
The liability is due to be settled within twelve months after the reporting period; or
It does not have unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

mezbah.ahmed@hotmail.co.uk

Page 12

F7 Financial Reporting (INT)

Believe in yourself! Have faith in your abilities! Without a


humble but reasonable confidence in your own powers
you cannot be successful or happy. - Norman Vincent
Peale (Author)

mezbah.ahmed@hotmail.co.uk

Page 13

F7 Financial Reporting (INT)


IAS 16 Property, plant and equipment

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

Property, plant and equipment are tangible assets that:


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

Initial recognition:
PPE should initially be recognised in an entity's statement of financial position at cost.
Cost is the amount of cash and cash equivalents paid to acquire the asset at the time of its
acquisition or construction PLUS the fair value of any other consideration given.
o In an exchange transaction if the entity is able to determine reliably the fair value of
either the asset received or the asset given up, then the fair value of the asset given
up is used to measure the cost of the asset received unless the fair value of the asset
received is more clearly evident. [IAS 16: 26]

Elements of Cost: Cost can include:


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

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

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

Borrowing costs incurred in the construction of qualifying assets if in accordance


with IAS 23 Borrowing costs.

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

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

mezbah.ahmed@hotmail.co.uk

Page 14

F7 Financial Reporting (INT)

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

Subsequent expenditure only to be capitalised if enhances the life of the asset, or improves
quality or quantity of output, or reduces the cost. If not capitalised then recognise as expense
in I/S.
Examples of subsequent expenditure to be capitalised can include:
Modification of an item of plant to extend its useful life
Upgrade of machine parts to improve the quality of output
Adoption of a new production process, leading to large reductions in operating costs

Where an asset is made up of many distinct (i.e. significant) parts (examples: aircraft, ship),
these should be separately identified and depreciated.

Major inspections or overhauls should be recognised as part of (i.e. increase) carrying


amount of the item of PPE, assuming that this meets the recognition criteria.
An example is where an aircraft is required to undergo a major inspection after so many
flying hours. Without the inspection the aircraft would not be permitted to continue flying.
As a separate component of PPE, the capitalised overhaul cost shall be depreciated over
the period to next overhaul.

Measurement after initial recognition: After initially recognising an item of property,


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

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

ASSET IS REVALUED

Upwards
Has the asset previously
suffered a downward valuation?

Yes

Downwards

No

Recognise the increase as a


revaluation surplus. (Other
comprehensive income)

Recognise the increase in profit or loss up to


the value of the downward valuation. Any
excess should be recognised as a revaluation
surplus. (Other comprehensive income)

mezbah.ahmed@hotmail.co.uk

No

Has the asset previously


suffered a upward valuation?

Recognise the decrease


directly in profit or loss

Yes

Recognise the decrease against the


revaluation surplus up to the value of the
upward valuation. Any excess should be
recognised directly in profit or loss.

Page 15

F7 Financial Reporting (INT)

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

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

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

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

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


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

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

mezbah.ahmed@hotmail.co.uk

Page 16

F7 Financial Reporting (INT)

Sal (Salman) Khan, founder of Khan Academy, in MIT 2012


commencement address:
'. . . Many of you will soon enter the outside world and be
somewhat taken aback. It will be far less efficient, far less
fair, far less productive, and far more political than what
you may have imagined it to be. There will be pessimism
and cynicism everywhere. It is easy to succumb to this, to
become cynical or negative yourself. If you do, you with the
potential that you have, it would be a loss for yourself and
for humanity.
To fight these forces of negativity, to increase the net
positivity in the world, to optimize the happiness of yourself
and the people you love, here are some tips and tools that I
like to return to. . .
Start every morning with a smile even a forced one it
will make you happier. Replace the words I have to with I
get to in your vocabulary. Smile with your mouth, your
eyes, your ears, your face, your body at every living thing
you see. Be a source of energy and optimism. Surround
yourself with people that make you better. Realize or even
rationalize that the grass is truly greener on your side of the
fence. Just the belief that it is becomes a self-fulfilling
prophecy . . .
Remember that real success is maximizing your internally
derived happiness. It will not come from external status or
money or praise. It will come from a feeling of contribution.
A feeling that you are using your gifts in the best way
possible. . . '

mezbah.ahmed@hotmail.co.uk

Page 17

F7 Financial Reporting (INT)


IAS 23 Borrowing costs

An entity shall capitalise (i.e. as part of the asset) borrowing costs that are directly attributable to
the acquisition, construction or production of a qualifying asset as part of the costs of that asset.
[IAS 23: 8]
Borrowing costs are interest and other
costs that an entity incurs in connection
with the borrowing of funds. [IAS 23: 5]

A qualifying asset is an asset that necessarily


takes a substantial period of time to get ready
for its intended use or sale. [IAS 23: 5]

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

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

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


When the following three conditions are first met:
Expenditures for the asset are being incurred
Borrowing costs are being incurred, and
Activities that are necessary to prepare the asset for its intended use are being undertaken.
Borrowing cost of 9
Borrowing
months (i.e. $75,000)
cost of 12
Borrowing
cost
(i.e.
interest
to be capitalised as
months (i.e.
expense) of 3 months (i.e. $25,000)
part of asset in
$100,000) to
to be recognised in Income
Statement of Financial
be recognised
Statement under Finance Costs
Position
in I/S

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

28.02.12
- Purchase order
made to buy the
asset

31.03.12
- Payment made
to buy the asset

31.12.12
- Asset is
delivered &
ready to use

31.12.13
- Loan is
matured and
repaid

All three
conditions are
met at this point.

Capitalisation is suspended if active development is interrupted for extended periods.


(Temporary delays or technical/administrative work will not cause suspension).
Interest income from deposit during this period is not deductible from capitalised borrowing
cost since cost from this suspended period is not capitalised. [IAS 23: 21]

mezbah.ahmed@hotmail.co.uk

Page 18

F7 Financial Reporting (INT)

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

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

Borrowing costs: To 31 December 20X6 ($500,000/$1,000,000 9%)


Less investment income: To 30 June 20X6 ($250,000/$500,000 7% 6/12)
Costs capitalised as part of assets:
Expenditure incurred
Borrowing costs

Asset A
$
45,000
(8,750)
36,250

Asset B
$
90,000
(17,500)
72,500

500,000
36,250
536,250

1,000,000
72,500
1,072,500

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

Acruni Co had the following loans in place at the beginning and end of 20X6.
1 January
31 December
20X6
20X6
$m
$m
10% Bank loan repayable 20X8
120
120
9.5% Bank loan repayable 20X9
80
80
8.9% debenture repayable 20X7

150
The 8.9% debenture was issued to fund the construction of a qualifying asset (a piece of mining
equipment), construction of which began on 1 July 20X6.
On 1 January 20X6, Acruni Co began construction of a qualifying asset, a piece of machinery for a
hydroelectric plant, using existing borrowings. Expenditure drawn down for the construction was: $30m on
1 January 20X6, $20m on 1 October 20X6.
Required: Calculate the borrowing costs that can be capitalised for the hydro-electric plant machine.

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

mezbah.ahmed@hotmail.co.uk

Page 19

F7 Financial Reporting (INT)

By failing to prepare, you are preparing to fail. - Benjamin


Franklin (one of the Founding Fathers of the United States,
author, printer, political theorist, politician, postmaster,
scientist, musician, inventor, satirist, civic activist,
statesman, and diplomat)

mezbah.ahmed@hotmail.co.uk

Page 20

F7 Financial Reporting (INT)


IAS 40 Investment property

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

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


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

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


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

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

Initial recognition and measurement:


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

mezbah.ahmed@hotmail.co.uk

Page 21

F7 Financial Reporting (INT)

Measurement after recognition: After initial measurement at cost, an entity can choose between
two models: [IAS 40: 30]
The IAS 16 cost model
The fair value model
If the fair value model is adopted, the accounting treatment of investment properties will be as
follows:
All investment properties should be measured at fair value at the end of each reporting
period provided fair value can be measured reliably.
Changes in fair value, whether gains or losses, should be recognised in profit or loss
for the period in which they arise. [IAS 40: 35]
When determining fair value, do not deduct costs to sale from the fair value. [IAS 40: 37]

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

mezbah.ahmed@hotmail.co.uk

Page 22

F7 Financial Reporting (INT)

Laziness is a secret ingredient that goes into failure. But


it's only kept a secret from the person who fails.
Robert Half

mezbah.ahmed@hotmail.co.uk

Page 23

F7 Financial Reporting (INT)


IAS 20 Government grants

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

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

Grants relating to assets: IAS 20 allows two alternatives:


Option 1:

Option 2:

Present the grant in the statement of financial


position as deferred income and systematically
recognise it in profit or loss over the asset's
useful life. [IAS 20: 26]

Deduct the grant when arriving at the cost of the


asset. The asset is included in SFP at cost minus
the grant. Depreciate the net amount over the
useful life of the asset. [IAS 20: 27]

Example: A company receives a grant from the EU for CU100,000 towards the cost of a new factory.
The overall cost of the factory is CU1,000,000. It has a 50 year useful life and NIL residual value. The
company's policy is to apply the straight-line method of depreciation.
Option 1

Option 2

At recognition:
Statement of financial position
Assets:
Factory
1,000,000
Liabilities:
Deferred income
100,000

At recognition:
Statement of financial position
Assets:
Factory (1,000,000 100,000)

At Year 1 end:
Statement of financial position
Assets: NCA
Factory
1,000,000
Accumulated depreciation
(20,000)
980,000
Liabilities:
Deferred income
100,000
Income released in the year
(2,000)
98,000
(Current liabilities 2,000; Non-current liabilities
96,000)

At Year 1 end:
Statement of financial position
Assets: NCA
Factory
900,000
Accumulated depreciation
(18,000)
882,000

Statement of comprehensive income


Other income
2,000
Depreciation
(20,000)

Statement of comprehensive income


Depreciation
(18,000)

mezbah.ahmed@hotmail.co.uk

900,000

Page 24

F7 Financial Reporting (INT)

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


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

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

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


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

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

Repayment of government grant: If a grant must be repaid it should be accounted for as a


revision of an accounting estimate (IAS 8). [IAS 20: 34]
- Repayment of grant related to income: apply first against any unamortised deferred income
set up in respect of the grant, any excess should be recognised immediately as an expense.
[IAS 20: 32]
- Repayment of a grant related to an asset: increase the carrying amount of the asset or reduce
the deferred income balance by the amount repayable. The cumulative additional
depreciation that would have been recognised to date in the absence of the grant should be
immediately recognised as an expense. [IAS 20: 32]
It is possible that the circumstances surrounding repayment may require a review of the
asset value and an impairment of the new carrying amount of the asset.

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


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

mezbah.ahmed@hotmail.co.uk

Page 25

F7 Financial Reporting (INT)

Everybody is a genius. But, if you judge a fish by its ability


to climb a tree, itll spend its whole life believing that it is
stupid. Albert Einstein

mezbah.ahmed@hotmail.co.uk

Page 26

F7 Financial Reporting (INT)


IAS 38 Intangible assets

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

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

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

Purchased

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


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

After initial recognition an entity can choose between: [IAS 38: 72]
the cost model, and
the revaluation model: if an active market exists for that type of asset [IAS 38: 75]
An active market cannot exist for brands, newspaper mastheads, music and film
publishing rights, patents or trademarks, because each such asset is unique and
transactions are relatively infrequent. The price paid for one asset may not provide
sufficient evidence of the fair value of another. Moreover, prices are often not available
to the public. [IAS 38: 78]

An intangible asset (other than goodwill) acquired as part of business combination should be
recognised at fair value. [IAS 38: 33]

mezbah.ahmed@hotmail.co.uk

Page 27

Development phase

Internally generated

Research phase

F7 Financial Reporting (INT)

Research is original and planned investigation, undertaken with the prospect of gaining new
scientific or technical knowledge and understanding. [IAS 38: 8]

The result of research is unknown and, so, no probable future economic benefit can be
expected

IAS 38 states that all expenditure incurred at the research stage should be written off
to the profit or loss statement as an expense when incurred [IAS 38: 54], and will never
be capitalised as an intangible asset. [IAS 38: 71]

An intangible asset arising from development must be capitalised if an entity can


demonstrate all of the following criteria: [IAS 38: 57]
the technical feasibility of completing the intangible asset (so that it will be available for
use or sale)
intention to complete and use or sell the asset
ability to use or sell the asset
existence of a market or, if to be used internally, the usefulness of the asset
availability of adequate technical, financial, and other resources to complete the asset
the cost of the asset can be measured reliably
If any of the recognition criteria are not met then the expenditure must be charged to the
income statement as incurred.

If an entity cannot distinguish the research phase from the development phase, treat that as
in the research phase. [IAs 38: 53]
Each development project must be reviewed at the end of each accounting period to ensure
that the recognition criteria are still met.

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

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

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

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

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

mezbah.ahmed@hotmail.co.uk

Page 28

F7 Financial Reporting (INT)

Throughout life people will make you mad, disrespect you and
treat you bad. Let God deal with the things they do, cause
hate in your heart will consume you too.
- Will Smith

mezbah.ahmed@hotmail.co.uk

Page 29

F7 Financial Reporting (INT)


IAS 36 Impairment of assets

An asset is impaired when its carrying amount is higher than its recoverable amount. [IAS 36: 6]
Impairment loss = Carrying value Recoverable amount [IAS 36: 59]
higher of

Fair value less costs to sell:

- IFRS 13

Value in use:
-

Based on cash-flow projections


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

Cash flows from financing activities or income tax receipts


and payments should be excluded.

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


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

If no impairment loss then do nothing!


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

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

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

mezbah.ahmed@hotmail.co.uk

Page 30

F7 Financial Reporting (INT)

Reversal of past impairment:


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

Once recognised, impairment losses on goodwill are not reversed [IAS 36: 124]

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

Impairment indicators:
The entity should look for evidence at the end of each period and conduct an impairment review on any
asset where there is evidence of impairment. [IAS 36: 9]
External indicators: [IAS 36: 12]

Internal indicators: [IAS 36: 12]

Significant decline in market value of asset


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

Evidence of obsolescence or physical


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

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

mezbah.ahmed@hotmail.co.uk

Page 31

F7 Financial Reporting (INT)

Being busy does not always mean real work. The object of all
work is production or accomplishment and to either of these
ends there must be forethought, system, planning,
intelligence, and honest purpose, as well as perspiration.
Seeming to do is not doing.
- Thomas A. Edison

mezbah.ahmed@hotmail.co.uk

Page 32

F7 Financial Reporting (INT)


IAS 8 Accounting policies, changes in accounting estimates and errors

Changes in accounting policies


o

The same accounting policies are usually adopted from period to period, to allow users to analyse
trends over time in profit, cash flows and financial position.

Examples of accounting policies:

Alternative presentation of government grant (IAS 20)

FIFO or Weighted average method of inventory valuation

Fair value model of cost model for investment properties (IAS 40: 31)

A change in accounting policy must be applied retrospectively.


-

Retrospective application means that the new accounting policy is applied to transactions
and events as if it had always been in use. In other words, at the earliest date such
transactions or events occurred, the policy is applied from that date.

This involves restating opening balances of current year and comparative previous year.

From earliest date of same transaction


(i.e. retrospective effect)
- Unless impractical

On future transactions

Policy change date

Two types of event which do not constitute changes in accounting policy:


(i)

Adopting an accounting policy for a new type of transaction or event not dealt with
previously by the entity.

(ii)

Adopting a new accounting policy for a transaction or event which has not occurred in
the past or which was not material.

Changes in accounting policy will be very rare and should be made only if:
-

The change is required by an IFRS, or

The change will result in a more appropriate presentation of events or transactions in the
financial statements of the entity, providing more reliable and relevant information.

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

Changes in accounting estimates


o

Management applies judgement based on information available at the time

Examples of accounting estimates:

Useful life or residual value of a non-current asset (IAS 16)

Provision made for future loss or expenses (IAS 37)

A change in accounting estimate must be applied prospectively.

Changes in accounting estimate

mezbah.ahmed@hotmail.co.uk

Page 33

F7 Financial Reporting (INT)

Errors:
o Errors discovered during a current period which relate to a prior period may arise through:
Mathematical mistakes
Mistakes in the application of accounting policies
Misinterpretation of facts
Omissions
Fraud
o Prior period errors correct retrospectively.
Either restating the comparative amounts for the prior period(s) in which the error occurred, or
when the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and equity for that period

Error/ fraud discovered

mezbah.ahmed@hotmail.co.uk

Page 34

F7 Financial Reporting (INT)

Life is pretty simple: You do some stuff. Most fails. Some


works. You do more of what works. If it works big, others
quickly copy it. Then you do something else. The trick is the
doing something else.
- Leonardo da Vinci

mezbah.ahmed@hotmail.co.uk

Page 35

F7 Financial Reporting (INT)


IAS 17 Leases

Operating lease: Any lease other than a finance lease.


Treat this as normal rental agreement.

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

IAS 17 identifies five situations which would normally lead to a lease being classified as a finance
lease:
i.
Transfer of ownership of the asset to the lessee at the end of the lease term
ii.
The lessee has the option to purchase the asset at a price sufficiently below fair value at the
option exercise date, that it is reasonably certain the option will be exercised
iii.
The lease term is for a major part of the assets economic life even if title is not transferred at
end of lease term
iv.
Present value of minimum lease payment amounts to substantially all of the assets fair value at
inception
Present value of minimum lease payments is the payments over the lease term that the
lessee is required to make discounted applying implicit interest rate.
v.

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

At commencement of a finance lease, leasee (i.e. user of the asset) recognises a Non-current asset and
a Liability in Statement of financial position.
The amount of non-current asset to be capitalized is
Liability component comprises a current
lower of: [IAS 17: 20]
portion and a non-current portion; and
- Present value of minimum lease payment, and
amortised over the lease term.
- Fair value of the leased asset

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


question should be sufficient.

Non-current asset is subsequently depreciated over shorter of:


Assets useful life, and
Lease term including any secondary period

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

Example: Leasee accounting


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

mezbah.ahmed@hotmail.co.uk

Page 36

F7 Financial Reporting (INT)


Answer:
Though the lease term is only 6.5 years ((26 quarter X 3)/ 12 months), the lease assumed to be a finance
lease because the present value of the minimum lease payment is similar to the fair value of the leased
asset.
Present value of the minimum lease payment:
$
st
1 instalment (in advance, so already at present value)
3,000
nd
th
Present value 2 26 installment ($3,000 X 19.5234) (25 years annuity at 2%) 58,570
61,570
And, fair value of the lease asset at commencement of the lease
61,570
Leaseee accounting:
Income statement for the year ending 31 Dec
20X3
Depreciation

(6,157)

Finance cost

(1,171)

Statement of financial position as at 31 Dec 20X3


Non-current assets: Leased assets
At lease commencement (@01 Oct
20X3)
st
Accumulated depreciation (1 year)
Carrying value
Liabilities:
Non-current liabilities: Finance lease
Current liabilities: Finance lease

Lease amortization schedule:


Y/ending 31
Dec 20X3
Quarter
1
$
Opening liability
61,570
Instalment in
(3,000)
advance
58,570
Interest @ 2%
1,171
(I/S)
Closing liability
59,741
(SFP)

61,570
(6,157)
55,413

51,033
8,708

Year ending 31 Dec 20X4


2
$
59,741

3
$
57,876

4
$
55,974

5
$
54,006

(3,000)

(3,000)

(3,000)

(3,000)

56,741

54,876

52,974

51,006

1,135

1,098

1,059

1,020

57,876

55,974

54,006

52,026

Current portion of total closing liability will be


calculated as:

Non-current portion of total closing liability will be


calculated as:

(Total instalment payable within next one year


Total interest expense charge before last
instalment in the next year) =
($3,000 + $3,000 + $3,000 + $3,000) ($1,135 +
$1,098 + $1,059) = $8,708

Total closing liability Current portion of the


liability = $59,741 - $8,708 = $51,033

mezbah.ahmed@hotmail.co.uk

Page 37

F7 Financial Reporting (INT)

People who say it cannot be done should not interrupt those


who are doing it.
- George Bernard Shaw

mezbah.ahmed@hotmail.co.uk

Page 38

F7 Financial Reporting (INT)


IAS 18 Revenue

Income

Revenue

Income is increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity participants. [Framework:
4.25(a)]
Revenue is income that arises in the course of ordinary activities of an entity. [IAS 18:
Objectives]

From sale of goods should only be recognised


when all of the five criteria are met: [IAS 18: 14]
It is probable that future economic benefits will
flow to the entity.
The amount of revenue can be measured
reliably.
The costs incurred in relation to the transaction
can be reliably measured.
The seller no longer has management
involvement or effective control of the goods.
The seller must have transferred to the buyer
all of the significant risks and rewards of
ownership.

Seller transfer significant risks and


rewards:
- In most cases the transfer of
significant risks and rewards of
ownership coincides with the
transfer of legal title or the
passing of possession to the
buyer.

From rendering of services should only be


recognised when all of the four criteria are met: [IAS
18: 20]
It is probable that future economic benefits will
flow to the entity.
The amount of revenue can be measured
reliably.
The costs incurred and the costs to complete in
relation to the transaction can be reliably
measured.
The stage of completion can be measured
reliably.

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


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

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

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

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


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

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

mezbah.ahmed@hotmail.co.uk

Page 39

F7 Financial Reporting (INT)

It is no use saying, 'We are doing our best.' You have got to
succeed in doing what is necessary.
- Winston Churchill

mezbah.ahmed@hotmail.co.uk

Page 40

F7 Financial Reporting (INT)


IAS 2 Inventories

Inventories are assets:


held for sale in the ordinary course of business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process or in the rendering of
services.
Inventories needs to be valued lower of:
Cost

Cost of purchase
Suppliers gross
price for raw
materials
+
Import duties, etc
+
Costs of transporting
materials to
business premises
Trade discounts

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

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

Costs should not include:


Abnormal waste, finished goods storage, unrelated administrative overheads

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

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

mezbah.ahmed@hotmail.co.uk

Page 41

F7 Financial Reporting (INT)

What is success? I think it is a mixture of having a flair for the


thing that you are doing; knowing that it is not enough, that
you have got to have hard work and a certain sense of
purpose.
- Margaret Thatcher

mezbah.ahmed@hotmail.co.uk

Page 42

F7 Financial Reporting (INT)


IAS 37 Provisions, contingent liabilities and contingent assets

Provision is a liability of uncertain timing or amount. [IAS 37: 10]


Provisions can be distinguished from other liabilities (e.g. trade payables and accruals)
because the level of uncertainty involve in provisions is generally higher. [IAS 37: 11]
A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits. [IAS 37: 10]
[Conceptual Framework: 4.4b]

A provision shall be recognised when all of the following conditions are met: [IAS 37: 14]
o Entity has a present obligation (legal or constructive) as a result of past event,
o It is probable (i.e. more likely than not) that an outflow of resources embodying economic
benefits will be required to settle the obligation, and
o A reliable estimate can be made of the amount of the obligation.
If not probable that a present obligation
exists and, also, if not remote (i.e. a
possible obligation) then disclose as
contingent liability. [IAS 37: 23]
If reliable estimate cannot be made then
disclose as contingent liability. [IAS 37: 26]

Established past practice or published policies which


indicate that the entity will accept certain
responsibilities. [IAS 37: 10]
- Management decision does not give rise to
constrictive obligation unless the decision has
been communicated to those affected by it in a
sufficiently specific manner. [IAS 37: 20]

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

If an entity sells goods with a warranty, a provision recognition (DR I/S: Expense; CR Liability: Provision)
can be required based on the best estimate of the expenditure required to settle the present obligation at
the end of the reporting period. [IAS 37: 36]
When the selling price includes an identifiable (i.e. distinguishable) amount for subsequent
servicing, that amount is deferred (DR Asset: Cash/ Receivable; CR Liability: Deferred income)
and recognised as revenue over the period during which the service is performed (DR Liability:
Deferred income; CR I/S: Revenue). [IAS 18: 13]
-

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

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

mezbah.ahmed@hotmail.co.uk

Page 43

F7 Financial Reporting (INT)

Discounting to present value: When there is a significant period of time between the end of
reporting period and settlement of the obligation, the amount of provision should be discounted to
present value. [IAS 37: 45]
-

Discount factor: (1+r)


The discount rate shall be a pre-tax rate that reflects current market assessment of the time
value of money and the risks specific to the liability.

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

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


discount value (i.e. at present value) the amount of the provision will increase over time, to reflect
the passage of time.
Unwinding of discount will be included in the finance cost.
Unwinding of discount (i.e. the amount to be charged in finance cost and by the amount the
provision needs to be increased) can be found by applying discount rate on opening balance of
the provision.
At end of Year-1: $83 ($827X10%); DR I/S: Finance cost; CR Liability: Provision (that makes
closing provision liability = $910 ($827+$83))
At end of Year-2: $91 ($910X10%); DR I/S: Finance cost; CR Liability: Provision (that makes
closing provision liability = $1,000 ($910+$91))
Y-0

Y-1

Y-2

83

91

827

910

1000

P/L:
Finance cost
SFP:
Liability: Provision

mezbah.ahmed@hotmail.co.uk

Page 44

F7 Financial Reporting (INT)

A restructuring programme changes the way business operates or scope of the business. [IAS 37: 10]
Examples: [IAS 37: 70]
- Sale or termination of a line of business
- Relocation of business activities from one region to another
- Change in management structure, for example, eliminating a layer of management

A provision for restructuring costs to be recognised when an entity has raised a valid expectation in
those affected by it by starting to implement the restructuring plan or by announcing its main features to
those affected by it. The entity has to devise a detailed formal plan for the restructuring. [IAS 37: 72]

A restructuring provision shall not include costs associated with ongoing activities or future
conduct of the entity. [IAS 37: 80, 81]
Example: retraining or relocating continuing staff, marketing, or investment in new systems or
distribution networks

mezbah.ahmed@hotmail.co.uk

Page 45

F7 Financial Reporting (INT)

A contingent liability is: [AS 37: 10]


o A possible obligation that arises from past events and whose existence will be confirmed only by
the occurrence or non-occurrence of one or more uncertain future events not wholly within the
control of the entity; or
o A present obligation that arises from past events but is not recognised as provision as outflow of
resources is not probable (at the same time, also not remote) or the amount cannot be
measured reliably.
-

Contingent liability is only disclosed in the notes of financial statements. [IAS 37: 13]

A contingent asset is a possible asset that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity. [IAS 37: 10]
A contingent asset should not be recognised in the financial statements
Contingent assets should only be disclosed in the notes of financial statements when the
expected inflow of economic benefits is probable. [IAS 37: 31, 34]

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

Virtually certain?

No

Probable?

Yes
Recognise in
financial statements
(DR Asset:
Receivable; CR I/S:
Other income

mezbah.ahmed@hotmail.co.uk

Yes

Disclosure as
contingent asset

No
Do nothing
(i.e. do not
recognise
or disclose
in the FSs.

Page 46

F7 Financial Reporting (INT)

I have been impressed with the urgency of doing. Knowing is


not enough; we must apply. Being willing is not enough; we
must do.
- Leonardo da Vinci

mezbah.ahmed@hotmail.co.uk

Page 47

F7 Financial Reporting (INT)


IFRS 5 Non-current assets held for sale and discontinued operations
A group of assets and liabilities that will be disposed of in
a single transaction are referred to as disposal group.
Held for sale:
An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will
be recovered principally through a sale transaction rather than through continuing use. [IFRS 5: 6]

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


be met:
Available for immediate sale in present condition [IFRS
5: 7].
Sale is highly probable [IFRS 5: 8].

The asset's current condition


should be adequate to be
effectively sold as seen.

For a sale to be highly probable, the following must apply:


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

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

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

Carry at lower of its carrying amount and fair value less cost to sell, which may give rise to an
impairment loss [IFRS 5: 15].
. . . can include transport costs and
costs to advertise that the asset is
This is an exception to the normal IAS 36 rule. IAS 36
available for sale
impairment of assets requires an entity to recognise
an impairment loss only when an assets recoverable
amount is lower than its carrying amount.
Do not depreciate even if still being used by the entity. [IFRS 5: 1]
Present separately in the statement of financial position. [IFRS 5: 1]
Non-current asset held for sale recognise under current asset. [IFRS 5: 3]

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

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

A non-current asset or disposal group that is no longer classified as held for sale (for example,
because the sale has not taken place within one year) is measured at the lower of: [IFRS 5: 27]
Its carrying amount before it was classified as held for sale, adjusted for any depreciation that
would have been charged had the asset not been held for sale.
Its recoverable amount at the date of the decision not to sell.

mezbah.ahmed@hotmail.co.uk

Page 48

F7 Financial Reporting (INT)

An asset that is to be abandoned should not be classified as held for sale. [IFRS 5: 13]

Discounted operation:

operations and cash flows that can be clearly distinguished, operationally


and for financial reporting purposes, from the rest of the entity. [IFRS 5: 31]

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

For discontinued operations, an entity should disclose a single amount in the statement of
comprehensive income comprising the total of: [IFRS 5: 33]
The post-tax profit or loss from discontinued operations; and
The post-tax gain or loss on the re-measurement to fair value less costs to sell or on the disposal of
the discontinued operation.

An entity should also disclose an analysis of the above single amount either on the face of the
statement of comprehensive income or in the notes.

An entity shall disclose the amount of income from continuing operations and from discontinuing
operations attributable to owners of the parent.

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

Gains and losses on the re-measurement of a non-current asset or disposal group that is not a
discontinued operation but is held for sale should be included in profit or loss from continuing operations.
[IFRS 5: 37]
XYZ plc - Consolidated statement of comprehensive income for the year ended 31 December 20X9
$000
Revenue
X
Cost of sales
(X)
Gross profit
X
Other income
X
Distribution costs
(X)
Administrative expenses
(X)
Other expenses
(X)
Profit/ (loss) from operations
X/(X)
Finance costs
(X)
Share of profit/(loss) of associates
X/(X)
Profit/ (loss) before tax
X
Income tax expense
(X)
PROFIT/ (LOSS) FOR THE YEAR FROM CONTINUING OPERATIONS
X/(X)
PROFIT/ (LOSS) FOR THE YEAR FORM DISCONTINUED OPERATIONS (SINGLE AMOUNT) X/(X)
Profit/ (loss) for the year
X/(X)

mezbah.ahmed@hotmail.co.uk

Page 49

F7 Financial Reporting (INT)

I don't pity any man who does hard work worth doing. I
admire him. I pity the creature who does not work, at
whichever end of the social scale he may regard himself as
being.
- Theodore Roosevelt

mezbah.ahmed@hotmail.co.uk

Page 50

F7 Financial Reporting (INT)


IAS 11 Construction contracts

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

Either, proportion of total contract costs incurred


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

Probable that economic benefit of the


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

When outcome of the contract cannot be reliably estimated:


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

Contract costs which cannot be recovered should be recognised as an expense straight away.

If a loss is predicted (i.e. the contract value < total contract cost) on a contract then it should be
recognised immediately in I/S.
Costs incurred to date + costs will be incurred

Costs that should be EXCLUDED from construction contract costs:


- General administration costs (unless reimbursement is specified to the contract)
- Selling costs
- Research and development (unless reimbursement is specified to the contract)
- Depreciation of idle plant and equipment not used on in the contract

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

Accounting treatments:
Income Statement:
Revenue
((Total contract value X % completed) Revenue recognised in previous periods )

Cost of sales
((Total contract costs X % completed) Costs and losses charged in previous periods)

(X)

Foreseeable loss not previously recognised (ALWAYS test for foreseeable loss)
(((Total contract value Total contract cost) X % yet to complete)
Any of this loss previously recognised)

(X)

Profit/(loss) (before non-reimbursable abnormal cost)


Abnormal cost (e.g. rectification cost which is not reimbursed by client)

X/(X)
(X)

Net profit/(loss)

X/(X)

(Any rectification cost which will be reimbursed by client will increase both total contract value and
total contract costs)
Statement of financial position:
Contract costs incurred to date
Profits/(losses) recognised to date (before deducting non-reimbursable abnormal cost)
Progress billing to date
Receivables / (payables) (current asset/liability)

mezbah.ahmed@hotmail.co.uk

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

Page 51

F7 Financial Reporting (INT)

Moral excellence comes about as a result of habit. We


become just by doing just acts, temperate by doing temperate
acts, brave by doing brave acts.
- Aristotle

mezbah.ahmed@hotmail.co.uk

Page 52

F7 Financial Reporting (INT)


IAS 12 Income taxes

Tax

Sales tax

Income tax

Also known as VAT (value added tax).


Seller collect sales tax at the point of sale and the
purchaser pays sales tax at the point of purchase.

If 15% sales tax applicable on sales made by


Company T; the accounting for $100 sales will be:

DR SFP: Cash
115
CR I/S: Revenue
100
CR SFP: Current liability: Sales tax payable 15
(Because as per IAS 18, revenue cannot be
recognised for the amount ($15) collected on behalf
of others (i.e. sales tax collected on behalf of
government).

If sales tax paid by Company T on purchase is


NOT recoverable; the accounting for $80
purchase will be:

Also known as current tax.


This is the tax on taxable profit (NOT on
accounting profit).
Companies prepare profit or loss account
based on accounting standards; but taxable
profit is calculated based on tax rules.
If taxable profit for the year is $100 (accounting
profit can be different) and applicable tax rate
is 30%; then the accounting treatment will be:
DR I/S: Expense: Income tax
CR SFP: Current liability: Tax payable
(If tax is paid as incurred; then CR SFP: Cash)

If 15% sales tax applicable on purchases made by


Company T and if the sales taxes paid by
Company T is recoverable; the accounting for $80
purchase will be:
DR Purchase
80
DR SFP: Current asset: Sales tax recoverable
12
(or, DR SFP: Current liability: Sales tax payable,
if there is already a sales tax payable balance)
CR SFP: Cash
92

DR SFP: Current asset: Tax recoverable


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

mezbah.ahmed@hotmail.co.uk

92
92

30
30

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


the accounting treatment will be:
30

30

Under-provision or over-provision of tax:


The actual tax liability for the year and the tax
charge in the income statement are not
necessarily the same amount. The actual tax
liability for the year is agreed with tax
authorities, may be, in a later year.
-

DR Purchase
CR SFP: Cash

Deferred tax

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


profit is $100 and in Year-2 the actual tax
charge for Year-1 determined $120; then
the tax charge for Year-2 will be increased
by $20 (this is the under-provision made
in Year-1). I.e. if tax charge in Year-2 on
Year-2 taxable profit is $150, the tax
expense amount in Year-2 I/S will be
$150+$20=$170.
o An over-provision of tax from year
1 is deducted from total tax charge
for year 2.
o The other side of the double entry
is an adjustment to the current tax
liability.

Page 53

F7 Financial Reporting (INT)

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

Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either taxable or
deductible.
Taxable temporary differences will result in taxable amounts in determining taxable profit (loss) of
future periods when the carrying amount of the asset or liability is recovered or settled.
Deferred tax liabilities: are the amounts of income taxes payable in future periods in respect
of taxable temporary differences.
DR Tax charge
CR SFP: Non-current liabilities: Deferred tax liability
-

Deductible temporary differences will result in amounts that are deductible in determining taxable
profit (tax loss) of future periods when the carrying amount of the asset is recovered or settled.
Deferred tax assets: are the amounts of income taxes recoverable in future periods in respect
of deductible temporary differences (and in respect of the carry forward of unused tax losses or
tax credits).
DR SFP: Non-current assets: Deferred tax asset
CR Tax charge

Recognise deferred tax (that is the difference between the opening and closing deferred tax
balances in the SFP) normally in profit or loss. But, exceptions are:
- Deferred tax relating to items dealt with as other comprehensive income (such as revaluation)
should be recognised as tax relating to other comprehensive income within the statement of
comprehensive income
- Deferred tax relating to items dealt with directly in equity (such as the correction of an error or
retrospective application of a change in accounting policy) should also be recognised directly in
equity

Steps to follow in determining deferred tax balances:


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

Step 2: Calculate the temporary difference (i.e. difference between carrying value and tax base
value) at year beginning and at year end.
- Temporary difference will be either taxable temporary difference or deductible temporary
difference. Check the decision tree below.

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

mezbah.ahmed@hotmail.co.uk

Income:
Asset
Liability

Page 54

F7 Financial Reporting (INT)


-

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

For asset:
Tax base value < Carrying amount

Tax base =
Carrying
amount

For liability:
Tax base > Carrying amount
Taxable temporary differences
Deferred tax liability

For asset:
Tax base value > Carrying amount
For liability:
Tax base value < Carrying amount

No deferred
tax
implications

Deductible temporary differences


Deferred tax asset

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

mezbah.ahmed@hotmail.co.uk

Page 55

F7 Financial Reporting (INT)


Question:
Company 'T' buys equipment for $50,000 and depreciates it on a straight line basis over its expected useful life of five years
(i.e. @20%). For tax purposes, the equipment is depreciated at 25% per annum on a straight line basis (i.e. will be fully
depreciated at end of Year-4). Accounting profit before tax is $5,000 for each of Year 1 to 5. The tax rate is 40%. Show current
and deferred tax impacts from Year 1 to 5.
Answer:
Current tax calculation:
Year
Accounting profit before tax
Add-back: Accounting depreciation
(since not deductible by tax rules)
(50,000X20%)
Less: Tax depreciation
(50,000X25%)
Taxable profit
Current tax expense @ 40% on taxable
profit (DR I/S: Expense: Current tax)

1
$
5,000
10,000

2
$
5,000
10,000

3
$
5,000
10,000

4
$
5,000
10,000

5
$
5,000
10,000

(12,500)

(12,500)

(12,500)

(12,500)

2,500

2,500

2,500

2,500

15,000

(1,000)

(1,000)

(1,000)

(1,000)

(6,000)

Temporary difference:
Year
Asset's carrying value (i.e. book value)
(Cost - Accumulated accounting depreciation)
Asset's tax base value
(Cost - Accumulated tax depreciation)
Taxable temporary difference
(since asset's carrying value is higher than the tax base
value)
Deferred tax liability:
(since taxable temporary difference results deferred
tax liability)
Year

Opening liability
Closing liability (in SFP under Non-current
liabilities)
(Apply tax rate of 40% on temporary difference)
Liability (increase)/decrease
Income:
Asset
Liability

I/S: For the year ending

1
$
40,000

2
$
30,000

3
$
20,000

4
$
10,000

5
$
0

37,500

25,000

12,500

2,500

5,000

7,500

10,000

1
$

2
$

3
$

4
$

5
$

1,000

2,000

3,000

4,000

1,000

2,000

3,000

4,000

(1,000)

(1,000)

(1,000)

(1,000)

4,000

Expense:
Asset
Liability

1
$
5,000

2
$
5,000

3
$
5,000

4
$
5,000

5
$
5,000

Current tax

(1,000)

(1,000)

(1,000)

(1,000)

(6,000)

Deferred tax
Profit after tax

(1,000)
3,000

(1,000)
3,000

(1,000)
3,000

(1,000)
3,000

4,000
3,000

Profit before tax


Tax expense:

mezbah.ahmed@hotmail.co.uk

Page 56

F7 Financial Reporting (INT)

You never achieve success unless you like what you are
doing.
- Dale Carnegie

mezbah.ahmed@hotmail.co.uk

Page 57

F7 Financial Reporting (INT)


Financial instruments

Four standards on financial instruments:


o IAS 32 Financial instruments: Presentation
IAS 32 deals with classification of financial instruments between liabilities and equity,
and presentation of certain compound instruments
o IFRS 7 Financial instruments: Disclosures
IFRS 7 revised, simplified and incorporated disclosure requirements previously in IAS 32
o IAS 39 Financial instruments: Recognition and measurement
IAS 39 deals with recognition, derecognition and measurement of financial instruments
and hedge accounting
o IFRS 9 Financial instruments
IFRS 9 is a work in progress and will replace IAS 39. It will come into force for
accounting periods ending in 2013.
Financial instruments
A financial instrument is any contract that gives rise to both a financial asset of one entity and a
financial liability or equity instrument of another entity.
A financial asset is any asset that
is:
(a) cash
(b) an equity instrument of another
entity; or
(c) a contractual right to receive
cash or another financial asset
from another entity;

A financial liability is any liability


that is:
(a) a contractual obligation:
(i) to deliver cash or another
financial asset to another
entity,

An equity instrument is
any
contract
that
evidences a residual
interest in the assets of
an entity after deducting
all of its liabilities.

....

....

Examples:
- Cash and timed deposits
- Trade and loan receivables
- Investments in shares issued
by other entities (typically below
20%)

Examples:
Trade payables
Loans
and
redeemable
preference shares
Bank overdraft

Examples:
Companys
equity share

own

Example 1: Accounting for a liability using amortised cost


Giles issues a debt instrument at discount of $500 and is redeemed at a premium of $1,075 (i.e. total of
$11,075). Nominal value of the instrument is $10,000 and redeemable in two years. Coupon rate is 2% and
effective rate is 10%.
Opening balance
Year 1 9,500 (10,000-500)
Year 2 10,250
-

Charge in I/S @ 10%


950 (9,500X10%)
1,025

Cash flow
(200) (10,000X2%)
(200)

Y/end balance (SFP)


10,250
11,075

If there was a issue cost of $500, instead of initial $500 discount, the result would have been same.

mezbah.ahmed@hotmail.co.uk

Page 58

F7 Financial Reporting (INT)


Compound financial instruments:
A compound or hybrid financial instrument is one that contains both a liability component and an equity
component. As an example, an issuer of a convertible bond has:
The obligation to pay annual interest and eventually repay the capital the liability component
The possibility of issuing equity, should bondholders choose the conversion option the equity
component.
In substance the issue of such a bond is the same as issuing separately a non-convertible bond and an
option to purchase shares. At the date of issue the components of such instruments should be classified
separately according to their substance. This is often called split accounting.
The amount received on the issue (net of any issue expense) should be allocated between the
separate components as follows:
The fair value of the liability component should be measured at the present value of the periodic
interest payments and the eventual capital repayment assuming the bond is redeemed.
The present value should be discounted at the market rate for an instrument of comparable
credit status and the same cash flows but without the conversion option.
-

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

On 1 January 20X7 an entity issued 10,000 6% convertible bonds at a par value of 100. Each bond is
redeemable at par or convertible into four shares on 31 December 20X8. Interest is payable annually in
arrears. The market rate of interest for similar debt without the conversion option is 8%.
Year
20X7
20X8
Total liability component
Total proceeds (10,000 100)
Equity element

Cash flow

60,000
1,060,000

Discount factor
1/1.08
1/1.082

Present value

55,556
908,779
964,335
1,000,000
35,665

The subsequent accounting for the liability component should be as follows:


Year
20X7
20X8

Opening balance

964,335
981,482
Will be charged in
I/S as Finance cost

Interest expense (8%)

77,147
78,518

Interest paid

(60,000)
(60,000)

The actual interest payment;


will reduce cash in SFP

Closing balance

981,482
1,000,000
These amounts will
be in SFP: Liabilities

If on 31 December 20X8 all the bond holders elect to convert into equity, then the 1 million
liability should be reclassified to equity, making 1,035,665 in total. The double entry should be:
DR Financial liability 1 million
CR Equity
1 million
If none of the bonds are converted to equity, the liability of 1 million will be extinguished by the
cash repayment. However, the amount already included in equity of 35,665 should remain there.
The
should
double
Note entry
that the
ratebe:
of interest on the convertible will be lower than the rate of interest on the
DR
Financial
liability without the1
million
comparable instrument
convertibility
option, because of the value of the option to acquire
CR
Cash
1
million
equity.

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

mezbah.ahmed@hotmail.co.uk

Page 59

F7 Financial Reporting (INT)


Equity
Share capital
Ordinary share capital
- This represents the
face value of total
issued share.
- To identify number
shares in issue,
divide total share
capital
by
face
value per share.
Irredeemable
preference share
Treat this preference
share as equity, and
recognise
dividend
paid to irredeemable
preference
shareholders
in
Statement
of
changes in Equity as
distribution
of
retained earnings.

Preference share

Redeemable preference
share
- Treat this preference
share as liability in
SFP.
- Recognise dividend
paid to Redeemable
preference
shareholders
as
Finance cost in I/S
(i.e. do not recognise
in
Statement
of
changes in equity).

Non-cumulative
- Dividend will be due only when it is declared.
But, ordinary shareholders typically cannot
get dividend before preference shareholders.
- Ordinary shares and, generally, Irredeemable
preference shares are non-cumulative.

mezbah.ahmed@hotmail.co.uk

Reserves

Convertible
preference share
- This
is
also
known
as
compound
or
hybrid
financial
instrument.
- It has liability
component and
equity
component.
(see compound
instrument note)

Cumulative
- Dividend will be due
irrespective
of
declaration
during
the year.
- Typically redeemable
and
convertible
preference
shares
are cumulative.

Share premium
- This
represents
the additional
amount than
the
face
value
collected on
issue
of
ordinary
share.
- If face value
is $1 of per
ordinary
share
and
$1.2
collected on
issue of per
1,000 share:

Retained
earnings
- Generally,
this is amount
accumulated
from year-onyear
undistributed
(i.e. retained)
profit
after
tax.
- Profit
after
tax can be
distributed to
ordinary
shareholders
and
irredeemable
preference
shareholders.

Revaluation
reserves
- This is the
amount
derived from
IAS
16
Property,
plant
and
equipment
revaluation.

DR
Cash
1,200
CR
Share
capital 1,000
CR
Share
premium 200

Page 60

F7 Financial Reporting (INT)

Half of the harm that is done in this world is due to people


who want to feel important. They don't mean to do harm. But
the harm does not interest them.
- T. S. Eliot

mezbah.ahmed@hotmail.co.uk

Page 61

F7 Financial Reporting (INT)


Consolidated statement of financial position

Different types of investment and required accounting:

INVESTMENT

CRITERIA

Subsidiary

Control (> 50% rule)

Associate

Significant influence (50% >


20% rule)

Joint venture (jointly


controlled entity)

Contractual agreement

Investments which is
none of the above
Investments held for
sale (IFRS 5: NonCurrent Asset Held for
Sale and Discontinued
Operations)

Asset held for accretion (i.e.


increase) of wealth
Sale is highly probable + rule

REQUIRED TREATMENT IN GROUP


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

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

Power over more than 50% of the voting rights by virtue of agreement with other investors.
The power to govern the financial and operating policies of the entity by statue or under an
agreement.
- The power to appoint or remove a majority of members of the board of directors.
- The power to cast a majority of votes at meetings of the board of directors.
Parent should cease to consolidate an entity which was a subsidiary when control is lost.
Control may be lost even without changing the ownership levels; when subsidiary becomes subject
to control of a government, court administration or regulator.

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

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

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

mezbah.ahmed@hotmail.co.uk

Page 62

F7 Financial Reporting (INT)


1) GROUP STRUCTURE:
Parent
50% + (control)

20% + (significant influence)

Subsidiary

Associate

2) NET ASSETS AT FAIR VALUE AT THE DATE OF:

Share capital
Reserves:
Retained earnings: credit/(debit) balance
Share premium
Other reserves (e.g. revaluation)
Unrealised profit when subsidiary sales to parent
Fair value adjustments
FV adj. Post-acquisition depreciation (cumulative effect from
acq. to y/e)
Total
Post-acquisition reserve (difference between Acq. & Y/end)

Subsidiary
Acq.
Y/end
$
$
X
X

Associate
Acq.
Y/end
$
$
X
X

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

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

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

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

Subsidiary
$
X
X

Associate
$
X
X

3) COST OF INVESTMENT:

Cash consideration
Acquisition date fair value of other consideration (e.g. acquisition
date market value of shares given by parent to subsidiary)
Contingent and deferred consideration (converted into PV
n
applying (1+r) )

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

Any contingent consideration payable must be included even at the date of acquisition if it is not
deemed probable that it will be paid
It is possible that the FV of the contingent consideration may change after the acquisition date. If it is
due to additional information obtained that affects the position at acquisition date, goodwill should be
remeasured (one year qualifying period applies). If the change is due to events after the acquisition
date (such as earnings target met) then the goodwill will not be remeasured (gain/loss from
remeasurement will be recognised in I/S)

4) GOODWILL:
i) New method: When examiner will require to use the new method, he will mention full, gross, new, or
calculate NCI at fair value. In this case FV of NCI (value of shares not acquired) at acquisition date will be
given.
ii) Old method: Where an exam question requires use of the old method, it will state that it is group policy to
value the non-controlling interest at its proportionate share of the fair value of the subsidiarys identifiable net
assets.

mezbah.ahmed@hotmail.co.uk

Page 63

F7 Financial Reporting (INT)


New method
Cost of investment (W-3)
FV of NCI at acquisition (value of share not purchased)(given in question)
Less: FV of net assets of subsidiary at acquisition date (W-2)
Goodwill at acquisition
Impairment of goodwill to year end (acquisition date to year-end)
Goodwill at year end in SFP
Old method
Cost of investment (W-3)
Non-controlling share of net asset at aqc. (NCI% X NA @ FV @ Acq.) (W-2)
Less: Total net assets of subsidiary at acquisition date (W-2)
Goodwill at acquisition
Impairment of goodwill to year end (acquisition date to year-end)
Goodwill at year end in SFP

Subsidiary
$
$
X
X
(X)
X
(X)
X
Subsidiary
$
$
X
X
(X)
X
(X)
X

5) NON-CONTROLLING INTEREST (NCI) IN SUBSIDIARY:


New method
FV of NCI at acquisition (value of share not purchased) (given in question)
NC% X Post-acquisition reserve (W-2)
NC% of Goodwill impairment to date
NCI at Y/end in SFP

Old method
Non-controlling share of net asset at aqc. (NCI% X NA @ FV @ Acq.) (W-2)
NC% X Post-acquisition reserve (W-2)
NCI at Y/end in SFP
-

Subsidiary
$
X
X
(X)
X

Subsidiary
$
X
X
X

NCI is not applicable for associates.

6) CONSOLIDATED RESERVE:
Parents reserves (Share premium, Retained earnings, Revaluation reserve) at
reporting date (100%)
Group share of post-acquisition reserve of:
Subsidiary: Acquisition % X Post-acquisition reserve (W2)
Associate: Acquisition % X Post-acquisition reserve (W2)
Unrealised profit - when parent sales to subsidiary
Unrealised profit when there is a transaction with associate (Group % X Unrealised
profit)
Unwinding of discounting of deferred/ contingent consideration (W-3)
Goodwill impairment to date (Acq. to Y/end):
Subsidiary: take only the G% of impairment if goodwill is calculated applying new method
Associate
Reserve in SFP

mezbah.ahmed@hotmail.co.uk

$
X / (X)

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

(X)
(X)
X

Page 64

F7 Financial Reporting (INT)


7) INVESTMENT IN ASSOCIATE:

Cost of investment in Associate (W-3)


Group share of post-acquisition reserve of Associate (G% X Post-acquisition reserve)
(W2)
Unrealised profit - when Parent or Subsidiary sales to Associate (G% X Unrealised
profit)
Impairment of Associate to date
Investment in Associate in SFP

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

P Group
Consolidated statement of financial position as at 31.XX.XXXX
$

ASSETS
Non-current assets
Property, plant and equipments (Parent + Sub +/- FV adj. (W2))
Intangible assets (Parent + Sub +/-FV adj. (W-2)

X
X

Goodwill (W-4)

Investment in Associate (W-7)

Other investments (excluding investment in Sub & Asso)

X
X

Current assets
Cash & bank (Parent + Sub)

Receivables (Parent + Sub - Inter-company receivables)

Closing inventory (Parent + Sub - Unrealised profit from


transaction with Sub - G% of Unrealised profit if Associate
sales to Parent/Sub) (W-2/W-6)

X
X

Total assets

EQUITY AND LIABILITIES


Equity
Share capital (only parent's)

Reserves (W-6)

Non-controlling interest (W-5)

X
X

Non-current liabilities (Parent + Sub - Inter-company loan)

Current liabilities
Bank overdraft (Parent + Sub)

Payables (Parent + Sub - Inter-company payables)

X
X

Deferred/contingent consideration after unwinding (W-3)

X
Total equity and liabilities

mezbah.ahmed@hotmail.co.uk

Page 65

F7 Financial Reporting (INT)


Consolidated statement of comprehensive income
P Group
Consolidated statement of profit or loss and other comprehensive income for the year ending
31.XX.XX
Subsidiar
Associat
Parent
Adj.
Total
y
e
$
$
$
$
$
Revenue

(X)

Cost of sales

(X)

(X)

Unrealised profit in closing inventory

(X)

(X)

X
(X)

(X)

Gross profit

Operating expenses

(X)

(X)

Dep. from FV adj.


Goodwill impairment during the year (sub)

(X)

(X)/X
(X)

Investment income

Dividend from subsidiary (parent's portion)

(X)

Old

(X)

(X)/X

New

(X)

(X)

(X)

Profit before interest & tax


Finance cost (e.g. Interest expense)

X
(X)

(X)

Profit before tax


Tax

(X)
X

(X)

(X)

(X)
X

Group share of Associate's profit after tax

Impairment of Associate during the year

(X)

(X)
X

Consolidated net profit


X
Other comprehensive income

Group share

Total comprehensive income


X

X
X

Net profit attributable to:


4

Non-controlling interests (Total of sub's column X NC%) (X )

Parent (balancing figure)

Net profit

Total comprehensive income


attributable to:
5
Non-controlling interests (Total of sub's column X NC%) (X )

Parent (balancing figure)

Total comprehensive income

* If subsidiary is acquired part way through the year then all income and expenses of subsidiary shall
be time apportioned
1

X : Transaction value of inter-company trading (i.e. the total selling price in inter-company trading)
2
X : Who is the seller? (only deduct the unrealised profit)
3
X : Interest on inter-company loan

mezbah.ahmed@hotmail.co.uk

Page 66

F7 Financial Reporting (INT)

Our greatest weakness lies in giving up. The most certain way
to succeed is always to try just one more time. - Thomas A.
Edison (Inventor)

mezbah.ahmed@hotmail.co.uk

Page 67

F7 Financial Reporting (INT)


IAS 7 Statement of cash flows
XYZ Co.
Statement of cash flows for the year ending 31.XX.XXXX
$

NET CASH FLOW FROM OPERATING ACTIVITIES


Indirect method
Profit before tax (after interest)

Adjustments for:
Finance cost (Interest expense) for the year (amount charged in I/S )

Depreciation and amortisation for the year (amount charged in I/S) (W-4/5)

(Gain)/loss on disposal of non-current asset (amount recognised in I/S) (W-7)

(X)/X

(Gain)/loss on revaluation of investment properties (IAS 40) (amount recognised in I/S)

(X)/X

Income from investment properties (amount recognised in I/S)

(X)

Investment income (e.g. interest/ dividend income) (amount recognised in I/S)

(X)

Operating cash flow before working capital changes

(Increase)/decrease in receivables (from last year to current year's SFP balance)

(X)/X

(Increase)/decrease in inventories (from last year to current year's SFP balance)

(X)/X

Increase/(decrease) in payables (from last year to current year's SFP balance)

X/(X)

Cash generated from operations

Interest paid (W-1)

(X)

Income tax paid (W-2)

(X)

Dividend paid* (W-11)

(X)

Net cash generated/ (used) from / (for) operating activities

X/(X)

Direct method
Cash receipts from customers (W-13)

Operating cash outflows (e.g. payment to suppliers & employees) (W-14)

(X)

Cash generated from operations

Interest paid (W-1)

(X)

Income tax paid (W-2)

(X)

Net cash generated/ (used) from / (for) operating activities

X/(X)

CASH FLOWS FROM INVESTING ACTIVITIES


Purchase of Non-current assets (W-3/5)

(X)

Development expenditure during the year (W-8)

(X)

Proceeds from sale of Non-current assets (W-7)

Income from investment properties (excluding revaluation gain & non-cash income)

Interest received

Divided received

Net cash generated/ (used) from/ (in) investing activities

X/(X)

CASH FLOWS FROM FINANCING ACTIVITIES


Proceeds from issue of shares (W-12)
Proceeds from issue of loan-notes (increase from last year to current years SFP
balance)
Repayment of loan-notes (decrease from last year to current years SFP balance)

Payment of finance lease liabilities (W-9)

(X)

Dividend paid* (W-11)

(X)

mezbah.ahmed@hotmail.co.uk

X
(X)

Page 68

F7 Financial Reporting (INT)


Net cash generated/ (used) from/ (in) financing activities

X/(X)

Net increase/ (decrease) in cash and cash equivalents

X/(X)

**Cash and cash equivalents at beginning of the period (from last year's SFP)

X/(X)

(including bank overdraft & short-term investments)


**Cash and cash equivalents at end of the period (agrees with current year's SFP)

X/(X)

(including bank overdraft & short-term investments)


*Dividend payment can be either in Operating Activities or in Financing Activities.
**Cash and cash equivalents includes Banks asset balance and overdraft balance and short-term deposits
(short-term deposits are normally for less than 3 months).
Workings-1
Interest payable
Payment during the year (balancing figure)

B/f (from last year's SFP)

C/f (from current year's SFP)

Charge for the year (I/S)

Workings-2
Tax payable
B/f - Asset (from last year's SFP):
Current
Deferred

X
X

Credit (similar to income) for the year (I/S):

B/f - Liability (from last year's


SFP):
Current
Deferred
Charge for the year (I/S):

Current
Deferred

X
X

Payment during the year (balancing figure)

Current
Deferred
Received during the year
(balancing figure)

X
X

C/f - Asset (from current


year's SFP):
Current
Deferred

C/f - Liability (from current year's SFP):


Current
Deferred

X
X

X
X
X

X
X
X

Workings-3
Property, plant and equipment: Cost
B/f (from last year's SFP or other
information)

Disposal

Revaluation gain during the year

Revaluation loss during the


year

Finance lease: Asset

Accumulated dep. with


revalued NCA on revaluation

Purchase (i.e. addition during the year)

C/f (from current year's SFP


or other information)

mezbah.ahmed@hotmail.co.uk

Page 69

F7 Financial Reporting (INT)


Workings-4
Property, plant and equipment: Accumulated depreciation
Acc. Dep. with disposed NCA on disposal

Acc. Dep. with revalued NCA on revaluation

c/f (from current year's SFP or other


information)

b/f (from last years SFP or


other information)

Depreciation charge for the


year

Workings-5
Property, plant and equipment: Net book value
B/f (from last year's SFP)

Disposal (NBV at disposal


date)

Revaluation gain during the year

Revaluation loss during the


year

Finance lease: Asset

Depreciation charge (I/S)

Purchase (i.e. addition during the year)

C/f (from current year's SFP)

X
X

Workings-7
Profit/ (loss) on disposal of PPE = Disposal proceed Carrying value at disposal date
Carrying value at disposal date = Cost Accumulated depreciation at disposal date
Workings-8
Development expenditure: NBV
B/f (from last year's SFP)

Amortisation charge for the


year (I/S)

Expenditure incurred during the year

C/f (from current year's SFP)

Workings-9
Finance lease: Liability
B/f - Liability (from last year's
SFP):
Payment during the year (balancing figure)
X
Current

Non-current

New finance lease

C/f - Liability (from current year's SFP):


Current

Non-current

X
X

mezbah.ahmed@hotmail.co.uk

Page 70

F7 Financial Reporting (INT)


Workings-10

Grant released during the year (I/S)

Government grant
B/f - Liability (from last year's
SFP):
X
Current
Non-current

X
X

C/f - Liability (from current year's SFP):


Current
Non-current

X
X

New grant in the year

Workings-11
Retained earnings
Bonus share issue from retained earnings

Dividend paid

C/f (from current year's SFP)

X
X

B/f (from last year's SFP)

Profit for the year (I/S)

Extra depreciation transfer


from revaluation reserve (IAS
16)
C/f (from current year's SFP)

Opening retained earnings


Profit for the year
Extra depreciation transfer from revaluation reserve (IAS 16)
Bonus share issue from retained earnings
Dividend payment (balancing figure)
Closing retained earnings

X
X

X
X
X
(X)
(X)
(X)

Workings-12
Share capital and share premium account
B/f (from last year's SFP):
Bonus share issue from share
premium
C/f (from current year's SFP):
Share capital
Share premium

X
X
X

mezbah.ahmed@hotmail.co.uk

Share capital

Share premium

Bonus issue

Share issue for cash

X
X

Page 71

F7 Financial Reporting (INT)


Workings-13
Receivables
B/f (from last year's SFP)

Sales revenue for the year

X
X

Cash received from


customers

C/f (from current year's SFP)

X
X

B/f (from last year's SFP)

Purchase during the year (W15)

Other operating expenses for


the year excluding
depreciation, profit/loss on
disposal, investment income,
interest expense & tax

Workings-14
Payables
Cash payment during the year

C/f (from current year's SFP)

Workings-15
Inventory
B/f (from last year's SFP)

Cost of sales: Inventory

Purchase during the year

X
X

C/f (from current year's SFP)

X
X

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

mezbah.ahmed@hotmail.co.uk

Page 72

F7 Financial Reporting (INT)

The keys to life are running and reading. When you're


running, there's a little person that talks to you and says, Oh
I'm tired. My lung's about to pop. I'm so hurt. There's no way I
can possibly continue. You want to quit. If you learn how to
defeat that person when you're running, you will know how to
not quit when things get hard in your life. For reading: there
have been gazillions of people that have lived before all of us.
There's no new problem you could have . . . There's no new
problem that someone hasn't already had and written about it
in a book.
Will Smith

mezbah.ahmed@hotmail.co.uk

Page 73

F7 Financial Reporting (INT)


Ratio analysis
Balance Sheet/Statement of Financial Position
as at X.X.X:
Assets:
Non-current assets
X
Current assets:
Cash
X
Receivables
X
Closing Inventory
X
X
Total assets
X
of
Statement
In
Changes in Equity

Income Statement for the year ending X.X.X:


Sales/Revenue/Turnover
X
Less: Cost of Sales
(X)
Gross profit
X
Less: Expenses
(X)
Operating profit
X
Less: Finance cost/Interest expense
(X)
Profit before tax (PBT)
X
Less: Tax
(X)
Profit after tax (PAT)/Profit for the year/Net profit X
Less: Preference (irredeemable) dividend
(X)
Profit attributable to ordinary shareholders
X
Less: Ordinary dividend
(X)
Retained profit for the year
X

Shareholders capital:
Ordinary share capital
Reserves
Preference share capital*
Long-term liabilities
Current liabilities

X
X
X
X
X
X
X

*Redeemable preference share capital will be treated as a long-term liability. In that case its dividend will be treated
as interest (Finance cost in Income Statement).

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

o
o

Current Asset
Current Liabilities

X:1

Current ratio is mainly used to give an idea of the company's ability to pay back its short-term
liabilities (debt and payables) with its short-term assets (cash, inventory, receivables).
The higher the current ratio, the more capable the company is of paying its obligations.
A current ratio of 1.5:1 to 2:1 can mean sufficient current asset to cover its current liabilities.
A current ratio of above 2:1 may mean over investment in working capital (i.e. in current assets).
Surplus assets can be used to
- to expand the business operation or to increase capacity which will earn additional profit,
- to repay debt which will save interest expenses,
- distribute to shareholders as dividend.
A current ratio below 1 suggests that the company would be unable to pay off all of its current
liabilities if they came due at that point.
Current ratio can be improved by
- selling of unused non-current assets,
- taking long-term loan,
- speeding up the receivables collection,
- slowing payables payment
A weak current ratio shows that the company is not in good financial health, but it does not
necessarily mean that it will go bankrupt as there are many ways to access financing; but it is
definitely not a good sign.
Companies that have trouble getting paid by its receivables or have long inventory turnover can run
into liquidity problems

mezbah.ahmed@hotmail.co.uk

Page 74

F7 Financial Reporting (INT)


2. Quick or Quick asset or Acid test ratio =
o
o
o
o

Current Asset-Closing Inventory


Current Liabilities

=X:1

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

PROFITIBALITY RATIOS:
1. Return on capital employed (ROCE) =
o
o

o
o

o
o
o

o
o

o
o

Profit EFORE Interest and Tax


Capital Employed

X 100% = X%

Capital employed = Total asset Current liabilities = Share capital + Reserves +


Long-term liabilities
Deferred Tax Liability or Asset normally excluded from Capital Employed. In that case,
Capital employed = Total asset Current liabilities Deferred tax liability or asset =
Share capital + Reserves + Long-term liabilities Deferred tax liability or asset
Current Liability portion of Long-term liabilities; and a constant amount of Overdraft
normally also considered as Non-current liability for Capital employed calculation
(Opening + Closing
Better to use average Capital Employed
2 where possible.
If you are required to compare ratios between two different years and cannot
calculate average for both of the years, then take only the SFP value of the
year (i.e. do not average). This is for comparability purpose.
If market value of equity is taken then do not include Reserves.
There is a lot other contexts to define capital employed. This is basically the capital
required for a business to function.

ROCE is the prime measure of operating performance. This ratio indicates how efficiently a business
(i.e. managers) is using the funds invested (equity and long-term debt).
It is the ratio over which operations management has most control.
ROCE increase from previous year or above industry average means a good sign and reflects the
fact that the company (by managers) has managed to increase the sales without a proportionate
increase in costs.
ROCE decrease from previous year or below industry average shows problem with controlling of
costs. Level of dividend may also fall as a consequence.
The value of capital employed is lower where company mainly uses rented assets (i.e. thorough
operating lease) rather owning or finance lease. This is also possible where assets carrying value is
lot less than the cost (remember in that case assets will need replacement). These may result a
higher ROCE.
Asset revaluation (especially land) will result a higher amount of Capital employed, which will give a
lower ROCE without indicating company performance became poorer.
ROCE should always be higher than the rate at which the company borrows; otherwise any increase
in borrowing will reduce shareholders' earnings.

mezbah.ahmed@hotmail.co.uk

Page 75

F7 Financial Reporting (INT)


2. Return on equity (ROE), or Return on Shareholders Capital (ROSC)
Profit AFTER Tax and Preference Dividend
Ordinary Share Capital and Reserve

o
o
o

o
o
o
o
o

Profit after tax and preference dividend is the Profit attributable to ordinary shareholders
It is common to use book values rather market value of shares (if market value used then
remember to exclude Reserves)
Better to use average of Shareholders Capital
(Opening + Closing Ordinary Share Capital and Reserves
2 where possible; specially,
when closing balance significantly differs from opening balance.
- If you are required to compare ratios between two different years and cannot calculate
average for both of the years, then take only the SFP value of the year (i.e. do not
average). This is for comparability purpose.

Return on equity (ROE) indicates to ordinary shareholders how well their investments have
performed measuring how much profit the company has generated for them with their money.
A good figure results in a high share price and makes it easy to attract new funds.
With a similar level of ROCE, a fall in ROE may mean increased finance cost because of new loans.
An improved ROE with a similar ROCE may mean some of the loans are repaid which resulted a
lower finance cost and, so, improved profit attributable to ordinary shareholders.
If new share issued sometime at period end, this may result a declined ROE without indicating poor
performance of the company because company really did not get time to utilise the new capital.

3. Gross profit margin =


o

Gross Profit
Sales

o
o

X 100% = X%

High gross profit margin may indicate effective purchasing strategy which results a lower material &/
production cost (i.e. lower cost of sales). A high gross profit margin may also indicate concentration
on low volume-high margin sales.
Low gross profit margin may be an indication of selling products cheaply (i.e. at discount) in order to
generate high volume of sales. This may also indicate increased production cost (including material
and labour cost) without a proportionate increase in selling price.

4. Operating profit margin =


o

X 100% = X%

Profit efore Interest and Tax


Sales

X 100% = X%

Operating profit margin gives analysts an idea of how much profit (before interest and tax) the
company is making from each dollar of sales.
Typically operational management has full control over operating costs (the amount of loan capital
and, so, interest expense normally depends on more higher level of management and the amount of
tax payable depends on government policy). So, operating profit margin effectively measures
performance of operational management.
A poor or declining Operating profit margin may indicate business is struggling in controlling the
costs. This may also happen because of decrease in selling price.
A healthy operating profit margin is required for a company to be able to pay interest on loans.

mezbah.ahmed@hotmail.co.uk

Page 76

F7 Financial Reporting (INT)


5. Net profit margin =
o

o
o
o

o
o

Profit After Tax


Sales

X 100% = X%

Net profit margin sometimes calculated based on Profit before tax (after interest). Check
question for indication.
A higher percentage than last year or industry average indicates costs are being controlled better.
This may also indicate products are sold at higher price.
A weaken Net profit margin may indicate management is struggling in controlling the costs.
Company can sell at a discount to retain market share during economic downturn (and/or because of
intense competition). If costs remain at similar level this will result a lower Net Profit Margin.
Companies trading cheaper products can gain during economic downturn when customers generally
stop buying luxury products and turn to cheaper ones.
In large companies, where higher level of economies of scale can be achieved (i.e. lower level of per
unit cost) the net profit margin can be higher as a result.
Multinational companies can gain or loss from favourable or adverse exchange rate movements.

6. Asset turnover or Asset utilisation ratio =


o

o
o

Sales
Capital Employed

= X:1

Use of Non-current assets instead of Capital employed is also correct. Check question for
indication. If question says nothing, then use Capital employed.
This shows the sales that is generated from each $1 worth of Capital (or asset) employed. The
higher the sales per $1 invested the more efficient use of the capital was.
If business is selling luxury products or products with higher profit margin that may result a lower
Asset turnover ratio without a weaken ROCE or Net profit margin ratio.

EFFICIENCY RATIOS:
1. Average receivables collection period =
o
o

o
o

o
o
o
o

Average Trade Receivables


Credit Sales

X 365 = X days

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

mezbah.ahmed@hotmail.co.uk

Page 77

F7 Financial Reporting (INT)


(may be 60 days) to win customers; whereas retailer may sell only or mainly on cash (may be
collection period of not more than 10 days).
A high or increasing collection period may mean poorly managed credit control function, and
increased risk of bad debts. This also may mean over investment in receivables.
However, increase in collection period might be a deliberate policy to increase sales by
offering better credit terms than competitors.
Decreasing or low collection period may mean tighten credit control policy; which may cause
declining customer numbers (i.e. reduction of sales).
Receivables collection days can be improved by offering discount to customers for early payment.

o
o
o
o

2. Average payables payment period =


o
o
o

Average Trade Payables


Credit Purchase

If Credit purchase or purchase amount cannot be identified from the question, use Cost of
sales as it serves as an approximation.
Use only Trade payables; i.e. payables generated from credit purchase.
Increasing or long payment period may indicate liquidity problem; and also may indicate loosing
opportunity of prompt payment discounts.
A longer payment period may also mean company has succeeded in obtaining very favourable credit
terms from its suppliers; contradictorily, this may also mean unethical business practice.
Long credit term from suppliers is a source of interest free financing. But, some suppliers may
charge interest if payment period exceeds a certain duration.
Declining or short payment period may indicate business has sufficient cash to meet payables. A
short payment period may put companys credit ratings in higher position.
If receivables collection period is longer than the payables payment period then it can cause cash
flow difficulties.

o
o
o
o

3. Inventory turnover/ holding period =

or,
o

o
o

X 365 = X days

Average Inventory
Cost of Sales

X 365 days = X days

Cost of Sales
Average Inventory

= X Times

Better to use Average Inventory figure to take into account the variation between Opening
inventory and Closing inventory. But, instead of Average Inventory the closing inventory
figure can be used where opening inventory level cannot be determined; in that case
comparable figure has to derive from same approach.
This ratio is an estimate of the average time that inventory is held before it is used or sold. If average
inventory holding period is 30 days, this means that the inventory is turned over (i.e. sold) on
average 12.16 times (= 365/30) in a year
A low turnover (i.e. high holding period) implies slow sales and, therefore, excess inventory and/ or
high level of inventory holding costs.
High inventory levels are unhealthy because they represent an investment with a zero rate of return.
It may also put company at a great loss if prices start to decline (think about technological products).

mezbah.ahmed@hotmail.co.uk

Page 78

F7 Financial Reporting (INT)

In F9:
Average FG Inventory
X 365 days = X days
Cost of Sales
Average R Inventory
Raw materials inventory turnover period =
X 365 days = X days
Annul Purchases
Average IP
Average production (WIP) period =
X 365 days = X days
Cost of Sales

1. Finished goods inventory turnover period =


2.
3.

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


Inventory holding period (days) + Receivables collection period Payables payment period
In F9:
Days
X
X
X
X
(X)
X/(X)

Finished goods inventory turnover period


Raw materials inventory turnover period
Average production (WIP) period
Average receivables collection period
Average payables payment period
Operating cycle
o
o

This cycle is the length of time between cash payment to suppliers and cash received form
customers. This measured how long a firm will be deprived of cash.
A company could even achieve a negative cycle by collecting from customers before paying
suppliers. This policy of strict collections and delay payments is not always sustainable or
appreciable by customers (because they have to pay early) and suppliers (because they are being
paid late).

INVESTMENT RATIOS:
1. Earnings per share (EPS) =

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


eighted Avg. Number of Ordinary Shares

or,

o
o
o
o
o
o

ar et Price per Share


Price Earnings Ratio

= $X

= $X

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

mezbah.ahmed@hotmail.co.uk

Page 79

F7 Financial Reporting (INT)


2. Dividend per share (DPS) =

Ordinary Dividend Declared and Paid for The ear


eighted Avg. Number of Ordinary Shares

= X$

o DPS is the actual portion of income received by the ordinary shareholders from EPS.
o DPS is important for shareholders who are seeking income from shares rather capital gain.
o Growth in dividend per share used in share price valuation. So, companies may have a policy of
achieving steady growth in dividend pay-out per share. A steady growth normally creates
positive market reaction (i.e. increase in share price).

3. Dividend pay-out ratio =

or,
o
o

or,

o
o
o
o

X 100% = X%

Ordinary Dividend Declared and Paid for The ear


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

X 100% = X%

Dividend pay-out ratio is the percentage of earnings paid to shareholders as dividends. This shows
how well earnings support the dividend payments.
High dividend pay-out ratio may mean company confidence on future earnings. But, where majority
of shares are held by a small number of shareholders, it may also mean that shareholders are taking
out as much profit as they can; and this does not necessarily serve companys long-term interest.
Low dividend pay-out ratio may mean company is expecting difficulties in the future; so now
interested in retaining earnings. But, it can also mean expansion (by reinvesting the retained
earnings) of business in the future.
Mature companies tend to have a higher pay-out ratio.

4. Dividend cover =

Dividend Per Share


Earnings Per Share

Earnings Per Share


Dividend Per Share

= X Times

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


Ordinary Dividend for the ear

= X Times

Dividend cover represents how many times dividend could have paid from the profit attributable to
ordinary shareholders.
Dividend cover is a measure of the ability of a company to maintain the level of dividend paid out.
The higher the cover, the better the ability to maintain dividend pay-out if profits drop.
Typically, a ratio of 2 or higher is considered safe in the sense that the company can well afford the
dividend; but dividend cover below 1.5 may seem risky.
If the dividend cover is below 1 then the company is using its retained earnings from previous years
to pay current years dividend
A low level of dividend cover might be acceptable in a company with very stable profits, but the same
level of cover for a company with volatile profits would indicate that company may not able to
maintain the current level of dividend pay-out.

mezbah.ahmed@hotmail.co.uk

Page 80

F7 Financial Reporting (INT)


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

or,
o
o

o
o

o
o

o
o
o

= X Times

Company s ar et Capitalisation
Earnings (i.e. Profit) Attributable to Ordinary Shareholders

= X Times

Market capitalisation is the total market value of all the issued ordinary shares of the
company.
P/E ratio also knows as Price Multiple or Earnings Multiple ratio

P/E ratio is a measure of company performance from the markets point of view.
P/E ratio shows how much money investors are currently willing to pay for each dollar of earnings. It
gives an indication of the confidence that the investors have in the future success (i.e. earnings) of
the business.
In a very basic term, a P/E ratio of 20 means investors are paying equivalent of 20 years earnings
(at current EPS level) to own a share in the company.
A P/E ratio of 1 means market is currently willing to pay $1 for each dollar of earnings currently made
by the company; this shows very little confidence on the companys future prosperity. Whereas, a
P/E ratio of 20 expresses a great deal of optimism about the future of the company since investors
are currently willing to pay $20 for each dollar of companys earnings. Investors paying 20 times of
current earnings believe that company will do significantly better in coming years, and this will not
take long to get the $20 earnings.
Market can over-value or under-value company shares depending of information available.

6. Dividend yield =
o

ar et Price Per Share


Earnings Per Share

Dividend Per Share


ar et Price Per Share

X 100% = X%

Dividend Yield is a financial ratio that shows how much a company pays out in dividends relative to
its share price.
In the absence of any capital gains, the Dividend Yield is the return on investment for a share.
Investors can secure a minimum stream of cash flow from their investment portfolio by investing in
shares which is paying relatively high and stable dividend yields.
Mature and well-established companies tend to have higher dividend yields; while young and growth
oriented companies tend to have lower yield. Many fast growing companies do not have a dividend
yield at all because they do not pay-out any dividend.

LONG-TERM SOLVENCY RATIOS:


1.

Debt ratio =

Total Debt
Total Assets

X 100% = X%

o
o

Total assets consist of non-current and current assets.


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

o
o

This ratio represents how much money company owes compared to its Total assets.
If Debt ratio is greater than 50%, the business can be considered as a risky company. But, a high
Debt ratio may also mean companys ability to raise debt finance which shows confidence of debt
holders on the company.

mezbah.ahmed@hotmail.co.uk

Page 81

F7 Financial Reporting (INT)


2. Gearing ratios:
a. Debt to Equity ratio =
Debt Capital
Redeemable Preference Share Capital Long-term Liabilities
X100% =
X 100% = X%
Equity Capital
Ordinary Share Capital Irredeemable Preference Share Capital Reserves

b. Debt to Total capital ratio =


Debt Capital
Total Capital

X100% =

3. Leverage ratio =

o
o
o
o

o
o
o

o
o
o

o
o

Equity Capital
Equity Capital Debt Capital

X 100% = X%
X100%

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

A gearing level of more than 50% (where Debt Capital to Total Capital used) or more than 100%
(where Debt Capital to Equity Capital used) or Leverage ratio of less than 50% means company is
highly geared (i.e. risky).
Risk is high for investors in a high geared company because of obligation to pay the interest and
repaying capital on time.
The standard level of gearing depends on industry sector.
A relatively higher gearing may mean company adopted an aggressive strategy to expand its
operation. This has to be justified with sales and profit growth. A higher gearing may also mean
company is having financial difficulties; so may be a going concern issue.
A low or declining gearing may mean company is getting stronger financially and confident on future
earnings.
Where gearing is high, shareholders required rate of return will increase because of high level of risk
involve in the investment.
To lend money in a highly geared company, lenders may impose some covenants on the company
(example: a maximum limit of gearing, a minimum level of interest cover, pledge on some assets)

4. Interest cover =
o

Debt Capital
Equity Capital Debt Capital

Profit efore Interest and Tax


Interest Charge

= X Times

Interest cover is a measure of the adequacy of a company's profit relative to interest payment on its
debt.
A high interest cover ratio means that the business is easily able to meet its interest obligations from
profits. Similarly, a low level of interest cover ratio means that the business is potentially in danger of
not being able to meet its interest obligations.
Interest cover of more than 2 is normally considered reasonably safe. But, companies with very
volatile earnings may require an even higher level of Interest cover.
Interest cover of less than 1 means the company did not earn sufficient earning (i.e. profit) to meet
its interest charge. This means company will have to pay some of its interest from retained profit
from previous years. This may also raise question about companys going concern.

mezbah.ahmed@hotmail.co.uk

Page 82

F7 Financial Reporting (INT)

Steve Jobs at Stanford Commencement Speech (2005): 'Stay


Hungry. Stay Foolish.'
' . . . Sometimes life hits you in the head with a brick. Don't lose

faith. I'm convinced that the only thing that kept me going was
that I loved what I did. You've got to find what you love. And
that is as true for your work as it is for your lovers. Your work is
going to fill a large part of your life, and the only way to be truly
satisfied is to do what you believe is great work. And the only
way to do great work is to love what you do. If you haven't
found it yet, keep looking. Don't settle. As with all matters of the
heart, you'll know when you find it. And, like any great
relationship, it just gets better and better as the years roll on. So
keep looking until you find it. Don't settle. . .

Your time is limited, so don't waste it living someone else's life.


Don't be trapped by dogma which is living with the results of
other people's thinking. Don't let the noise of others' opinions
drown out your own inner voice. And most important, have the
courage to follow your heart and intuition. They somehow
already know what you truly want to become. Everything else is
secondary. . .'

mezbah.ahmed@hotmail.co.uk

Page 83

F7 Financial Reporting (INT)


IAS 33 Earnings per share

An entity is required to calculate and present a basic EPS and a diluted EPS amount based on the profit/
(loss) attributable to the ordinary shareholders (of the parent entity).
Basic and diluted EPS figures should be presented on the face of the statement of comprehensive
income with equal prominence.
Shares are usually included
in the weighted average
number of shares from the
date
consideration
is
receivable.

Net profit or (loss attributable to ordinary shareholders

Basic EPS =

Weighted average number of shares can be calculated as:

eighted average number of ordinary shares

Number of shares at year beginning

Number of shares issued with full market


price X (Number of months remaining after
the issue / 12)

Total number of shares after new issue at full


Price X (Number of months remaining / 12)

Weighted average number of shares

Weighted average number of shares

Number of shares at year beginning X (Number


of months to new issue at full price / 12)
X

Example:
Number of shares at year beginning (at 01.01.11)
New issue of shares at full market price (at 31.05.11)
Number of share at year end

170,000 + (80,000 X 7/12) = 216,666

170,000
80,000
250,000

(170,000 X 5/12) + (250,000 X 7/12) = 216,666

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

Simple example: Bonus issue


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

2010
$60,000

Number of shares before bonus issue


Bonus issue

400,000
100,000
500,000

400,000
100,000
500,000

EPS

$0.13, i.e. 13c

$0.12, i.e. 12c (restated)

Earnings

As shares were in
existence
at
the
beginning of both
years!

$0.12 is the restated EPS of 2010 in 2011 financial statements for comparison.
Originally, in 2010, the EPS was reported as ($60,000/400,000) = $0.15
Calculating corresponding previous years restated EPS using a formula
Original EPS X

Original number of shares


Number of shares after bonus issue

= $0.15 X

400,000
500,000

= $0.12

mezbah.ahmed@hotmail.co.uk

Original EPS X

Holding ratio to have the bonus share(s


Share ratio with bonus shares

= $0.15 X

4
4+1

= $0.12

Page 84

F7 Financial Reporting (INT)


Complex example: Bonus issue after a full market price issue
At year beginning (01.01.2011), company A has a share capital of 400,000 ordinary shares. It made a full
market price issue on 01 March 2011 of 100,000 shares and a bonus issue of 1 for 4 on 01 April 2011. Its
profit for the year to 31 December 2010 and 2011 was $60,000 and $65,000 respectively. Calculate the EPS
for the year ending 2011 and for corresponding previous year.
Date
01.01.11
01.03.11
01.04.11

Description
Opening balance
Full market price issue
Total N. of shares
Bonus issue:
400,000/4
=
100,000/4
=
Total N. of shares

N. of shares
400,000 X
100,000 X
500,000

Month weight
12/12
10/12

=
=

100,000 X
25,000 X
625,000

12/12
10/12

=
=

Weighted avg. N. of shares


400,000
83,333

100,000
20,833
604,166

Alternative way:
Date

Description

01.01.11
01.03.11

Opening balance
Full market price
issue
Total N. of shares
after full market
price issue
Bonus issue (1 for
4 held)
(500,000/4)
Total N. of shares
after bonus issue

01.04.11

Number
shares
400,000
100,000

of

Bonus
effect
5/4
-

issue

Month weight
2/12
-

Weighted
avg.
number of shares
83,333
-

500,000

5/4

1/12

52,083

125,000

625,000

9/12

468,750
604,166

EPS for year ending 2011: $65,000/604,166 = $0.108, i.e. 10.8c


Corresponding previous years (2010) restated EPS: Original EPS X
=
o

$60,000
4

4
4+1

Holding ratio to have the bonus share(s


Share ratio with bonus shares

= $0.12, i.e. 12c

Basic EPS with right issue:


A rights issue offers existing shareholders the right to buy new shares in proportion of their existing
holding at a price slightly below the market price.
To calculate EPS when right issue is made we need to know:
The cum right price: This is the market price of a share just before the right issue
The ex-right price: This is the price of a share after the right issue. In theory the ex-right
price should be the weighted average of the cum right price of the shares and issue price of
corresponding number of share. This price is called the theoretical ex-right price.
Example: A company has 10,000,000 shares in issue. It is now proposes to make a 1 for 4 rights issue at a
price of $3 per share. The market value of existing shares on the final day before the issue is made is $3.50.
What is the theoretical ex-rights price per share?
Solution:
$
Before right issue: 4 shares @ $3.50
14
Right issue: 1 share @ $3
3
Theoretical value of 5 shares
17
So, theoretical ex-rights price per share is ($17/5) = $3.40
-

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

mezbah.ahmed@hotmail.co.uk

Page 85

F7 Financial Reporting (INT)


-

Steps to follow in a right issue:


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

Original shares plus bonus shares = Original number of shares X

Cum right price


Theoretical ex right price

The resulted Original shares plus bonus shares


will be a higher number of shares as we are
multiplying by a bigger figure and dividing by a
smaller figure.

Deduct original number of shares from the result of the above formula to get the bonus
shares

From above Theoretical ex-right price example:


i. Number of rights share issued: 10,000,000/4 = 2,500,000
ii. Amount received from rights issue: 2,500,000 X $3 = $7,500,000
iii. $7,500,000 can be raised by issuing ($7,500,000/ $3.5) = 2,142,857 shares at full market price
iv. So, we can say, 2,142,857 shares were issued at full market price and (2,500,000 2,142,857) =
357,143 shares were bonus issue
To verify the formula in Step 2:
(Original shares + Bonus shares) X TERP = Original shares X Cum right price
(10,000,000 + 357,143) X $3.4 = 10,000,000 X $3.5
$35,214,286 = $35,000,000
So, there is a mismatch of ($35,214,286 - $35,000,000) = $214,286 (0.6%) if we use above formula!
But, we still need to use formula in Step-2 to identify bonus fraction in a rights issue, as it is required by
IAS 33 (Para A2).
Step 3: Calculate current years EPS
-

PROBLEM!!
when there will be multiple issues
check the example below

Step 4: Calculate corresponding previous years EPS taking the bonus share effect. We can use
following formula:
Re-stated EPS of the previous year =
Original EPS of the previous year X
Holding ratio to have the bonus share(s) Theoretical ex right price
X
Share ratio with bonus shares
Cum right price

Use this part of the formula only if there


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

mezbah.ahmed@hotmail.co.uk

The resulted Re-stated EPS will be a


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

Page 86

F7 Financial Reporting (INT)


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

Narrative

Shares

1.1.X1 b/d
31.1.X1 Rights issue

Time weight

5,000,000 X
1,250,000
6,250,000 X
30.6.X1 Full-market price125,000
6,375,000 X
30.11.X1 Bonus issue 637,500
7,012,500 X
EPS for y/e 31.12.X1 =

$2,900,000
6,840,918

5
12
5
12
1
12

1.95

11

Weighted avg.

470,085

2,864,583

2,921,875

- =

584,375
6,840,918

10
11
10
11
10

= $0.424, i.e. 42.4c

Restated EPS for y/e 31.12.X0 = 46.4c X

12

Bonus in right Bonus issue

10
11

1.95
2

= 41.1c

Diluted EPS:
Diluted EPS warns existing shareholders that the EPS may fall in future years because of potential
new ordinary shares that have been issued.
Potential ordinary shares may be issued in the following forms:
- Convertible bonds (bonds and debentures that can be converted into ordinary shares)
- Convertible preference shares (Preference shares that can be converted into ordinary
shares)
- Options and warrants (Option holders has right, but not obligation, to buy ordinary shares
in a future date at a predetermined price)
- Contingently issuable shares (these are ordinary shares will be issued if certain conditions
are met)
-

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

When calculating the revised weighted average number of shares, the convertible instrument (e.g.
convertible bond) is deemed to have been converted into ordinary shares at the beginning of the period
or, if later, the date of the convertible instrument issued.

mezbah.ahmed@hotmail.co.uk

Page 87

F7 Financial Reporting (INT)

Example: Diluted EPS with convertible bond


In 2010 Farrah Co had a basic EPS of 105c based on earnings of $105,000 and 100,000 ordinary $1
shares. It also had in issue $40,000 15% convertible bond which is convertible in two years time at the
rate of 4 ordinary shares for every $5 of bond. Tax is 30% of profit before tax. In 2010 gross profit of
$200,000 and expenses of $50,000 were recorded, including interest payable of $6,000. Calculate the
diluted EPS.
Solution:
Gross profit
Expenses
Add-back: Interest (40,000X15%)
Profit before tax
Tax expense (30%)
Earnings attributable to ordinary shareholders

$
200,000
(50,000)
6,000
156,000
(46,800)
109,200

Number of shares issued


100,000
Additional shares from conversation ($40,000X4/$5)
32,000
When more than one basis of conversion exists, the conversion assumes
132,000 the most advantageous
conversion rate or exercise price from the standpoint of the holder of the potential ordinary shares.
Diluted EPS = ($109,000/132,000) = $0.82.6, i.e. 82.6c
Dilution (i.e. decrease) in earnings would be (105c 82.6c) = 22.4c per share

o
-

Dilutive or antidilutive:
Only diluted shares should be included in the diluted EPS calculation.
Potential new ordinary shares are not dilutive if EPS would have been higher if the potential shares
had been actual shares in the period.
Example: Ardent Co has 5,000,000 ordinary shares of 25 cents each in issue. The total earnings in
2010 were $1,750,000. The rate of income tax is 35%. Decide which one of the following will dilute the
EPS and will be included in diluted EPS calculation:
(a) $1,000,000 of 14% convertible loan stock, convertible in three years time at the rate of 2 shares
per $10of stock
(b) $2,000,000 of 10% convertible loan stock, convertible in one years time at the rate of 3 shares
per $5 of stock
Solution:
Basic EPS = $1,750,000/5,000,000 = 35 cents
(a) Earnings increased (i.e. interest expense saves): i X(1 t) = $1,000,000 X 0.14 (1 0.35) =
$91,000
Potential ordinary shares: ($1,000,000 X 2)/ $10 = 200,000 shares
So, incremental EPS = $91,000/200,000 = 45.5c
Incremental EPS is higher than basic EPS; so NOT diluted and do not include in the diluted EPS
calculation.
(b) Earnings increased (i.e. interest expense saves): i X(1 t) = $2,000,000 X 0.10 (1 0.35) =
$130,000
Potential ordinary shares: ($2,000,000 X 3)/ $5 = 1,200,000 shares
So, incremental EPS = $130,000/1,200,000 = 10.8c
Incremental EPS is lower than basic EPS; so diluted (i.e. weakened) and need to include in the
diluted EPS calculation.

mezbah.ahmed@hotmail.co.uk

Page 88

F7 Financial Reporting (INT)

o
-

Adequate to use a simple average of weekly or monthly prices; or,


Average of closing market prices; or,
Average of high and low prices when prices fluctuate widely.
Whichever method used, must be applied consistently

Diluted EPS with option:


Options and warrants are dilutive when they would result in the issue of ordinary shares for less than
the average market price of ordinary shares during the period (i.e. when they are in the money).
The shares that would be issued if the options or warrants are exercised are divided into full priced
shares and free shares. The free fraction is the dilutive.

Example: Brand Co had net profit of $1,200,000 for the year ending 31 December 2010. Weighted
average number of ordinary shares outstanding during the year was 500,000. Average fair value of
one ordinary share during the year was $20. Brand Co issued share option of 100,000 shares with
exercise price applicable of $15. Calculate both basic and diluted EPS.
Solution:
If the options are exercised, the company will raise cash of (100,000 shares X $15) = $1,500,000. That
is ($1,500,000 / $20) = 75,000 shares if issued full price. So, the company is giving away (100,000
75,000) = 25,000 shares for free. These 25,000 shares will dilute the basic EPS.
Number of shares
Profit after tax
Basic
500,000
$1,200,000
Dilutive effect
25,000
No effect
525,000
$1,200,000
Basic EPS in 2010 = $1,200,000 / 500,000 = $2.40
Diluted EPS in 2010 = $1,200,000 / 525,000 = $2.29
o

Contingently issuable shares:


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

Stay with the company

Performance related

Dilutive effect exists from:

Grant date

When performance criteria are met

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

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

Post reporting date issues:


-

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

mezbah.ahmed@hotmail.co.uk

Page 89

F7 Financial Reporting (INT)

The value of a man should be seen in what he gives and not in


what he is able to receive.
- Albert Einstein

mezbah.ahmed@hotmail.co.uk

Page 90

F7 Financial Reporting (INT)


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

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

Factoring with recourse:


- The seller retains the risk of any under-collection of receivables by the factor. If the factor fails to
collect any amount of receivables then the seller reimburses that uncollected amount to the factor.
- Accounting:
i.
When the seller receives money from factor, the double entry is: DR SFP: Bank, CR SFP:
Liability
ii.
Interest charged by factor to the seller: DR I/S: Finance cost, CR SFP: Bank
iii.
Amount received by factor from Receivables: DR SFP: Liability, CR: SFP: Receivables
iv.
Any remaining receivables amount reimbursed by the seller: DR SFP: Liability, CR: SFP:
Bank

Factoring without recourse:


- The seller transfers risk associated with collection of receivables to the factor. If the factor fails to
collect any amount of receivables, the seller does NOT reimburse that amount.
- Accounting:
i.
Amount received by the seller from factor: DR SFP: Bank, CR: Receivables
ii.
Any cash commission charged by the factor: DR I/S: Finance cost, CR SFP: Bank
iii.
If factor charge commission by paying a lower amount of Receivables the seller: DR SFP:
Bank, DR I/S: Finance cost: amount under-received by seller, CR SFP: Receivables

mezbah.ahmed@hotmail.co.uk

Page 91

F7 Financial Reporting (INT)


Exercise question:
On 1 October 20X0, Jedders signed a receivables factoring agreement with a company Fab Factors.
Jedders trade receivables are to be split into three groups, as follows.
Group A receivables will not be factored or administered by Fab Factors under the agreement, but instead
will be collected as usual by Jedders.
Group B receivables are to be factored and collected by Fab Factors on a with recourse basis. Fab Factors
will charge a 1% per month finance charge on the balance outstanding at the beginning of the month.
Jedders will reimburse in full any individual balance outstanding after three months.
Group C receivables will be factored and collected by Fab Factors without recourse; Fab Factors will pay
Jedders 95% of the book value of the debtors.
Jedders has a policy of making a receivables allowance of 20% of a trade receivables balance when it
becomes three months old.
The receivables groups have been analysed as follows:

Group A
Group B
Group C

Balance @ 1 October 20X0


$000
1,250
1,500
2,000

% of 1 October 20X0 balance collected in:


October
November
December
$000
$000
$000
30%
30%
20%
40%
30%
20%
50%
25%
22%

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

Solution:
Group A: No factoring
By 31 December 20X0, 80% (30%+30%+20%) of the receivables collected by Jedders. So, Receivables
allowance of 20% to be recognised on remaining 20% receivables balance.
@ 31 October 20X0:
DR SFP: Bank
($1,250,000 X 30%)
CR SFP: Receivables
(30% of receivables collected by Jedders. So, decrease in receivables)

$375,000
$375,000

@ 30 November 20X0:
DR SFP: Bank
($1,250,000 X 30%)
$375,000
CR SFP: Receivables
$375,000
(Further 30% of receivables collected by Jedders. So, decrease in receivables)

mezbah.ahmed@hotmail.co.uk

Page 92

F7 Financial Reporting (INT)


@ 31 December 20X0:
DR SFP: Bank
($1,250,000 X 20%)
$250,000
CR SFP: Receivables
$250,000
(Further 20% of receivables collected by Jedders. So, decrease in receivables)
DR I/S: Expense: Increase in receivables allowance
(($1,250,000 X 20%) X 20%)
$50,000
CR SFP: Receivables: Allowance for receivables
$50,000
(Receivables allowance of 20% recognised on remaining 20% receivables balance. This is provision
for doubtful debts and presented as decrease in receivables in SFP.)
So, Group A receivables balance to be presented in SFP as at 31 December 20X0: (($1,250,000 - $375,000
- $375,000 - $250,000) - $50,000) = $200,000.

Group B: Factoring with recourse


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

mezbah.ahmed@hotmail.co.uk

Page 93

F7 Financial Reporting (INT)


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

Group B: Factoring without recourse


Risk associated with any under-collection of receivables is transferred to Fab Factors. So, receivables
balance shall be derecognised (i.e. removed from SFP) at the point of cash received from Fab Factors. Any
commission charged by Fab Factors (may be by under-payment of receivables balance to Jedders or cash)
shall be recognised as Finance cost.
@ 1 October 20X0:
DR SFP: Bank
($2,000,000 X 95%)
DR I/S: Finance cost: Factors commission
($2,000,000 X 5%)
CR SFP: Receivables (decrease in receivables)

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

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

mezbah.ahmed@hotmail.co.uk

Page 94

F7 Financial Reporting (INT)

Most of the important things in the world have been


accomplished by people who have kept on trying when there
seemed to be no hope at all.
- Dale Carnegie

mezbah.ahmed@hotmail.co.uk

Page 95

F7 Financial Reporting (INT)


IAS 10 Events after reporting period

Events after the reporting period are split into:


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

Settlement of a court case that confirms that


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

Non-adjusting events: are events that are


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

A major business combination after the


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

The cut-off date for the consideration of events after the reporting period is the date on which the
financial statements are authorised for issue.
Normally the financial statements are authorised by the directors before being issued to the
shareholders for approval.
Where a supervisory board is made up wholly of non-executive directors, the financial statements
will first be authorised by the executive directors for issue to that supervisory board for its approval.
The relevant cut-off date is the date on which the financial statements are authorised for issue to the
supervisory board.
The date on which the financial statements were authorised for issue should be disclosed.

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

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

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

mezbah.ahmed@hotmail.co.uk

Page 96

F7 Financial Reporting (INT)

'Whatever you do will be insignificant, but it is very important


that you do it'. - Mohandas Karamchand Gandhi

mezbah.ahmed@hotmail.co.uk

Page 97

F7 Financial Reporting (INT)


Important definitions

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

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

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

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

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

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

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

Underlying assumptions in preparing financial statements:


Accruals basis: The effects of transactions and other events are recognised when they occur (and
not as cash or its equivalent is received or paid) and they are recorded in the accounting records and
reported in the financial statements of the periods to which they relate. [Conceptual Framework:
OB17]
-

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

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

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

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

mezbah.ahmed@hotmail.co.uk

Page 98

F7 Financial Reporting (INT)

'As is a tale, so is life: not how long it is, but how good it is, is
what matters.' - J. K. Rowling Speaks at Harvard
Commencement 08

mezbah.ahmed@hotmail.co.uk

Page 99

F7 Financial Reporting (INT)

* * * End * * *

This document is prepared


based on experience as a
student and as a lecturer.
Most of the lines in this
document copied from
relevant IASs/IFRSs or
ACCA books. It took more
than 100 hours in planning,
writing, rewriting, organising
and reorganising this
26,000 word document.

Wish you the very best with


your study. Mezbah

mezbah.ahmed@hotmail.co.uk

Page 100