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Private Bag 98,

Blantyre, Malawi
Telephone: 265 991 095 434
Email: nelliekishombe31@[Link]
Lecturer: Miss Nellie Kishombe

COURSE OUTLINE

Financial Reporting I: (ACF 211)

1. Programme : Bachelor of Accounting and Finance

2. Department : Accounting and Finance
3. Course Title : Financial Reporting I
4. Course Code : ACF 211
5. Course Duration : Semester
6. Lecture hours per week :3
7. Tutorial hours per week :1
8. Course Credits :3
9. Course Assessment : Course Work 40%
: Final Examination 60%

10. Course Description

This course provides an in-depth examination of corporate accounting issues and International Financial
Reporting Standards as well as the analysis and interpretation of financial statements prepared under those
standards.

11. Aim of this Course

The aim of this course is to develop students’ knowledge of regulations and theories of financial accounting for
preparing financial statements in `accordance with International Financial Reporting Standards.

12. Learning Outcomes

By the end of this course, students should be able to:
a) Describe the disclosure requirements for each item on financial statements. .
b) Define investment property and make the appropriate accounting entries.
c) Calculate depreciation of property, plant and equipment (PP&E).
d) Present PP &E on the balance sheet in accordance with international accounting standards.
e) Explain revenue recognition requirements for contracting firms.
f) Calculate the revenue to be recognised each year for long term contracts such as construction of a building.
g) Compute deferred taxation and treat it accordingly in the financial statements.
h) Explain the different types of leases and ascertain lease payments as per the lease agreement.
i) Calculate earnings per share under the different scenarios.

13. Topics of Study

13.1. Framework for preparation and presentation of financial statements (IAS 1)

a) Objectives of financial statements
b) Elements of financial statements

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c) Presentation of financial statements.

13.2. Investment property - IAS 40

a) Characteristics of investment property;
b) Accounting for investment property;
c) Disposals;
d) Disclosure requirements.

13.3. Property, Plant and Equipment (PP&E) - IAS 16

a) Recognition and valuation methods
b) Useful life and carrying amount of assets;
c) Depreciation of assets;
d) Disclosure requirements.

13.4. Impairment of Non-Current Assets - IAS 36

a) Determination and measure of value of assets;
b) Determination of impairment loss;
c) Reversal of impairment;
d) Disclosure requirements.

13.5. Revenue - IAS 18 (Revenue Recognition) and IFRS 15 (Revenue from Contracts)
a) Recognition and measure of revenue;
b) Disclosure requirements;
c) Fundamental errors and changes in accounting policies.

13.6. Income taxes - IAS 12

a) Recognition of deferred tax liabilities;
b) Recognition of deferred tax assets;
c) Presentation and disclosure.

13.7. Leasing (IFRS 16)

a) Introduction to Leases Accounting (as well as comparison with IAS 17);
b) Accounting for Leases Accounting;
c) Taxation implications on choice of particular type of finance lease.

13.8. Earnings per share IAS 33

a) Calculation of Earnings Per Share: simple capital structure; Bonus issue; convertible
securities; options or warrants to subscribe for shares;
b) Disclosure requirements.

14. Prescribed Texts

Deegan, Craig. and Ward, Anne. Marie. (2013) Financial Accounting and Reporting: An International Approach,
European Edition, McGraw Hill Higher Education.
Gallimberti, Carlo. Maria., Marra. Antonio. and Principe, Annalisa. (2013) Consolidation. Preparing and
Understanding Consolidated Financial Statements under IFRS, McGraw Hill Higher Education.
Hoyle, Joe. Ben., Schaefer, Thomas. and Doupnik, Timothy. (2017) Fundamentals of Advanced Accounting, 7th
Edition, McGraw-Hill Education.

15. Recommended Texts

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Hilton, M. and Herauf, D. (2013) Modern advanced accounting in Canada, 7th ed. Toronto, ON: McGraw-Hill
Ryerson.

Revsine, Lawrence., Collins, Daniel., Johnson, Bruce., Mittelstaedt, Fred. and Soffer, Leonard. (2017)
Financial Reporting and Analysis, 7th Edition, McGraw-Hill Education.

Scott, William. R. (2012) Financial Accounting Theory, Sixth Edition, Pearson Prentice Hall.

Spiceland J. David., Sepe, James., Nelson, Mark. and Thomas, Wayne. (2015) Intermediate Accounting, 8th
Edition, McGraw-Hill Education.
Weygandt, J., Kieso, D., Kimmel P., Trenholm, B., Warren, B and Novak, L. (2016) Accounting Principles,
Volume 1. 7th Canadian ed. Mississauga, ON: John Wiley and Sons Canada, Ltd.

Weygandt, J., Kieso, D., Kimmel P., Trenholm, B., Warren, B and Novak, L. (2016) Accounting Principles,
Volume 2. 7th Canadian ed. Mississauga, ON: John Wiley and Sons Canada, Ltd.

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CHAPTER 1: Framework for preparation and presentation of financial statements

The Financial Reporting Environment

While this module is still concerned with legalities, techniques, numbers and calculations, we
are shifting our perspective towards a more conceptual approach. This module is concerned
with far more than just knowledge of standards and techniques, but moves to the realm of the
theories behind financial accounting practice, the motivations behind corporate reporting, and
the issues and controversies which make news in the financial press.

The debate on financial reporting has been widened and deepened by recent unexpected
corporate failures, particularly, AIG, Lehman Brothers, Freddy Mac, e.t.c in the United States of
America in 2008, culminating in the current world financial crisis.

The regulatory framework Main

sources of regulation a)Malawi
Government
b) Accounting Standards
In Malawi, the regulatory framework derives mainly from the government through the
Companies Act of 1984, and accounting standards.
The Malawi Companies Act 1984 (Cap 46:03)
a) does not require application of International Financial Reporting Standards (IFRS)
or any other standards.
b) T here is no requirement for applying accounting standards or generally accepted
accounting principles (GAAP) in the Companies Act. The Act requires financial
statements to show a true and fair view. But whether a true and fair view requires the
application of IFRS has been left to the requirements of specific sector legislation or
regulation. This is a significant gap in this fundamental legislation.
c) Almost all commercial institutions are regulated under the Act, which would be expected
to identify either the basis of financial reporting or the institution that is charged with the
responsibility of giving the necessary direction for such reporting.
d) Although the Society of Accountants in Malawi (SOCAM) has directed that all
companies in Malawi shall apply IFRS, there is no link between SOCAM and the
Companies Act. However, the Act elaborates requirements for keeping proper
accounting records and preparing financial statements. These requirements are useful
in ensuring an adequate base from which financial statements (whether IFRS compliant
or not) can be prepared and in stipulating generally the obligation for preparing financial
statements.

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Accounting Standards
An accounting standard is a rule or set of rules which prescribes the method or methods by
which accounts should be prepared and presented. Some accounting principles such as
valuation of assets are embodied in legislation, while others such as cash flow statements are
regulated by accounting standards.
The international Accounting Standards Board (IASB)
Financial statements are prepared and presented for external users by many enterprises around
the world. Although such financial statements may appear similar from country to country, there
are differences which have probably been caused by a variety of social, economic, and legal
circumstances and by different countries having in mind the needs of different users of financial
statements when setting national requirements.

These different circumstances have led to the use of a variety of definitions of the elements of
financial statements; for example assets, liabilities, equity, income and expenses.
They have also resulted in the use of different criteria for the recognition of items in the financial
statements and in a preference for different bases of measurement. The scope of the financial
statements and the disclosures made in them have also been affected.
The international Accounting Standards Board (IASB) is an independent private sector body,
formed with the objective of achieving uniformity in the accounting principles which are used by
businesses and other organisations for financial reporting around the world. It was formed in
1973 through an agreement made by professional accountancy bodies from Australia, Canada,
France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland, and the United
States of America. As at January 1999, the organisation had grown to include 142 members
(professional Accountancy bodies) in 103 countries, representing 2 million accountants. Many
other organisations are now involved in the work of IASB and many countries that are not
members of IASB make use of International Accounting Standards.

The objectives of IASB as stated in its constitution are:

a) To formulate and publish in the public interest accounting standards to be observed in

the presentation of financial statements and to promote their worldwide acceptance and
observance;

b) To work generally for the improvement and harmonisation of regulations, accounting

standards and procedures relating to the presentation of financial statements.

International Harmonisation
In today‟s globalised economies, business is impacted by worldwide competition. Although the
legal, political, socio-cultural and economic conditions vary from country to country, the
international environment has an influence in the way in which financial statements are
prepared and produced.
There are various bodies which are working on different aspects of harmonisation and these
include the International Accounting Standards Board (IASB), European Commission (EC),
United Nations (UN), and International Federation of Accountants (IFAC).
IASB is committed to narrowing the differences that exist from country to country by seeking to
harmonise regulations, accounting standards and procedures relating to the preparation and
presentation of financial statements.
IASB believes that further harmonisation can best be pursued by focusing on financial
statements that are prepared for the purpose of providing information that is useful in making
economic decisions.

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Barriers to harmonisation
The main problems are as follows:
a) Different purposes of financial reporting. In some countries the purpose is solely for tax
assessment, while in others it is for investor decision-making.
b) Different legal systems. These prevent the development of certain accounting practices
and restrict the options available.
c) Different user groups. Countries have different ideas about who the relevant user groups
are and their respective importance, for example in USA investor and creditor groups is
given prominence, while in Europe employees enjoy a higher profile.
d) Needs of developing countries. Developing countries in most cases are behind in the
standard setting process and they need to develop the basic standards and principles
already in place in most developed countries.
e) Nationalism. Is demonstrated in an unwillingness to accept another country‟s standard
f) Cultural difference results in objectives for accounting systems differing from country to
country.
g) Unique circumstances. Some countries may be experiencing unusual circumstances
which affect all aspects of everyday life and impinge on the ability of companies to
produce proper reports, for example hyperinflation, civil war, currency restriction and so
on.
h) The lack of strong accountancy bodies. Many countries do not have strong independent
accountancy or business bodies which would press for better standards and greater
harmonisation.
.
Advantages of harmonisation
The advantages of harmonisation will be based on the benefits to users and preparers of
accounts as follows:
a) Investors, both individual and corporate, would like to be able to compare the financial
results of different companies internationally as well as nationally in making investment
decisions. Differences in accounting practice and reporting can prove to be a barrier to
such cross-border analysis. There are a growing number of investments taking place
across borders and there are few financial analysts able to follow shares in international
markets. Harmonisation would therefore be of benefit to such analysts.
b) Multinational companies would benefit from harmonisation for many reasons including
the following: 1) Management and control would be improved, because harmonisation
would aid internal communication of financial information. 2) Transfer of accounting staff
across national borders would be easier. 3) It would be easier to comply with the
reporting requirements of overseas stock exchanges. 4) Appraisal of foreign enterprises
for take-overs and mergers would be more straightforward.
c) Regional economic groups such as the SADC or COMESA usually promote trade within
a specific geographical region. This would be aided by common accounting practices
within the region.
d) Tax authorities. It will be easier to calculate the tax liability of investors, including
multinationals who receive income from overseas sources.
e) Large international accounting firms would benefit as accounting and auditing would be
much easier if similar accounting practices existed throughout the world.

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Framework

What is a “conceptual framework?

“A Conceptual Framework is defined as a set of interrelated concepts that define the nature,
subject, purpose and broad content of general purpose financial reporting in the private and
public sectors”

“It is the explicit rendition of the thinking of the standard-setting body as it lays down the
requirements for general purpose financial reporting” (McGregor, 1990, p. 48).

In other words, a conceptual framework is a statement of generally accepted theoretical

principles which form the frame for financial reporting. The financial reporting process is
concerned with providing information that is useful in the business and economic
decision making process; therefore a conceptual framework will form the theoretical
basis for determining which events should be accounted for, how they should be
measured and how they should be communicated to the user.

Need for a Conceptual Framework

A framework is required in order to have coherence in rules and standards, and to provide quick
solutions to new and emerging practical problems by reference to an existing framework of
basic theory.
Scope
In this case the framework deals with:
a) The objective of financial statements;
b) The qualitative characteristics that determine the usefulness of information in financial
statements;
c) The definition, recognition and measure of the elements from which financial statements
are constructed; and
d) Concepts of capital and capital maintenance.
The framework is concerned with general purpose financial statements including consolidated
financial statements. Such financial statements are prepared and presented at least annually
and are directed toward the common information needs of a wide range of users.

A complete set of financial statements normally includes a balance sheet, an income statement,
and a statement of changes in financial position such as the statement of cash flows.

The objective of financial statements The

objectives state that:
• Financial statements should provide information that is useful to present and
potential investors and creditors and other users in making rational investment, credit,
and similar decisions. The information should be comprehensible to those who have a
reasonable understanding of business and economic activities and are willing to study
the information with reasonable diligence.
• Financial statements should provide information to help present and potential investors
and creditors and other users in assessing the amounts, timing, and uncertainty of
prospective cash receipts from dividends or interest and the proceeds from the sale,
redemption, or maturity of securities or loans. Since investors' and creditors' cash flows
are related to enterprise cash flows, financial reporting should provide information to

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 help investors, creditors, and others assess the amounts, timing, and uncertainty of
prospective net cash inflows to the related enterprise.
• Financial statements should provide information about the economic resources of an
enterprise, the claims to those resources (obligations of the enterprise to transfer
resources to other entities and owners' equity), and the effects of transactions, events,
and circumstances that change its resources and claims to those resources.
• Financial statements are expected to provide information about an enterprise's financial
performance during a period and about how management of an enterprise has
discharged its stewardship responsibility to owners.

Underlying Assumptions
Accrual Basis
In order to meet their objectives, financial statements are prepared on the accrual basis of
accounting. Under this basis, the effects of transactions and other events are recognised when
they occur, and not as cash or its equivalent is received or paid. This means that transactions
are recorded in books of accounts and reported in financial statements for the period to which
they relate.
Going Concern
The financial statements are normally prepared on the assumption that an enterprise is a going
concern and will continue in operation for the foreseeable future. Hence it is assumed that the
enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its
operations.

Qualitative Characteristics of Financial Statements

Qualitative characteristics are the attributes that make the information provided in financial
statements useful to users.
For information to be useful, it must be:

Relevance
Accounting information is relevant if it is capable of making a difference in a decision. Relevant
information has
(a) Predictive value.
(b) Feedback value.
(c) Timeliness.
To be useful, information must be relevant to the decision making needs of users. Information
has the quality of relevance when it influences the economic decisions of users by helping them
to evaluate past, present or future events or confirming or correcting their past evaluations.
Information about financial position and past performance is frequently used as the basis for
predicting future financial position and performance. To have predictive value, information need
not be in form of an explicit forecast. The ability to make predictions from financial statement is
enhanced by the manner in which information on past transactions and events is displayed. For
example the predictive value of the income statement is enhanced if unusual, abnormal and
infrequent items of income or expense are separately disclosed.

Information about financial position and past performance is frequently used as the basis for predicting
future financial position and performance; for example the ability of the enterprise

to meet its obligations as they fall due.

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Materiality
The relevance of information is affected by its nature and materiality. Information is material if its
omission or misstatement could influence the economic decisions of users. Materiality depends
on the size of the item or error judged in the particular circumstances of its omission or
misstatement. Thus the materiality provides a threshold or cut-off point rather than being a
primary qualitative characteristic which information must have if it is to be useful.

Reliability
Accounting information is reliable to the extent that users can depend on it to represent the
economic conditions or events that it purports to represent. Reliable information has
(a) Verifiability.
(b) Representational faithfulness.
(c) Neutrality.
Information has the quality of reliability when it is free from material error and bias and can be
depended upon by users to represent faithfully that which it either purports to represent or could
reasonably be expected to represent.

Completeness
To be reliable, the information in financial statements must be complete within the bounds of
materiality and cost. An omission can cause information to be false or misleading and thus
unreliable and deficient in terms of its relevance.

In addition, the information must also be comparable and consistent.

Comparability
Users must be able to compare the financial statements of an enterprise through time in order to
identify trends in its financial position and performance. Users must also be able to compare the
financial statements of different enterprises in order to evaluate their relative financial position,
performance and changes in financial position. Compliance with International Accounting
Standards, including the disclosure of the accounting policies used by the enterprise, helps to
achieve comparability.

The elements of financial statements

Financial statements portray the financial effects of transactions by grouping them into broad
classes according to their economic characteristics. These broad classes are termed the
elements of financial statements.
The elements directly related to the measurement of performance in the income statement are:
 Income
 Expenses
The elements directly related to the measurement of financial position in the balance sheet are:
 Assets
 Liabilities
 Equity

Practice Questions
1. Financial Accounting is a discipline with a heavy bias towards practical issues. Why is it
necessary or desirable to have a theoretical framework?

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Measurement of the elements of financial statements/ recognition of financial statement
items
Measure is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognised and carried in the balance sheet and income
statement.
This involves the selection of a particular basis of measurement, such as;
a) Historical cost. Assets are recorded at the amount of cash or cash equivalents paid at
the time of their acquisition. Liabilities are recorded at the amount of proceeds received
in exchange for the obligation.
b) Current market value. Assets are carried at the amount of cash or cash equivalents
that would have to be paid if the same or an equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount of cash or its equivalents that would
be required to settle the obligation currently.
c) Realisable (settlement value) Assets are carried at the amount of cash or its
equivalents that could be obtained by selling the asset (disposal value). Liabilities are
carried at their settlement values
d) Present Value. Assets are carried at the present discounted value of the future net cash
flows that the item is expected to generate. Liabilities are carried at the present
discounted value of the future net cash flows that are expected to be required to settle
the liabilities.

The measurement basis most commonly adopted by enterprises in preparing their financial
statements is historical cost. This is usually combined with other measurement bases, for
example inventories can be carried at the lower of cost and net realisable value, and marketable
securities may be carried at market value, while pension liabilities are carried at their present
value.

Concepts of Capital and Capital Maintenance

A financial concept of capital is usually adopted in preparing financial statements, rather than a
physical concept of capital. Under financial concept of capital, such as invested money, capital
is synonymous with the net assets or equity of the enterprise. Under physical concept of capital
such as operating capability, capital is regarded as the productive capacity of the enterprise
based on, for example units of output per day.
Concepts of Capital Maintenance and the determination of profit
The concepts of capital as explained above give rise to the following concepts of capital
maintenance:
a) Financial Capital Maintenance. Under this concept a profit is earned only if the financial
or money amount of net assets at the end of the period exceeds the financial or money
amount of net assets at the beginning of the period, after excluding any distributions to
and contributions from owners during the period.
b) Physical Capital Maintenance. Under this concept a profit is earned only if the physical
productive capacity or operating capability of the enterprise at the end of the period
exceeds the physical productive capacity at the beginning of the period.

The concept of capital maintenance provides a linkage between the concepts of capital and the
concept of profit because it provides the point of reference by which profit is measured. The
principal difference between the two concepts of capital maintenance is the treatment of the
effects of changes in the prices of assets and liabilities of the enterprise. In general terms an
enterprise has maintained its capital if it has as much capital at the end of the period as it had at
the beginning of the period. Any amount over and above that required to maintain the capital at
the beginning of the period is profit!

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IAS 1: Presentation of Financial Statements
The objective of IAS 1 (revised 1997) is to prescribe the basis for presentation of general
purpose financial statements, to ensure comparability both with the entity's financial statements
of previous periods and with the financial statements of other entities. IAS 1 sets out the overall
framework and responsibilities for the presentation of financial statements, guidelines for their
structure and minimum requirements for the content of the financial statements. Standards for
recognising, measuring, and disclosing specific transactions are addressed in other Standards
and Interpretations.

Scope
Applies to all general purpose financial statements based on International Financial Reporting
Standards. General purpose financial statements are those intended to serve users who do not
have the authority to demand financial reports tailored for their own needs.

Objective of Financial Statements

The objective of general purpose financial statements is to provide information about the
financial position, financial performance, and cash flows of an entity that is useful to a wide
range of users in making economic decisions. To meet that objective, financial statements
provide information about an entity's:
• Assets.
• Liabilities.
• Equity.
• Income and expenses, including gains and losses.
• Other changes in equity. Cash flows.
That information, along with other information in the notes, assists users of financial statements
in predicting the entity's future cash flows and, in particular, their timing and certainty.

Components of Financial Statements

A complete set of financial statements should include:
• a statement of financial position at the end of the period,
• a statement of comprehensive income for the period,
• a statement of changes in equity for the period
• statement of cash flows for the period, and
• notes, comprising a summary of accounting policies and other explanatory notes.

Fair Presentation and Compliance with IFRSs

The financial statements must "present fairly" the financial position, financial performance and
cash flows of an entity. Fair presentation requires the faithful representation of the effects of
transactions, other events, and conditions in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses set out in the Framework. The application of
IFRSs, with additional disclosure when necessary, is presumed to result in financial statements
that achieve a fair presentation.
IAS 1 requires that an entity whose financial statements comply with IFRSs make an explicit
and unreserved statement of such compliance in the notes. Financial statements shall not be
described as complying with IFRSs unless they comply with all the requirements of IFRSs
(including Interpretations).
Inappropriate accounting policies are not rectified either by disclosure of the accounting policies
used or by notes or explanatory material.
IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that
compliance with an IFRS requirement would be so misleading that it would conflict with the

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objective of financial statements set out in the Framework. In such a case, the entity is required
to depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and impact
of the departure.

Structure and Content of Financial Statements in General

Clearly identify:
• the financial statements
• the reporting enterprise
• whether the statements are for a single entity or for a group
• the date or period covered
• the presentation currency e.g. Kwacha
• the level of precision (thousands, millions, etc.)

Reporting Period
There is a presumption that financial statements will be prepared at least annually (i.e. for a
period of 12 months or 52 weeks). If the annual reporting period changes and financial
statements are prepared for a different period, the enterprise must disclose the reason for the
change and a warning about problems of comparability. IAS 1 requires an entity to present its
financial statements within 6 months after the balance sheet date

Statement of Financial Position

An entity must normally present a classified statement of financial position, separating current
and noncurrent assets and liabilities. Only if a presentation based on liquidity provides
information that is reliable and more relevant may the current/noncurrent split be omitted. In
either case, if an asset (liability) category commingles amounts that will be received (settled)
after 12 months with assets (liabilities) that will be received (settled) within 12 months, note
disclosure is required that separates the longer-term amounts from the 12-month amounts.

Current assets are cash; cash equivalent; assets held for collection, sale, or consumption
within the enterprise's normal operating cycle; or assets held for trading within the next 12
months. All other assets are noncurrent.

Current liabilities are those to be settled within the enterprise's normal operating cycle or due
within 12 months, or those held for trading, or those for which the entity does not have an
unconditional right to defer payment beyond 12 months. Other liabilities are noncurrent. Long-
term debt expected to be refinanced under an existing loan facility is noncurrent, even if due
within 12 months.
If a liability has become payable on demand because an entity has breached an undertaking
under a long-term loan agreement on or before the reporting date, the liability is current, even if
the lender has agreed, after the reporting date and before the authorisation of the financial
statements for issue, not to demand payment as a consequence of the breach. However, the
liability is classified as non-current if the lender agreed by the reporting date to provide a period
of grace ending at least 12 months after the reporting date, within which the entity can rectify
the breach and during which the lender cannot demand immediate repayment.

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Minimum items on the face of the statement of financial position

XYZ GROUP
STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 2010
2010 2009
K‟000 K‟000 K‟000 K‟000
Assets
Non-Current Assets
Property, plant and equipment x x
Goodwill x x
Other intangible assets x x
Investments in associates x x
Available-for-sale investments x x
X X
Current assets
Inventories x x
Trade receivables x x
Other current assets x x
Cash and cash equivalents x x
X X
Total assets X X
Equity and liabilities
Equity attributable to equity holders of the parent
Share capital x x
Other reserves x x
Retained earnings x x
X X
Non-controlling interest X X
X X
Non-current liabilities
Long-term borrowings x x
Deferred tax x x
Long-term provisions x x
X X
Current liabilities
Trade and other payables x x
Short-term borrowings x x
Current portion of long term borrowings x x
Current tax payable x x
Short-term provisions x x

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 X X
Total equity and liabilities X X

The break downs of the totals in the statement of financial position are shown in the notes.

Regarding issued share capital and reserves, the following disclosures are required:
• numbers of shares authorised, issued and fully paid, and issued but not fully paid par
value
• reconciliation of shares outstanding at the beginning and the end of the period
• description of rights, preferences, and restrictions
• treasury shares, including shares held by subsidiaries and associates
• shares reserved for issuance under options and contracts
• a description of the nature and purpose of each reserve within owners' equity

Statement of Comprehensive Income

Minimum items on the face of the statement of comprehensive income should include:

XYZ GROUP
STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2010
2010 2009
K‟000 K‟000
Revenue x x
Cost of sales (x) (x)
Gross profit x x
Other income x x
Distribution costs (x) (x)
Administrative expenses (x) (x)
Other expenses (x) (x)
Finance costs (x) (x)
Share of profits of associates x x
Profit before tax x x
Income tax expense (x) (x)
Profit for the year X X
Attributable to:
Equity holders of the parent x x
Non-controlling interest x x
X X

No items may be presented on the face of the statement of comprehensive income or in the
notes as "extraordinary items".
Certain items must be disclosed either on the face of the statement of comprehensive income or
in the notes, if material, including:
• write-downs of inventories to net realisable value or of property, plant and equipment to
recoverable amount, as well as reversals of such write-downs
• restructurings of the activities of an entity and reversals of any provisions for the costs of
restructuring
• disposals of items of property, plant and equipment
• disposals of investments
• discontinuing operations

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• litigation settlements
• other reversals of provisions
Expenses should be analysed either by nature (raw materials, staffing costs, depreciation, etc.)
or by function (cost of sales, selling, administrative, etc.) either on the face of the statement of
income or in the notes. If an enterprise categorises by function, additional information on the
nature of expenses – at a minimum depreciation, amortisation, and staff costs – must be
disclosed.

Statement of Cash Flows

Rather than setting out separate standards for presenting the cash flow statement, IAS 1 refers
to IAS 7, Cash Flow Statements

Statement of Changes in Equity

IAS 1 requires an entity to present a statement of changes in equity as a separate component of
the financial statements. The statement must show:
• profit or loss for the period
• each item of income and expense for the period that is recognised directly in equity, and the
total of those items;
• total income and expense for the period (calculated as the sum of (a) and (b)), showing
separately the total amounts attributable to equity holders of the parent and to minority
interest
• for each component of equity, the effects of changes in accounting policies and corrections
of errors recognised in accordance with IAS 8
The following amounts may also be presented on the face of the statement of changes in equity,
or they may be presented in the notes:
• capital transactions with owners
• the balance of accumulated profits at the beginning and at the end of the period, and the
movements for the period
• a reconciliation between the carrying amount of each class of equity capital, share premium
and each reserve at the beginning and at the end of the period, disclosing each movement

The format is as follows (this is just a simple extract):

XYZ GROUP
STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2010
Share Other Retained total
Capital reserves earnings
K‟000 K‟000 K‟000 K‟000
Balance at 1 January 2010 X X X X
Loss on property valuation (X) (X)
Dividends (X) (X)
Issue of share capital X X
Balance at 31 December 2010 X X X X

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Notes to the Financial Statements Functions of the notes
• present information about the basis of preparation of the financial statements and the
specific accounting policies used;
• disclose any information required by IFRSs that is not presented on the face of the balance
sheet, income statement, statement of changes in equity, or cash flow statement; and
• provide additional information that is not presented on the face of the balance sheet, income
statement, statement of changes in equity, or cash flow statement that is deemed relevant to
an understanding of any of them.
Notes should be cross-referenced from the face of the financial statements to the relevant note.

Other Disclosures
• the amount of dividends proposed or declared before the financial statements were
authorised for issue but not recognised as a distribution to equity holders during the period,
and the related amount per share; and
• the amount of any cumulative preference dividends not recognised.

The following other note disclosures are required by IAS 1 if not disclosed elsewhere in
information published with the financial statements:
• domicile of the enterprise
• country of incorporation
• address of registered office or principal place of business
• description of the enterprise's operations and principal activities
• name of its parent and the ultimate parent if it is part of a group

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CHAPTER 2
IAS 16: PROPERTY, PLANT AND EQUIPMENT

Objective of IAS 16
The objective of IAS 16 is to prescribe the accounting treatment for property, plant, and
equipment. The principal issues are the timing of recognition of assets, the determination of
their carrying amounts, and the depreciation charges to be recognised in relation to them.

Scope
IAS 16 does not apply to biological assets related to agricultural activity (see IAS 41) or mineral
rights and mineral reserves such as oil, natural gas and similar non-regenerative resources.

Definitions
The standard gives a large number of definitions.
• 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.
• Fair value is the amount for which an asset could be exchanged and a liability settled
between knowledgeable, willing parties in an arm‟s length transaction. Where there is an
active market for an asset, the fair value is simply the market price.
• Carrying amount is the amount at which an asset is recognised in the statement of
financial position after deducting any accumulated depreciation and accumulated
impairment losses. Put simply, it is the net book value (NBV) of an asset.
• An impairment loss is the loss in value of an asset such that its carrying amount
exceeds its recoverable amount. Recoverable amount will be covered in detail under IAS
36: Impairment of assets.

Recognition of Items of PPE

Items of property, plant, and equipment should be recognised as assets when it is probable that:
the future economic benefits associated with the asset will flow to the enterprise; and
The cost of the asset can be measured reliably.

This recognition principle is applied to all property, plant, and equipment costs at the time they
are incurred. These costs include costs incurred initially to acquire or construct an item of
property, plant and equipment and costs incurred subsequently to add to, replace part of, or
service it.

Future economic benefits: The entity should be assured that it will receive the rewards
attached to the asset and it will incur the associated risks. If the entity is not assured, then the
asset should not be recognised. Economic benefits can be in form of cash generation or cost
reduction/ cost saving.

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Cost measured reliably: cost is measured as the consideration (amount) transferred on
purchase, i.e. what was paid for the asset. For Self-constructed assets, the cost is the sum of
all costs incurred to build the asset. These costs include material, labour etc.

Separate items

Major components or spare parts: IAS 16 recognises that parts of some items of property,
plant, and equipment may require replacement at regular intervals. The carrying amount of an
item of property, plant, and equipment will include the cost of replacing the part of such an item
when that cost is incurred if the recognition criteria (future benefits and measurement reliability)
are met. The carrying amount of those parts that are replaced is derecognised in accordance
with the derecognition provisions of IAS 16.

Very large and specialized items: an apparently single asset should be broken down into its
composite parts. This occurs where the different parts have different useful lives and different
depreciation rates are applied to each part, e.g. an aircraft, where the body and the engine are
separated as they have different useful lives.

Smaller items such as tools and moulds are written off as an expense although they meet the
definition of property plant and equipment. The accounting concept of materiality is applied
here.

Measurement of items of PPE

Initial Measurement
They should be initially recorded at cost. Cost includes all costs necessary to bring the asset to
working condition for its intended use. This would include not only its original purchase price but
also costs of site preparation, delivery and handling, installation, related professional fees for
architects and engineers, and the estimated cost of dismantling and removing the asset and
restoring the site.
If payment for an item of property, plant, and equipment is deferred, interest at a market rate
must be recognised or imputed.
If an asset is acquired in exchange for another asset (whether similar or dissimilar in nature),
the cost will be measured at the fair value unless:
a. the exchange transaction lacks commercial substance; or
b. the fair value of neither the asset received nor the asset given up is reliably measurable.
If the acquired item is not measured at fair value, its cost is measured at the carrying
amount of the asset given up.

Measurement Subsequent to Initial Recognition IAS

16 permits two accounting models:
• Cost Model. The asset is carried at cost less accumulated depreciation and impairment.
• Revaluation Model. The asset is carried at a revalued amount, being its fair value at the
date of revaluation less subsequent depreciation, provided that fair value can be measured
reliably.

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The Revaluation Model
Under the revaluation model, revaluations should be carried out regularly, so that the carrying
amount of an asset does not differ materially from its fair value at the balance sheet date.
If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
Revalued assets are depreciated in the same way as under the cost model (see below).

Accounting treatment for revaluations

If a revaluation results in an increase in value;
DEBIT asset account
CREDIT revaluation surplus

If a revaluation results in a decrease in value;

DEBIT statement of comprehensive income (as an expense)
CREDIT asset account

However, if there is an increase in value of an asset which decreased in value in previous years
and that decrease was recognised as an expense, then;
DEBIT asset account
CREDIT statement of comprehensive income (to reverse a previous decrease)
Revaluation surplus (with the excess)

If there is a decrease in value of an asset which increased in value in previous years and that
increase was credited to the revaluation surplus, then;
DEBIT revaluation surplus (to reverse a previous increase)
Statement of comprehensive income (with the excess)
CREDIT Asset

Example: revaluation
Tseketseke Co has land carried in its books at K12,000. Three years ago a slump in land values
led the company to reduce the carrying amount from K17,000. This was taken as an expense in
the statement of comprehensive income. There has been a boom in land prices in the current
year and the land is now worth K25,000. Account for the revaluation in the current year.

Solution:
DEBIT asset value K13,000
CREDIT statement of comprehensive income K5,000
Revaluation surplus K8,000

Normally, a revaluation surplus is only realised when the asset is sold, but when it is being
depreciated, part of that surplus is being realised as the asset is being used. The amount of the
surplus realised is the difference between depreciation charged on the revalued amount and the
depreciation that would have been charged on the asset‟s original cost (old value). This amount
is transferred to retained earnings through the statement of changes in equity (and not through
statement of comprehensive income).
Please note that there is a difference between recognition and realisation

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Example: Realising revaluation surplus
Mtimaukanena Co bought an asset for K20,000 at the beginning of 2007. It had a useful life of
five years. On 1 January 2009 the asset was revalued to K24,000. The expected useful life has
remained unchanged (i.e. three years remaining).
Account for the revaluation and state the treatment for depreciation from 2008 onwards.

Solution:
On 1 January 2009 the carrying amount of the asset is:

Cost less Accumulated depreciation: K20,000 –

Revaluation increase will, therefore, be K12,000 (K24,000 less carrying amount of K12,000).

The accounting entries on 1 January 2009 will be:

DEBIT asset account K12,000
CREDIT revaluation surplus K12,000

Depreciation for the next three years will be K24,000 ÷ 3 years = K8,000 compared to
depreciation on cost of K20,000 ÷ 5 years = K4,000. So each year, the extra K4,000 can be
treated as part of the surplus realised:
DEBIT revaluation surplus K4,000
CREDIT retained earnings K4,000

So at 31 December 2009 the balance in the revaluation surplus account will be K8,000 (being
K12,000 less K4,000 that has been realised).

Depreciation (Cost and Revaluation Models) For

all depreciable assets:
The depreciable amount (cost less prior depreciation, impairment, and residual value) should be
allocated on a systematic basis over the asset's useful life.
The residual value and the useful life of an asset should be reviewed at least at each financial
year-end and, if expectations differ from previous estimates, any change is accounted for
prospectively.
The depreciation method used should reflect the pattern in which the asset's economic benefits
are consumed by the enterprise;
The depreciation method should be reviewed at least annually and, if the pattern of
consumption of benefits has changed, the depreciation method should be changed
prospectively.
Depreciation should be charged to the income statement, unless it is included in the carrying
amount of another asset.
Depreciation begins when the asset is available for use and continues until the asset is
derecognised, even if it is idle.

Review of Useful Life

A review of useful life of property, plant and equipment should be carried out at least at each
financial year end and the depreciation charge for the current and future periods should be
adjusted if expectations have changed significantly from previous estimates.

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Example: Review of Useful life
Zagwazatha Co acquired a non-current asset on 1 January 2002 for K40,000. It had no residual
value and a useful life of 10 years.
On 1 January 2005 the total useful life was reviewed and revised to 7 years. What
will be the depreciation charge for 2005?

Solution:
K
Original cost 40,000
Depreciation 2002-2004 (40,000 × 3/10) (12,000)
Carrying amount at 1 January 2005 2 , 00
0
Remaining useful life (7-3) 4 years
Depreciation charge for years 2005-2008 (28,000 ÷ 4) K7,000

Impairment of Asset Values

An item of property, plant, or equipment shall not be carried at more than recoverable amount.
Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.
Any claim for compensation from third parties for impairment is included in profit or loss when
the claim becomes receivable.
An impairment loss should be treated the same way as a revaluation decrease.
The reversal of an impairment loss should be treated the same way as a revaluation increase.

Derecogniton (Retirements and Disposals)

An asset should be removed from the balance sheet on disposal or when it is withdrawn from
use and no future economic benefits are expected from its disposal. The gain or loss on
disposal is the difference between the proceeds and the carrying amount and should be
recognised in the income statement.

Disclosure
For each class of property, plant, and equipment, disclose:
• basis for measuring carrying amount;
• depreciation method(s) used;
• useful lives or depreciation rates;
• gross carrying amount and accumulated depreciation and impairment losses;
• reconciliation of the carrying amount at the beginning and the end of the period, showing: o
additions; o disposals;
o acquisitions through business combinations; o
revaluation increases; o impairment
losses; o reversals of impairment losses; o
depreciation; o net foreign exchange
differences on translation; o Other
movements.
Also disclose:
• restrictions on title;

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• expenditures to construct property, plant, and equipment during the period;
Commitments to acquire property, plant, and equipment.
• Compensation from third parties for items of property, plant, and equipment that were
impaired, lost or given up that is included in profit or loss.
If property, plant, and equipment are stated at revalued amounts, certain additional disclosures
are required:
• the effective date of the revaluation;
• whether an independent valuer was involved;
• the methods and significant assumptions used in estimating fair values;
• the extent to which fair values were determined directly by reference to observable prices in
an active market or recent market transactions on arm's length terms or were estimated
using other valuation techniques;
• the carrying amount that would have been recognised had the assets been carried under the
cost model;
• The revaluation surplus, including changes during the period and distribution restrictions.

Chapter3: investment property IAS 40

3.1 introduction
IAS 40 Investment property was published in March 2000 and has recently been [Link] objective is to
prescribe the accounting treatment for investment property and related disclosure requirements. The standard
includes investment property held under a finance lease or leased out under an operating lease. However, the
current IAS 40 does not deal with matters covered in IAS 17 Leases. You now know what is an investment
property under IAS 40. Below are examples of items that are not
investment property.
Type of non-investment property Applicable IAS
Property intended for sale in the ordinary course
of business IAS 2 Inventories
Property being constructed or developed on
behalf of third parties IFRS 15 Revenue from contracts with
customers
Owner-occupied property IAS 16 Property, plant and equipment

3.2 Recognition
Investment property should be recognised as an asset when two conditions are met:
(a) It is probable that the future economic benefits that are associated with the investment property will flow to
the entity.
(b) The cost of the investment property can be measured reliably.
3.2.1Initial measurement
An investment property should be measured initially at its cost, including transaction costs. A property interest
held under a lease and classified as an investment property shall be accounted for as if it were a finance lease.

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The asset is recognised at the lower of the fair value of the property and the present value of the minimum lease
payments. An equivalent amount is recognised as a liability.
3.2.2 Measurement subsequent to initial recognition
IAS 40 requires an entity to choose between two models:
The fair value model
The cost model
Whatever policy it chooses should be applied to all of its investment property.
Where an entity chooses to classify a property held under an operating lease as an investment property, there is
no choice. The fair value model must be used for all the entity's investment property, regardless of whether it is
owned or leased.
Fair value model
(a) After initial recognition, an entity that chooses the fair value model should measure all of its investment
property at fair value, except in the extremely rare cases where this cannot be measured reliably. In such cases it
should apply the IAS 16 cost model.
(b) A gain or loss arising from a change in the fair value of an investment property should be
recognised in net profit or loss for the period in which it arises.
(c) The fair value of investment property should reflect market conditions at the end of the reporting period.
This was the first time that the IASB has allowed a fair value model for non-financial assets. This is not the same
as a revaluation, where increases in carrying amount above a cost-based measure are recognised as revaluation
surplus. Under the fair-value model all changes in fair value are recognised in profit or loss.
The standard elaborates on issues relating to fair value.
(a) Fair value assumes that an orderly transaction has taken place between market participants, ie both buyer and
seller are reasonably informed about the nature and characteristics of the investment property.
(b) A buyer participating in an orderly transaction is motivated but not compelled to buy. A seller participating
in an orderly transaction is neither an over-eager nor a forced seller, nor one prepared to sell at any price or to
hold out for a price not considered reasonable in the current market.
(c) Fair value is not the same as 'value in use'as defined in IAS 36 Impairment of assets. Value in use reflects
factors and knowledge specific to the entity, while fair value reflects factors and knowledge relevant to the market.
(d) In determining fair value an entity should not double count assets. For example, elevators or air conditioning
are often an integral part of a building and should be included in the investment property, rather than recognised
separately.
(e) In those rare cases where the entity cannot determine the fair value of an investment property reliably, the
cost model in IAS 16must be applied until the investment property is disposed of. The residual value must be
assumed to be zero.
Cost model

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The cost model is the cost model in IAS 16. Investment property should be measured at depreciated cost, less any
accumulated impairment losses. An entity that chooses the cost model should disclose the fair value of its
investment property.
3.3 Changing models
Once the entity has chosen the fair value or cost model, it should apply it to all its investment property. It should
not change from one model to the other unless the change will result in a more appropriate presentation. IAS 40
states that it is highly unlikely that a change from the fair value model to the cost model will result in a more
appropriate presentation.
3.4Transfers
Transfers to or from investment property should only be made when there is a change in use. For example, owner
occupation commences so the investment property will be treated under IAS 16 as an owner-occupied property.
When there is a transfer from investment property carried at fair value to owner-occupied property or inventories,
the property's cost for subsequent accounting under IAS 16 or IAS 2 should be its fair value at the date of change
of use. Conversely, an owner-occupied property may become an investment property and need to be carried at
fair value. An entity should apply IAS 16 up to the date of change of use. It should treat any difference at that
date between the carrying amount of the property under IAS 16 and its fair value as a revaluation under IAS 16.
Worked example: Transfer to investment property
A business owns a building which it has been using as a head office. In order to reduce costs, on 30 June 20X9 it
moved its head office functions to one of its production centres and is now letting out its head office. Company
policy is to use the fair value model for investment property. The building had an original cost on 1 January20X0
of $250,000 and was being depreciated over 50 years. At 31 December 20X9 its fair value was judged to be
$350,000.
How will this appear in the financial statements at 31 December 20X9?
Solution
The building will be depreciated up to 30 June 20X9.
$
Original cost 250,000
Depreciation 1.1.X0 – 1.1.X9 (250/50 x9) (45,000)
Depreciation to 30.6.X9 (250/50 x6/12) (2,500)
Carrying amount at 30.6.X9 202,500
Revaluation surplus 147,500
Fair value at 30.6.X9 350,000
The difference between the carrying amount and fair value is taken to a revaluation surplus in accordance with
IAS 16. However the building will be subjected to a fair value exercise at each year end and these gains or losses
will go to profit or loss. If at the end of the following year the fair value of the building is found to be $380,000,
$30,000 will be credited to profit or loss.
3.5Disposals
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Derecognise (eliminate from the statement of financial position) an investment property on disposal or when it is
permanently withdrawn from use and no future economic benefits are expected from its disposal. Any gain or
loss on disposal is the difference between the net disposal proceeds and the carrying amount of the asset. It should
generally be recognised as income or expense in profit or loss. Compensation from third parties for investment
property that was impaired, lost or given up shall be recognised in profit or loss when the compensation becomes
receivable.
3.6Disclosure requirements
These relate to:
Choice of fair value model or cost model
Whether property interests held as operating leases are included in investment property
Criteria for classification as investment property
Assumptions in determining fair value
Use of independent professional valuer (encouraged but not required)
Rental income and expenses
Any restrictions or obligations
Fair value model – additional disclosures
An entity that adopts this must also disclose a reconciliation of the carrying amount of the investment property at
the beginning and end of the period.
Cost model – additional disclosures
These relate mainly to the depreciation method. In addition, an entity which adopts the cost model must disclose
the fair value of the investment property.

Chapter Roundup
IAS 16 covers all aspects of accounting for property, plant and equipment. This represents the
bulk of items which are 'tangible' non-current assets.
Where assets held by an entity have a limited useful life it is necessary to apportion the value of
an asset over its useful life.
An entity may own land or a building as an investment rather than for use in the business. It may
therefore generate cash flows largely independently of other assets which the entity holds. The
treatment of investment property is covered by IAS 40.

Quick Quiz
1 Define depreciation.

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2 Which of the following elements can be included in the production cost of a non-current asset?
(i) Purchase price of raw materials
(ii) Architect's fees
(iii) Import duties
(iv) Installation costs
3 Market value can usually be taken as fair value.
True
False
4 Investment properties must always be shown at fair value.
True

False

5 What is the correct treatment for property being constructed for future use as investment prope

CHAPTER 4 IAS 36: IMPAIRMENT OF ASSETS

Objective
To ensure that assets are carried at no more than their recoverable amount, and to define how
recoverable amount is determined.

Scope
IAS 36 applies to all assets except: inventories ( IAS 2), assets arising from construction
contracts ( IAS 11), deferred tax assets (IAS 12), assets arising from employee benefits (IAS
19), financial assets (IAS 39), investment property carried at fair value (IAS 40), agricultural
assets carried at fair value (IAS 41), insurance contract assets (IFRS 4), non-current assets
held for sale (IFRS 5)

Therefore, IAS 36 applies to (among other assets): land, buildings, machinery and equipment,
investment property carried at cost, intangible assets, goodwill, investments in subsidiaries,
associates, and joint ventures carried at cost, assets carried at revalued amounts under IAS 16
and IAS 38

Key Definitions

Impairment: a fall in value of an asset, so that its recoverable amount is now less than the
carrying amount in the statement of financial position.

Carrying amount: the amount at which an asset is recognised in the balance sheet after
deducting accumulated depreciation and accumulated impairment losses

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Recoverable amount: the higher of an asset's fair value less costs to sell (sometimes called
net selling price) and its value in use

Fair value: the amount obtainable from the sale of an asset in an arm's length transaction
between knowledgeable, willing parties

Value in use: the discounted present value of the future cash flows expected to arise from:
• the continuing use of an asset, and from
• its disposal at the end of its useful life

The basic principle underlying IAS 36 is straightforward. If an asset‟s value in the accounts is
higher than its realistic value, measured as the recoverable amount, the asset is said to have
suffered an impairment loss. It should therefore be reduced in value, by the amount of the
impairment loss. The loss should be written off as an expense in the statement of
comprehensive income.

Identifying an Asset That May Be Impaired

At each balance sheet date, review all assets to look for any indication that an asset may be
impaired (its carrying amount may be in excess of the greater of its net selling price and its
value in use). IAS 36 has a list of external and internal indicators of impairment. If there is an
indication that an asset may be impaired, then you must calculate the asset's recoverable
amount.

The recoverable amounts of the following types of intangible assets should be measured
annually whether or not there is any indication that it may be impaired. In some cases, the most
recent detailed calculation of recoverable amount made in a preceding period may be used in
the impairment test for that asset in the current period:
• an intangible asset with an indefinite useful life
• an intangible asset not yet available for use
• goodwill acquired in a business combination

Indications of Impairment External

sources:
• market value declines
• negative changes in technology, markets, economy, or laws
• increases in market interest rates that are used in the calculation of value in use.
• company stock price is below book value Internal sources:
• obsolescence
• physical damage
• asset is part of a restructuring or held for disposal worse economic
performance than expected

These lists are not intended to be exhaustive. Further, an indication that an asset may be
impaired may indicate that the asset's useful life, depreciation method, or residual value may
need to be reviewed and adjusted.

Determining Recoverable Amount

The recoverable amount the higher of:

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 i. fair value ii.
value in use
If fair value less costs to sell cannot be determined, then recoverable amount is value in use.
For assets to be disposed of, recoverable amount is fair value less costs to sell.

Fair Value less Costs to Sell

• If there is a binding sale agreement, the fair value is the price under that agreement less
costs of disposal.
• If there is an active market for that type of asset, the fair value is market price less costs
of disposal. Market price means current bid price if available, otherwise the price in the
most recent transaction.
• If there is no active market, the fair value is the best estimate of the asset's selling price
less costs of disposal.
• Costs of disposal are the direct added costs only (not existing costs or overhead).

Value in Use
Value in use of an asset is measured as the present value of estimated future net cash flows
(inflows less outflows) generated by the asset, including its estimated net disposal value (if any)
at the end of its expected useful life.

Cash flow projections should be based on reasonable and supportable assumptions, the most
recent budgets and forecasts, and extrapolation for periods beyond budgeted projections. IAS
36 presumes that budgets and forecasts should not go beyond five years.

Recognition of an Impairment Loss

• An impairment loss should be recognised whenever recoverable amount is below
carrying amount.
• The impairment loss is an expense in the statement of comprehensive income (unless it
relates to a revalued asset where the value changes are recognised directly in equity).
• Adjust depreciation for future periods.

Example: Determining an impairment loss

Bwekabweka Limited is a firm that is mining uranium in Karonga district. They bought
equipment used to mine uranium, some four years ago, for MK100 million. The equipment has
been depreciated using the straight-line method with a 10-year useful life and a 10% residual
value. Bwekabweka‟s operations have, recently, experienced significant disruptions due to
breakdowns of the equipment. As a result, the company‟s finance director had decided that the
equipment be evaluated for possible impairment.
The management of Bwekabweka estimates that the equipment has a remaining useful life of 2
years. Net cash inflows from the equipment will be MK 19.6 million per year. The fair value of
the equipment is MK33.6 million (based on the market values of similar equipment at Barlow
World limited).
Required: Assuming the discount rate is 12%, determine if an impairment loss should be
recognized.

Solution:
Carrying amount of the asset:
Cost K100,000,000

Accumulated depreciation
K64,000,000
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Recoverable amount:
Remember the recoverable amount is the higher of fair value and value in use
1. Fair value is K33,600,000
2. Value in use is calculated as follows:
Since it is the present value of expected future cash flows, then we have to use
discounting or annuity tables.
The cash flows given are the same for the remaining five years. As a result we will use
annuity tables.
Extract of annuity tables
Discounting rate
Year 7% 8% 9% 10% 11% 12% 13% 14%
1 0.935 0.926 0.917 0.893
2 1.808 1.783 1.759 1.690
3 2.624 2.577 2.531 2.402
4 3.387 3.312 3.239 3.037
5 4.100 3.993 3.889 3.605

6 4.766 4.623 4.485 4.111

7 5.389 5.206 5.032 4.546

From the annuity tables we will take 1.690 which is the figure under the discount rate of
12% and in year 2 (because the number of years remaining is now two). We will multiply
it by the estimated future cash flow of K19,600,000 per annum.

1.690 × 19,600,000 = K33,124,000

From this we can now find the recoverable amount which is the higher of fair value or
value in use. Therefore, our recoverable amount is K33,600,000 which is higher.

Therefore, an impairment loss is: K64,000,000 – K33,600,000 = K30,400,000

The asset will be reduced to K33,600,000 in the statement of financial position while an
impairment loss of K30,400,000 will be charged to the statement of comprehensive
income. (Debit: Statement of comprehensive income with K30.4M, Credit: Asset with
K30.4M).

Cash-Generating Units (CGU)

The CGU 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.

Recoverable amount should be determined for the individual asset, if possible.

If it is not possible to determine the recoverable amount (fair value less cost to sell and value in
use) for the individual asset, then determine recoverable amount for the asset's cash-generating
unit (CGU).

Impairment of Goodwill
Goodwill should be tested for impairment annually.

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To test for impairment, goodwill must be allocated to each of the acquirer's cash-generating
units, or groups of cash-generating units, that are expected to benefit from the synergies of the
combination, irrespective of whether other assets or liabilities of the acquiree are assigned to
those units or groups of units. Each unit or group of units to which the goodwill is so allocated
shall:
• represent the lowest level within the entity at which the goodwill is monitored for internal
management purposes; and
• not be larger than an operating segment determined in accordance with IFRS 8
Operating Segments.

A cash-generating unit to which goodwill has been allocated shall be tested for impairment at
least annually by comparing the carrying amount of the unit, including the goodwill, with the
recoverable amount of the unit:
• If the recoverable amount of the unit exceeds the carrying amount of the unit, the unit
and the goodwill allocated to that unit is not impaired.
• If the carrying amount of the unit exceeds the recoverable amount of the unit, the entity
must recognise an impairment loss.

The impairment loss is allocated to reduce the carrying amount of the assets of the unit (group
of units) in the following order:
• first, reduce the carrying amount of any goodwill allocated to the cash-generating unit
(group of units); and
• then, reduce the carrying amounts of the other assets of the unit (group of units) pro rata
on the basis.
The carrying amount of an asset should not be reduced below the highest of:
• its fair value less costs to sell (if determinable), its value in use (if determinable), and
• zero.
If the preceding rule is applied, further allocation of the impairment loss is made pro rata to the
other assets of the unit (group of units).

Reversal of an Impairment Loss

• Same approach as for the identification of impaired assets: assess at each balance
sheet date whether there is an indication that an impairment loss may have decreased. If
so, calculate recoverable amount.
• No reversal for unwinding of discount.
• The increased carrying amount due to reversal should not be more than what the
depreciated historical cost would have been if the impairment had not been recognised.
• Reversal of an impairment loss is recognised as income in the statement of
comprehensive income.
• Adjust depreciation for future periods.
• Reversal of an impairment loss for goodwill is prohibited.

Disclosure
Disclosure by class of assets:
• impairment losses recognised in profit or loss
• impairment losses reversed in profit or loss
• which line item(s) of the statement of comprehensive income
• impairment losses on revalued assets recognised in other comprehensive income

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 • impairment losses on revalued assets reversed in other comprehensive income
Disclosure by reportable segment:
• impairment losses recognised
• impairment losses reversed Other disclosures:
If an individual impairment loss (reversal) is material disclose:
• events and circumstances resulting in the impairment loss
• amount of the loss
• individual asset: nature and segment to which it relates
• cash generating unit: description, amount of impairment loss (reversal) by class of
assets and segment
• if recoverable amount is fair value less costs to sell, disclose the basis for determining
fair value
• if recoverable amount is value in use, disclose the discount rate

chapter 5: Revenue - IAS 18 (Revenue Recognition) and IFRS 15 (Revenue from Contracts)

The primary issue in accounting for revenue is determining when to recognise revenue.
Revenue is recognised when it is probable that future economic benefits will flow to the entity
and these benefits can be measured reliably. This Standard identifies the circumstances in
which these criteria will be met and, therefore, revenue will be recognised. It also provides
practical guidance on the application of these criteria.
Revenue is the gross inflow of economic benefits during the period arising in the course of the
ordinary activities of an entity when those inflows result in increases in equity, other than
increases relating to contributions from equity participants.

This Standard shall be applied in accounting for revenue arising from the following transactions
and events:
• the sale of goods;
• the rendering of services; and
• the use by others of entity assets yielding interest, royalties and dividends.

The recognition criteria in this Standard are usually applied separately to each transaction.
However, in certain circumstances, it is necessary to apply the 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.

Conversely, the recognition criteria are applied to two or more transactions together when they
are linked in such a way that the commercial effect cannot be understood without reference to
the series of transactions as a whole. 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, thus negating the
substantive effect of the transaction; in such a case, the two transactions are dealt with
together.

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Revenue shall be measured at the fair value of the consideration received or receivable. Fair
value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm‟s length transaction.

The amount of revenue arising on a transaction is usually determined by agreement between

the entity and the buyer or user of the asset. It is measured at the fair value of the consideration
received or receivable taking into account the amount of any trade discounts and volume
rebates allowed by the entity.
Sale of goods
Revenue from the sale of goods shall be recognised when all the following conditions have
been satisfied:
a. the entity has transferred to the buyer the significant risks and rewards of ownership of
the goods;
b. the entity retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
c. the amount of revenue can be measured reliably;
d. it is probable that the economic benefits associated with the transaction will flow to the
entity; and
e. the costs incurred or to be incurred in respect of the transaction can be measured
reliably.

Rendering of services
When the outcome of a transaction involving the rendering of services can be estimated reliably,
revenue associated with the transaction shall be recognised by reference to the stage of
completion of the transaction at the balance sheet date. The outcome of a transaction can be
estimated reliably when all the following conditions are satisfied:
a. the amount of revenue can be measured reliably;
b. it is probable that the economic benefits associated with the transaction will flow to the
entity;
c. the stage of completion of the transaction at the balance sheet date can be measured
reliably; and
d. the costs incurred for the transaction and the costs to complete the transaction can be
measured reliably.

The recognition of revenue by reference to the stage of completion of a transaction is often

referred to as the percentage of completion method. Under this method, revenue is recognised
in the accounting periods in which the services are rendered. The recognition of revenue on this
basis provides useful information on the extent of service activity and performance during a
period.
When the outcome of the transaction involving the rendering of services cannot be estimated
reliably, revenue shall be recognised only to the extent of the expenses recognised that are
recoverable.

Interest, royalties and dividends

Revenue shall be recognised on the following bases:
a. interest shall be recognised using the effective interest method as set out in IAS 39.
b. royalties shall be recognised on an accrual basis in accordance with the substance of
the relevant agreement; and
c. dividends shall be recognised when the shareholder‟s right to receive payment is
established.

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IFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS
IFRS 15 sets out rules for the recognition of revenue based on transfer of controlto the customer from the entity
supplying the goods or services. IFRS 15 Revenue from contracts with customers was issued in May 2014. It is
the result of a joint IASB and FASB project on revenue recognition. It seeks to strike a balance between the IASB
rules in IAS 18, which were felt to be too general, leading to a lot of diversity in practice, and the FASB
regulations, which were too numerous.
IFRS 15 replaces both IAS 18 Revenue and IAS 11Construction contracts. It is effective for reporting periods
beginning on or after 1 January 2017. Its core principle is that revenue is recognised to depict the transfer of goods
or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in
exchange for those goods or services. Under IFRS 15 the transfer of goods and services is based upon the transfer
of control, rather than the transfer of risks and rewards as in IAS 18. Control of an assetis described in the standard
as the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. For
straightforward retail transactions IFRS 15 will have little, if any, effect on the amount and timing of revenue
recognition. For contracts such as long-term service contracts and multi-element arrangements it could result in
changes either to the amount or to the timing of revenue recognised.
Scope
IFRS 15 applies to all contracts with customers except:
Leases within the scope of IAS 17
Insurance contracts within the scope of IAS 4
Financial instruments and other contractual rights and obligations within the scope of IFRS 9, IFRS 10, IFRS
11, IAS 27 or IAS 28
Non-monetary exchanges between entities in the same line of business
Definitions
The following definitions are given in the standard.

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Income. Increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in an increase in equity, other than those
relating to contributions from equity participants.
Revenue. Income arising in the course of an entity's ordinary activities.
Contract. An agreement between two or more parties that creates enforceable rights and obligations.
Contract asset. An entity's right to consideration in exchange for goods or services that the entity has
transferred to a customer when that right is conditioned on something other than the passage of time (for
example the entity's future performance).
Receivable. An entity's right to consideration that is unconditional – ie only the passage of time is required
before payment is due
Contract liability. An entity's obligation to transfer goods or services to a customer for which the entity
has received consideration (or the amount is due) from the customer.
Customer. A party that has contracted with an entity to obtain goods or services that are an output of the
entity's ordinary activities in exchange for consideration.
Performance obligation .A promise in a contract with a customer to transfer to the customer either:
(a) a good or service (or a bundle of goods or services) that is distinct; or
(b) a series of distinct goods or services that are substantially the same ad that have the same pattern of
transfer to the customer.
Stand-alone selling price. The price at which an entity would sell a promised good or service separately
to a customer.
Transaction price. The amount of consideration to which an entity expects to be entitled in exchange for
transferring promised goods or services to a customer, excluding amounts collected on behalf of third
parties.
(IFRS 15)

Recognition and measurement

Generally revenue is recognised when the entity has transferred promised goods or services to the customer. IFRS
15 sets out five steps for the recognition process.

The five-step model

Under IFRS 15 revenue is recognised and measured using a five step model.
Step 1 Identify the contract with the customer.
A contract with a customer is within the scope of IFRS 15 only when:
(a) The parties have approved the contract and are committed to carrying it out.

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(b) Each party's rights regarding the goods and services to be transferred can be
identified.
(c) The payment terms for the goods and services can be identified.
(d) The contract has commercial substance.
(e) It is probable that the entity will collect the consideration to which it will be entitled.
(f) The contract can be written, verbal or implied.
Step 2 Identify the separate performance obligations.
The key point is distinct goods or services. A contract includes promises to provide goods or services to a
customer. Those promises are called performance obligations. A company would account for a performance
obligation separately only if the promised good or service is distinct. A good or service is distinct if it is sold
separately or if it could be sold separately or if it could be sold separately because it has a distinct function and a
distinct profit margin.
Factors for consideration as to whether an entity's promise to transfer the good or service to the customer is
separately identifiable include, but are not limited to:
(a) The entity does not provide a significant service of integrating the good or service with other goods or services
promised in the contract.
(b) The good or service does not significantly modify or customise another good or
service promised in the contract.
(c) The good or service is not highly dependent on or highly interrelated with other
goods or services promised in the contract.
Step 3 Determine the transaction price.
The transaction price is the amount of consideration a company expects to be entitled to from the customer in
exchange for transferring goods or services. The transaction price would reflect the company's probability-
weighted estimate of variable consideration(including reasonable estimates of contingent amounts) in addition to
the effects of the customer's credit risk and the time value of money (if material). Variable contingent amounts
are only included where it is highly probable that there will not be a reversal of revenue when any uncertainty
associated with the variable consideration is resolved. Examples of where a variable consideration can arise
include: discounts, rebates, refunds, price concessions, credits and penalties.
Step 4 Allocate the transaction price to the performance obligations.
Where a contract contains more than one distinct performance obligation a company allocates the transaction
price to all separate performance obligations in proportion to the stand-alone selling price of the good or service
underlying each performance obligation. If the good or service is not sold separately, the company would have to
estimate its standalone selling price. So, if any entity sells a bundle of goods and/or services which it also supplies
unbundled, the separate performance obligations in the contract should be priced in the same proportion as the
unbundled prices. This would apply to mobile phone contracts where the handset is supplied 'free'. The entity

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must look at the stand-alone price of such a handset and some of the consideration for the contract should be
allocated to the handset.
Step 5 Recognise revenue when (or as) a performance obligation is satisfied.
The entity satisfies a performance obligation by transferring control of a promised good or service to the customer.
A performance obligation can be satisfied at a point in time, such as when goods are delivered to the customer,
or over time. An obligation satisfied over time will meet one of the following criteria:
The customer simultaneously receives and consumes the benefits as the
performance takes place.
The entity's performance creates or enhances an asset that the customer controls as
the asset is created or enhanced.
The entity's performance does not create an asset with an alternative use to the
entity and the entity has an enforceable right to payment for performance completed
to date.
The amount of revenue recognised is the amount allocated to that performance obligation in Step 4.
An entity must be able to reasonably measure the outcome of a performance obligation before the related revenue
can be recognised.
In some circumstances, such as in the early stages of a contract, it may not be possible to reasonably measure the
outcome of a performance obligation, but the entity expects to recover the costs incurred. In these circumstances,
revenue is recognised only to the extent of costs incurred.
Example: identifying the separate performance obligation
Office Solutions, a limited company, has developed a communications software package called CommSoft.
Office Solutions has entered into a contract with Logisticity to supply the following:
(a) Licence to use Commsoft
(b) Installation service. This may require an upgrade to the computer operating system, but the
software package does not need to be customised.
(c) Technical support for three years
(d) Three years of updates for Commsoft
Office Solutions is not the only company able to install CommSoft, and the technical support can also be provided
by other companies. The software can function without the updates and technical support.
Required
Explain whether the goods or services provided to Logisticity are distinctin accordance with IFRS 15 Revenue
from contracts with customers.
Solution

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CommSoft was delivered before the other goods or services and remains functional without the updates and the
technical support. It may be concluded that Logisticity can benefit from each of the goods and services either on
their own or together with the other goods and services that are readily available.
The promises to transfer each good and service to the customer are separately identifiable. In particular, the
installation service does not significantly modify the software itself and, as such, the software and the installation
service are separate outputs promised by Office Solutions rather than inputs used to produce a combined output.
In conclusion, the goods and services are distinct and amount to four performance obligations in the contract
under IFRS 15.
Example: determining the transaction price
Taplop supplies laptop computers to large businesses. On 1 July 20X5, Taplop entered into a contract with
TrillCo, under which TrillCo was to purchase laptops at$500 per unit. The contract states that if TrillCo purchases
more than 500 laptops in a year, the price per unit is reduced retrospectively to $450 per unit.
Taplop's year end is 30 June.
(a) As at 30 September 20X5, TrillCo had bought 70 laptops from Taplop. Taplop therefore estimated that Trill
Co's purchases would not exceed 500 in the year to 30 June 20X6, and TrillCo would therefore not be entitled to
the volume discount.
(b) During the quarter ended 31 December 20X5, TrillCo expanded rapidly as a result of a substantial acquisition,
and purchased an additional 250 laptops from Taplop. Taplop then estimated that TrillCo's purchases would
exceed the threshold for the volume discount in the year to 30 June 20X6.
Required
Calculate the revenue Taplop would recognise in:
(a) Quarter ended 30 September 20X5
(b) Quarter ended 31 December 20X5
We need to apply the principles of IFRS 15 Revenue from contracts with customers.

Solution
(a) Applying the requirements of IFRS 15 to TrillCo's purchasing pattern at 30 September 20X5, Taplop should
conclude that it was highly probable that a significant reversal in the cumulative amount of revenue recognised
($500 per laptop)would not occur when the uncertainty was resolved, that is when the total amount of purchases
was known.
Consequently, Taplop should recognise revenue of 70 × $500 = $35,000 for the first quarter ended 30 September
20X5.

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(b) In the quarter ended 31 December 20X5, TrillCo's purchasing pattern changed such that it would be legitimate
for Taplop to conclude that TrillCo's purchases would exceed the threshold for the volume discount in the year to
30 June 20X6, and therefore that it was appropriate to reduce the price to $450 per laptop.
Taplop should therefore recognise revenue of $109,000 for the quarter ended 31 December 20X5. The amount is
calculated as from $112,500 (250 laptops × $450) less the change in transaction price of $3,500 (70 laptops × $50
price reduction) for the reduction of the price of the laptops sold in the quarter ended 30 September 20X5.
3.4 Example: allocating the transaction price to the performance obligations
A mobile phone company gives customers a free handset when they sign a two-year contract for provision of
network services. The handset has a stand-alone price of $100 and the contract is for $20 per month. Prior to IFRS
15, the company would recognise no revenue in relation to the handset and a total of $240 per annum in relation
to the contract.
Under IFRS 15, revenue must be allocated to the handset because delivery of the handset constitutes a
performance obligation. This will be calculated as follows:
$ %
Handset 100 17%
Contract – two years 480 83%
Total value 580 100%
As the total receipts are $480, this is the amount which must be allocated to the separate performance obligations.
Revenue will be recognised as follows (rounded to nearest $).
$
Year 1
Handset (480 × 17%) 82
Contract (480 – 82)/2 199
281
Year 2
Contract as above 199
So application of IFRS 15 has moved revenue of $41 from Year 2 to Year 1.

Contract costs
The incremental costs of obtaining a contract (such as sales commission) are recognised as an asset if the entity
expects to recover those costs. Costs that would have been incurred regardless of whether the contract was
obtained are recognised as an expense as incurred.
Costs incurred in fulfilling a contract, unless within the scope of another standard (such as IAS 2 Inventories, IAS
16 Property, plant and equipment or IAS 38 Intangible assets) are recognised as an asset if they meet the following
criteria:
(a) The costs relate directly to an identifiable contract (costs such as labour, materials, management costs)

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(b) The costs generate or enhance resources of the entity that will be used in satisfying (or continuing to satisfy)
performance obligations in the future; and
(c) The costs are expected to be recovered Costs recognised as assets are amortised on a systematic basis
consistent with the transfer to the customer of the goods or services to which the asset relates.
Performance obligations satisfied over time
A performance obligation satisfied over time meets the criteria in Step 5 above and, if it entered into more than
one accounting period, would previously have been described as a long-term contract. In this type of contract an
entity often has an enforceable right to payment for performance completed to date. The standard describes this
as an amount that approximates the selling price of the goods or services transferred to date (for example recovery
of the costs incurred by the entity in satisfying the performance plus a reasonable profit margin).
Methods of measuring the amount of performance completed to date encompass output methods and input
methods. Output methods recognise revenue on the basis of the value to the customer of the goods or services
transferred. They include surveys of performance completed, appraisal of units produced or delivered etc. Input
methods recognise revenue on the basis of the entity's inputs, such as labour hours, resources consumed, costs
incurred. If using a cost-based method, the costs incurred must contribute to the entity's progress in satisfying the
performance obligation.
Performance obligations satisfied at a point in time
A performance obligation not satisfied over time will be satisfied at a point in time. This will be the point in time
at which the customer obtains control of the promised asset and the entity satisfies a performance obligation.
Some indicators of the transfer of control are:
(a) The entity has a present right to payment for the asset.
(b) The customer has legal title to the asset.
(c) The entity has transferred physical possession of the asset.
(d) The significant risks and rewards of ownership have been transferred to the customer.
(e) The customer has accepted the asset.

Presentation and disclosure

The presentation and disclosure requirements are important in relation to contracts where performance obligations
are satisfied over time, where there are likely to be contract assets and liabilities to be accounted for at the end of
the reporting period.
Presentation
Contracts with customers will be presented in an entity's statement of financial position as a contract liability, a
contract asset or a receivable, depending on the relationship between the entity's performance and the customer's
payment.

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A contract liability s recognised and presented in the statement of financial position where a customer has paid
an amount of consideration prior to the entity performing by transferring control of the related good or service to
the customer. When the entity has performed but the customer has not yet paid the related consideration, this will
give rise to either a contract asset or a receivable. A contract asset is recognised when the entity's right to
consideration is conditional on something other than the passage of time, for instance future performance. A
receivable is recognised when the entity's right to consideration is unconditional except for the passage of time.
Where revenue has been invoiced a receivable is recognised. Where revenue has been earned but not invoiced, it
is recognised as a contract asset.
Disclosure
The objective is for an entity to disclose sufficient information to enable users of financial statements to
understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with
customers. The following amounts should be disclosed unless they have been presented separately in the financial
statements in accordance with other standards.
(a) Revenue recognised from contracts with customers, disclosed separately from other sources of revenue
(b) Any impairment losses recognised (in accordance with IFRS 9) on any receivables or contract assets arising
from an entity's contracts with customers, disclosed separately from other impairment losses
(c) The opening and closing balances of receivables, contract assets and contract liabilities from contracts with
customers
(d) Revenue recognised in the reporting period that was included in the contract liability balance at the beginning
of the period, and
(e) Revenue recognised in the reporting period from performance obligations satisfied in previous periods (such
as changes in transaction price)
Other information that should be provided;
(a) An explanation of significant changes in the contract asset and liability balances during the reporting period
(b) Information regarding the entity's performance obligations, including when they are typically satisfied (upon
delivery, upon shipment, as services are rendered etc), significant payment terms (such as when payment is
typically due) and details of any agency transactions, obligations for returns or refunds and warranties granted
(c) The aggregate amount of the transaction price allocated to the performance obligations that are not fully
satisfied at the end of the reporting period and an explanation of when the entity expects to recognise these
amounts as revenue
(d) Judgements, and changes in judgements, made in applying the standard that significantly affect the
determination of the amount and timing of revenue from contracts with customers
(e) Assets recognised from the costs to obtain or fulfil a contract with a customer. This would include pre-contract
costs and set-up costs. The method of amortisation should also be disclosed

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 Chapter Roundup
Revenue recognition is straightforward in most business transactions, but it is open to
manipulation.
IFRS 15 sets out rules for the recognition of revenue based on transfer of control to the customer
from the entity supplying the goods or services.
Generally revenue is recognised when the entity has transferred promised goods or services to
the customer. IFRS 15 sets out five steps for this recognition process.
The application notes to IFRS 15 provide guidance on how to deal with a number of different
transactions.
The presentation and disclosure requirements are important in relation to contracts where
performance obligations are satisfied over time, where there are likely to be contract assets and
liabilities to be accounted for at the end of the reporting period.
Where performance obligations are satisfied over time, an entity must determine what amounts
to include as revenue and costs in each accounting period.

Quick Quiz
1 Why was a new standard on revenue needed?
2 What are output methods of measuring satisfaction of performance obligations?
3 What are the two types of contract dealt with in IFRS 15?
4 What is the transfer that must take place before revenue can be recognised?
5 What is a repurchase agreement?
6 List the five steps for recognising revenue under IFRS 15.

CHAPTER 6 IAS 12: INCOME TAXES

IAS 12 covers both current tax and deferred tax. The parts relating to current tax are brief as
this is simple and straightforward. Complexities arise when we consider future tax
consequences of what is going on in our accounts now. This is an aspect of tax called deferred
tax.

Note that taxable profit is different from accounting profit. Accounting profit (loss) is simply net
profit (loss) for a period before deducting tax expense.

On the other hand, Taxable profits (loss) is profit (loss) for a period, determined in accordance
with the rules established by the tax authorities, upon which income taxes are payable
(recoverable).
.

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Current Tax
Current tax is the amount of income taxes payable (recoverable) in respect of taxable profit (tax
loss) for a period. It is the amount actually payable to the tax authorities in relation to the trading
activities of the entity during the period

Current tax for the current and prior periods should be recognised as a liability to the extent that
it has not yet been settled, and as an asset to the extent that the amounts already paid exceed
the amount due. The benefit of a tax loss which can be carried back to recover current tax of a
prior period should be recognised as an asset.

Current tax assets and liabilities should be measured at the amount expected to be paid to
(recovered from) taxation authorities, using the rates/laws that have been enacted or
substantively enacted by the balance sheet date.

Deferred Tax
Deferred tax is an accounting measure used to match tax effects of transactions with their
accounting impact and thereby produce less distorted results.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of
taxable temporary differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect
of:
i. deductible temporary differences ii. The
carry forward of unused tax losses iii. he
carry forward of unused tax credits

Temporary difference is a difference between the carrying amount of an asset or liability and
its tax base.

Taxable temporary difference is a temporary difference that will result in taxable amounts in
the future when the carrying amount of the asset is recovered or the liability is settled.

Deductible temporary difference is a temporary difference that will result in amounts that are
tax deductible in the future when the carrying amount of the asset is recovered or the liability is
settled.

Taxable Temporary Differences

All taxable temporary differences give rise to deferred tax liabilities.

Examples
a. Interest revenue received in arrears and include in accounting profit on the basis of time
apportionment. It is included in taxable profit, however, on cash basis.
b. Development costs which have been capitalized will be amortised in the statement of
comprehensive income but were fully deducted from taxable profit in the period they
were incurred.
c. The carrying amount of an asset is greater than its tax base.

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Recognition of Deferred Tax Liabilities
The general principle in IAS 12 is that deferred tax liabilities should be recognised for all taxable
temporary differences. There are three exceptions to the requirement to recognise a deferred
tax liability, as follows:
• liabilities arising from initial recognition of goodwill for which amortisation is not
deductible for tax purposes;
• liabilities arising from the initial recognition of an asset/liability other than in a business
combination which, at the time of the transaction, does not affect either the accounting or
the taxable profit; and
• liabilities arising from undistributed profits from investments where the entity is able to
control the timing of the reversal of the difference and it is probable that the reversal will
not occur in the foreseeable future.

Deductible Temporary Differences

All deductible temporary differences give rise to deferred tax assets.

Examples
a. the recoverable amount of an item of property, plant and equipment falls, and the
carrying amount is therefore reduced, but that reduction is ignored for tax purposes until
the asset is sold.
b. Income is deferred in the statement of financial position but has already been included in
taxable profit of current/prior periods.
c. The carrying amount of an asset is less than its tax base.

Recognition of Deferred Tax Assets

A deferred tax asset should be recognised for deductible temporary differences, unused tax
losses and unused tax credits to the extent that it is probable that taxable profit will be available
against which the deductible temporary differences can be utilised, unless the deferred tax
asset arises from:
the initial recognition of an asset or liability other than in a business combination which,
at the time of the transaction, does not affect the accounting or the taxable profit.

The carrying amount of deferred tax assets should be reviewed at the end of each reporting
period and reduced to the extent that it is no longer probable that sufficient taxable profit will be
available to allow the benefit of part or all of that deferred tax asset to be utilised. Any such
reduction should be subsequently reversed to the extent that it becomes probable that sufficient
taxable profit will be available.

Measurement of Deferred Tax Assets and Liabilities

Deferred tax assets and liabilities should be measured at the tax rates that are expected to
apply to the period when the asset is realised or the liability is settled (liability method), based
on tax rates/laws that have been enacted or substantively enacted by the end of the reporting
period. The measurement should reflect the entity's expectations, at the balance sheet date, as
to the manner in which the carrying amount of its assets and liabilities will be recovered or
settled.
Deferred tax assets and liabilities should not be discounted.

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Recognition of Tax Expense or Income
Current and deferred tax should be recognised as income or expense and included in profit or
loss for the period, except to the extent that the tax arises from: a transaction or event that
is recognised directly in equity; or a business combination accounted for as an acquisition.

If the tax relates to items that are credited or charged directly to equity, the tax should also be
charged or credited directly to equity.

If the tax arises from a business combination that is an acquisition, it should be recognised as
an identifiable asset or liability at the date of acquisition in accordance with IFRS 3 Business
Combinations (thus affecting goodwill).

Presentation
Current tax assets and current tax liabilities should be offset on the balance sheet only if the
entity has the legal right and the intention to settle on a net basis.
Deferred tax assets and deferred tax liabilities should be offset on the balance sheet only if the
entity has the legal right to settle on a net basis and they are levied by the same taxing authority
on the same entity or different entities that intend to realise the asset and settle the liability at
the same time.

Disclosure
In addition to the disclosures required by IAS 12, some disclosures relating to income taxes are
required by IAS 1, as follows:
• IAS 1 requires disclosures on the face of the statement of financial position about current
tax assets, current tax liabilities, deferred tax assets, and deferred tax liabilities.
• IAS 1 requires disclosure of tax expense (tax income) on the face of the statement of
comprehensive income.
• IAS 12 requires disclosure of tax expense (tax income) relating to ordinary activities on
the face of the statement of comprehensive income.
• IAS 12 requires that if an entity presents a statement of income, in addition to a
statement of comprehensive income, tax expense (income) from ordinary activities
should be presented in the statement of income.
IAS 12 requires the following disclosures:
• major components of tax expense (tax income) Examples include:
o current tax expense (income) o any adjustments of taxes of prior periods
o amount of deferred tax expense (income) relating to the origination and
reversal of temporary differences
o amount of deferred tax expense (income) relating to changes in tax rates or the
imposition of new taxes
o amount of the benefit arising from a previously unrecognised tax loss, tax credit
or temporary difference of a prior period
o write down, or reversal of a previous write down, of a deferred tax asset o
amount of tax expense (income) relating to changes in accounting
policies and corrections of errors

IAS 12 requires the following disclosures:

• aggregate current and deferred tax relating to items reported directly in equity
• tax relating to each component of other comprehensive income

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• explanation of the relationship between tax expense (income) and the tax that would be
expected by applying the current tax rate to accounting profit or loss (this can be
presented as a reconciliation of amounts of tax or a reconciliation of the rate of tax)
• changes in tax rates
• amounts and other details of deductible temporary differences, unused tax losses, and
unused tax credits
• temporary differences associated with investments in subsidiaries, associates, branches,
and joint ventures
• for each type of temporary difference and unused tax loss and credit, the amount of
deferred tax assets or liabilities recognised in the statement of financial position and the
amount of deferred tax income or expense recognised in the income statement
• tax relating to discontinued operations
• tax consequences of dividends declared after the end of the reporting period

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CHAPTER 7: LEASES IAS 17 AND ifrs16

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IAS 17 Leases standardises the accounting treatment and disclosure of assets held under lease.
In a leasing transaction there is a contract between the lessor and the lessee for the hire of an asset. The lessor
retains legal ownership but conveys to the lessee the right to use the asset for an agreed period of time in return
for specified rentals.
IAS 17 defines a lease and recognises two types.
Lease. An agreement whereby the lessor conveys to the lessee in return for rent the right to use an asset for an
agreed period of time.
Finance lease. A lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title
may or may not eventually be transferred.
Operating lease. A lease other than a finance lease. (IAS 17)
In this chapter the user of an asset will often be referred to simply as the lessee, and the supplier as the lessor.
You should bear in mind that identical requirements apply in the case of hirers and vendors respectively under
hire purchase agreements.
IAS 17 also applies in some circumstances to sale and repurchase agreements (see Chapter 6). In situations where
the seller has the right or obligation to repurchase at a price below the original selling price, the contract is
accounted for as a lease in accordance with IAS 17. To expand on the definition above, a finance lease should be
presumed if at the inception of a lease the present value of the minimum lease payments is approximately equal
to the fair value of the leased asset.
The present value should be calculated by using the interest rate implicit in the lease.

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 Minimum lease [Link] payments over the lease term that the lessee is or can be
required
to make.
Interest rate implicit in the lease. The discount rate that, at the inception of the lease, causes
the aggregate present value of:
(a) The minimum lease payments, and (b) The unguaranteed residual value
to be equal to the sum of:
(a) The fair value of the leased asset, and (b) Any initial direct costs.
Lease term. The non-cancellable period for which the lessee has contracted to lease the asset
together with any further terms for which the lessee has the option to continue to lease the asset,
with or without further payment, when at the inception of the lease it is reasonably certain that
the lessee will exercise the option.

[Link] an exam question you will be given the interest rate implicit in the lease.
Accounting for operating leases
Operating leases do not really pose an accounting problem. The lessee pays amounts periodically to the lessor
and these are charged to the statement of profit or loss. Where the lessee is offered an incentive such as a rent-
free period or cashback incentive, this is effectively a discount, which will be spread over the period of the
operating lease in accordance with the accruals principle. For instance, if a company entered into a four-year
operating lease but was not required to make any payments until year 2, the total payments to be made over years
2–4 should be charged evenly over years 1–4. Where a cashback incentive is received, the total amount payable
over the lease term, less the cashback, should be charged evenly over the term of the lease. This can be done by
crediting the cashback received to deferred income and releasing it to profit or loss over the lease term.
Accounting for finance leases
For assets held under finance leases or hire purchase this accounting treatment would not disclose the reality of
the situation. If a lessor leases out an asset on a finance lease, the asset will probably never be seen on his premises
or used in his business again. It would be inappropriate for a lessor to record such an asset as a non-current asset.
In reality, what he owns is a stream of cash flows receivable from the lessee. The asset is an amount receivable
rather than a non-current asset. Similarly, a lessee may use a finance lease to fund the 'acquisition' of a major asset
which he will then use in his business perhaps for many years. The substance of the transaction is that he has
acquired a noncurrent asset, and this is reflected in the accounting treatment prescribed by IAS 17, even though
in law the lessee never becomes the owner of the asset.
The following summary diagram should help you when deciding whether a lease is an operating lease or a finance
lease

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 L
E
Y
Does the lease contain a bargain purchase ?
e
option n
o Y
I ship transferred by the end of the e
s lease? n
o Y
Is the lease term for a major part of the asset’s useful e
n
o
Is the present value of minimum lease payments greater Y
than or equal to the asset’s fair ? e
value
N
Fin
O o l
an
p e

Note:.A finance lease can also be presumed if the leased assets are of such a specialised nature that only the lessee
can use them without major modifications.
Land and buildings
Under IAS 17 the land and buildings elements of a lease of land and buildings are considered separately for the
purposes of lease classification. As land has an indefinite economic life, the practice up to 2009 was to treat it as
an operating lease unless title was expected to pass at the end of the lease term. The IASB reconsidered this and
decided that in substance, for instance in a long lease of land and buildings, the risks and rewards of ownership
of the land do pass to the lessee even if there is no transfer oftitle. So a lease of land can be treated as a finance
lease if it meets the existing criteria, specifically if the risks and rewards of ownership can be considered to have
been transferred. This would be the case if the present value of the minimum lease payments in respect of the land
element amounts to 'substantially all' of the fair value of the land.
A lease of buildings will be treated as a finance lease if it satisfies the requirements above. The minimum lease
payments are allocated between the land and buildings elements in proportion to the relative fair values of the
leasehold interests in the land and the buildings. If the value of the land is immaterial, classification will be
according to the buildings.
If payments cannot be reliably allocated, the entire lease is classified as a finance lease, unless both elements are
operating leases, in which case the entire lease is classified as an operating lease.
Example
A business has taken out a new lease on a factory building and surrounding land. The fair value of the building is
$5m and the fair value of the land is $3m. The lease is for 20 years, which is the expected life of the factory, with

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annual payments in arrears of $500,000. The business has a cost of capital of 8%. The annuity factor for $1
receivable every year for 20 years is 9.818.
Solution
The lease payments will be split in line with the fair values of the land and the building.
$187,500 (500,000 × 3/8) will be treated as lease payment for the land and $312,500 will be treated as payment
on a finance lease for the building. The payment for the building will be treated as a finance lease because it is
for the expected useful life of the building. The present value of the minimum lease payments in respect of the
land amounts to $1.84m (187,500 × 9.818). This is not 'substantially all' of the fair value of the land, so the lease
of land will be treated as an operating lease.
LESSEES
Under finance leases:
Assets acquired should be capitalised
The interest element of instalments should be charged against profit
Operating leases are rental agreements and all instalments are charged against profit.
Accounting treatment
IAS 17 requires that, when an asset changes hands under a finance lease, lessor and lessee should account for the
transaction as though it were a credit sale. In the lessee's books therefore:
DEBIT Asset account
CREDIT Lessor (liability) account
The amount to be recorded in this way is the lower of the fair value and the present value of the minimum lease
payments. IAS 17 states that it is not appropriate to show liabilities for leased assets as deductions from the leased
assets. A distinction should be made between current and non-current lease liabilities, if the entity makes this
distinction for other liabilities.
The asset should be depreciated (on the bases set out in IASs 16 and 38) over the shorter of:
The lease term
The asset's useful life
If there is reasonable certainty of eventual ownership of the asset, then it should be depreciated over its useful
life.
Apportionment of rental payments
When the lessee makes a rental payment it will comprise two elements.
(a) An interest charge on the finance provided by the lessor. This proportion of each payment is interest payable
in the statement of profit or loss of the lessee.
(b) A repayment of part of the capital cost of the asset. In the lessee's books this proportion of each
rental payment must be debited to the lessor's account to reduce the outstanding liability.

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The accounting problem is to decide what proportion of each instalment paid by the lessee represents interest,
and what proportion represents a repayment of the capital advanced by the lessor. There are two
usual apportionment methods:
The actuarial method
The sum-of-the-digits method
The actuarial method is the best and most scientific method. It derives from the common-sense assumption that
the interest charged by a lessor company will equal the rate of return desired by the company, multiplied by the
amount of capital it has invested:
(a) At the beginning of the lease the capital invested is equal to the fair value of the asset (less any
initial deposit paid by the lessee).
(b) This amount reduces as each instalment is paid. It follows that the interest accruing is greatest in the early
part of the lease term, and gradually reduces as capital is repaid. In this section, we will look at a simple example
of the actuarial method.
Example:
Kamtsitsi acquires an asset on 1 January, 2004 which has a fair value of K17,500 on a lease the
terms of which are that he pays a deposit of K460 followed by seven annual installments of K3,500
payable in arrears. Depreciation is to be provided at the rate of 20% per annum on cost. Calculate
the interest charge for each year using the actuarial method. The interest rate implicit in the
lease is 10% and the extracts of Statement of financial position and statement of
comprehensive income for 31 Decmber 2005.

Solution:
Fair value of the asset: K17,500
Deposit: K 460
K17,040

Year Installment Principal Interest

1 January 2004 17,040
31 December 2004 3,500 1,796 1,704
1 January 2005 15,244
31 December 2005 3,500 1,976 1,524
1 January 2006 13,268
31 December 2006 3,500 2,173 1,327
1 January 2007 11,095
31 December 2007 3,500 2,390 1,110
1 January 2008 8,705
31 December 2008 3,500 2,630 870
1 January 2009 6,075
31 December 2009 3,500 2,893 607
1 January 2010 3,182
31 December 2010 3,500 3,182 318
0

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 Statement of comprehensive income for the year to 31 December 2005 (extracts)
K
Depreciation (20% of K17,500) 3,500
Interest paid 1,524

Statement of financial position as at 31 December 2005 (extracts)

Non-current Assets
Assets held under finance lease at cost 17,500
Accumulated depreciation (K17,500 20% 2yrs) (7,000)
10,500
Current Liabilities
Obligation under finance leases (K3,500 – 1,524) 1,976
Accrued interest 1,524

Non-current Liabilities
Obligation under finance leases (13,268 – 1,524) 11,744
Interest expense for the year to 31 December 2005 is K1,524 (from above),which is a current liability because the
installments are made in arrears. The total capital amount outstanding at 31 December 2005 is 13,268 (the same
as at 1 January 2006 as no further payments have been made). This must be split between current and non-current
liabilities. Next year‟s payment will be K3,500 of which K1,524 is interest. Therefore capital repaid in the next
year will be K1,976 (3,500 – 1,524). This leaves capital of K11,744 (K13,268 – 1,524) as a non-current liability.

You will not be required to do this whole calculation in an exam. You will probably have to calculate the first
few instalments in order to obtain figures for current and non-current liabilities (as in Section 2.5). Note that you
may be asked to account for a finance lease which is in its second or subsequent year. Do the calculation above
for one extra year (ie up to the end of year 3 if you are preparing amounts for year 2).
This will give you the split for current/non-current liabilities.
Disclosure requirements for lessees
IAS 17 (revised) requires the following disclosures by lessees in respect of finance leases:
The net carrying amountat the end of the reporting period for each class of asset
A reconciliationbetween the total of minimum lease payments at the end of the reporting period, and their
present value. In addition, an entity should disclose the total of minimum lease payments at the end of the reporting
period, and their present value, for each of the following periods:
– Not later than one year
– Later than one year and not later than five years
– Later than five years

Operating leases: disclosures

For operating leases the disclosures are as follows.
The total of future minimum lease payments under non-cancellable operating leases for each of the following
periods:
(a) Not later than one year
(b) Later than one year and not later than five years
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 (c) Later than five years
Classification of leases
A final issue to consider is the importance of correctly classifying a lease. A finance lease gives rise to a non-
current asset and a lease liability in the statement of financial position. If it is treated as an operating lease, there
will be no asset or liability in the statement of financial position. All that will be shown is the lease payments
going through as an expense in the statement of profit or loss. If the asset is not shown, assets will be understated
and return on capital employed (ROCE) will be overstated. If the lease liability is not shown, gearing (ratio of
debt to equity) will be understated. (These ratios are covered in Chapter 19). This is why finance leases must be
accounted for according to their 'substance', rather than their legal form (under which the asset is treated as being
owned by the lessor.)
Sale and leaseback transactions
A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. The lease
payment and the sale price are usually negotiated as a package. The accounting treatment depends upon the type
of lease involved. If the transaction results in a finance lease, then it is in substance a loan from the lessor to the
lessee (the lessee has sold the asset and then leased it back), with the asset as security. In this case ,any 'profit' on
the sale should not be recognised as such, but should be deferred and amortised over the lease term. The
transaction results in an operating lease and the transaction has been conducted at fair value, then it can be
regarded as a normal sale transaction. The asset is derecognised and any profit on the sale is recognised.
The operating lease instalments are treated as lease payments, rather than repayments of capital plus interest. If
the result is an operating lease and the sale price was below fair value, this may be being compensated for by
lower rental sin the future. If this is the case, any loss on sale should be amortised over the period for which the
asset is expected to be used. If the sale price was above fair value any excess is deferred and amortised over the
period for which the asset is expected to be used.
Chapter Roundup
A finance lease is a means of acquiring the long-term use of an asset whereas an operating
lease is a
short-term rental agreement. Substance over form is important in distinguishing between them.
Under finance leases:
– Assets acquired should be capitalised
– The interest element of instalments should be charged against profit
Operating leases are rental agreements and all instalments are charged against profit.

Quick Quiz
1 (a) ……………….leases transfer substantially all the risks and rewards of ownership.
(b) ………………. leases are usually short-term rental agreements with the lessor being responsible
for the repairs and maintenance of the asset.

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2 A business acquires an asset under a finance lease. What is the double entry?
3 List the disclosures required under IAS 17 for lessees in respect of finance leases.
4 A lorry has an expected useful life of six years. It is acquired under a four year finance lease. Over which
period should it be depreciated?
5 A company leases a photocopier under an operating lease which expires in June 20X2. Its office is lease d
under an operating lease due to expire in January 20X3. How should past and future operating leases be disclosed
in its 31 December 20X1 accounts?

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Page 56 of 72
CHAPTER 8 IAS 33: EARNINGS PER SHARE (EPS)

Objective of IAS 33
The objective of IAS 33 is to prescribe principles for determining and presenting earnings per
share (EPS) amounts to improve performance comparisons between different entities in the
same reporting period and between different reporting periods for the same entity.

Scope
IAS 33 applies to entities whose securities are publicly traded or that are in the process of
issuing securities to the public. Other entities that choose to present EPS information must also
comply with IAS 33.
If both parent and consolidated statements are presented in a single report, EPS is required
only for the consolidated statements.

Key Definitions
Ordinary share: also known as a common share or common stock. An equity instrument that is
subordinate to all other classes of equity instruments.
Potential ordinary share: a financial instrument or other contract that may entitle its holder to
ordinary shares.

Common Examples of Potential Ordinary Shares

convertible debt
convertible preference shares
share warrants
share options
share rights
employee stock purchase plans
contractual rights to purchase shares
contingent issuance contracts or agreements (such as those arising in
business combination)

Dilution: a reduction in earnings per share or an increase in loss per share resulting from the
assumption that convertible instruments are converted, that options or warrants are exercised,
or that ordinary shares are issued upon the satisfaction of specified conditions.
Ant dilution: an increase in earnings per share or a reduction in loss per share resulting from the
assumption that convertible instruments are converted, that options or warrants are exercised,
or that ordinary shares are issued upon the satisfaction of specified conditions.

Requirement to Present EPS

An entity whose securities are publicly traded (or that is in process of public issuance) must
present, on the face of the statement of comprehensive income, basic and diluted EPS for:
• profit or loss from continuing operations attributable to the ordinary equity holders of the
parent entity; and
• profit or loss attributable to the ordinary equity holders of the parent entity for the period for
each class of ordinary shares that has a different right to share in profit for the period. If
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 an entity presents the components of profit or loss in a separate income statement, it
presents EPS only in that separate statement.

Basic and diluted EPS must be presented with equal prominence for all periods presented.

Basic and diluted EPS must be presented even if the amounts are negative (that is, a loss per
share).
If an entity reports a discontinued operation, basic and diluted amounts per share must be
disclosed for the discontinued operation either on the face of the statement of comprehensive
income (or separate income statement if presented) or in the notes to the financial statements.

Basic EPS
Basic EPS is calculated as follows:

Basic EPS =

Earnings
The earnings numerators (profit or loss from continuing operations and net profit or loss) used
for the calculation should be after deducting all expenses including taxes, non-controlling
interests, and preference dividends.

Per share
The denominator (number of shares) is calculated by adjusting the shares in issue at the
beginning of the period by the number of shares bought back or issued during the period,
multiplied by a time-weighting factor. IAS 33 includes guidance on appropriate recognition dates
for shares issued in various circumstances.
Contingently issuable shares are included in the basic EPS denominator when the contingency
has been met.

Example: weighted average number of shares

Mzeru Co, a listed company, has the following share transactions during 2010.

Date Details shares issued

1 January 2010 balance at beginning of year 170,000
31 May 2010 issue of new shares for cash 80,000
31 December 2010 balance at year end 250,000

Required: calculate the weighted average number of shares outstanding for 2010.

Solution:
The weighted average number of shares can be calculated in two ways:
1. Shares on 1 Jan 2010 170,000 × = 70,833
Shares on 31 Dec 2010 250,000 = 145,833
Total shares at 31 Dec 2010 216,666 shares

2. Shares on 1 Jan 2010 170,000 × = 170,000

Issue on 31 May 2010 80,000 = 46,666

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 Total shares at 31 Dec 2010 216,666 shares

The first method is preferred as it will be easy to use when calculating bonus and rights issues.

Effects on EPS of changes in capital structure

Decreases in share capital occur, rarely, when an entity buys back shares from its investors and
cancels them. Increases in share capital can happen in a variety of ways: (1) issues at full
market price, (2) bonus issues, (3) capitalization, (4) share split, (5) scrip issues and (6) rights
issues.

Issues at full market price

Theory suggests that the market price of a share represents the present value of the future
earnings of that share, discounted for time. There is, therefore, no effect on the earning
capacity of existing shares.
The weighted average number of equity shares calculation will be affected, but only to account
for the increase with effect from the date of the issue.

Example: issues at full market price

On 30 September 2010, Puludzu Co made an issue at full market price of 1 million ordinary
shares. The company‟s accounting year runs from 1 January to 30 December. Relevant
information for 2009 and 2010 is as follows:
2010 2009
Shares in issue as at 31 December 9,000,000 8,000,000
Profits after tax and preference dividend K3,300,000 K3,280,000

Required: calculate the EPS for 2010 and the corresponding figure for 2009.

Solution:
2010 2009
Earnings K3,300,000 K3,280,000
Weighted average number of shares:
8,000,000 = 6,000,000 9,000,000
= 2,250,000
Total number of shares 8,250,000 8,000,000

Basic EPS (K3,300,000/8,250,000 shares) 40t

(K3,280,000/8,000,000 shares) 41t

Bonus issue/Capitalisation/scrip issue

These types of issues can be considered together as they have similar effects.
A bonus issue is a free issue of shares, given to existing shareholders. No extra funds are
available to the entity.
A bonus issue is treated as though the additional shares had been in existence from the first
day of the year, and an adjustment is required also, to reflect the issue, to the disclosed EPS
for the previous year. The rule to apply is:
• multiply all prior periods this year by the BONUS FRACTION, and •
multiply last year‟s disclosed EPS by the reciprocal of the bonus fraction.

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The bonus fraction is calculated as:

If an entity had 400,000 shares in issue, and made a 1 for 8 bonus issue, then after the issue,
there would be 450,000 shares in issue.
So we could express the bonus fraction as:
But it is so much easier to express it on the basis of 8 shares originally moving to 9 shares after
the bonus i.e. .

Example:
Greymatter Co has 400,000 thousand shares in issue, until 30 September 2010 it made a
bonus issue of 100,000 shares (or a 1 for 4 bonus issue). Calculate the EPS for 2010 and
the corresponding figure for 2009 if total earnings were K80,000 in 2010 and K75,000 in
2009. The company‟s year runs from 1 January to 31 December.

Solution:
There are two ways of solving this problem. The first one is simple and straight forward.

First method
Using the first method, we do not weight the shares. We ignore the time weighting factor. We
adjust the number of shares outstanding before the event as if the bonus issue occurred at
the beginning of the previous corresponding period.
2010 2009
Earnings K80,000 K75,000
Shares:
At 1 January 400,000 400,000
Bonus issue on 30 September 100,000 100,000
Share outstanding as at 31 December 500,000 500,000

Basic EPS for 2010: (K80,000/500,000 shares) 16t

Adjusted EPS for 2009: (K75,000/500,000 shares) 15t

Second method
Using this method, we weight the shares to get the weighted average number of shares. We
adjust the EPS of the previous corresponding period by the reciprocal of the bonus fraction.
This method is useful when you are given more than one types of share issues e.g. an issue
at full market price and a bonus issue in one period. The number of shares after the bonus
issue will be 500,000 from 400,000 giving us a bonus fraction of . The reciprocal is,
therefore, .
2010 2009
Earnings K80,000 K75,000
Weighted average number of shares:
Shares time weighting bonus fraction
400,000 × × = 375,000
500,000 × = 125,000
500,000 400,000

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Basic EPS (K80,000/500,000 shares) 16t
(K75,000/400,000 shares) 18.75t
Adjusted EPS (19t × ) 15t
Example: issue of different types of shares in one period
This example will combine elements of an issue at full market prices and a bonus issue.

XYZ Co had 8 million shares at 1 January 2010. On 31 May 2010 it issued 1 million new shares
at full market price, and on 30 September 2010 it made a 1 for 3 bonus issue. Earnings in 2010
were K1.5 million and the basic EPS for 2009 was 15t.

Solution:
Shares Time Bonus weighted average
weighting Fraction number of shares
1 Jan 8,000,000 × × = 4,444,444
31 May 9,000,000 × × = 4,000,000
30 Sept 12,000,000 × = 3,000,000
Weighted average number of shares at 31 Dec 2010 11,444,444

Basic EPS for 2010 = K1,500,000/11,444,444 shares = 13t

Adjusted EPS for 2009 = 15t × = 11t

Rights issues
a rights issue occurs when an entity offers to its existing shareholders the right to acquire
more shares in the entity at a price lower than the current mid-market price i.e. at a discount
on mid-market price. The offer of new shares is made on the basis of x shares for every y
shares held.
To arrive at the figures for EPS when a rights issue is made, we need to calculate first of all the
theoretical ex-rights price. This will be explained better with an example.

The rule to apply is:

a. EPS for the current year
i. Multiply the number of shares before the rights issue by the time weighting factor
and the RIGHTS FRACTION,
The rights fraction is calculated as follows:

ii. Multiply the number of

shares after the rights issue by the time weighting factor.

Add the figures found in i and ii above

b. EPS for the corresponding previous year

Multiply last year‟s disclosed EPS by the reciprocal of the rights fraction:

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Example:
Mzeruzayekha Co has produced the following net profits for the years ending 31 December.
Million
2006 1.1
2007 1.5
2008 1.8

On 1 January 2007 the number of shares outstanding was 500,000. During 2007 the company
announced a rights issue with the following details.

Rights: 1 new share for each 5 outstanding

Exercise price: K5.00
Last date to exercise: 1 March 2007

The market (fair) value of one share in Mzeruzayekha immediately prior to exercise on 1 March
2007 was K11.00

Required:
Calculate the EPS for 2006, 2007 and 2008.

Solution:
Theoretical ex-rights price:
5 shares @ K11.00 each 55.00
1 share @ K5.00 each 5.00
6 shares 60.00

Theoretical ex-rights price: K60.00 ÷ 6 shares = K10.00

i. EPS for 2006

Basic EPS for 2006: = K2.20

Adjusted EPS for 2006: K2.20 × = K2.00

ii. EPS for 2007

Number of shares issued under rights issue: × 500,000 = 100,000 shares

Shares Time weighting Rights Weighted average

Factor fraction number of shares
1 Jan 500,000 × × = 91,667 shares
1 Mar 600,000 × = 500,000 shares
31 Dec 591,667 shares

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 EPS for 2007:

iii. EPS for 2008

EPS for 2008:

Diluted EPS
At the end of an accounting period, a company may have in issue some securities which do not
(at present) have any claim to equity earnings, but may give rise to such a claim in the future. In
such circumstances, the future number of ordinary shares in issue might increase, which in turn
results in a fall in the EPS. In other words future increases in the number of ordinary shares will
cause a dilution of equity, and it is possible to calculate a diluted earnings per share (the EPS
that would have been obtained during the financial period if the dilution had already taken
place). This will indicate to investors the possible effects of a future dilution.

Diluted EPS is calculated by adjusting the earnings and number of shares for the effects of
dilutive options and other dilutive potential ordinary shares. The effects of anti-dilutive potential
ordinary shares are ignored in calculating diluted EPS.

Guidance on Calculating Dilution

Convertible securities. The numerator should be adjusted for the after-tax effects of
dividends and interest charged in relation to dilutive potential ordinary shares and for
any other changes in income that would result from the conversion of the potential
ordinary shares. The denominator should include shares that would be issued on the
conversion.
Options and warrants. In calculating diluted EPS, assume the exercise of
outstanding dilutive options and warrants. The assumed proceeds from exercise
should be regarded as having been used to repurchase ordinary shares at the
average market price during the period. The difference between the number of
ordinary shares assumed issued on exercise and the number of ordinary shares
assumed repurchased shall be treated as an issue of ordinary shares for no
consideration.
Contingently issuable shares. Contingently issuable ordinary shares are treated as
outstanding and included in the calculation of both basic and diluted EPS if the
conditions have been met. If the conditions have not been met, the number of
contingently issuable shares included in the diluted EPS calculation is based on the
number of shares that would be issuable if the end of the period were the end of the
contingency period. Restatement is not permitted if the conditions are not met when
the contingency period expires.

In short, Earnings calculated for basic EPS should be adjusted by the post-tax effect of:
• Any dividends on dilutive potential ordinary shares that were deducted to arrive at
earnings for basic EPS.
• Interest recognized in the period for the dilutive potential ordinary shares
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 • Any other changes in income or expenses (fees or discount) that would result from the
conversion of the dilutive potential ordinary shares.

Example: diluted EPS

In 2010 Farrah Co had basic EPS of 105t based on earnings of K105,000 and 100,000 ordinary
K1 shares. It also had in issue K40,000 15% convertible loan stock which is convertible in two
years‟ time at the rate of 4 ordinary shares for every K5 of stock. The rate of tax is 30%. In 2007
gross profit of K200,000 and expenses of K50,000 were recorded, including interest payable on
loan stock.
Required: calculate diluted EPS.

Solution:
The additional equity on the conversion of the loan stock will be: K40,000 = 32,000
shares

Farrah Co will save interest payments of K6,000 but this increase in profits will be taxed. Hence
the earnings figure may be recalculated:
K

Gross profit 200,000

Expenses (50,000 – 6,000) (44,000)
Profit before tax 156,000
Tax at 30% (46,800)
Earnings 109,800

Diluted EPS = = 82.7t

The dilution in earnings will be 105t – 82.7t = 22.3t

Example 2:
Zinaukaona Co has 5,000,000 ordinary shares of 25t each in issue, and also had in issue in
2004:

a. K1,000,000 of 14% convertible loan stock, convertible in three years‟ time at the rate of
two shares per K10 of stock;
b. K2,000,000 of 10% convertible loan stock, convertible in one year‟s time at the rate of 3
shares per K5 of stock.
c.
The total earnings in 2004 were K1,750,000.
The rate of income tax is 35%.

Required: calculate the basic EPS and the diluted EPS for 2004.

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Solution:

t
a. Basic EPS =

b. Diluted EPS: we must decide whether the potential ordinary shares are dilutive.

i. For the 14% loan stock, incremental EPS:

K
Interest saved (14% of K1,000,000) 140,000
Tax on interest saved (35% of K140,000) (49,000)
Incremental earnings 91,000

Additional shares (K1,000,000 × 2/10) 2,000,000 shares

Incremental EPS (K91,000/200,000 shares) 45.5t

NOTE: The 14% loan stock is anti-dilutive because its incremental EPS is higher
than basic EPS, therefore, will not be included in the calculation of diluted EPS.

ii. For the 10% loan stock, incremental EPS:

K
Interest saved (10% of K2,000,000) 200,000
Tax on interest saved (35% of K200,000) (70,000)
Incremental earnings 130,000

Additional shares (K2,000,000 × 3/5) 1,200,000 shares

Incremental EPS (K130,000/1,200,000 shares) 10.8t

NOTE: the 10% loan stock is dilutive because its incremental EPS is
lower than the basic EPS, therefore, will be included in the calculation of
diluted EPS.

iii. Diluted EPS = = 30.3t

Disclosure
If EPS is presented, the following disclosures are required:
• the amounts used as the numerators in calculating basic and diluted EPS, and a
reconciliation of those amounts to profit or loss attributable to the parent entity for the
period
• the weighted average number of ordinary shares used as the denominator in calculating
basic and diluted EPS, and a reconciliation of these denominators to each other

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 • instruments (including contingently issuable shares) that could potentially dilute basic
EPS in the future, but were not included in the calculation of diluted EPS because they
are antidilutive for the period(s) presented
• a description of those ordinary share transactions or potential ordinary share
transactions that occur after the balance sheet date and that would have changed
significantly the number of ordinary shares or potential ordinary shares outstanding at
the end of the period if those transactions had occurred before the end of the reporting
period. Examples include issues and redemptions of ordinary shares issued for cash,
warrants and options, conversions, and exercises.

An entity is permitted to disclose amounts per share other than profit or loss from continuing
operations, discontinued operations, and net profit or loss earnings per share. Guidance for
calculating and presenting such amounts is included in IAS 33.

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 BLANTYRE INTERNATIONAL UNIVERSITY

Financial reporting 1.

Jan -june Semester 2018 Assignment 1

Lecturer: Miss Nellie Kishombe
Email: nelliekishombe31@[Link]
Due Date: 21st march 2018 and 21st April for the second assignment
NB: Only Students on Distance learning mode are allowed to submit assignments
via email.

INSTRUCTIONS FOR ASSISGNEMT 1&2

 Make sure that your name, registration number, programme and academic year appear on the
cover page
 Marks are awarded for depth and application of knowledge, flow of your ideas and referencing
to other academic and credible sources( sites like Wikipedia are not academic)
 You are required to use citations for the questions that need citations (not the ones they
require calculations). Use the Harvard style of referencing, you must have separate page of
your references at the end of your assignment and you are required to have no less than five
references
 Do not copy assignments from classmates, plagiarism will not be tolerated
 Late assignments will not be marked.

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 QUESTION 1
The International Accounting Standards Board’s (IASB's) Framework for the Preparation and Presentation of
Financial Statements identifies seven user groups that are interested in information that is provided through an
enterprise’s financial statements.
Required:Identify the needs and objectives of each of the user groups above (14marks)

QUESTION 2

2. On 1 October 20X5 BIU acquired a machine under the following terms.

Hours $
Manufacturer's base price 1,050,000
Trade discount (applying to base price only) 2 0%
Early settlement discount taken (on the payable amount of the base cost
only) 5%
Freight charges 30,000
Electrical installation cost 28,000
Staff training in use of machine 40,000
Pre-production testing 22,000
Purchase of a three-year maintenance contract 60,000
On 1 October 20X7 BIU decided to upgrade the machine by adding new components at a cost of $200,000. This
upgrade led to a reduction in the production time per unit of the goods being manufactured using the machine.
a. What amount should be recognised under non-current assets as the cost of the machine? (5 marks)
b. How should the $200,000 worth of new components be accounted for? (1 mark)

QUESTION 3
Historical cost balance sheets have been criticised in recent years. Why has their meaningfulness been questioned
and to what extent do you think that adverse criticism is justified? (10 marks)
QUESTION 4

4. Within the International Accounting Standards Board’s Framework for the preparation and
presentation of financial statements, assets and liabilities are defined and criteria identified for their
recognition.

Required

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Define ‘assets’ and ‘liabilities’ and explain why these definitions are important in the preparation of an
enterprise’s balance sheet and income statement. ( 10 marks )

QUESTION 5

5. Assets are defined as being “probable future economic benefits obtained or controlled by a particular
entity as a result of past transactions or events” (IASB framework)

Identify whether each of the following are assets of the given enterprise. Give reasons for your answer.

1. Waste material from the factory of Kazembe enterprise worth £100 as scrap but which
would cost £150 to transport to the scrap dealer.

2. The benefits from next year’s sales of Kazembe enterprise.

3. Expenditure by Kazembe on trying to find a cure for bird flu. No marketable product
has yet been identified from the research by Kazembe.

4. Favour rents a machine from Beta enterprise at a cost of £1,000 per month, payable in
advance and terminable at any time by either party.

5. Favour rents another machine from Alpha enterprise at a cost of six half-yearly
payments in advance of £5,200. The cash price of the machine is £35,000 and has an
estimated life of five years.
(Total 10 marks)

TOTAL MARKS (50 MARKS)

Jan -june Semester 2018 Assignment 2

QUESTION 1

1 The trial balance of Mwimwi enterprise for the year ended 30 September 2007 is as follows:
£000 £000
Debits Credits
Purchases 5,200
Revenue 12,363
Trade receivables (debtors) 1,180

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Trade payables (creditors) 550
Distribution costs 920
Administration costs 1,650
Inventory 1 October 2006 1,620
Bank interest 5
Bank overdraft 220
Wages and salaries – administration 420
Provision for bad debts 52
Bad debts written off 5
Property at cost 3,100
Plant and equipment at cost 2,200
Vehicles at cost 900
Property accumulated depreciation as at 1 October 2006 750
Plant and equipment accumulated depreciation as at 1 October 2006 520
Vehicles accumulated depreciation as at 1 October 2006 230
Retained earnings as at 1 October 2006 415
Ordinary share capital £1 shares 700
Other reserves 250
Long-term loan 6% redeemable 2012 1,500
Bank 350
–––––– –––––
–
17,550 17,550
–––––– –––––
The following information is also available: –
1. The inventory (stock) as at 30th September 2007 has been valued at £1,570,000.

2. As at 30th September 2007 – rent owing is £90,000, and £25,000 had been paid in
advance for insurance. Both these expenses are chargeable 60% to distribution and 40% to
administration.

3. The interest on the long-term loan needs accruing for the year.

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 4. Tax is to be provided at 20% of profit after charging all expenses and interest.

5. Depreciation is to be provided for the year at the following rates:

• Property 2% on cost, chargeable 50% distribution and 50% administration
• Plant and equipment 10% on cost, chargeable 60% distribution and 40%administration
• Vehicles 20% reducing balance, all chargeable to distribution.

6. Provision for doubtful debts is to be set at 5% of trade receivables as at 30th September

2007.

7. Administration costs include £350,000 in relation to spending on research and

development in connection with a new product. The product is set to go on sale on 1st
January 2008 and revenue from the product is expected to cover all costs of production.

Required

Prepare the Income Statement (profit and loss account) for the year ended 30th September 2007
and the Balance Sheet as at that date for Mwimwi enterprise in accordance with IASs. (15 marks)

QUESTION 2
2. You are part of the external audit team working on accounts for Chisomo Ltd. You have been
given the following information for the year ended 31 December 2014:

CHISOMO LTD
STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 2013
Share Share Revaluation Accumulated Total
Capital premium Reserve Loss
K’000 K’000 K’000 K’000 K’000
Balance at 1 January 2013

At beginning of the year 500 560 3,043 (800) 3,303

Profit for year _____ _____ ____ 200 200
31 December 2013 500 560 3,043 (600) 3,503

Additional information

(1) The issued share capital of Chisomo Ltd is made up of 500,000 K1

ordinary shares.

(2) Chisomo Ltd sold property whose revaluation reserve amounted to

K750,000.

(3) A bonus issue of shares of K1 share for each outstanding share was
made on 31 December 2014.

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 (4) Profit for year amounted to K1,500,000.
(5) Dividends of 50 tambala per share were paid out.
(6) The opening figure for the revaluation reserve was overstated by
K93,000.

Required:

Prepare a statement of changes in equity for the year ended 31 December 2014.
8Marks

QUESTION 3

(a) Alinafe Trading acquired a fleet of 4 identical trucks from Stamfield Motors under a finance lease
arrangement that saw Alinafe paying K18,450,000 at the beginning of 2010 and K18,450,000 at the beginning
of each of the next three years (with the exact amount to settle outstanding balance with the fourth payment).
The implied interest rate for the finance lease is 30%. The cash selling price of each truck was K13,000,000.

Required: Prepare a schedule showing the finance lease instalment payments, and interest obligations that will
be recorded in the books of Alinafe Trading. 6 Marks

(b) “Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather
than the form of the contract” according to IAS 17 on leases. A number of situations or indicators may
individually or in combination normally lead to a lease being classified as a finance lease.
Required: Mention any Five situations that may individually or in combination with others lead to a lease being
classified as a finance lease. 5 Marks

QUESTION 4

(a) .Additional new shares could be issued to the existing shareholders through a bonus issue or a rights issue.

Required:
Briefly explain what is meant by a bonus issue and a rights issue and indicate the fundamental difference
between these two types of share issue. 6 Marks

b) XYZ Co had 8 million shares at 1 January 2010. On 31 May 2017 it issued 1 million new
shares at full market price, and on 30 September 2017 it made a 1 for 3 bonus issue to finance
a project. The funds seemed inadequate as the company made another issue, a 1 for 4 rights
issue, on 30 November 2017 at an exercise price of K3. The mid-market price immediately
before the rights issue was K4. Earnings in 2010 were K1.5 million and the basic EPS for 2016
was 15t.
Calculate the earnings per share for 2017 and the adjusted earnings per share for 2016.
10 marks

TOTAL MARKS (50 MARKS)

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