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Chartered Accountants Financial Reporting Guide

This document provides an index of activities for a Chartered Accountants program on financial accounting and reporting. The index lists 14 units that cover topics such as financial reporting, presentation of financial statements, revenue, income taxes, and fair value measurement. Each unit includes 1-2 activities for students to complete. For example, Unit 1 on financial reporting includes an activity applying the regulatory framework in Australia and New Zealand. Unit 3 on revenue includes an activity on measuring revenue from the sale of goods. The index provides page numbers for the solutions to each activity.

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0% found this document useful (0 votes)

32 views150 pages

Chartered Accountants Financial Reporting Guide

Uploaded by

JAGRUITI JAGRITI

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PDF, TXT or read online on Scribd

Chartered Accountants Program

Financial Accounting & Reporting

Index of activities

Unit 1: Financial reporting 1-1

Activity 1.1 (Australia): Applying the regulatory framework 1-1
Activity 1.1 (New Zealand): Applying the regulatory framework 1-11

Unit 2: Presentation of financial statements 2-1

Activity 2.1: Preparing a statement of cash flows 2-1
Activity 2.2: Preparing key financial statements (SPLOCI and SOCE) 2-9
Activity 2.3: Accounting for changes in accounting policies and estimates 2-15
Activity 2.4: Identifying related parties 2-17
Activity 2.5: Accounting for events after the reporting period 2-19

Unit 3: Revenue 3-1

Activity 3.1: Measuring revenue for the sale of goods 3-1
Activity 3.2: Identifying the potential impact of IFRS 15 3-5

Unit 4: Income taxes 4-1

Activity 4.1: Accounting for income taxes 4-1

Unit 5: Foreign exchange 5-1

Activity 5.1: Determining the functional currency of a foreign operation 5-1
Activity 5.2: Translating from the functional currency to the presentation currency 5-5

Unit 6: Fair value measurement 6-1

Activity 6.1: Measuring fair value of non-financial assets 6-1

Unit 7: Property, plant and equipment 7-1

Activity 7.1: Accounting for property, plant and equipment 7-1

Unit 8: Intangible assets 8-1

Activity 8.1: Accounting for intangible assets 8-1

Unit 9: Financial instruments 9-1

Activity 9.1: Classification of financial instruments 9-1
Activity 9.2: Basic accounting comparing FVTPL and FVTOCI 9-7
Activity 9.3: Basic accounting under amortised cost 9-11
Activity 9.4: Integrated financial instruments activity 9-13

Unit 10: Impairment of assets 10-1

Activity 10.1: Accounting for impairment loss for a CGU and reversal of impairment loss 10-1

Unit 11: Provisions (including employee benefit entitlements),

contingent liabilities and contingent assets 11-1
Activity 11.1: Calculating employee benefit liabilities 11-1
Activity 11.2: Provisions, contingent liabilities and contingent assets 11-7

Unit 12: Leases 12-1

Activity 12.1: Accounting for a lease by a lessee and lessor 12-1

Activity solutions index Page i

Financial Accounting & Reporting Chartered Accountants Program

Unit 13: Earnings per share (EPS) 13-1

Activity 13.1: Calculating basic EPS 13-1
Activity 13.2: Calculating diluted EPS 13-5

Unit 14: Share-based payments 14-1

Activity 14.1: Accounting for a cash-settled share-based payment transaction 14-1

Unit 15: Business combinations 15-1

Activity 15.1: Accounting for a business combination 15-1

Unit 17: Equity accounting 17-1

Activity 17.1: Accounting for an investment in an associate under the equity method of
accounting 17-1

Page ii Activity solutions index

Chartered Accountants Program Financial Accounting & Reporting

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Unit 1: Financial reporting AU

Activity 1.1 (Australia)

Applying the regulatory framework

Solution – Task A
The treatment of each item in the statement of financial position at 30 June 20X5, based on the
definitions of an asset and a liability and the recognition criteria in the Conceptual Framework,
is summarised in the following table:

Item Recognise in the statement Explanation

of financial position?

Goodwill No While it is probable that future economic benefits

will flow to the entity, the value cannot be measured
reliably and therefore the goodwill cannot be
recognised as an asset at 30 June 20X5

Legal claim No The outflow of benefits is not probable and therefore

a liability cannot be recognised in the statement of
financial position at 30 June 20X5

Note: The accounting treatment for these items has been established by applying the principles
from the Conceptual Framework. Specific Accounting Standards relating to these items will be
covered in later units of the module. However, you will see that the Standards themselves also
apply the principles from the Conceptual Framework and applying the Accounting Standards
would reach the same conclusion.

Recommended approach – Task A

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the conceptual framework

Review the following paragraphs from the Conceptual Framework:
•• 4.4(a) for the definition of an asset.
•• 4.44 for the recognition criteria of an asset.
•• 4.4(b) for the definition of a liability.
•• 4.46 for the recognition criteria of a liability.
fin31701_actsols

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AU Step 2 – Consider the definitions of an asset and a liability from the

Conceptual Framework
An asset is a resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity.
Internally generated goodwill is not a resource that is controlled by the entity; it is an integral
part of the business and could not be sold separately. It arises as a result of past performance
or actions of the entity. Ways in which future economic benefits could flow to the entity from
internally generated goodwill include:
•• Sale of products.
•• Sale of business.

A liability is a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
It is uncertain whether glass fragments were present in the toothpaste and the lawyers have
estimated a 20% chance of Alpha being found liable. There is a possible obligation rather than
a present obligation. If glass fragments were not present in the toothpaste, it is unlikely that this
claim will result in an outflow of resources embodying economic benefits.

Step 3 – Apply the recognition criteria from the Conceptual

Framework
To establish whether an asset or liability should be recognised in respect of each of the items,
each of the recognition criteria should be considered:

Internally generated goodwill

Criterion Met? Explanation

Yes/No

Probable that future economic Yes It is unclear from the scenario whether
benefits will flow to the entity Alpha is a profitable business. However,
receiving an offer in excess of the fair value
of identifiable net assets would indicate
it is profitable
Ways in which future economic benefits
could flow to the entity include:
•• Sale of products
•• Sale of business

Cost or value that can be measured No While an offer has been received for all
reliably of the share capital at $1.5 million above
the estimated value of the identifiable net
assets, this is not a reliable measurement of
the value of goodwill in Alpha. This is prior
to any due diligence work and is also the
value placed on Alpha’s business by only
one party. This amount is also not a reliable
measure as Alpha declined the offer

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Legal claim AU
Criterion Met? Explanation

Yes/No

Probable that an outflow embodying No Alpha’s lawyers have estimated that there is
economic benefits will result from the a 20% chance of Alpha being liable for this
settlement of the obligation claim. 20% is not probable that an outflow
will occur1

Amount at which the settlement will N/A2 As it is not probable that there will be an
take place can be measured reliably outflow of economic benefit in relation to
the legal claim, reliable measurement is
irrelevant

Notes
1. Probable has been taken to mean ‘more likely than not’ or that there is more than a 50% chance. There have
been problems with applying the recognition criteria under the existing Conceptual Framework. Concepts such
as ’probable’ have been interpreted in many different ways by practitioners. This has been addressed in the new
recognition criteria in ED/2015/3, which brings the focus back to the qualitative characteristics of useful information.
2. A liability is only recognised in the financial statements where the recognition criteria are met. Recognising a liability
for an expected value of $10,000 (calculated as 20% × $50,000) is incorrect. If the recognition criteria has not been
met, no liability is recognised.

Step 4 – Form a conclusion as to whether the items should be

recognised as an asset/liability in the financial statements
The conclusion is shown in the solution.

Solution – Task B
The key fundamental ethical principle at risk is integrity as the other shareholders did not
authorise the loan and Jack is being dishonest by not disclosing it and trying to hide it from
them.

Recommended approach – Task B

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the IESBA Code

Review the fundamental ethical principles from s. 100.5 of the IESBA Code.

Step 2 – Consider each of the fundamental ethical principles and

determine whether they are at risk
Consider each of the fundamental ethical principles in turn and determine whether Jack’s actions
are putting the principle at risk

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AU Fundamental ethical Explanation At risk?

principle
Yes/No

Integrity Jack wants to hide the details of the loan from the other Yes
shareholders, as authorisation for the loan was not
granted. This behaviour is dishonest and is therefore in
breach of the fundamental principle of integrity

Objectivity Jack has a conflict of interest as the loan was made to Yes
him even though it was not authorised to be made,
and now he does not want to disclose the detail. Jack
is protecting his position which may be overriding his
professional judgement

Professional competence and Jack has not made the required disclosures in the Yes
due care financial statements as he is not aware of the detail of
IAS 24; therefore, he has not acted in accordance with
applicable technical standards. It also indicates that
he has not maintained his knowledge and skill at the
appropriate level to perform his role as a CFO

Confidentiality The issue does not relate to the disclosure of information No

acquired as a result of professional or business
relationships

Professional behaviour Jack’s actions are not in accordance with the Yes
Corporations Act 2001 as he is not following the
Accounting Standards. In addition, as a Chartered
Accountant, his actions of taking out the loan without
authorisation and trying to hide the loan by not
disclosing it could discredit the profession

Step 3 – Form a conclusion on the key fundamental ethical principle

at risk providing an explanation for the principle identified
Four of the five fundamental ethical principles are at risk, demonstrating the interlinked
relationship between the principles.
As the task specifically asks for the key fundamental ethical principle at risk, a conclusion must
be made as to which one is the key principle.
Jack’s dishonest actions of taking out the loan when it had not been authorised by the other
shareholders and not disclosing the loan in order to avoid his actions being found out is key;
therefore, integrity would be the key fundamental principle at risk.
The conclusion is shown in the solution.

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Solution – Task C AU
The annual reporting requirements for Gamma and Kappa are summarised in the following
table:

Annual reporting requirements

Company Requirement Justification

Gamma GPFR – Gamma would apply Tier 2 Gamma is a reporting entity and must
reporting requirements under the produce a GPFR. However, as it is not
RDR unless it elects to apply full IFRS publically accountable, it would apply
via Tier 1 Tier 2 reporting requirements under
the RDR

Kappa Special purpose financial report Kappa is a non-reporting entity

(SPFR). Alternatively, Kappa can and can therefore produce a SPFR.
choose to prepare a GPFR Alternatively, it can choose to prepare
a GPFR

Recommended approach – Task C

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the relevant guidance for establishing the reporting

requirements of an entity
Review Corporations Act s. 292 for entities operating under the Corporations Act.
Review SAC 1 Definition of the Reporting Entity (SAC 1) para. 40 for the definition of a reporting
entity.

Step 2 – Establish whether the entities are within the scope of the
Corporations Act and whether they are required to file an annual
report
Proprietary companies are within the scope of the Corporations Act. As both Gamma and Kappa
are proprietary companies, they are within the scope of the Corporations Act.
Gamma and Kappa are large proprietary companies and therefore must prepare and lodge an
audited financial report.

Step 3 – Establish whether the entity is a reporting entity

Referring to the definition from SAC 1, factors to consider when establishing whether an entity is
a reporting entity include:
•• The degree to which management and ownership interest is separated.
•• Political or economic interest.
•• Financial characteristics.

Professional judgement is exercised in determining whether an entity is a reporting entity – the

users and users’ needs should be considered.
Gamma is a large proprietary company with a significant number of investors, many of whom
are not involved in the day-to-day running of the company. Investors cannot command specific
reports, but would require the reports to help them make decisions about where to allocate their

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AU capital. Gamma would therefore be a reporting entity and, accordingly, would be required to
prepare a GPFR.
The facts state that Kappa is a non-reporting entity and this is because it is a wholly owned
subsidiary of Lambda, a large proprietary company that is required to prepare and lodge an
annual financial report with ASIC.
As a non-reporting entity, Kappa would prepare an SPFR. Alternatively, Kappa could choose
to prepare a GPFR.

Step 4 – Establish whether entities required to prepare a GPFR have

public accountability
Gamma is required to prepare a GPFR. It would have public accountability if its debt or equity
instruments are traded in a public market, or it is in the process of issuing such instruments, or it
holds assets in a fiduciary capacity for a broad group of outsiders.
Gamma does not meet any of these criteria and therefore does not have public accountability.
It would therefore apply the Tier 2 reporting requirements under the RDR.

Step 5 – Form a conclusion as to the annual reporting requirements

The conclusion is shown in the solution.

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Solution – Task D AU
The requirement for each company to lodge a financial report is summarised in the following
table:

Requirement to lodge a financial report

Company Requirement Justification

Delta Not required to prepare and lodge a Small proprietary company and
financial report additional requirements from
s. 292(2) are not met

Eta Lodge a financial report Large proprietary company and no

relief from ASIC Class orders

Theta Not required to prepare and lodge a Small proprietary company and no
financial report additional relevant information from
which to gain relief

Recommended approach – Task D

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the criteria for preparing and lodging financial

reports for small and large proprietary companies
Review Corporations Act s. 45(A) for the criteria applying to small and large proprietary
companies.
Section 292(2) of the Corporations Act details when a small proprietary company is required to
prepare a financial report.
Consider the ASIC Class orders where relief is provided from certain financial reporting
requirements, specifically CO 98/98, CO 98/1417, CO 98/1418, CO 02/1432 and CO 10/654.

Step 2 – Compare the details for each company to the Section 45(A)
criteria
Where two out of three of the thresholds are exceeded, the company is classed as a large
proprietary company and is required to lodge a financial report with ASIC.
Note that the thresholds are based on:
•• consolidated revenue
•• consolidated gross assets, and
•• number of full time equivalent employees at year end.

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AU Therefore, the information Rosie received on consolidated net assets and average number of full
time equivalent employees is not relevant in establishing whether each company is classified
as small or large.

Company details for reporting requirements

Company Threshold Delta Exceed Eta Exceed Theta Exceed

threshold? threshold? threshold?

Consolidated $25 million $19.8 N $26.2 Y $83.5 Y

revenue million million million

Consolidated $12.5 $11.1 N $12.8 Y $10.3 N

gross assets at million million million million
30 June 20X5

Number of full 50 51 Y 37 N 47 N
time equivalent
employees at
30 June 20X5

Classification Exceed at Small Large Small

based on least 2
thresholds

Step 3 – Consider other relevant information in accordance with

s. 292(2) to establish whether the small proprietary companies are
required to prepare a financial report
Both Delta and Theta are classified as small proprietary companies based on the s. 45(A) criteria.
Other relevant information to be considered is analysed in the following table:

Other relevant information

Company Detail Required to prepare?

Delta Bob Black holds 207,600 of the Bob holds 4.8% of the equity shares
4,325,000 equity shares. Following in Delta. Shareholders holding at
a dispute between Bob and one of least 5% of the votes can direct
the directors, Bob has notified the the company to prepare a financial
company in writing that he requires report. Bob does not have a sufficient
a financial report to be prepared holding to do this therefore Delta is
not required to prepare a financial
report

Theta N/A As there is no other relevant

information to consider, Theta is not
required to prepare a financial report

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Step 4 – Consider other relevant information in accordance with AU

the ASIC Class orders to establish whether the large proprietary
companies can obtain relief from preparing and lodging a financial
report
Eta is classified as a large proprietary company based on the s. 45(A) criteria.
Other relevant information to be considered is analysed in the following table:

Other relevant information

Company Detail Required to prepare?

Eta Controlled by Lota, a foreign Eta is controlled by a foreign company. CO

company. Lota prepares consolidated 98/98 only provides relief from preparing and
financial statements but they are not lodging an audited financial report to small
lodged with ASIC proprietary companies that are controlled
by a foreign company but which are not
part of a large group. Therefore, ETA cannot
obtain relief under this class order and will be
required to prepare a financial report

Step 5 – Form a conclusion as to whether a financial report needs to

be lodged with ASIC
The conclusion is shown in the solution.

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AU Solution – Task E
Responses to each of Polly’s questions:
1. There are some AASB Standards that do not have an international equivalent and AASB 1053
is one example. AASB 1053 sets out the application of tiers of Australian Accounting
Standards to different categories of entities.
2. The RDR is not a single document like IFRS for SMEs. In each AASB Standard, any disclosure
paragraphs that are not required for entities following the RDR are shaded in grey.
3. Entities following the RDR must comply with the recognition and measurement paragraphs
in each Standard; however, the disclosures are reduced. In order to comply with IFRS, the
full Standards need to be complied with (including full disclosure requirements), so there
is no explicit compliance with IFRS.

Recommended approach – Task E

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the relevant guidance

Review AASB 1053.

Step 2 – Apply the guidance to the scenario

Application of the guidance to Polly’s questions is shown in the solution.

Page 1-10 Suggested solutions to activities – Unit 1

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Activity 1.1 (New Zealand) NZ

Applying the regulatory framework

Item Recognise in the statement of Explanation

financial position?

Goodwill No While it is probable that future economic benefits

will flow to the entity, the value cannot be measured
reliably and therefore the goodwill cannot be
recognised as an asset at 30 June 20X5

Legal claim No The outflow of benefits is not probable and therefore

a liability cannot be recognised in the statement of
financial position at 30 June 20X5

Recommended approach – Task A

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the conceptual framework

Step 2 – Consider the definitions of an asset and a liability from the

Unit 1 – Suggested solutions to activities Page 1-11

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NZ •• Sale of products.
•• Sale of business.

Step 3 – Apply the recognition criteria from the Conceptual

Framework
To establish whether an asset or liability should be recognised in respect of each of the items,
each of the recognition criteria should be considered:

Internally generated goodwill

Criterion Met? Explanation

Yes/No

Legal claim

Criterion Met? Explanation

Yes/No

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as ’probable’ have been interpreted in many different ways by practitioners. This has been addressed in the new
recognition criteria in ED/2015/3, which brings the focus back to the qualitative characteristics of useful information. NZ
2. A liability is only recognised in the financial statements where the recognition criteria are met. Recognising a liability
for an expected value of $10,000 (calculated as 20% × $50,000) is incorrect. If the recognition criteria has not been
met, no liability is recognised.

Step 4 – Form a conclusion as to whether the items should be

recognised as an asset/liability in the financial statements
The conclusion is shown in the solution.

Solution – Task B
The key fundamental ethical principle at risk is integrity as the other shareholders did
not authorise the loan and Jack is being dishonest by not disclosing it and trying to hide it
from them.

Recommended approach – Task B

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the IESBA Code

Review the fundamental ethical principles from s. 100.5 of the IESBA Code.

Step 2 – Consider each of the fundamental ethical principles and

determine whether they are at risk
Consider each of the fundamental ethical principles in turn and determine whether Jack’s actions
are putting the principle at risk

Fundamental ethical Explanation At risk?

principle
Yes/No

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NZ Fundamental ethical Explanation At risk?

principle
Yes/No

Confidentiality The issue does not relate to the disclosure of information No

acquired as a result of professional or business
relationships

Professional behaviour Jack’s actions are not in accordance with the Companies Yes
Act 1993 as he is not following the Accounting
Standards. In addition, as a Chartered Accountant, his
actions of taking out the loan without authorisation
and trying to hide the loan by not disclosing it could
discredit the profession

Step 3 – Form a conclusion on the key fundamental ethical principle

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Solution – Task C NZ
The annual reporting requirements for Gamma and Kappa are summarised in the following
table:

Annual reporting requirements

Company Requirement Justification

Gamma General purpose financial report Gamma is a large private company

(GPFR) – Gamma must apply Tier 1 and must produce a GPFR. This is
financial reporting, which is full IFRS because it has public accountability
financial statements due to the previous issue of shares
(a regulated product under the
Financial Markets Conduct Act 2013
(FMCA 2013)). It also has more than
50 shareholders; therefore, it is an
FMC reporting entity (less than 50
shareholders would be exempt).
Gamma is not able to apply Tier 2 but
must report under Tier 1 (per Part 7 of
FMCA 2013)

Kappa Special purpose financial report Kappa is not an FMC reporting entity,
(SPFR). Alternatively, Kappa can elect and does not meet the size criteria in
to prepare a GPFR the FRA 2013 requiring it to prepare a
GPFR, Kappa can produce an SPFR, or
elect to prepare a GPFR

Recommended approach – Task C

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the relevant guidance for establishing the reporting

requirements of an entity
Review s. 451–452 FMCA 2013 to determine what is an FMC reporting entity.
Review s. 45 FRA 2013 for provisions relating to companies that are large and have a reporting
requirement.
Review XRB standards A1 Accounting Standards Framework (XRB A1) and A2 Meaning of Specified
Statutory Size Thresholds (XRB A2) to assess which tiers of reporting an entity fits into and the
related size criteria.

Step 2 – Establish whether the entities are within the scope of the
Financial Reporting Act 2013 and the Financial Markets Conduct Act
2013 and whether they are required to prepare an annual report
Gamma is an FMC reporting entity, as they the original issue of shares meets s. 451(a) FMCA
2013 (as they have more than 50 shareholders). Kappa is not an FMC reporting entity, as none of
the requirements are met.
Under s. 208 CA 2013, Gamma will be required to prepare an annual report as it is large. Kappa
does not meet any of the requirements of s. 208, so will not have to prepare an annual report.

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NZ Step 3 – Establish whether the entities are required to prepare

financial statements
Any entity that is an FMC reporting entity is directed to the FMCA 2013 where there are specific
financial reporting provisions in Part 7 (s. 56 FRA 2013). An entity that is not an FMC reporting
entity will prepare financial statements under FRA 2013 only if it meets the size criteria in s. 45.
As Gamma is an FMC reporting entity under s. 451 of the FMCA 2013, it therefore is required to
prepare a GPFR.
Kappa is not large under the FRA 2013; therefore, it does not have to prepare a GPFR and can
prepare an SPFR instead.

Step 4 – Establish whether entities required to prepare a GPFR have

public accountability
Gamma, as an FMC reporting entity, has public accountability and therefore must prepare
financial statements under Tier 1 following the provisions of Part 7 FMCA 2013, as it is not
eligible to elect to report under Tier 2.

Step 5 – Form a conclusion as to the annual reporting requirements

The conclusion is shown in the solution.

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Solution – Task D NZ
The requirement for each company to prepare, audit and file its financial statements is
summarised in the following table:

Requirement to lodge a financial report

Company Requirement Justification

Delta Required to prepare and audit Delta is not a large company and
financial statements. The financial does not have a wide shareholding.
statements are not required to be However, a shareholder owning more
filed with the Registrar than 5% of the company’s shares
can request in writing that financial
statements are prepared and audited

Pi Prepare, audit and file financial Large overseas company

statements

Theta Not required to prepare a financial Small company; therefore, not

report required to prepare, audit or file
financial statements

Recommended approach – Task D

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the criteria for preparing, auditing and filing

financial statements for small and large companies
Review FMCA 2013 ss 451– 452 to determine who is an FMC reporting entity, ss 460–461 for
requirement to prepare financial statements, and s. 461D for audit requirements.
Review FRA 2013 ss 45 and 46 for size criteria relating to companies that are large, have a
reporting requirement, and are for-profit entities.
Review the XRB table of information on different types of entity and their requirement to
prepare, file and audit financial statements to establish the category for each of the different
types of entity (available on [Link] → Accounting Standards → Know your Standard).
Review XRB A1 for the criteria to be apublic benefit entity (Appendix A).
Review ss 207H – 207K CA 1993 for any specific ‘opt–in’ provisions for companies, ss 200–204 for
provisions relating to overseas companies, and s. 207E for registration requirements for overseas
companies.

Step 2 – Establish what type of entity is being dealt with and the
relevant legislation. Compare the details for each company to the
legislative criteria
Delta Limited
Delta is a small company as it does not meet the size criteria in s. 45 FRA 2013 (which would
require it to prepare financial statements). However, a company with fewer than 10 shareholders
may opt in to comply with one or more of the financial statement preparation, audit and annual
report preparation requirements for an accounting period if shareholders holding at least 5% of
the voting shares require the company to comply (s. 207K CA 1993). In Delta’s case Bob Black has

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NZ written to require the company to prepare it financial statements and have them audited. Delta
will need to comply with this request as Bob holds more than 5% of the shares; however, the
financial statements do not need to be filed with the Registrar.
Pi Limited
Pi is an overseas owned company, which means that the size criteria (for whether it is required to
prepare financial statements) is smaller than for New Zealand resident companies. Section. 45(2)
FRA 2013 provides the size criteria which is: that as at the balance date of each of the two
preceding accounting periods, the total assets of the entity exceed $20 million or the total revenue
of the entity exceeds $10 million. If this criteria is met then s. 201 CA 1993 requires the company
to prepare financial statements. These financial statements must be audited and filed with the
Registrar of Companies (s. 207E CA 1993).
An overseas company qualifies as ‘large’ if they meet either of these two thresholds. In Pi’s
case, both revenue and assets are above the size criteria, so Pi is considered as a large overseas
company and therefore must prepare, file and have its financial statements audited.
Theta Limited
Theta is not an FMC reporting entity and is not large. In the absence of any other factors, there is
no requirement for Theta to prepare, file or have audited financial statements.

Step 3 – Form a conclusion as to whether each of the companies are

required to prepare, audit or file their financial statements with the
Registrar of Companies
The conclusion is shown in the solution.

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Solution – Task E NZ
Responses to each of Polly’s questions:
1. There are some New Zealand Accounting Standards that do not have an international
equivalent and FRS 44 New Zealand Additional Disclosures is an example. FRS 44 sets
out the specific disclosure requirements for entities preparing financial statements under
New Zealand GAAP (NZ IFRS and RDR).
2. The RDR is not a single document like IFRS for SMEs. In each New Zealand IFRS and
NZ IAS Standards any disclosures that are not required for entities following the RDR
are marked with an asterisk (*). Specific paragraphs relating to entities following RDR are
marked as RDR, for example ’RDR 8.1’.
3. Entities following the RDR must comply with the recognition and measurement paragraphs
in each Standard; however, the disclosures are reduced. In order to comply with IFRS, the
full Standards need to be complied with (including full disclosure requirements), so there is
no explicit compliance with IFRS.

Recommended approach – Task E

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the relevant guidance

Review FRS 44.

Step 2 – Apply the guidance to the scenario

Application of the guidance to Polly’s questions is shown in the solution.

Unit 1 – Suggested solutions to activities Page 1-19

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Page 1-20
Chartered Accountants Program Financial Accounting & Reporting

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Unit 2: Presentation of financial

statements
Activity 2.1
Preparing a statement of cash flows

Solutions

Task A
Stanhope Services Limited
Statement of cash flows for the year ended 30 June 20X6

Cash flows from operating activities

Cash receipts from customers 5,660,000

Cash payments to suppliers, employees and others (3,630,000)

Interest paid (10,000)

Income tax paid (300,000)

Net cash provided by operating activities 1,720,000

Cash flows from investing activities

Payment for equipment (500,000)

Net cash used in investing activities (500,000)

Cash flows from financing activities

Proceeds from share issue 1,300,000

Dividends paid (170,000)

Net cash from financing activities 1,130,000

Net increase in cash held 2,350,000

Cash at beginning of the year 240,000

Cash at end of the year 2,590,000

fin31702_actsols

Unit 2 – Suggested solutions to activities Page 2-1

Financial Accounting & Reporting Chartered Accountants Program

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Task B
Reconciliation of cash flows from operating activities to profit

Net profit for the year 994,000

Adjustments for items not related to operating activities

Depreciation expense 450,000

Changes in operating assets and liabilities

Trade receivables 250,000

Allowance for impairment loss – trade receivables (10,000)

Trade payables (90,000)

Current tax liability 126,000

Net cash provided by operating activities 1,720,000

Recommended steps

Task A
Step 1 – Determine the movement in the cash balances for the year
•• Scan through the extract from the financial statements to identify the cash and cash
equivalent balances:
–– The 20X5 comparatives show cash of $380,000 and a bank overdraft of $140,000.
Therefore, the opening cash balance for the statement of cash flows is $240,000 ($380,000
– $140,000).
–– At 30 June 20X6 there is a cash balance of $2,590,000.
–– The net increase in cash held is therefore $2,350,000 ($2,590,000 – $240,000).

•• The statement of cash flows will explain how Stanhope Services’ operating, investing and
financing activities created this $2,350,000 net cash inflow for the year ended 30 June 20X6.

Step 2 – Classify the items in the extract from the financial statements
Scan through the items in the extract from the financial statements and classify each according to
one of the following categories to determine which line item in the statement of cash flows each
item impacts:
•• Cash and cash equivalents.
•• Operating activity.
•• Investing activity.
•• Financing activity.
•• Non-cash item.

This classification will enable related accounts to be reconstructed/analysed when calculating the
specific cash flow. Comments are added to identify the interrelationship between accounts and
to take note of any specific facts.

Page 2-2 Suggested solutions to activities – Unit 2

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Classification of items from extract from financial statements

Account 30 June 20X6 30 June 20X5 Classification Comments

within cash
$ $ flow statement

Cash 2,590,000 380,000 Cash and cash Opening and closing balances
equivalents contribute to the cash movement
for the year

Trade receivables 750,000 1,000,000 Operating Receipts from customers are

activities credited to this account. Other
items (e.g. bad debts expense)
impact this account, therefore the
account must be reconstructed

Allowance for (50,000) (60,000) Operating Not a cash flow but used in the
impairment loss – activities calculation of receipts from
trade receivables customers. Impacts the trade
receivables account

Equipment at cost 2,500,000 2,000,000 Investing There have been no disposals

activities during the year, therefore the
debit movement represents asset
acquisitions

Accumulated (1,250,000) (800,000) Investing Not a cash flow, and given there
depreciation of activities are no asset disposals for the year,
equipment the movement will not impact
the calculation of equipment
acquisitions

Bank overdraft 0 (140,000) Cash and cash Opening and closing balances
equivalents contribute to the cash movement
for the year

Trade payables (590,000) (680,000) Operating Payment of creditors is debited

activities to this account. Other items
(e.g. other expenses) impact this
account, therefore the account
must be reconstructed

Dividend payable (150,000) (120,000) Financing Dividend payments are debited

activities to this account. Related to the
dividends declared account to
determine dividends paid

Current tax liability (426,000) (300,000) Operating Income taxes paid are debited
activities to this account. Related to the
income tax expense account to
determine income taxes paid

Share capital (2,500,000) (1,200,000) Financing The share issue during the year
activities was credited to this account

Revenue 5,500,000 Operating Not a cash flow but related to

activities the trade receivables account
to determine receipts from
customers

Impairment loss – (70,000) Operating Not a cash flow but related to

trade receivables activities the trade receivables account
to determine receipts from
customers

Bad debts expense (10,000) Operating Not a cash flow but related to
activities the trade receivables account
to determine receipts from
customers

Unit 2 – Suggested solutions to activities Page 2-3

Financial Accounting & Reporting Chartered Accountants Program

ACT

Classification of items from extract from financial statements

Account 30 June 20X6 30 June 20X5 Classification Comments

within cash
$ $ flow statement

Other expenses (4,000,000) Operating May be a mix of cash and non-

(including activities cash flows. Other expenses are
depreciation and related to the trade payables
interest expense) account to determine payments to
suppliers, employees and others
Other expenses includes
depreciation and interest paid,
neither of which relates to
payments to suppliers, employees
and others. Depreciation and
interest paid must be excluded
from the $4 million in other
expenses so that the correct cash
flow will be calculated in the trade
payables account

Income tax expense (426,000) Operating Not a cash flow but related to the
activities current tax liability account to
determine income taxes paid

Dividends declared (200,000) Financing Not a cash flow but related to the
activities dividends payable account to
determine dividends paid

Step 3 – Reconstruct the related accounts to calculate the specific cash flow
Remember this is only an extract from the company’s financial statements and thus there are no
balancing totals. However, sufficient information has been provided to prepare the statement of
cash flows.
The reconstruction method can be used to calculate the specific cash flows. T-accounts can be
created and reconstructed for each cash flow line item identified in Step 2. Other approaches can
be used to arrive at the same values.
T-accounts to calculate cash receipts from customers
Trade receivables
Dr Cr
$ $
Opening balance 1,000,000 Allowance for impairment loss – trade 80,000
receivables
Sales revenue 5,500,000 Bad debts expense 10,000
Closing balance 750,000
Cash – receipts from customers 5,660,000
6,500,000 6,500,000

Allowance for impairment loss – trade receivables

Dr Cr
$ $
Trade receivables 80,000 Opening balance 60,000
Closing balance 50,000 Impairment loss expense – trade 70,000
receivables
130,000 130,000

Page 2-4 Suggested solutions to activities – Unit 2

Chartered Accountants Program Financial Accounting & Reporting

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T-account to calculate payments to suppliers, employees and others

Trade payables

Dr Cr
$ $

Cash – payments to suppliers, 3,630,000 Opening balance 680,000

employees and others

Closing balance 590,000 Other expenses1 3,540,000

4,220,000 4,220,000

Note
1 Depreciation, as a non-cash item, does not belong in the trade payables reconstruction. The depreciation expense
must be calculated and then excluded from the other expenses value. Here, the movement in accumulated
depreciation provides the $450,000 depreciation expense, given that there were no disposals during the period.
Interest paid must be separately disclosed (as per IAS 7 para. 31) and therefore the cash outflow cannot be included
with payments to suppliers, employees and others. The $10,000 in interest paid must be subtracted from other
expenses so that the correct payments to suppliers, employees and others can be calculated.
Other expenses excluding depreciation and interest is therefore $3,540,000 ($4,000,000 in total for other expenses
– $450,000 depreciation expense – $10,000 interest paid)

T-account to calculate income tax paid

Cash – dividends paid2 170,000 Opening balance 120,000

Closing balance 150,000 Dividends declared1 200,000

320,000 320,000

Notes
1 Includes the $50,000 interim dividend paid in November 20X5.
2 The dividends paid represents the payment of the $120,000 dividend in the opening balance of the liability account
plus the $50,000 interim dividend.

T-account to calculate proceeds from share issue

Share capital

Dr Cr
$ $

Opening balance 1,200,000

Closing balance 2,500,000 Cash – proceeds from share issue 1,300,000

2,500,000 2,500,000

Step 4 – Prepare the statement of cash flows

Prepare the statement of cash flows by entering the cash flows calculated in Step 3 into a format
that complies with the disclosure requirements of IAS 7.
Check that the sum of the cash flows from operating, investing and financing activities agrees to
the movement in cash balances for the year in Step 1.
The statement of cash flows is shown in the solution.

Page 2-6 Suggested solutions to activities – Unit 2

Chartered Accountants Program Financial Accounting & Reporting

ACT

Task B
Step 1 – Calculate the profit for the year
The reconciliation starts with the net profit for the year; therefore, this value must be calculated
from the relevant amounts in the extract from the financial statements.
Net profit for the year is calculated as:

Revenue 5,500,000

Impairment loss – trade receivables 70,000

Bad debts expense 10,000

Other expenses 4,000,000

Income tax expense 426,000

Net profit for the year 994,000

Unit 2 – Suggested solutions to activities Page 2-7

Financial Accounting & Reporting Chartered Accountants Program

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Step 2 – Determine an approach to performing the reconciliation

AASB 1054 and FRS-44 do not specify how the reconciliation should be performed; however, the
approach discussed below is one common method used in practice.

Approach to performing the reconciliation

Disclosure Explanation for inclusion

Profit for the year While the requirements in AASB 1054 and FRS-44 refer to a reconciliation
of net cash flow from operating activities to profit (loss), in practice the
reconciliations are usually performed by using profit or loss as the starting
point, similar to the indirect method discussed in IAS 7 para. 20

Adjustments for non-cash As described in IAS 7 paras 20(b) and (c), profit or loss is adjusted for items
items or items for which the (i.e. items of income or expense) that are non-cash, such as depreciation, and
cash flows are investing or for items that relate to investing or financing cash flows
financing cash flows
Some items that are non-cash but relate to operating assets and liabilities are
not adjusted here, but in the next section of the reconciliation. For example,
impairment losses on trade receivables are non-cash items, but they are not
adjusted here, rather they are accounted for in the movement in the trade
receivables balance

Changes in operating assets Profit or loss is adjusted for the movement in operating assets and liabilities
and liabilities in the statement of financial position. It does not matter if these account
movements do not contain any cash flows. Non-cash flow entries cancel
themselves out when added to, or subtracted from, related items.
A useful rule to follow is to:
•• Subtract debit movements (i.e. an increase in assets or decrease in
liabilities) from profit, and
•• Add credit movements (i.e. a decrease in assets or increase in liabilities)
to profit

Net cash flow from operating The total profit for the period and all the adjustments and changes in
activities operating assets and liabilities should equal the net cash flow from operating
activities in the statement of cash flows

Step 3 – Prepare the reconciliation

The bottom line of the reconciliation agrees with the $1,720,000 net cash provided by operating
activities value in the statement of cash flows in Task A.
The reconciliation is shown in the solution.

Page 2-8 Suggested solutions to activities – Unit 2

Chartered Accountants Program Financial Accounting & Reporting

ACT

Activity 2.2
Preparing key financial statements (SPLOCI
and SOCE)

Solutions

Task A
Fur-Mates Limited
Statement of profit or loss and other comprehensive income for the year ended 30 June 20X6

Profit

Revenue 7,000,000

Cost of sales (3,700,000)

Gross profit 3,300,000

Settlement of legal suit 500,000

Other income 10,000

Distribution expenses (280,000)

Marketing expenses (640,000)

Occupancy expenses (700,000)

Administrative expenses (400,000)

Other expenses (90,000)

Finance costs (50,000)

Profit before tax 1,650,000

Income tax expense (495,000)

Profit for the year 1,155,000

Other comprehensive income

Items that will not be reclassified to profit or loss

Revaluation of land 300,000

Income tax effect (90,000)

Items that are or may be reclassified to profit or loss*

Item (on a before tax basis) _

Income tax effect on the item _

Other comprehensive income, net of tax 210,000

Total comprehensive income for the period 1,365,000

* This section in italics is presented here for illustration only.

Unit 2 – Suggested solutions to activities Page 2-9

Financial Accounting & Reporting Chartered Accountants Program

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Task B
Fur-Mates Limited
Statement of changes in equity for the year ended 30 June 20X6

Share Revaluation Retained Total

capital surplus earnings equity
$ $ $ $

Balance at 1 July 20X5 as previously 7,000,000 0 2,000,000 9,000,000

reported

Adjustment for impact of error – – 560,000 560,000

Restated balance at 1 July 20X5 7,000,000 0 2,560,000 9,560,000

Profit – – 1,155,000 1,155,000

Other comprehensive income – 210,000 – 210,000

Total comprehensive income – 210,000 1,155,000 1,365,000

Transactions with owners

Shares issued 3,000,000 3,000,000

Dividend (600,000) (600,000)

Balance at 30 June 20X6 10,000,000 210,000 3,115,000 13,325,000

Page 2-10 Suggested solutions to activities – Unit 2

Recommended steps

Task A
Step 1 – Identify the types of issues and read the relevant paragraphs in the Accounting Standards
Type of issue Relevant Accounting Standard paragraphs
Chartered Accountants Program

Revenue and expense items for the year are included IAS 1 paras 81A–82 and 97–105
in the statement of profit or loss section

Unit 2 – Suggested solutions to activities

Prior period error IAS 8 para. 42

Prepaid insurance Conceptual Framework, definitions of expense

(para. 70(b)) and asset (para. 49(a))

Other comprehensive income disclosure for a current IAS 1 paras 82A and 90–91
year movement in a reserve

Step 2 – Prepare the SPLOCI

•• Work through each line in the extract from the trial balance to prepare the SPLOCI.
•• Tick off each piece of information that you use to ensure you capture all the items.
•• If you are unsure of the accounting treatment for the prepayments or other items in the extract from the trial balance, you should revise your bookkeeping
notes from your university study, or other resources.
•• Consider the additional information as this has implications for the categorisation within the SPLOCI.
•• The table below can be used to prepare the SPLOCI. It contains a summary of the relevant information to help you apply the requirements from the relevant
Accounting Standards.
ACT

Page 2-11
Financial Accounting & Reporting
ACT

Page 2-12
Fur-Mates Limited Not part of the statement but provided to support the values and explain the treatment*
Statement of profit or loss and other Workings Explanation of treatment Reference to the relevant
comprehensive income for the year ended 30 June Accounting Standard to
20X6 support treatment

Profit IAS 1 para. 81A

Financial Accounting & Reporting

Revenue 7,000,000 $5,000,000 dog food Fur-Mates wants to comply with the minimum disclosure requirements IAS 1 para. 82(a)
+ $2,000,000 cat of the Accounting Standards, therefore information from the trial balance
food should be summarised

Cost of sales (3,700,000) $3,000,000 dog food The company classifies expenses by function IAS 1 paras 99 and 103
+ $700,000 cat food

Gross profit 3,300,000 IAS 1 para. 103

Settlement of legal suit 500,000 Separate disclosure as this item of income is material IAS 1 paras 97 and 98(f )

Other income 10,000 Interest income IAS 1 paras 85 and 103

Distribution expenses (280,000) $200,000 dog food + Not required to be itemised IAS 1 para. 103
$80,000 cat food

Marketing expenses (640,000) Not required to be itemised IAS 1 para. 103

Occupancy expenses (700,000) $800,000 – $100,000 Rather than expensing the $100,000 in insurance costs, the amount should IAS 1 para. 103 (in relation to
in prepaid insurance have been recognised as a prepayment. It should have been recognised the $700,000)
in the statement of financial position as an asset and the following journal
entry should have been recorded:
Dr Prepayment $100,000 Conceptual Framework
definitions of expense
Cr Cash $100,000
(para. 70(b)) and asset
(Being prepayment of insurance for July–September 20X6) (para. 49(a))
A correcting journal entry will need to be recorded to transfer the amount
from occupancy expenses to the prepayments account

Administrative expenses (400,000) IAS 1 para. 103

Other expenses (90,000) $140,000 –$50,000 The interest expense must be separately disclosed so it cannot be included IAS 1 para. 103
Chartered Accountants Program

although para. 103 shows this

Unit 2 – Suggested solutions to activities

line in an example IAS 1 para. 85

Income tax expense (495,000) Must be separately disclosed IAS 1 para. 82(d)

Profit for the year 1,155,000 IAS 1 para. 81A(a)

Other comprehensive income IAS 1 para. 82A

Items that will not be reclassified

to profit or loss

Revaluation of land 300,000 Movement in revaluation surplus reserve for the year. This is the first time IAS 1 para. 82A(a)
there is an increment

Income tax effect (90,000) The tax relating to the reserve movement must also be disclosed IAS 1 para. 91
(alternatively the revaluation could be shown net of tax)

Items that are or may be There are no items in OCI that may be reclassified through profit or loss;
reclassified to profit or loss however, it has been shown here in the workings for completeness

Item (on a before tax basis) _ IAS 1 para. 82A(b)

Income tax effect on the item _ IAS 1 para. 91

Other comprehensive income, 210,000 IAS 1 para. 81A(b)

net of tax

Total comprehensive income for 1,365,000 $1,155,000 profit for IAS 1 para. 81A(c)
the period the year + $210,000
OCI
* Note that these workings, explanation of treatment and reference to the Accounting Standards are provided to explain the values and descriptions in the SPLOCI.
ACT

Page 2-13
Financial Accounting & Reporting
Financial Accounting & Reporting Chartered Accountants Program

ACT

Exclusion
The $800,000 dividend income understatement should be accounted for as a prior period
error (along with the related $240,000 in income tax expense). The error should be recognised
retrospectively (IAS 8 para. 42) by adjusting the comparative financial statements for the year
ended 30 June 20X5, and therefore should not be included in this year’s profit. This $560,000
adjustment after tax ($800,000 – $240,000) will increase the opening retained earnings balance
from $2,000,000 to $2,560,000.

Task B
Step 1 – Review the Standard
Review IAS 1 paras 106–110.

Step 2 – Identify the equity items that will be shown in the statement
Review the extract from Fur-Mates’ trial balance to identify that the statement of changes in
equity will need to reconcile three equity items for their movements during the year:
•• Share capital.
•• Revaluation surplus.
•• Retained earnings.

Step 3 – Identify the movements that will be shown in the statement

The movement during the year for each equity item should capture the following:

Equity item Movements to be shown in the statement

Share capital Share issue

Revaluation surplus Movement in the revaluation surplus

Retained earnings •• Adjustment to opening retained earnings for the prior year error
•• Profit for the year
•• Dividend paid

Step 4 – Prepare the statement of changes in equity

•• Prepare the statement of changes in equity using the wording from IAS 1 to create
appropriate descriptions within the statement.
•• Bring forward the relevant totals from SPLOCI along with the appropriate information from
the extract from Fur-Mates’ trial balance.
•• Ensure that the statement adds across and adds down to the same total.
•• The statement of changes in equity is shown in the solution.

Page 2-14 Suggested solutions to activities – Unit 2

Chartered Accountants Program Financial Accounting & Reporting

ACT

Activity 2.3
Accounting for changes in accounting
policies and estimates

Solution
The impact of IAS 8 on each issue and the related impact on the financial statements are
summarised in the following table:

Summary of IAS 8 impact on financial statements

Item 20X6 20X5 comparative financial

statements

Reassessing the useful life of the No change to the depreciation No impact as the change in
machinery expense up to 31 December 20X5 accounting estimate is applied
prospectively from 1 January 20X6
Lower depreciation expense from
1 January 20X6 when the useful
life is increased to apply the
change in the accounting estimate
prospectively

Presentation of statement of cash The statement of cash flows will be The 20X5 statement of cash flows
flows presented using the direct method will be presented using the direct
for the change in account policy method to give retrospective effect
to this change in accounting policy

Long service leave entitlement in IAS 8 has no impact as it is neither IAS 8 has no impact as it is neither
new industrial agreement a change in accounting policy or a change in accounting policy or
change in accounting estimate change in accounting estimate

The explanation for the accounting treatment is summarised in Step 3 of the recommended
approach.

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Review IAS 8 for guidance to determine the nature of each issue. IAS 8 para. 5 contains the
definitions of ‘accounting policies’ and ‘change in accounting estimate’. More detail is provided
in IAS 8 in the following paragraphs:
Changes in accounting policies – paras 14–19.
Changes in accounting estimates – paras 32–38.

Unit 2 – Suggested solutions to activities Page 2-15

Financial Accounting & Reporting Chartered Accountants Program

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Step 2 – Identify the nature of the issues

Apply the relevant guidance from IAS 8 in order to identify the nature of each issue.

Heavy Industries Limited – Nature of issues

Issue Explanation Nature

Reassessing the useful life Changing the calculation of the depreciation Change in accounting estimate
of the machinery meets the definition of a change in accounting
estimate in IAS 8 para. 5 (i.e. the original estimate
of the useful life was changed to reflect new
information, notwithstanding that it was correct
at the time of purchase)

Presentation of statement The change from the indirect to the direct Change in accounting policy
of cash flows method of presenting a statement of cash flows
is a voluntary change in accounting policy
The change to the direct method should result in
the financial statements providing reliable and
more relevant information about the cash flows
of Heavy Industries, in accordance with IAS 8
para. 14(b)

Long service leave The improved entitlement under the agreement Not a change in accounting
entitlement in new represents a change in a condition that differs policy
industrial agreement substantially from the previous agreement.
Therefore, it is not a change in accounting policy
in accordance with IAS 8 para. 16(a)
Neither is it an estimate as the entitlement is Not a change in accounting
specified rather than estimated (IAS 8 para. 32) estimate

Step 3 – Determine the accounting treatment for the issues

Determine the accounting treatment for each of the issues, in accordance with IAS 8.

Heavy Industries Limited – IAS 8 accounting treatment for each issue

Issue Accounting treatment

Reassessing the useful A change in accounting estimate should be applied prospectively (IAS 8 paras 36–
life of the machinery 38)
Depreciation from 1 January 20X6 for the machinery should be calculated based on
the revised estimate of the useful life. This will decrease the depreciation expense
due to the increased estimate of the useful life
As a change in an accounting estimate is applied prospectively:
•• Depreciation on the machinery for the six months to 31 December 20X5 should
be recognised on the basis of the original estimate of the useful life
•• Depreciation recognised to date that is captured within opening retained
earnings for prior reporting periods is not changed

Presentation of A voluntary change in accounting policy must be accounted for retrospectively

statement of cash flows (IAS 8 para. 19(b))
Accordingly, the 30 June 20X5 comparative statement of cash flows should be
presented using the direct method to apply this change retrospectively

Long service leave IAS 8 does not apply to this change

entitlement in new
The improved entitlement arising under the agreement reached on 30 June 20X6
industrial agreement
will be accounted for in accordance with the relevant Accounting Standard (IAS 19
Employee Benefits)

A summary of the impact of each issue on the financial statements is shown in the solution.

Page 2-16 Suggested solutions to activities – Unit 2

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ACT

Activity 2.4
Identifying related parties

Solution
Identifying related parties of Renovation

Party Related Justification IAS 24

party? para. 9
Yes/No reference

Plasterer No Plasterer does not meet the definition of a related party as none of n/a
the conditions in IAS 24 para. 9(b) apply

Plumbing Yes Plumbing is an associate of Renovation (b)(ii)

Electrician Yes Electrician is a joint venture of a member of the group (b)(ii)

Building Yes Building and Renovation are members of the same group (b)(i)

Mike Hammer Yes Mike is a member of the key management personnel (KMP) of (a)(iii)
Renovation

Sue Hammer Yes Sue is the spouse of Mike and therefore is a close family member of (a)(iii)
a member of the KMP of Renovation

Eloise Hammer Yes* Eloise is the child of Mike and therefore is a close family member of (a)(iii)
the KMP of Renovation

Mandy Saw No Mandy is a member of the KMP of an investment of Renovation – n/a

this entity is not classified as a related party of Renovation – she is
not classified as a related party as IAS 24 para. 9(a)(iii) is limited to
KMPs of the reporting entity or a parent of the reporting entity

Tran Saw No Tran is a member of the KMP of a subsidiary of Renovation – he is n/a

not classified as a related party as IAS 24 para. 9(a)(iii) is limited to
KMPs of the reporting entity or a parent of the reporting entity

John Pipe No John is a member of the key management personnel of an n/a

associate of Renovation and of the associate’s joint venture – he is
not classified as a related party as IAS 24 para. 9(a)(iii) is limited to
KMPs of the reporting entity or a parent of the reporting entity

*A
pplying the strict definition of a related party and close members of the family of a person from IAS 24 para. 9, Eloise
could be a related party of Renovation. However, as Eloise is only two years old, it could be argued that in substance
she is not a related party (IAS 24 para. 10) as she would not have influence over Renovation.

Unit 2 – Suggested solutions to activities Page 2-17

Financial Accounting & Reporting Chartered Accountants Program

ACT

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Review IAS 24 para. 9 for definitions that are relevant to identifying the related parties of
Renovation, specifically:
•• Related party.
•• Close members of the family of a person.
•• Key management personnel.

Step 2 – Prepare to apply the Standard

Identify all parties that have a connection with Renovation and create a table to apply the
definitions from IAS 24 para. 9 in order to establish whether or not they are related parties of
Renovation.

Identifying related parties of Renovation

Party Related Justification IAS 24

party? para. 9
Yes/No reference

Plasterer

Plumbing

Electrician

Building

Mike Hammer

Sue Hammer

Eloise Hammer

Mandy Saw

Tran Saw

John Pipe

Step 3 – Identify the related parties of Renovation

Consider the relationship of the parties identified in Step 2 to Renovation, with reference to the
definition of a related party in IAS 24 para. 9.
Complete the table, justifying why a party is or is not a related party.
The table is shown in the solution.

Page 2-18 Suggested solutions to activities – Unit 2

Chartered Accountants Program Financial Accounting & Reporting

ACT

Activity 2.5
Accounting for events after the reporting
period

Solution
The table summarises the impact of the two events on ABC’s financial statements for the year
ended 30 June 20X6.

Accounting treatment of the events

Event Accounting treatment

Warranty claim The warranty claim occurred after the reporting period and is therefore
an adjusting event. It provides evidence that the entity had a present
obligation for warranty costs at 30 June 20X6
Recognise a provision
As the total cost of replacement ($250,000 + $1,000,000) is material, it will
be recorded as a warranty provision at 30 June 20X6 in ABC’s financial
statements (i.e. IAS 10 paras 8–9 require adjusting events to be recognised
in the financial statements). ABC’s current treatment of disclosing this
event in the notes to the financial statements is not correct, as such
treatment applies only to to non-adjusting events
Write down the inventory
The inventory from the affected batches must be written down to the
lower of cost and net realisable value as at 30 June 20X6

Car crash The car crash occurred after the end of the reporting period. Consequently,
the lawsuit against ABC provides evidence of a condition that arose after
the reporting date. It is therefore a non-adjusting event
Although ABC does not expect the claim to be successful, the event itself
is material, and must therefore be disclosed as a non-adjusting event
under IAS 10 para. 21 in the notes to ABC’s financial statements. This note
disclosure should also include an estimate of the financial effect of the
claim

Unit 2 – Suggested solutions to activities Page 2-19

Financial Accounting & Reporting Chartered Accountants Program

ACT

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Review IAS 10 paras 3, 8–11, 19 and 21.

Step 2 – Plot the events on a timeline

Read the scenario and plot each event on a timeline.
A timeline could be presented as follows:

End of
reporting Issue of financial
Did condition of
period statements
the faulty breaks
exist at 30 June
20X6? 20X6
JUNE

30
Did the condition
that triggered the
lawsuit exist at
30 June 20X6?
EVENT
EVENT car crash
warranty
claim for
Brakes sold faulty brakes

Step 3 – Identify any evidence of the condition existing at the end of

the reporting period
Apply the relevant guidance from IAS 10 to identify whether there is evidence that the condition
existed at the end of the reporting period.

Identification of the nature of events

Event Nature of the event Conclusion – did the

condition exist at the end
of the reporting period?

Warranty The brakes and the associated warranty were sold in January and Yes, the condition existed
claim February 20X6. The recall confirms that the entity had a present at 30 June 20X6
obligation at the end of the reporting period

According to the three signed sales contracts, Build-and-Drive has agreed to the following three
performance obligations:
•• Sale of 20 heavy haulage trucks.
•• Sale of 10 small delivery vehicles.
•• Maintenance and service of the trucks and delivery vehicles for one year.

Step 3 – Determine the transaction price

The transaction price can be calculated as follows:

Contract with Deliver-a-Lot – heavy haulage trucks (20 × $100,000) 2,000,000

Contract with Deliver-a-Bit – delivery vehicles (10 × $15,000) 150,000

Contract with All-Your-Delivery-Needs – service and maintenance (per contract) 100,000

Transaction price 2,250,000

There is no financing component in the transaction price, because there is not more than
12 months difference between the date of cash received and the date of revenue recognition.
The transaction price also does not include a variable consideration.

Step 4 – Allocate the transaction price

The transaction price of $2,250,000 is allocated to the three performance obligations based on
their stand-alone selling prices as follows:

Performance obligation Stand-alone Transaction rice

selling price allocated

$ $

Sale of 20 heavy haulage trucks (20 × $95,000) 1,900,000 1,820,698

Sale of the 10 small delivery vehicles (10 × $40,000) 400,000 383,305

Maintenance and service of the 20 heavy haulage trucks (20 × $2,000) 48,000 45,997
and the 10 small delivery vehicles (10 × $800)

Total 2,348,000 2,250,000

Page 3-2 Suggested solutions to activities – Unit 3

Chartered Accountants Program Financial Accounting & Reporting

ACT

Step 5 – Recognise revenue when a performance obligation is

satisfied
Build-and-Drive will recognise revenue when the performance obligations are satisfied
as follows:

•• Sale of 20 heavy haulage trucks – at a point in time 1 January 20X7

•• Sale of the 10 small delivery vehicles – at a point in time 1 January 20X7

•• Maintenance and service of the heavy haulage trucks and delivery 1 January 20X7 to 31 December 20X7
vehicles – over time

It is important to note that the dates of receipt of the cash amounts have no impact on the timing
of the revenue recognition. None of the steps in the five-step revenue model refers to cash
received. Therefore, the date of recognition of revenue does not necessarily coincide with the
date of receipt of the related cash.
The following journal entries illustrate the recognition of revenue in terms of the five-step
revenue model, as well as the receipt of the related cash amounts. The revenue being recognised
on the sale of the trucks differs to the trade receivable, because the contracts were combined and
the transaction price allocated between performance obligations based on relative stand-alone
selling prices.

Page 3-4 Suggested solutions to activities – Unit 3

Chartered Accountants Program Financial Accounting & Reporting

ACT

Activity 3.2
Identifying the potential impact of IFRS 15

Step 1 – Identify the contract(s) with a customer

Identifying the contract
The contract should be accounted for in terms of IFRS 15, for the following reasons:
•• There was no information to suggest that the parties to the contract have not approved the
contract and that they are not committed to perform their respective obligations.
•• Buildicoat can identify each party’s rights regarding the goods and services to be delivered.
•• Buildicoat can identify the payment terms outlined in the contract.
•• The contract has commercial substance.
•• It is probable that the entity will collect the consideration (or nothing in the information that
suggests otherwise).

Considering the potential combination of contracts

Not applicable, because only one contract.

Step 2 – Identify the separate performance obligations

According to the signed sales contract, Buildicoat has agreed to the following two performance
obligations:
•• A coating service.
•• An after-sales cleaning service.

Step 3 – Determine the transaction price

The transaction price is $120,000.
There is no financing component in the transaction price, because there is not more than 12
months difference between the date of cash received and the date of revenue recognition. The
transaction price also does not include a variable consideration.

Step 4 – Allocate the transaction price

The stand-alone selling price of the coating service is $90,000 and the stand-alone selling price
of the after-sales cleaning cannot be determined. Also, Buildicoat’s engineers cannot provide
an expected cost estimate for the future cleaning costs. Therefore, the residual approach is used
to allocate the transaction price to the two performance obligations. The transaction price of
$120,000 is allocated as follows:

Unit 3 – Suggested solutions to activities Page 3-5

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Contract price 120,000

A coating service 90,000

An after-sales cleaning service (residual) 30,000

Step 5 – Recognise revenue when a performance obligation is

satisfied
Buildicoat will recognise revenue for both services over time, for the following reasons:
•• Coating service – Buildicoat has an enforceable right to payment for work completed to date,
and Buildicoat’s performance creates an asset with no alternative use to the entity.
•• After-sales cleaning service – the customer simultaneously receives and consumes the
benefits provided by Buildicoat’s performance as Buildicoat performs. Buildicoat would
recognise this revenue on a straight line basis during the period of this service.

Buildicoat will recognise revenue when the two performance obligations are satisfied as follows:

A coating service 1 June 20X7 to 31 October 20X7, recognised in line with % completion

An after-sales cleaning service 1 November 20X7 to 30 June 20X8, recognised on a straight line basis

Date Account description Dr Cr

$ $

30.11.20X7# Revenue received in advance 30,000

and each Trade receivable 30,000

month end to
30.06.20X8

Allocation of revenue received in advance against trade receivables

Notes
# The last two journals for after sales cleaning revenue recognition would generally be done on a monthly basis,
at $30,000 ÷ 8 = $3,750 each month, from 31 December 20X7 to 30 June 20X8.
** the revenue from the coating work would normally recognised each month, in line with the percentage completion
at each month end. Exam questions will either direct candidates on the timing of revenue recognition, or markers
would accept a variety of responses.

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Page 3-8
Chartered Accountants Program Financial Accounting & Reporting

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Unit 4: Income taxes

Activity 4.1
Accounting for income taxes

Solution
The two tax journal entries which will be included in Kunapipi’s financial statements for the year
ended 30 June 20X3 are as follows:
Journal entry to account for the current tax liability at 30 June 20X3

Date Account description Dr Cr

$ $

30.06.X3 Income tax expense 45,300

Share capital 1,200

Deferred tax asset (DTA) 27,000

Current tax liability 17,100

To record the current tax liability and recognise the utilisation of carryforward tax losses

Journal entry to account for the deferred tax movement at 30 June 20X3

Date Account description Dr Cr

$ $

30.06.X3 DTA 23,400

Income tax expense 9,600

Deferred tax liability (DTL) 9,000

Share capital 4,800

To record the movement in the deferred tax balances at 30 June 20X3

fin31704_actsols

Unit 4 – Suggested solutions to activities Page 4-1

Financial Accounting & Reporting Chartered Accountants Program

ACT

Recommended approach
The followings steps outline the recommended approach to successfully complete this task:

Preliminary step – Identify the journal entries required

Journal entries will need to be prepared, to account for Kunapipi’s current tax liability at 30 June
20X3 and for the movement in deferred tax balances for the year ended 30 June 20X3.

Preliminary step – Review the Standard

Review IAS 12 Income Taxes for the relevant guidance.
The following paragraphs are applicable in relation to current tax and deferred tax:

IAS 12 paragraphs that offer relevant guidance

Item Definition Recognition Measurement

Current tax Para. 5 Para. 12 Para. 46

Deferred tax liability (DTL) Para. 5 Para. 15 Paras 47, 51, 53

Deferred tax asset (DTA) Para. 5 Para. 24 Paras 47, 51, 53, 56

Unused tax losses and unused tax credits – Paras 34–36 Paras 47, 51, 53, 56

The following paragraphs provide further guidance relating to the tax base, taxable temporary
differences (TTDs) and deductible temporary differences (DTDs) for calculating deferred tax:

IAS 12 paragraphs relevant to calculating deferred tax

Item Definition Guidance

Tax base Para. 5 Paras 7–11

TTDs Para. 5 Paras 15 and 16

DTDs Para. 5 Paras 24 and 25

Current tax liability

Step 1 – Set up a worksheet to calculate the current tax liability
Set up a worksheet to calculate the current tax liability. Start with the accounting profit for
the period and note the categories of adjustments that may be identified from the financial
information for the period. These categories are:
•• Items where the tax and accounting treatments are never the same (non-temporary difference
adjustments).
•• Items where tax and accounting treatments are the same but in different periods (temporary
difference adjustments). This information will be useful later when performing the deferred
tax journal entries.
•• Equity or other comprehensive income (OCI) differences affecting taxable income.

Page 4-2 Suggested solutions to activities – Unit 4

Chartered Accountants Program Financial Accounting & Reporting

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Worksheet to calculate the current tax liability at 30 June 20X3

Item $ $

Accounting profit before tax 115,000

1. Non-temporary difference adjustments

2. Temporary difference adjustments

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability

Step 2 – Identify the items that require adjustment in the calculation

of taxable income
Review the statement of profit or loss and the statement of financial position to identify items
where the accounting treatment is different from the treatment for tax purposes. Categorise the
items and provide a summary of where adjustments are required:

Nature of adjustment Items requiring adjustment

1. Items where the tax and accounting treatments •• Profit on sale of investment
are never the same (non-temporary difference •• Entertainment expenses
adjustments)

2. Items where tax and accounting treatments are •• Depreciation – buildings

the same but in different periods (temporary •• Development costs incurred and amortisation
difference adjustments) thereon
•• Annual leave
•• Allowance for impairment loss – trade receivables
expense

3. Equity or OCI differences Share issue costs

Unit 4 – Suggested solutions to activities Page 4-3

Financial Accounting & Reporting Chartered Accountants Program

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Step 3 – Calculate the adjustments required to complete the calculation

of taxable income and current tax liability
Deal with each item in turn and total the worksheet to calculate the taxable income and the
current tax liability.
Please note that an explanation of the treatment has been provided to aid understanding but it is
not required to complete the worksheet.

Worksheet to calculate current tax liability at 30 June 20X3

Item Explanation of treatment $ $

Accounting profit before tax 115,000

1. Non-temporary difference
adjustments

Profit on sale of investment The profit on sale is income for accounting (8,000)
purposes. It will never be assessable for tax
and needs to be subtracted to undo the
income recognised in the accounting profit

Entertainment expenses The costs are an accounting expense 12,000

but are not allowable as a tax deduction
and need to be added back to undo
the expense recognised in the
accounting profit

4,000

2. Temporary difference
adjustments

Accounting depreciation – The item is an expense for accounting 100,000

buildings purposes but is not allowable as a tax
deduction and needs to be added back

Tax depreciation – buildings The deduction for tax depreciation needs (50,000)
to be subtracted

Development amortisation The item is an expense for accounting 20,000

purposes but is not allowable as a tax
deduction and needs to be added back

Development costs incurred1 The deduction for development costs (50,000)

incurred during the year needs to be
subtracted

Annual leave expense The item is an expense for accounting 4,000

purposes but is not allowable as a tax
deduction and needs to be added back

Annual leave paid2 The deduction for annual leave paid needs (12,000)
to be subtracted

Allowance for impairment loss – The item is an expense for accounting 25,000
trade receivables expense purposes but is not allowable as a tax
deduction and needs to be added back

Bad debts written off3 The deduction for the bad debts written off (5,000)
needs to be subtracted

32,000

Taxable income prior to equity 151,000

or OCI adjustments and utilising
carryforward tax losses

Page 4-4 Suggested solutions to activities – Unit 4

Chartered Accountants Program Financial Accounting & Reporting

ACT

Worksheet to calculate current tax liability at 30 June 20X3

Item Explanation of treatment $ $

3. Equity or OCI adjustments

affecting taxable income

Tax deduction for share issue costs The $20,000 in share issue costs were (4,000)
correctly debited against the share
capital account and, of this total, $4,000
are deductible this year. The $4,000 tax
deduction has not been included in
the accounting profit and needs to be
subtracted when calculating taxable
income

Taxable income prior to utilising 147,000

carryforward tax losses

Less: Utilisation of carryforward tax The tax losses may be utilised in the year (90,000)
losses ended 30 June 20X3. They are treated
under the tax law as a tax deduction and
need to be subtracted as they are not
included in the accounting profit

Taxable income 57,000

Current tax liability at 30% 17,100

Notes
1. $140,000 capitalised development cost balance at 30 June 20X3 – $90,000 capitalised development cost balance
at 30 June 20X3 = $50,000.
2. $30,000 annual leave liability balance at 30 June 20X2 + $4,000 annual leave expense – $22,000 annual leave liability
balance at 30 June 20X3 = $12,000 annual leave paid.
3. $20,000 allowance for impairment loss – trade receivables balance at 30 June 20X2 + $25,000 allowance for
impairment loss – trade receivables expense – $40,000 allowance for impairment loss – trade receivables balance
at 30 June 20X2 = $5,000 bad debts written off.

Step 4 – Prepare the journal entry to record the current tax liability
Using the figure calculated in the worksheet, prepare the journal entry for the current tax liability
at 30 June 20X3. The journal entry is shown in the solution.
To aid your understanding, the lines in the journal entry can be explained as follows:
•• The debit of $45,300 in the journal entry against the income tax expense equates to 30% of
the $151,000 taxable income prior to deducting the $4,000 in share issue costs and utilising
the $90,000 in carryforward losses. This is because the underlying transactions were all
recognised in profit (and not in other comprehensive income or equity).
•• The credit of $1,200 in the journal entry against share capital equates to 30% of the $4,000
share issue costs that give rise to a tax deduction this year. IAS 12 para. 61A(b) requires the
tax relating to an underlying transaction recognised directly in equity to be recorded against
that transaction.
•• The credit of $27,000 in the journal entry against the DTA equates to 30% of the $90,000 tax
losses that have been utilised in the current year as a tax deduction to reduce taxable income
that had been recognised as an asset under IAS 12.
•• The credit of $17,100 in the journal entry to the current tax liability equates to 30% of the
$57,000 taxable income.

Unit 4 – Suggested solutions to activities Page 4-5

Financial Accounting & Reporting Chartered Accountants Program

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Deferred tax movements

Step 1 – Calculate temporary differences at the end of the reporting period
To identify a temporary difference, examine those assets and liabilities at 30 June 20X3 where
the tax base and the accounting carrying amount differ. This can be done by examining the
following:
•• The assets and liabilities included in the extract of the internal statement of financial position
at 30 June 20X3.
•• The worksheet will allow you to calculate the current tax liability at 30 June 20X3 as item 2 in
the worksheet showed temporary difference adjustments.

A temporary difference also arises in relation to some of the $20,000 in share issue costs that have
been recognised directly in equity. Of these total costs, $16,000 will be tax deductible in future
years, thus giving rise to a temporary difference at 30 June 20X3.
The treatment of items such as cash, trade payables and borrowings is the same for tax and
accounting purposes for Kunapipi, and these items therefore do not give rise to a temporary
difference.
The items where there is a temporary difference are:
•• Trade receivables.
•• Buildings.
•• Capitalised development costs.
•• Annual leave liability.
•• Share issue costs (recognised within the share capital account).

Calculate the temporary differences at 30 June 20X3 by subtracting the tax base of the item from
its carrying amount as follows:

Calculation of temporary differences at 30 June 20X3

Item Carrying amount Tax base Temporary difference

$ $ $

Trade receivables 145,000 185,0001 40,000

Buildings 700,000 850,0002 150,000

Capitalised development costs 80,000 03 80,000

Annual leave liability 22,000 04 22,000

Share issue costs 06 16,0005 16,000

Page 4-6 Suggested solutions to activities – Unit 4

Chartered Accountants Program Financial Accounting & Reporting

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Notes Tax base calculation

Formula-based approach OR Notional tax balance sheet approach

1. Trade receivables $145,000 carrying amount – $0 If a notional tax balance sheet

future taxable amounts (as the was prepared, $185,000 would be
$185,000 tax base
revenue has already been assessed recognised for the trade receivables
for tax purposes) + $40,000 in future asset.
deductible amounts
The $40,000 allowance for
impairment loss would not be
recognised because a tax deduction
only arises when the receivables are
actually written off

2. Buildings $700,000 carrying amount – If a notional tax balance sheet was

$700,000 future taxable amounts prepared, the building’s $850,000
$850,000 tax base
(capped at the asset’s carrying tax written down value would be
amount) + $850,000 in future recognised
deductible amounts

3. Capitalised $80,000 carrying amount – $80,000 If a notional tax balance sheet was
development costs future taxable amounts (capped at prepared, $0 would be recognised
the asset’s carrying amount) + $0 in for capitalised development costs as
$0 tax base
future deductible amounts the costs were tax deductible when
incurred

4. Annual leave liability $22,000 carrying amount – $22,000 If a notional tax balance sheet
in future deductible amounts (as was prepared, the liability for the
$0 tax base
the deduction is allowed at the time annual leave liability would not be
of payment) + $0 future taxable recognised, as the tax deduction will
amounts (as a liability will not be only be recognised for tax purposes
taxable) when annual leave is paid

5. Share issue costs IAS 12 does not suggest a formula for If a notional tax balance sheet
a temporary difference within equity. was prepared, $16,000 would
$16,000 tax base
However, para. 10 provides guidance be recognised for the future tax
that the tax base can be determined deductions
by considering whether future tax
payments will be smaller or larger.
Accordingly, the tax base of the share
issue costs is $16,000 representing
the future deductible amounts as
these will result in smaller future tax
payments

6. The carrying amount of the share issue costs is $0 as this amount is offset against equity, and not included
as an asset or liability.

Unit 4 – Suggested solutions to activities Page 4-7

Financial Accounting & Reporting Chartered Accountants Program

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Step 2 – Allocate temporary differences

Once the temporary difference for each item has been calculated, determine whether each item
resulted in a taxable temporary difference or a deductible temporary difference.

Allocation of temporary differences

Item Carrying Tax base Temporary Applicable rule TTD or DTD

amount difference
$ $ $

Trade receivables 145,000 185,000 40,000 Asset rule: $40,000 DTD

Carrying amount < tax base

Buildings 700,000 850,000 150,000 Asset rule: $150,000 DTD

Carrying amount < tax base

Capitalised 80,000 0 80,000 Asset rule: $80,000 TTD

development costs Carrying amount > tax base

Annual leave 22,000 0 22,000 Liability rule: $22,000 DTD

liability Carrying amount > tax base

Share issue costs 0 16,000 16,000 No applicable rule $16,0001 DTD

Note
1. The $16,000 in future tax deductions for share issue costs will make future tax payments smaller. Accordingly, the $16,000
is a DTD.

Step 3 – Calculate deferred tax balances at the end of the reporting period
Create a table to input the relevant information from the previous steps. Complete the table to
calculate the deferred tax balances at the end of the reporting period. A separate column is added
for the share issue cost DTD as the deferred tax movement will be recognised in equity rather
than in income tax expense (IAS 12 para. 61A requires the related tax effect to be recognised
outside profit or loss where the tax relates to an item recognised outside profit or loss).

Calculation of deferred tax balances as at 30 June 20X3

Item Carrying Tax base TTD DTD DTD

amount (equity)
$ $ $ $ $

Trade receivables 145,000 185,000 40,000

Buildings 700,000 850,000 150,000

Capitalised 80,000 0 80,000

development costs

Annual leave liability 22,000 0 22,000

Share issue costs 0 16,000 16,000

Total temporary 80,000 212,000 16,000

differences

DTL/DTA at 30% 24,000 63,600 4,800

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Step 4 – Apply recognition criteria

Examine the criteria for recognising a DTA and DTL. Assume that, in these circumstances,
Kunapipi continues to satisfy the IAS 12 requirements at 30 June 20X3.

Step 5 – Calculate movement in deferred tax balances

The opening balances in the deferred tax asset and liability accounts carry forward from the
previous year. Therefore, it is necessary to determine the movement in the deferred tax balances
from 30 June 20X2 to 30 June 20X3 as the movement will be recorded in a journal entry. The
movement is calculated by subtracting the opening balance in the deferred tax asset and
liability accounts.
The DTA relating to the carryforward tax loss that was fully utilised when calculating the current
tax liability is excluded, as the journal entry has already been recorded to derecognise the related
$27,000 DTA balance.

Calculation of deferred tax balances as at 30 June 20X3

Item Carrying Tax base TTD DTD DTD

amount (equity)
$ $ $ $ $

Trade receivables 145,000 185,000 40,000

Buildings 700,000 850,000 150,000

Capitalised development 80,000 0 80,000

costs

Annual leave liability 22,000 0 22,000

Share issue costs 0 16,000 0 0 16,000

Total temporary 80,000 212,000 16,000

differences

DTL/DTA at 30% 24,000 63,600 4,800

Less: opening balances (15,000) (45,000) 0

Movement 9,000 18,600 4,800

Step 6 – Prepare journal entry

Record the journal entries based on the movement calculated in Step 5.

Date Account description Dr Cr

$ $

30.06.X3 DTA 18,600

Income tax expense1 9,600

DTL 9,000

To record the movement in the deferred tax balances at 30 June 20X3

Note
1. The credit is made to income tax expense. This is because the underlying transactions were all recognised in profit
(and not in other comprehensive income or equity).

Unit 4 – Suggested solutions to activities Page 4-9

Financial Accounting & Reporting Chartered Accountants Program

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Date Account description Dr Cr

$ $

30.06.X3 DTA 4,800

Share capital 1
4,800

To record the movement in the deferred tax balance at 30 June 20X3

Note
1. The $4,800 DTA relating to the future deductions for the share issues costs is recognised as a credit to share capital
(IAS 12 para. 61A).

The above entries may be summarised into a single entry, as shown in the solution.
Although the share capital account is not required to complete the activity, it has a closing credit
balance of $586,000 after recording the tax effect journal entries. As the underlying transaction
($20,000 in share issue costs) was recognised in equity, the related tax effect is also recognised
in equity, as shown below in the share capital T-account.

Share capital

$ $

Cash (share issue costs) 20,000 Opening balance 100,000

Cash (share issue proceeds) 500,000

Current tax liability 1,200

Closing balance 586,000 DTA 4,800

606,000 606,000

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Unit 5: Foreign exchange

Activity 5.1
Determining the functional currency
of a foreign operation

Solution
The functional currency of Climbing Switzerland and Climbing Japan is the New Zealand dollar
after applying indicative factors, as follows.

Application of indicative factors to determine functional currency

IAS 21 Indicative factor Application to Climbing Application to Climbing

reference Switzerland Japan

Paragraph 9(a)(i) The currency that mainly Sales prices are determined Sales prices are determined
influences sales prices principally by the New principally by the New
Zealand dollar, given the Zealand dollar, given the
selling price is determined selling price is determined
based on a margin over based on a margin over
the New Zealand dollar the New Zealand dollar
denominated purchase price denominated purchase price
of the product of the product

Paragraph 9(a)(ii) The currency of the country The pricing is not impacted No information
whose competitive forces by Swiss or European
and regulations mainly competitive forces
determine the sales price

Paragraph 9(b) The currency that mainly All products are supplied The prime focus of the
influences labour, materials from New Zealand, so the branch is research and
and other costs New Zealand dollar mainly these costs are incurred in
influences input costs Japanese yen
All products are supplied
from New Zealand, so the
New Zealand dollar mainly
influences these input costs

Paragraph 10(a) The currency in which funds No information Operations are funded from
from financing activities Japanese funds and New
(debt and equity) are Zealand investment
generated

Paragraph 10(b) The currency in which Profits are retained All profits are retained in
receipts from operating to support European Japan
activities are usually retained operations
fin31705_actsols

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Application of indicative factors to determine functional currency

IAS 21 Indicative factor Application to Climbing Application to Climbing

reference Switzerland Japan

Paragraph 11(a) Whether the activities of The activities of Climbing The principal activities of
the foreign operation are Switzerland are carried Climbing Japan are to carry
carried out as an extension out as an extension of out research for Climbing
of the reporting entity or Climbing New Zealand New Zealand
autonomously to the extent that it is,
in effect, a distributor of
products manufactured in
New Zealand

Paragraph 11(b) Whether inter-entity All products are sourced Distributes products sourced
transactions are a significant from Climbing New Zealand, from Climbing New Zealand
proportion of the foreign so one would expect it and conducts research for
operation’s activities would be a significant the group, but is primarily
proportion of Climbing focused on future products.
Switzerland’s activities Climbing Japan could supply
products for sale in New
Zealand and Europe in the
future

Paragraph 11(c) Whether cash flows of the Profits are not remitted Profits are not remitted to
foreign operation directly to New Zealand, so there New Zealand and regular
affect the cash flows of is no direct impact on funding is provided by
the reporting entity and Climbing New Zealand’s Climbing New Zealand for
are readily available for cash flows. However, there operational purposes, so one
remittance is no information to suggest would anticipate an impact
that any retained profits on Climbing New Zealand’s
are not readily available for cash flows
remittance to Climbing New
Zealand

Paragraph 11(d) Whether cash flows of No information Regular funding provided by

the foreign operation are Climbing New Zealand
sufficient to service existing
and normally expected debt
obligations

The functional currency of Climbing Switzerland would probably change if:

•• the pricing of its goods became subject to European competitive forces and regulations,
•• goods were not sourced from Climbing New Zealand, or
•• the cost to the branch for their purchases were made in a currency other than New Zealand
dollars.

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

First review the definitions of functional currency and presentation currency that are set out
in IAS 21 para. 8. Then identify the indicative factors to be considered when determining
the functional currency of each of the branches. These indicative factors are set out in IAS 21
paras 9–11. Paragraph 9 sets out the primary indicators and paras 10 and 11 provide additional
supporting evidence.

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If the indicators are mixed, then para. 12 states that judgement should be used to determine
the functional currency that most faithfully represents the economic effects of the underlying
transactions, events and conditions. Priority should be given to the primary factors before
considering the additional supporting evidence.

Step 2 – Apply the indicative factors

Prepare the table requested by the CFO showing the Standard reference, the indicative factor
and the application of the Standard to Climbing Switzerland and Climbing Japan. The table is
presented in the solution.

Step 3 – Determine the functional currencies

Based on the application of the facts to the indicative factors, the functional currency of each
branch can be determined.

Functional currency based on indicative factors

Branch Implications Details Functional currency

of application
of indicative
factors

Climbing The indicative IAS 21 para. 12 requires management to use On this basis, it is concluded
Switzerland factors are its judgement to determine the functional that the functional currency
mixed currency that most faithfully represents of Climbing Switzerland is
the economic effects of the underlying the New Zealand dollar
transactions, events and conditions
Priority must be given to the factors in
para. 9 before considering the factors in
paras 10 and 11

Climbing Japan The indicative Para. 12 should be applied to determine the As Climbing Japan appears
factors are functional currency to be an extension of
mixed Climbing New Zealand,
it is concluded that the
functional currency is the
New Zealand dollar

Step 4 – Identify circumstances that may lead to a change in the functional

currency
To identify the circumstances that may lead to a change in the functional currency of
Climbing Switzerland, review the table detailed in the solution, showing the application of
the indicative factors.
The factors that indicate that the functional currency is the New Zealand dollar are the ones that
would need to change in order for the functional currency to change. These factors are detailed
in the solution.

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Activity 5.2
Translating from the functional currency
to the presentation currency

Solution
The outcome of this translation is that the financial statements are now presented in Australian
dollars rather than New Zealand dollars. In addition, due to exchange rate movements and the
specific translation rules contained in IAS 21, there is now an additional item reflected in the
statement of financial position (i.e. a ‘foreign currency translation reserve’).
This email to Jane Jones, the New Zealand branch operations manager, shows the translated
financial statements.

To: Jane Jones

Dear Jane,

The following are the New Zealand branch financial statements translated
into Shafiq’s presentation currency as requested.

Shafiq’s New Zealand branch’s statement of profit or loss for the

year ended 30 June 20X4
A$
Revenue 1,577,287
Expenses (excluding depreciation and finance costs) (394,322)
Depreciation (19,826)
Finance costs (19,716)
Profit before income tax expense 1,143,423
Income tax expense (197,161)
Profit for the period 946,262

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Shafiq’s New Zealand branch’s statement of financial position as at

30 June 20X4
A$
Current assets
Cash 121,971
Trade receivables 243,942
Inventories 630,184
Total current assets 996,097
Non-current assets
Property, plant and equipment 1,199,382
Total non-current assets 1,199,382
Total assets 2,195,479
Current liabilities
Trade and other payables 121,971
Current tax liability 203,285
Provisions 162,628
Total current liabilities 487,884
Non-current liabilities
Provisions 121,971
Other payables 121,971
Total non-current liabilities 243,942
Total liabilities 731,826
Net assets 1,463,653

Net investment
Investment from head office (Shafiq) 796,495
Retained earnings 621,323
Foreign currency translation reserve 45,835
Total investment 1,463,653

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standards

First, review IAS 21 to establish the guidance for translating financial statements of a foreign
branch into the presentation currency of its reporting entity. Paragraphs 39 and 40 provide
the relevant information for translating the statement of profit or loss and the statement of
financial position from the functional currency. In addition, the principles contained elsewhere
in IAS 21 can be applied to translate equity balances. Relevant guidance for translation into the
presentation currency is as follows:

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Translation to presentation currency – statement of profit or loss and statement of financial position

Item Exchange rate

Assets and liabilities Closing rate (spot exchange rate at reporting date)

Income and expenses Exchange rate at date of transaction

If items occur regularly throughout the period, an average rate is used unless the
exchange rate fluctuates significantly

Equity/net investment Spot exchange rate in force at the date of the investment
Spot exchange rate on the date of payment of the distribution

Step 2 – Determine the exchange rate to use

The next step is to establish which rate is relevant for translating each balance. The guidance
from the Standards and the information provided by Jane is relevant.

Translation to presentation currency – NZ branch

Item Relevant rate/date Exchange rate

Income and expenses Average rate for the year to 30 June 20X4 A$1 = NZ$1.2680
(excluding depreciation
expense)

Depreciation expense Average rate for the month of June 20X4 A$1 = NZ$1.2610

Remittance to Shafiq Rate at date of transaction (1 June 20X4) A$1 = NZ$1.2310

Assets and liabilities Closing rate (30 June 20X4) A$1 = NZ$1.2298

Initial investment/equity Rate at date of transaction (1 March 20X3) A$1 = NZ$1.2555

Step 3 – Translate the statement of profit or loss

Access the Excel spreadsheet [Activity [Link]] sent by Jane and input the relevant exchange
rates from Step 2 for the statement of profit or loss. Check that the exchange rates are applied in
the correct way. You are converting New Zealand dollars into Australian dollars and therefore
need to divide the NZ$ amount by the NZ$ exchange rate.

Shafiq New Zealand branch’s statement of profit and loss for the year ended 30 June 20X4

Description NZ$ FX rate A$

Revenue 2,000,000 1.2680 1,577,287

Expenses (excluding depreciation and finance costs) (500,000) 1.2680 (394,322)

Depreciation expense (25,000) 1.2610 (19,826)

Finance costs (25,000) 1.2680 (19,716)

Profit before income tax expense 1,450,000 1,143,423

Income tax expense (250,000) 1.2680 (197,161)

Profit for the period 1,200,000 946,262

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Step 4 – Translate the statement of financial position

Repeat Step 3 for the statement of financial position. The statement of financial position will
not balance. To make it balance, insert the ‘foreign currency translation reserve’ (FCTR) as a
balancing figure.

Shafiq New Zealand branch’s statement of financial position as at 30 June 20X4

Description NZ$ FX rate A$

Current assets

Cash 150,000 1.2298 121,971

Trade receivables 300,000 1.2298 243,942

Inventories 775,000 1.2298 630,184

Total current assets 1,225,000 996,097

Non-current assets

Property, plant and equipment 1,475,000 1.2298 1,199,382

Total non-current assets 1,475,000 1,199,382

Total assets 2,700,000 2,195,479

Current liabilities

Trade and other payables 150,000 1.2298 121,971

Current tax liability 250,000 1.2298 203,285

Provisions 200,000 1.2298 162,628

Total current liabilities 600,000 487,884

Non-current liabilities

Provisions 150,000 1.2298 121,971

Other payables 150,000 1.2298 121,971

Total non-current liabilities 300,000 243,942

Total liabilities 900,000 731,826

Net assets 1,800,000 1,463,653

Net investment

Investment from head office (Shafiq) 1,000,000 1.2555 796,495

Retained earnings1

Profit 1,200,000 From 946,262

statement of
profit or loss

Distribution to Shafiq (400,000) 1.2310 (324,939)

800,000 621,323

Foreign currency translation reserve2 0 Balance 45,835

Total investment 1,800,000 1,463,653

Notes
1. The retained earnings figure can be obtained from the statement of profit or loss. In future years this figure will
be obtained by adding together the retained earnings brought forward and the current year movement from
the statement of profit or loss and other comprehensive income (where relevant), adjusting for any distributions
to Shafiq.

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2. To ensure the balancing item recorded in the FCTR is correct, a verification of the balance can be performed and
is considered best practice (although not specifically required by this task). As net assets were all translated at the
closing rate, exchange differences will arise on the initial investment and retained earnings, as these have been
translated at historical, average or other rates. This verification may be performed as follows:

Verification of FCTR

Item FX rates Calculation

Closing rate –
NZ$ rate used A$ A$

Opening net investment 1,000,000 1.2298 – 1.2555 813,140 – 796,495 16,645

(initial investment)

Post-acquisition movements in net investment

Profit for the period 1,225,000 1.2298 – 1.2680 996,097 – 966,088 30,009
(excluding depreciation)

Depreciation (25,000 ) 1.2298 – 1.2610 (20,328) – (19,826) (502)

Amount remitted (400,000) 1.2298 – 1.2310 (325,256) – (324,939) (317)

Closing net investment 1,800,000

FCTR 45,835

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Chartered Accountants Program Financial Accounting & Reporting

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Unit 6: Fair value measurement

Activity 6.1
Measuring fair value of non-financial assets

Solution

Task A
Step Application to the fair value measurement of the vacant land
Step 1. Determine the asset The vacant land is the asset and a market participant would factor in the zoning
or liability to be measured restrictions in measuring its fair value
Step 2. Measure fair value Look at the price from a market participant’s perspective rather than from MEL’s
using an exit price perspective
Step 3. In the principal (or No mention of other markets, therefore the local market is the principal market
most advantageous) market as this is where MEL would normally enter into a transaction to sell the asset
Step 4. Between market A fair value measurement should be based on the assumptions of market
participants participants. In particular, they are assumed to be knowledgeable about and
have a reasonable understanding of the parcel of land including:
•• How it could be used including zoning restrictions
•• Selling prices for industrial use versus high density residential use

Step 5. Based on the highest The land’s current use of being held as vacant land for future factory
and best use for non- construction and manufacturing operations cannot be presumed to be its
financial assets highest and best
The land’s highest and best use will be as residential-zoned land as it would
attract a considerably higher selling price than MEL’s current use of the land
as vacant industrial land
The fair value is taken from the viewpoint of a market participant where the use
of the asset is:
•• physically possible – the land is physically suitable for residential housing
•• legally permissible – it is possible to rezone as indicated by the local planning
department
•• financially feasible – the selling price for residential use would be significantly
higher than as vacant industrial land.
The fair value of the land is therefore measured on the basis of redevelopment
even though MEL is intending to hold the asset for the next two years
The $50,000 in rezoning costs are included in the fair value calculation. They
are not excluded from the calculation on the basis of being ‘transaction costs’
(as defined in IFRS 13 Appendix A). A decision to rezone could be made regardless
of whether the land were later to be sold, therefore the costs do not ‘result directly
from’ a transaction to dispose of the asset. [This treatment of the rezoning costs is
supported by the illustrative examples to IFRS 13, Example 2 ‘Land’]
Step 6. Using an appropriate A market approach (for each of the alternate uses) is appropriate because real
valuation technique estate selling prices are available from the market for recent sales for both
industrial and residential use
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Step Application to the fair value measurement of the vacant land

Step 7. Based on inputs from Level 2: Sales price per square metre from comparable vacant land sales in
the fair value hierarchy similar locations that are zoned for residential use
Level 3: A factor (e.g. a probability factor) to reflect the risk that rezoning may
not be approved
Level 3: Estimates of costs to be incurred to rezone the land
Step 8. To arrive at a fair Not required by the activity
value measurement

Task B
Step 8. To arrive at a fair value measurement
NZ$375,000 fair value (NZ$380,000 selling price – NZ$5,000 transport costs).
Justification (only three paragraph references are required)
The NZ$380,000 selling price is used as it is the price in the principal market for the asset
(IFRS 13 para. 16).
The principal market is defined as the market with the greatest volume and level of activity for
the asset or liability (IFRS 13 Appendix A). For the specialised asset, Australia is the principal
market for this asset because its annual sales volume and average monthly transactions exceed
those in the New Zealand market. As MEL can access the Australian market, it must use the
Australian market prices (IFRS 13 para. 18) even though it transacts in the New Zealand market.
The fair value is an exit price (IFRS 13 para. 24), which therefore factors in transport costs
(IFRS 13 para. 26).
When performing the fair value measurement, the NZ$1,000 in transaction costs are excluded
as they are characteristics of the transaction rather than of the asset (IFRS 13 para. 25).

Recommended approach

Task A
The steps outline the recommended approach for successfully completing this task.
Step 1 – Review the Standard and identify the relevant paragraphs
The relevant paragraphs of IFRS 13 for the task are:

Step Issue Relevant IFRS 13

paragraphs

Step 1 - Determine the asset or Identify the asset and its unit of account 11
liability to be measured
Restrictions on the asset’s use

Step 2 - Measure fair value using Pricing from a market participant’s perspective 15
an exit price

Step 3 - In the principal (or most Identify the principal market (the most 16–17
advantageous) market advantageous market is only considered if there
is no principal market)

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Step Issue Relevant IFRS 13

paragraphs

Step 4 - Between market Based on assumptions of market participants 22

participants

Step 5 - Based on the highest and Determine the highest and best use 27
best use for non-financial assets
Transaction costs incurred Appendix A, definition
of ‘transaction costs’

Step 6 - Using an appropriate Market approach, income approach and cost 61–63
valuation technique approach

Step 7 - Based on inputs from the The fair value hierarchy categorises the inputs 72
fair value hierarchy used in a valuation technique into three levels

Step 2 – Determine the basis of measuring the fair value of the vacant land
Based on the steps within the table above and considering the requirements of the Standard in
the paragraphs identified, the fair value measurement process for the vacant land can be applied
as summarised in the table shown in the solution.

Task B
The steps outline the recommended approach for successfully completing this task.
Step 1 – Review the Standard and identify the relevant paragraphs
The relevant paragraphs of IFRS 13 for the task are:

Issue Relevant paragraphs

Identify the principal (or most advantageous) market for the 16

asset

Analyse the definition of ‘principal market’ Appendix A, definition of ‘principal

market’

Use of the price in the principal market 18

The fair value is an exit price 24

Treatment of transaction costs 25

Treatment of transport costs 26

Step 2 – Perform the calculation

The fair value calculation for the specialised asset is shown in the solution.
Step 3 – Justify the fair value calculation with reference to IFRS 13
The fair value calculation for the specialised asset is justified with reference to the paragraphs
mentioned in the table above as shown in the solution. Only three references are required to
justify the calculation for this task.

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Unit 7: Property, plant and equipment

Activity 7.1
Accounting for property, plant and
equipment

Solution – Task A
The carrying value of the machine as at 30 June 20X4 is $12,483,958.

Recommended approach – Task A

The steps outline a recommended approach for successfully completing Task A.

Step 1 – Review the Standards

Two Standards are applicable to Task A: IAS 16 and IAS 23.
Access IAS 16 and review the relevant paragraphs for the task:

Relevant IAS 16 paragraphs

Paragraphs Relevance to task

6 Provides definitions for:

•• Property, plant and equipment, which enables you to determine when the new machine
becomes plant and equipment for Avenga
•• The carrying amount, which tells you that as well as determining the cost to correctly
respond to the task, you will also need to calculate the accumulated depreciation
•• The depreciable amount, which tells you that you need to take into consideration the
residual value when calculating the depreciation expense
•• Depreciation, which tells you that you need to allocate the depreciable amount of the asset
over the asset’s useful life

15–23 Provides an understanding of which costs can be capitalised as part of the value of the
machine, and which need to be expensed. Paragraph 23 provides that the cost of the asset is
the cash price equivalent at acquisition date. It also reminds you to refer to IAS 23 regarding the
capitalisation of interest

50 Requires the systematic allocation of the depreciable amount over the asset’s useful life. The
general additional information states that the machine has a residual value of $500,000, which
must be taken into account when calculating the depreciable amount, and Avenga uses the
straight-line method over the useful life of 10 years

55 Determines the commencement of depreciation for an asset. Based on the additional

information for this machine, depreciation will commence on 1 February 20X4, as this is when
the machine was available for use
fin31707_actsols

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Now access IAS 23 and review the relevant paragraphs for the task:

Relevant IAS 23 paragraphs

Paragraphs Relevance to task

5 Provides definitions for:

•• Borrowing costs: the interest on the bank loan meets the definition
•• Qualifying assets: as the time from the signing of the contract to the delivery of the machine
is a substantial period of time, the machine would meet the definition of a qualifying asset

8 and 10 Provides that any borrowing costs directly attributable to the acquisition of a qualifying asset
shall be capitalised and explains what is meant by directly attributable. The interest on the
Avenga bank loan would qualify as being directly attributable, as the loan was specifically taken
out to fund the purchase of the machine

12 Explains that the borrowing costs that can be capitalised are the actual borrowing costs
incurred less any investment income on the temporary investment of those borrowings. While
the borrowing costs from the bank loan are capitalised, the interest income on the investment
account will reduce the value of the borrowing costs capitalised

17 Specifies when the capitalisation of borrowing costs commences. For the machine it is 1
November 20X2, as this is when the conditions of para. 17 are all met

22 Specifies when capitalisation of borrowing costs will cease. For the machine it is 1 February
20X4, as this will be when the machine is substantially ready for its intended use

Step 2 – Determine the cost of the machine

Applying the relevant guidance from IAS 16 paras 15–23 and IAS 23 paras 17 and 22, calculate
the cost of the machine.

Cost of the machine

Description Amount
$

Value of the contract 12,000,000

Additional site costs 125,000

Delivery costs 250,000

Capitalised interest on bank loan1 1,125,000

Interest income on investment account2 (495,000)

Cost of the machine 13,005,000

Notes
1. The first payment on the contract was made on 1 November 20X2 and capital WIP was recognised at this date.
The asset was not completed until 1 February 20X4. It therefore took a substantial period of time to be ready for its
intended use and is a qualifying asset under IAS 23. On this basis, interest on the loan is capitalised into the cost of
the machine.
$12,000,000 × 0.075 × (15 ÷ 12) = $1,125,000
1 November 20X2 – 31 January 20X4 = 15 months
2. $270,000 + $225,000 = $495,000
($12,000,000 – $1,200,000) × 0.05 × (6 ÷ 12) = $270,000
1 November 20X2 – 1 May 20X3 = 6 months
(($12,000,000 – $1,200,000) – $4,800,000) × 0.05 × (9 ÷ 12) = $225,000
1 May 20X3 – 31 January 20X4 = 9 months

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The cost of staff training has not been included in the cost of the machine, as it is an example of
the cost of conducting business and is excluded under IAS 16 para. 19(c).
The cost of the procurement manager’s time has not been included in the cost of the machine as
it is an example of an administration and other general overheads cost, and is excluded under
IAS 16 para. 19(d).

Step 3 – Calculate the depreciation expense for the year ended 30 June 20X4
Applying the relevant guidance from IAS 16 paras 6, 50 and 55, calculate the depreciation of the
new machine.

Depreciation expense for the year ended 30 June 20X4

Description Amount
$

Cost of the machine (Step 2) 13,005,000

Less residual value (500,000)

Depreciable amount 12,505,000

Useful life 10 years

Depreciation expense per year 1,250,500

Depreciation expense for the year ended 30 June 20X4 (asset was ready for use from 521,042
1 February 20X4, i.e. five months)

As this is the first year, the depreciation expense is the same as the accumulated depreciation.

Step 4 – Calculate the carrying amount of the machine

Applying the definition of carrying amount from IAS 16 para. 5, calculate the carrying amount of
the machine as at 30 June 20X4.

Carrying amount of the machine as at 30 June 20X4

Description Amount
$

Cost of the machine (Step 2) 13,005,000

Less: accumulated depreciation (Step 3) (521,042)

Carrying amount of machine 12,483,958

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Financial Accounting & Reporting Chartered Accountants Program

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Solution – Task B

Journal entries for Avenga for the year ended 30 June 20X5
There are four journal entries in relation to the machine for the year ended 30 June 20X5.

Journal entry for depreciation of the machine

Date Account description Dr Cr
$ $

30.06.X5 Depreciation expense 1,250,500

30.06.X5 Accumulated depreciation 1,250,500

Depreciation of the machine for the year ended 30 June 20X5 (as calculated in Task A, Step 3)

Journal entry for reversal of accumulated depreciation on revaluation

Date Account description Dr Cr

$ $

30.06.X5 Accumulated depreciation 1,771,542

30.06.X5 Machine 1,771,542

Reversal of accumulated depreciation on revaluation, in accordance with Avenga’s policy (IAS 16 para. 35(b))

Journal entry for revaluation of machine

Date Account description Dr Cr

$ $

30.06.X5 Machine 266,542

30.06.X5 Revaluation surplus (equity account) 186,580

30.06.X5 Deferred tax liability (DTL) 79,962

Revaluation of machine to fair value of $11,500,000 from a carrying amount of $11,233,458, including tax
impact

Journal entry for the tax impact of differing depreciation rates for accounting and tax

Date Account description Dr Cr

$ $

30.06.X5 Income tax expense 15,000

30.06.X5 DTL 15,000

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Date Account description Dr Cr

$ $

Tax impact of the difference in the depreciation rates between accounting and tax

Recommended approach – Task B

The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standards

There are two Standards that are applicable to Task B: IAS 16 and IAS 12.
Access IAS 16 and review the following paragraphs that are relevant to this task:

Relevant IAS 16 paragraphs

Paragraphs Relevance to task

29 and 35 Gives the preparer of the financial statements a choice between the cost model and the
revaluation model. Paragraph 35 deals with how to treat the accumulated depreciation on
revaluation. As per the general additional information, Avenga has a policy of reversing all
the accumulated depreciation against the value of the asset. That is, they use the method
described in para. 35(b)

39 and 40 Specifies how the revaluation increments and decrements need to be treated. In this
instance, the revaluation is an increase and there have been no previous decreases in value;
therefore, para. 39 will apply

42 Reminds you to go to IAS 12 to determine if there are any effects of tax that may arise as a
result of the revaluation

IAS 12 applies as the accounting carrying amount of the machine and the tax base will be
different due to two factors:
1. There will be a difference in the amount of depreciation that is charged in the statement
of profit or loss and other comprehensive income, and the amount that is claimed as a
deduction in Avenga’s tax return, as the machine has a residual value for accounting
purposes.
2. The revaluation increases the carrying value for accounting purposes, but has no impact on
the tax base (IAS 12 para. 20).
These concepts are covered in the unit on income taxes.

Step 2 – Prepare the journal entry for the depreciation expense for the year
ended 30 June 20X5
The annual depreciation expense was calculated as $1,250,500 in Task A, Step 3. As nothing has
changed during the year regarding the use or value of the machine, the depreciation expense
calculated in 20X4 is correct for the year ended 30 June 20X5.
The journal entry is shown in the solution.

Step 3 – Prepare the journal entry to reverse the accumulated depreciation as at

30 June 20X5
Avenga has elected to treat the accumulated depreciation in accordance with IAS 16 para. 35(b)
and eliminate the accumulated depreciation at the date of revaluation against the gross carrying
amount of the asset. The accumulated depreciation at 30 June 20X5 is $1,771,542 ($521,042 +
$1,250,500).
The journal entry is shown in the solution.

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Step 4 – Prepare the journal entry to account for the revaluation as at 30 June
20X5
The carrying value of the asset has increased from $11,233,500 ($13,005,000 − $521,042 −
$1,250,500) to $11,500,000 based on the valuation. The revaluation changes the accounting
carrying value but not the tax base; therefore, there is a tax consequence to the revaluation.
As the revaluation is taken directly into equity, the deferred tax liability is credited directly into
equity in accordance with IAS 12 para. 61A.
The journal entry is shown in the solution.

Step 5 – Calculate the deferred tax consequences for the year ended 30 June
20X5 and prepare the journal entry
Calculate the carrying amount and the tax base at 30 June 20X5.

Calculation of impairment loss

Date Description Carrying Tax base

amount $
$

01.02.X4 Cost1 13,005,000 13,005,000

30.06.X4 Depreciation 521,042 1 541,875 2

30.06.X4 Closing value 12,483,958 3 12,463,125

30.06.X5 Depreciation 1,250,500 1 1,300,500

30.06.X5 Closing value 11,233,458 4 11,162,625

Notes
1. From Task A, Step 3.
2. Tax depreciation is 10 years straight-line ($13,005,000 ÷ 10 × 5 ÷ 12).
3. Answer to Task A.
4. There is no need to take into account the revaluation at this time as the deferred tax impact of the revaluation is
accounted for separately, going directly into equity (refer to Task B, Step 4).

As the carrying amount is greater than the tax base, a taxable temporary difference (TTD) has
arisen. When the TTD is multiplied by the tax rate a DTL is created.

Deferred tax consequences

Date Description Carrying Tax base TTD DTL

amount $ $ $
$ (b) (a) – (b) = (c) × 30%
(a)

01.02.X4 Cost 13,005,000 13,005,000

30.06.X4 Depreciation 521,042 541,875

30.06.X4 Closing value 12,483,958 12,463,125 20,833 6,250

30.06.X5 Depreciation 1,250,500 1,300,500

30.06.X5 Closing value 11,233,458 11,162,625 70,833 21,250

As 30 June 20X5 is the second year of operation of the machine, the DTL as at 30 June 20X4
has already been recorded. The tax effect entry for 30 June 20X5 needs to only account for the
movement of $15,000 ($21,250 – $6,250) in the DTL account.
The journal entry is shown in the solution.
To double-check your tax entries compare the revalued amount to the tax base as at 30 June 20X5.

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Deferred tax consequences

Date Revalued carrying Tax base TTD DTL

amount $ $ $
$ (b) (a) – (b) = (c) × 30%
(a)

30.06.X5 11,500,000 11,162,625 337,375 101,212

The DTL comprises:

Composition of DTL

Item Amount Source

DTL on revaluation 79,962 Step 4, Task B

DTL on depreciation 21,250 Earlier in Step 5, Task B

Total DTL 101,212

Solution – Task C
The depreciation expense for the machine for the year ended 30 June 20X6 is $1,281,553.

Recommended approach – Task C

Calculate the depreciation expense for the year ended 30 June 20X6
Use the same logic from Task A, Step 3 and update the depreciation calculation for the new
information received as a result of the revaluation.

Depreciation expense calculation for the year ended 30 June 20X6

Description Amount
$

Value of the machine 11,500,000

Less: residual value (500,000)

Depreciable amount 11,000,000

Useful life 8 years 7 months

Depreciation expense for the year ended 30 June 20X6 1,281,553

(($11,000,000 ÷ 103 months) × 12 months))

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Unit 8: Intangible assets

Activity 8.1
Accounting for intangible assets

Solution
A. Alpha’s classification of the distribution licence and computer software as intangible assets
is appropriate at 1 July 20X2. They both meet the three conditions in the definition of an
intangible asset from IAS 38 para. 10 and they each meet the two recognition criteria from
IAS 38 para. 21.
B.
Acquisition of intangible assets

Date Account description Dr Cr

$ $

01.07.X2 Distribution licence 6,000,000

01.07.X2 Computer software 3,000,000

01.07.X2 Cash/payables 9,000,000

To record the acquisition of the distribution licence and computer software

01.12.X3 Loss on retirement of distribution licence 3,166,667

01.12.X3 Accumulated amortisation – distribution licence 2,833,333

01.12.X3 Distribution licence 6,000,000

To record loss on derecognition (retirement) of the distribution licence as no future economic benefits
are expected from its use [$6,000,000 original cost less accumulated amortisation – distribution licence
$2,833,333]

Amortisation of computer software – 30 June 20X4

Date Account description Dr Cr

$ $

30.06.X4 Amortisation expense – computer software 600,000

30.06.X4 Accumulated amortisation – computer software 600,000

To record amortisation expense for computer software costs for the year ended 30 June 20X4 [$3,000,000 ÷
5 years]

Amortisation of computer software – 30 June 20X5

Date Account description Dr Cr

$ $

30.06.X5 Amortisation expense – computer software 900,000

30.06.X5 Accumulated amortisation – computer software 900,000

To record amortisation expense for the computer software for the year ended 30 June 20X5 [($3,000,000
original cost – $1,200,000 accumulated amortisation = $1,800,000 net carrying amount) ÷ 2 years revised
remaining useful life]

Amortisation of computer software – 30 June 20X6

Date Account description Dr Cr

$ $

30.06.X6 Amortisation expense – computer software 900,000

30.06.X6 Accumulated amortisation – computer software 900,000

To record amortisation expense for the computer software for the year ended 30 June 20X6 ($1,800,000 ÷
2 years)

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Recommended approach
The steps outline a recommended approach for successfully completing the task.

Part A
Step 1 – Review the Standard
Review IAS 38 para. 10, which specifies that an intangible asset must satisfy the conditions of
identifiability, control and future economic benefits. These are further explained in paras 11–17.
In addition, review IAS 38 para. 21, which specifies the two recognition criteria for an intangible
asset.
Step 2 – Apply the Standard
Applying the requirements of IAS 38 to recognise an intangible asset, Alpha must satisfy the
three conditions in the definition of an intangible asset (IAS 38 para. 10), and also meet the
two recognition criteria (IAS 38 para. 21).
A table helps to identify whether the distribution licence costs and computer software costs meet
the definition (three conditions) and recognition criteria (two conditions) of an intangible asset.

Distribution licence costs – 1 July 20X2

Criterion Met? Yes/No Explanation

Definition of intangible asset (IAS 38 paras 10–17)

Identifiable Yes The distribution licence is identifiable as it arises from

contractual or other legal rights from the legal agreement
with Beta

Control Yes Alpha has control as it can deny other parties access to
specific product lines of Beta due to its sole distribution
rights

Future economic benefits Yes Future economic benefits will occur to Alpha through sales
of specific product lines of Beta

Recognition of intangible asset (IAS 38 para. 21)

Probable future economic Yes The distribution licence is likely to provide future economic
benefits benefits to Alpha through sales of Beta’s product lines

Cost measured reliably Yes The cost of a separately acquired intangible asset can
usually be measured reliably. As the distribution licence
has been acquired by way of an agreement, the cost can
be measured reliably

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Computer software costs – 1 July 20X2

Criterion Met? Yes/No Explanation

Definition of intangible asset (IAS 38 paras 10–17)

Identifiable Yes The computer software is identifiable as it can be

separated from Alpha and has arisen from a contractual
agreement with the external supplier

Control Yes The specific nature of the software will deny other parties
the opportunity to use it; therefore, Alpha has control over
the computer software

Future economic benefits Yes Future economic benefits will occur to Alpha by capturing
information about Alpha’s operations in current and
subsequent accounting periods

Recognition of intangible asset (IAS 38 para. 21)

Probable future economic Yes The computer software is likely to provide future economic
benefits benefits to Alpha by capturing information about Alpha’s
operations in current and subsequent accounting periods

Cost measured reliably Yes The cost of a separately acquired intangible asset can
usually be measured reliably. As the computer software
has been acquired by way of an agreement, the cost can
be measured reliably

Part B
Step 1 – Review the Standard
Review IAS 38 paras 24–27, 72, 74, 88–90, 94, 97, 99, 100 and 104, which provide guidance
and requirements regarding the measurement of an intangible asset on initial recognition,
measurement after recognition, the cost model, useful life, amortisation period and amortisation
method, and a review of amortisation periods and methods for intangible assets with a finite
useful life.
Step 2 – Prepare the journal entry for the acquisition of intangible assets
Applying the requirements of IAS 38 para. 24, both of the intangible assets are measured initially
at cost. The cost of a separately acquired intangible asset comprises its purchase price and any
directly attributable cost of preparing the asset for its intended use (IAS 38 para. 27). Costs
recorded for both of the intangible assets in the management accounts are assumed to include
the purchase price and any directly attributable costs. The journal entry is shown in the solution.
Step 3 – Assess the useful life of intangible assets on acquisition
Applying the requirements and guidance in IAS 38 paras 88–90 and 94, the distribution licence
is assessed to have a useful life of three years because the intangible asset arises from a legal
agreement with Beta, which gives Alpha the sole distribution rights for a period of three years.
The computer software is initially assessed to have a useful life of five years because the
intangible asset, which is specifically designed for Alpha’s operations, arises from a contractual
agreement with an external supplier and is expected to be used for five years.

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Step 4 – Prepare the journal entries for intangible assets for the year ended 30 June 20X3
IAS 38 para. 97 requires the depreciable amount of an intangible asset with a finite useful life
to be allocated on a systematic basis over its useful life, which should begin when the asset is
available for use.
As both of the intangible assets were purchased on 1 July 20X2 and are in the form of distribution
rights and computer software, it can be concluded that these assets were available for use on that
date.
The amortisation method should reflect the pattern in which the asset’s future economic benefits
are expected to be consumed by the entity. However, based on the available information, the
pattern cannot be determined reliably. Hence, the straight-line method of amortisation is used, as
required by IAS 38 para. 97. The journal entries are shown in the solution.
Step 5 – Prepare the journal entries for intangible assets for the year ended 30 June 20X4
As Beta went into liquidation on 1 December 20X3 and no future economic benefits are expected
from the intangible assets’ use or disposal, the distribution licence asset is derecognised at that
date, in accordance with IAS 38 para. 112.
A journal entry is required to record the amortisation expense for the distribution licence for the
period from 1 July 20X3 and ending on the date before derecognition (i.e. 30 November 20X3).
The journal entry is shown in the solution.
Alpha needs to derecognise the distribution licence asset, at 1 December 20X3 as required by
IAS 38 para. 112(b).
The loss arising from derecognition of the distribution licence asset is recognised in profit or loss
on the date of derecognition (IAS 38 para. 113). The journal entry is shown in the solution.
The computer software is amortised for the year ended 30 June 20X4 in accordance with IAS 38
para. 97. The journal entry is shown in the solution.
Step 6 – Prepare the journal entry for intangible assets for the year ended 30 June 20X5
On 1 July 20X4 the remaining useful life of the computer software was reviewed and revised
to two years. The amortisation period is therefore changed to two years, as required by IAS 38
para. 104.
The net carrying amount at the date the useful life was revised is amortised over the revised
remaining useful life of two years. Such a change is accounted for as a change in accounting
estimate in accordance with IAS 8 para. 36. The journal entry is shown in the solution.
Step 7 – Prepare the journal entry for intangible assets for the year ended 30 June 20X6
The computer software is amortised for the year ended 30 June 20X6 in accordance with IAS 38
para. 97. The journal entry is shown in the solution.

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Unit 9: Financial instruments

Activity 9.1
Classification of financial instruments

Solution
The IFRS 9 classification of the financial assets and liabilities held by Sorrenti at 30 June 20X7 are
as follows:

Financial instrument Classification Explanation

IAS 32 IFRS 9

Cash at bank Financial asset Amortised cost Cash is included in the definition of a
financial asset under IAS 32
SPPI – this instrument meets the SPPI
test as the principal amount is the
balance of the account (which may be
repaid on demand) and interest is zero
Business model – this account is held to
collect contractual cash flows

Trade receivables Financial asset Amortised cost Trade receivables are a contractual right
to receive cash from another entity
SPPI – the principal amount is the
amount resulting from each transaction.
Payment terms are 30 days so there
is no financing element present and,
accordingly, the interest rate is deemed
to be zero
Business model – Sorrenti’s intention
is to hold the receivables to collect
the contractual cash flows. It has no
intention of selling the trade receivables

Trade payables Financial liability Amortised cost Trade payables are a contractual
obligation to deliver cash to another
entity
Financial liabilities are measured at
amortised cost unless they are held
for trading or initially designated as
measured at fair value through profit or
less (FVTPL)
fin31709_actsols

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Financial instrument Classification Explanation

IAS 32 IFRS 9

FX forward contracts Financial asset/ FVTPL These are contracts that contain a
liability contractual obligation to exchange cash
with another entity on settlement
FX forward contracts are derivatives
that fail the SPPI test as cash flow
variability is dependent on FX rates and
do not represent principal and interest
on principal outstanding. In addition,
they contain considerable leverage

Secured bank loan Financial liability Amortised cost Bank loans involve a contractual
obligation to deliver cash to the bank
Financial liabilities are measured at
amortised cost unless they are held
for trading or initially designated as
measured at FVTPL

Equity investment in Financial asset FVTPL or FVTOCI if Equity investments are assets that are
unlisted companies election made equity instruments of another entity
and therefore are included in the
definition of a financial asset under
IAS 32
Investments in equity instruments fail
the SPPI test as the cash flows do not
represent payments of principal and
interest on the principal outstanding.
Accordingly, they should be classified
as FVTPL. However, Sorrenti can make
an irrevocable election to present
subsequent changes in the fair value of
these shares in other comprehensive
income (OCI) if the shares are not
held for trading. These shares are held
for long-term strategic purposes –
accordingly, Sorrenti is permitted to
make the election

Portfolio of short-term Financial asset FVTOCI This asset is a contractual right to

debt securities receive cash from another entity
SPPI – the debt securities will give rise
to cash flows that represent payments
of principal and interest on the principal
outstanding
Business model – Sorrenti holds the
portfolio to collect contractual cash
flows and to sell the securities to fund
business needs

Investment in Financial asset FVTPL This investment involves a contractual

convertible notes right to receive cash or another financial
asset (shares) from the relevant banks
SPPI – the convertible notes will
give rise to regular coupon receipts,
but the value received at maturity is
dependent on the share price of the
issuer. Accordingly, the contractual cash
flows are not payments of principal and
interest on the principal outstanding

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Financial instrument Classification Explanation

IAS 32 IFRS 9

Interest rate swaps Financial asset/ FVTPL These are contracts that contain a
liability contractual obligation to exchange cash
with another entity on settlement
Even though interest rate swaps involve
interest payments and receipts on
notional principal amounts, they are
derivatives with no physical principal
cash flows and, accordingly, fail the SPPI
test

Ordinary shares Equity N/A Ordinary shares issued by a company

reflect a residual interest in the net
assets of the company and, accordingly,
are equity

Convertible preference Financial liability Amortised cost The shares contain a contractual
shares obligation to make dividend payments
and, in 10 years’ time, deliver a variable
number of Sorrenti’s ordinary shares
(equalling $500,000 in value) to the
holders. This means the convertible
preference shares meet the definition of
a financial liability under IAS 32
Financial liabilities are measured at
amortised cost unless they are held
for trading or initially designated as
measured at FVTPL

Recommended approach

Step 1 – Review the Standard

The relevant paragraphs of IAS 32 and IFRS 9 are as follows:

Standard Paragraphs Relevance

IAS 32 11 Definitions of financial asset, financial liability and equity

28 Compound financial instruments

IFRS 9 4.1.1–4.1.5 Classification of financial assets

4.2.1 Classification of financial liabilities

5.7.5 Provisions relating to investments in equity instruments

Appendix A Definition of ‘financial liability at fair value through profit or loss’

Step 2 – Identify the categories available

From your reading of IAS 32 and IFRS 9, you identify the following categories available to you:
•• Financial assets (defined in IAS 32 para. 11).
•• Amortised cost – instruments with cash flows that are solely principal and interest on the
principal outstanding, and held under a business model to collect contractual cash flows
(IFRS 9 para. 4.1.2).

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•• Fair value through other comprehensive income (FVTOCI) – instruments with cash flows
that are solely principal and interest on the principal outstanding, and held under a business
model to both collect contractual cash flows and sell the assets (IFRS 9 para. 4.1.2A).
•• Fair value through profit or loss (FVTPL) – instruments with cash flows that are not solely
principal and interest on the principal outstanding, are held under a business model to sell
the assets, or are initially designated as FVTPL (IFRS 9 paras 4.1.4 and 4.1.5).
•• Investments in equity instruments – entities may make an irrevocable election on initial
designation to present changes in fair value in OCI as long as the investment is not held for
trading (IFRS 9 para. 5.7.5).
•• Financial liabilities (defined in IAS 32 para. 11).
•• Amortised cost – default classification for financial liabilities (IFRS 9 para. 4.2.1).
•• Fair value through profit or loss – only available if the liability is held for trading, or it is
designated upon initial recognition (IFRS 9 Appendix A).
•• Equity (defined in IAS 32 para. 11).
•• Compound financial instruments (defined in IAS 32 para. 28).

Step 3 – Identify the relevant factors for each financial instrument

Financial instrument Relevant factors

Financial assets (assets that are cash, equity instruments of another entity, or contractual rights to
receive cash or another financial asset from another entity)

Cash at bank Funds in the account are held on demand and there is no interest payable on the
account. As the account is on demand, the principal is the balance of the account. The
fact that the interest rate is zero does not mean the asset fails the SPPI test. Sorrenti
is holding the asset in order to collect the balance of the account (the contractual
amount due to it)

Trade receivables The principal on trade receivables is the amount resulting from the sales transactions.
As terms are 30 days, the receivables do not contain a financing component and the
interest rate is deemed to be zero. Again, this does not mean the asset fails the SPPI
test. The information provided also indicates Sorrenti does not have any intention
of selling the trade receivables (through factoring). Accordingly, the business model
is to hold the asset to collect contractual cash flows (i.e. the invoiced amounts
outstanding)

Equity investment in In order to meet the SPPI test, cash flows need to arise on specified dates. Equity
unlisted companies investments fail this test as they do not contractually deliver payments on specified
dates. In addition, dividends do not have characteristics of interest. Therefore, this
instrument should be classified as FVTPL, which means changes in the fair value of
the investment will be recognised in profit or loss. However, under IFRS 9 para. 5.7.5,
Sorrenti may elect to present these changes in OCI, which will remove any volatility
in the profit or loss that may result from this long-term strategic investment

Portfolio of short-term The instruments within this portfolio (bank bills and corporate bonds) are ‘vanilla’
debt securities debt instruments (debt instruments that result in payments of principal and interest
on the principal outstanding). The business model under which Sorrenti holds these
instruments is a combination of collecting contractual cash flows (the interest and
principal payments) as well as selling the securities in order to fund the liquidity
needs of the business. Since this sales activity is relatively frequent, it is part of the
objective of the business model

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Financial instrument Relevant factors

Investment in From Sorrenti’s perspective, this investment is a financial asset as it involves a

convertible notes contractual right to receive cash or another financial asset from the banks that have
issued the notes. The principal that Sorrenti will be repaid at maturity will depend on
the share price of the relevant bank at the time, since Sorrenti may receive either cash
or a fixed number of shares. The choice Sorrenti makes will depend on the share price
at maturity. If the share price has risen so the value of the shares received on maturity
is higher than the cash amount, Sorrenti will likely exercise the option, receive the
shares and then sell them – resulting in a higher principal amount received. If the
share price has fallen so the value is below the cash amount, Sorrenti will not exercise
the option and will instead receive the cash principal amount. When applying the
SPPI test, the amount repaid on maturity does not meet the definition of principal in
para. 4.1.3(a) of IFRS 9 because it changes depending on the prevailing share price.
The return received on these notes is linked to the value of the equity of the issuer.
This is inconsistent with a basic lending arrangement and, therefore, does not meet
the SPPI test. Accordingly, the notes are classified as FVTPL

Financial liabilities (a liability that is a contractual obligation to deliver cash or another financial asset
to another entity, or a non-derivative for which Sorrenti may be obliged to deliver a variable number of
their own equity instruments)

Trade payables These liabilities are not held for trading and there is no reason for Sorrenti to
designate them at FVTPL upon initial recognition. Accordingly, they fit the default
classification for financial liabilities

Secured bank loan Refer above

Convertible preference While these are shares issued by Sorrenti (and, accordingly, may be equity), they have
shares contractual characteristics that meet the definition of a financial liability. They include
a contractual obligation to make fixed dividend payments annually, and repay a fixed
value of ordinary shares in 10 years’ time (i.e. a variable number based on the share
price at the time). There is no reason for Sorrenti to designate these shares at FVTPL
upon initial recognition – accordingly they should be measured at amortised cost.
These shares are not a compound financial instrument as they do not contain any
characteristics of equity

Equity (a contract that evidences a residual interest in the net assets of an entity)

Ordinary shares From Sorrenti’s perspective, these shares do not meet the definition of either a
financial asset or a financial liability, but reflect a residual interest in the net assets of
Sorrenti

Other

FX forward contracts These are derivatives and so do not meet the SPPI test, as they contain significant
leverage and do not represent payments of principal and interest on the principal
outstanding

Interest rate swaps Refer above

Step 4 – Identify and explain the choice of category for each

financial instrument
Based on the category options available and the relevant factors for each instrument, you are
now able to classify them appropriately and explain the reasons for your choice of classification.

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Activity 9.2
Basic accounting comparing FVTPL and
FVTOCI

Solution
Options available for classification:
•• Fair value through other comprehensive income (FVTOCI) – since the loan meets the SPPI
test, this option will only be available if it can be demonstrated that the business model under
which the loan is managed is to collect contractual cash flows as well as sell the loan (IFRS 9
para. 4.1.2A). There is no information to suggest that the loan is being managed in order to
earn a return from selling it – accordingly, it is unlikely this classification could be justified.
•• Fair value through profit or loss (FVTPL) – this option is only available to Giant under
para. 4.1.5 of IFRS 9 as an election that can be made to irrevocably designate the loan as
FVTPL if doing so eliminates an accounting mismatch. Giant already has $5 million of fixed
rate liabilities that are classified as measured at FVTPL – accordingly, electing to measure
the loan at FVTPL will offset the impact on the profit or loss (P&L) of the liabilities and
significantly reduce the measurement inconsistency.

In order to prepare the journal entries for the loan using the FVTOCI classification, interest needs
to be calculated using the effective interest method (EIM):

Date Opening Principal Interest Interest accrued Closing

balance repayments receipts using EIM balance
$ $ $ $ $

01.01.X7 3,030,000

30.06.X7 3,030,000 (82,500)1 77,8122 3,025,312

31.12.X7 3,025,312 (82,500) 77,691 3,020,503

1. Calculated as 3,000,000 × 5.5% x 6 months/12 months (for half a year)

2. Calculated as 3,030,000 × 5.1361% (EIR) × 6 months/12 months (for half a year)

Journal entries for the two classification options are as follows.

Fair value through other comprehensive income (FVTOCI)

Date Description Dr Cr
$ $

01.01.X7 Loan – Tiny Blades (transaction costs) [statement of financial 30,000

position]

Loan – Tiny Blades 3,000,000

Cash at bank 3,030,000

Recognition of the loan to Tiny Blades at 1 January 20X7

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Date Description Dr Cr
$ $

30.06.X7 Cash at bank 82,500

Loan – Tiny Blades 4,688

Interest revenue 77,812

Recognition of interest revenue and coupon received for the 6 months to 30 June 20X7

Date Description Dr Cr
$ $

30.06.X7 FVTOCI reserve 8,312

Loan – Tiny Blades 8,312

Revaluation of loan to fair value at 30 June 20X7 [$3,030,000 – $4,688 – $3,017,000]

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Date Description Dr Cr
$ $

30.06.X7 Cash at bank 82,500

Gain/loss on FVTPL assets 70,500

Loan – Tiny Blades 12,000

Recognition of the coupon receipt of $82,500, the change in fair value of the loan at 30 June 20X7 of $12,000
[$3,017,000 – $3,005,000] and the gain/loss on the loan for the previous 6 months [$3,017,000 – $82,500 –
$3,005,000]

Recommendation
While the FVTOCI classification cannot be justified from the background information, if the
FVTOCI and FVTPL classifications are compared, the FVTOCI will result in lower volatility in
P&L for the year. This is because, under FVTOCI, transaction costs are included in the value of
the loan, rather than being recognised directly in P&L, and changes in the fair value that do not
relate to interest accruals are recognised in the FVTOCI reserve and do not impact on P&L.
However, the election to classify as measured at FVTPL is made in order to reduce an accounting
mismatch. Currently, the medium term note (MTN) is being accounted for under the FVTPL
classification, and measuring the loan at FVTPL will offset P&L volatility created by the MTN.
Accordingly, it is recommended that the loan be classified as measured at FVTPL in order to
reduce the accounting mismatch of the MTN.

Recommended approach

Step 1 – Review the Standard

The relevant paragraphs of IFRS 9 are as follows:

Standard Paragraphs Relevance

IFRS 9 4.1.1–4.1.5 Classification of financial assets

5.1.1 Initial measurement of financial instruments

5.2.1 Subsequent measurement of financial assets

5.7.1 Recognition of gains and losses

5.7.10–5.7.11 Assets measured at fair value through other comprehensive income

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Step 2 – Assess the classification requirements for financial assets

Fair value through other comprehensive income (FVTOCI)
•• The cash flows of the loan asset are solely payments of principal and interest on the principal
outstanding. However, there is no information to indicate that the loan has been entered
into for any other reason than to be held until maturity, and the return earned relates solely
to collecting the contractual cash flows. This does not fit into the business model required
to measure an asset at FVTOCI, which requires that the business model objective needs to
include selling the loan as well as collecting contractual cash flows.

Fair value through profit or loss (FVTPL)

•• Given the assessment for FVTOCI classification, the loan would not comply with the normal
requirements for being classified as measured at FVTPL. However, under para. 4.1.5 of
IFRS 9, an election can be made to irrevocably designate the loan as measured at FVTPL if it
significantly reduces or eliminates an accounting mismatch. Because of the measurement of
the MTN issued at FVTPL, an accounting mismatch would exist unless Giant classified the
loan as FVTPL as well.

Step 3 – Calculate the amounts to be recorded

Fair value through other comprehensive income (FVTOCI)
•• The loan will be recorded at its fair value ($3 million) plus transaction costs of $30,000 (IFRS 9
para. 5.1.1).
•• Interest will be measured using the effective interest method (IFRS 9 para. 5.7.11).
•• At 30 June 20X7 and 31 December 20X7, the loan will be restated to its fair value with the
difference being recognised in other comprehensive income (IFRS 9 para. 5.7.10).

Fair value through profit or loss (FVTPL)

•• The loan will be recorded at its fair value ($3 million), with transaction costs recognised in
profit or loss (IFRS 9 para. 5.1.1).
•• Changes in fair value at 30 June 20X7 and 31 December 20X7 are recognised in the profit or
loss (IFRS 9 para. 5.7.1).

Step 4 – Prepare the journal entries required

Under both the FVTOCI and FVTPL classifications, the journal entries can be prepared for:
•• initial recognition of the loan
•• initial recognition of transaction costs
•• interest received on 30 June 20X7 and 31 December 20X7
•• changes in fair value at 30 June 20X7 and 31 December 20X7.

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Activity 9.3
Basic accounting under amortised cost

Suggested solution
The amortised cost and interest accrued each year based on the effective interest method (EIM)
needs to be calculated first, as follows:

Date Opening Principal Interest Interest accrued Closing

balance repayments payments using EIM balance
$ $ $ $ $

01.01.X6 3,935,000

01.01.X7 3,935,000 (220,000) 240,389 3,955,389

01.01.X8 3,955,389 (220,000) 241,635 3,977,024

Journal entries to account for the bond until 30 June 20X7 are as follows.

Initial recognition
Date Description Dr Cr
$ $

01.01.X6 Cash at bank 3,935,000

Corporate bond issued (transaction costs) 75,000

Corporate bond issued (fair value) 4,010,000

Recognition of corporate bond issued on 1 January 20X6, including transaction costs

30 June 20X6 year-end accounting entries

Date Description Dr Cr
$ $

30.06.X6 Interest expense 120,195

Corporate bond issued 120,195

Accrual of interest expense for the 6 months to 30 June 20X6

30 June 20X7 year-end accounting entries

Date Description Dr Cr
$ $

01.01.X7 Interest expense 120,194

Corporate bond issued 99,806

Cash at bank 220,000

Recognition of the corporate bond coupon paid on 1 January 20X7

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Date Description Dr Cr
$ $

30.06.20X7 Interest expense 120,818

Corporate bond issued 120,818

Recognition of interest expense for the 6 months to 30 June 20X7

Recommended approach

Step 1 – Review the Standard

The relevant paragraphs of IFRS 9 are as follows:

Paragraphs Relevance

4.2.1–4.2.2 Classification of financial liabilities

5.1.1 Initial measurement of financial instruments

5.3.1 Subsequent measurement of financial liabilities

Appendix A Definition of amortised cost

Step 2 – Calculate the amounts to be recorded for the corporate

bond
You calculate the interest expense and amortised cost of the bond using the effective interest
method (EIM). You know from IFRS 9 that the amortised cost is the initial balance less principal
repayments less coupon payments plus interest accrued using the EIM. The interest expense is
calculated by applying the effective interest rate to the opening balance of the bond each year.

Step 3 – Prepare the journal entries required

The journal entries can be prepared for initial recognition, as well as for the years ended 30 June
20X6 and 30 June 20X7.
You need to be careful with accounting for the transaction costs, as these costs reduce the value
of the bond recognised.
From the facts you know that the bond pays interest in January each year, whereas the balance
date for Giant is 30 June. This means that six months’ interest will need to be accrued at 30 June
each year to recognise the interest owing under the EIM between 1 January (the date of coupon
payment) and 30 June. If this did not occur, there would be no interest expense recognised at 30
June 20X6, which would be incorrect.

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Activity 9.4
Integrated financial instruments activity

Solution – Part A
The basis for determining the asset portfolio’s classification rests on two primary tests contained
within IFRS 9 para. 4.1: these tests relate to the business model for managing financial assets, and
the characteristics of the contractual cash flows.
Generous Bank has historically split the portfolio into two parts. Given the two parts have
different characteristics, they should be assessed separately, as follows:
1. Longer term part – the portfolio consists of high-grade corporate and government bonds.
These are ‘vanilla’ securities that comprise payments of principal (on maturity) and interest
on the principal outstanding. Accordingly, they meet the solely payments of principal
and interest (SPPI) test. The business model that Generous uses to manage these assets
involves collecting contractual cash flows as well as selling securities in order to maximise
the portfolio return. This is further supported by the fact that the portfolio performance is
assessed based on changes in fair value as well as interest earned. Therefore, the business
model and SPPI characteristics would lead this part of the portfolio to be categorised as fair
value through other comprehensive income (FVTOCI).
2. Shorter term part – this part of the portfolio consists of short-term debt securities as well as
futures contracts. While the debt securities are ‘vanilla’ securities that will meet the SPPI
test, the futures contracts do not have cash flows that are solely payments of principal and
interest. Accordingly, the portfolio as a whole does not meet the SPPI test. This means that
this part of the portfolio should be categorised as fair value through profit or loss (FVTPL).
The objective of the business model that Generous uses to manage this part of the portfolio
does not impact on this classification, although it appears to be managed to buy and sell
financial assets rather than to collect contractual cash flows.

Solution – Part B
Based on the categorisation of the asset portfolio in Part A, the debt security will be measured
at FVTOCI. Interest on the security should be measured using the effective interest method
(EIM). This means that in order to prepare the journal entries to account for the debt security, the
amortisation profile needs to be prepared. This is shown below.
(Note: The entire profile is shown, but in an exam candidates would only need to calculate as
much as is required to prepare the journal entries.)

Date Opening Principal Interest Interest Closing

balance repayments receipts accrued balance
using EIM
$ $ $ $ $

30.06.X6 10,150,000

31.12.X6 10,150,000 (175,000) 138,258 10,113,258

30.06.X7 10,113,258 (175,000) 137,757 10,076,015

31.12.X7 10,076,015 (175,000) 137,249 10,038,264

30.06.X8 10,038,264 (10,000,000) (175,000) 136,736 –

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Journals are as follows:

Date Description Dr Cr
$ $

01.07.X6 Long term portfolio asset 10,150,000

Cash at bank 10,150,000

Recognition of the government bond on 1 July 20X6

Date Description Dr Cr
$ $

31.12.X6 Cash at bank 175,000

Long term portfolio asset 36,742

Interest revenue 138,258

Recognition of interest coupon received 31 December 20X6

Date Description Dr Cr
$ $

31.12.X6 Long term portfolio asset 5,742

FVTOCI reserve [OCI] 5,742

Recognition of the change in fair value of the security at 31 December 20X6 [$10,150,000 – $36,742 –
$10,119,000]

Date Description Dr Cr
$ $

30.06.X7 Cash at bank 175,000

Long term portfolio asset 37,243

Interest revenue 137,757

Recognition of interest coupon received 30 June 20X7

Date Description Dr Cr
$ $

30.06.X7 FVTOCI reserve [OCI] 11,757

Long term portfolio asset 11,757

Recognition of the change in fair value of the security at 30 June 20X7 [$10,119,000 – $37,243 – $10,070,000]

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Solution – Part C

Memorandum
To: Johnny Fudge
From: C Accountant
Generous has a number of Australian government bonds in the longer term part of its asset
portfolio that have been hedged with interest rate swaps. Using one bond as an example, this
memo outlines how the hedges will be classified and accounted for under IFRS 9 and how their
effectiveness will be assessed.
How the hedge will be classified
The risk that is being hedged on these bonds is the interest rate risk and its impact on the fair
value of the bond. The cash flows received on the investment are fixed, and therefore Generous
is not subject to cash flow risk. This means the hedge will be classified as a fair value hedge, and
gains and losses on both the bond and the swap will be recognised in profit or loss (P&L). To
the extent the hedge is effective, gains and losses will offset and only the ineffective portion will
remain in P&L.
Hedge journal entries
If we ignore hedging of the government bond, the revaluation of the bond would be recognised
entirely in OCI. At 30 June 20X7, the journal entry would be as follows:

Date Description Dr Cr
$ $

30.06.X7 FVTOCI reserve [OCI] 11,757

Long term portfolio asset 11,757

Recognition of the change in fair value of the debt security at 30 June 20X7 [$10,119,000 – $37,243 –
$10,070,000]

If we assume a fair value hedge is in place, the journal entries for the six months to 30 June 20X7
will change to the following:

Date Description Dr Cr
$ $

30.06.X7 Loss on revaluation of long term portfolio asset 11,757

Long term portfolio asset 11,757

Recognition of the change in fair value of the security at 30 June 20X7 [$10,119,000 – $37,243 – $10,070,000]

Date Description Dr Cr
$ $

30.06.X7 Interest rate swap [statement of financial position] 12,000

Gain on interest rate swap [P&L] 12,000

Recognition of the fair value of the interest rate swap at 30 June 20X7 [$5,000 – ($7,000)]

It is evident from the journal entries that there is a very small amount of hedge ineffectiveness
($243) in the six months to 30 June 20X7, which is recognised in P&L.

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Effectiveness testing
There are two primary changes relating to hedge effectiveness under IFRS 9 compared to IAS 39,
as follows:
•• Hedge effectiveness only needs to be tested prospectively, not retrospectively.
•• There is no 80–125% test as testing is principals-based.

In order for the hedge between the bond and the swap to be effective, it needs to meet the
following requirements:
•• There is an economic relationship between the government bond and the interest rate swap.
It would be expected that the fair values of the bond and the swap will move in opposite
directions on an ongoing basis, as they are based on the same underlying interest rates.
•• The effect of credit risk does not dominate the value changes. As the bond is issued by the
Australian Government, it is unlikely changes in credit risk will have a material impact on
the value of the bond. However, the value of the interest rate swap will change based on the
credit standing of the counterparty bank, and this will need to be monitored over the life of
the hedge to ensure it does not move materially.
•• The accounting hedge ratio remains the same as the economic hedge ratio. The only reason
the economic hedge ratio would need to change over the life of the hedge is if there was basis
risk that was resulting in significant hedge ineffectiveness. If this was the case, the hedge
ratio for accounting purposes would also need to change to reflect this.

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Solution – Part D
IFRS 9 requires credit losses to be recognised on financial assets regardless of whether a default
has actually occurred. The impact on the portfolio’s performance should be considered for each
part of the portfolio separately:
•• Longer term part – this part of the portfolio contains predominantly high-grade securities
that are accounted for at FVTOCI. Generous’ credit department has rated these securities
as having low credit risk, which means that low credit risk operational simplification can
be adopted. The implications are that no ongoing assessment of credit risk is required and
Generous can just recognise 12-month expected credit losses (ECLs) on these assets, which
will be calculated at 2% of the long-term portfolio value. This loss allowance will effectively
transfer a portion of the fair value revaluation from OCI to P&L and will not impact on the
fair value of the asset recognised. Since the level of ECL recognised will remain at 12-month
ECL, there will be minimal ongoing impact on the portfolio’s performance after initial
recognition of ECLs.
•• Shorter term part – this part of the portfolio contains short-term debt securities and futures
contracts that are measured at FVTPL. Since changes in credit risk are already incorporated
into the fair value of these assets and recognised in P&L, there is no need to recognise
additional expected credit losses. Accordingly, there will be no impact on the financial
statements or portfolio’s performance as compared to IAS 39.

Recommended approach

Step 1 – Review the Standard

The relevant paragraphs of IFRS 9 are as follows:

Standard Paragraphs Relevance

IFRS 9 4.1.1–4.1.5 Classification of financial assets

5.2.1 Subsequent measurement of financial assets

5.4.1 Recognition of interest on financial assets using effective interest

method

5.5.1–5.5.5 Recognition of expected credit losses

5.5.10 Low credit risk operational simplification

5.7.10–5.7.11 Recognition of interest on FVTOCI assets

6.4.1 Hedge effectiveness criteria

6.5.2 Fair value and cash flow hedges

6.5.8 Fair value hedge accounting

Appendix A Definitions

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Part A
Step 2 – Identify the categories available
From your reading of IFRS 9, you identify the following categories available to you:
•• Amortised cost – instruments with cash flows that are solely principal and interest on the
principal outstanding, and held under a business model to collect contractual cash flows
(IFRS 9 para. 4.1.2).
•• Fair value through other comprehensive income – instruments with cash flows that are solely
principal and interest on the principal outstanding, and held under a business model to both
collect contractual cash flows and sell the assets (IFRS 9 para. 4.1.2A).
•• Fair value through profit or loss – instruments with cash flows that are not solely principal
and interest on the principal outstanding, are held under a business model to sell the assets,
or are initially designated as FVTPL (IFRS 9 paras 4.1.4 and 4.1.5).

Step 3 – Identify the relevant factors for each part of the portfolio
You know that the portfolio has historically been split into two parts and that each part has
different characteristics. Accordingly, you should evaluate each part separately.

Portfolio part Relevant factors

Longer term This part of the portfolio consists of corporate and government bonds. In the absence of
any information to the contrary, the securities within this part are considered to be ‘vanilla’
securities. Accordingly, cash flows would be expected to consist solely of interest coupons
on the face value of the security and repayments of principal
The background information also clearly sets out the business model that Generous
adopts for managing these securities – receiving contractual cash flows and selling
securities in order to maximise portfolio returns. In addition, the performance of the
portfolio is measured based on these two activities

Shorter term The background information indicates this part of the portfolio contains a combination of
‘vanilla’ debt securities as well as futures. Futures are derivatives that will not have interest
and principal cash flows. Even though the short-term debt securities will have interest and
principal cash flows, the portfolio as a whole does not have cash flows that consist solely
of interest and principal payments

Step 4 – Identify and explain the choice of category for each financial
instrument
Based on the options available and the relevant factors for each instrument, you can classify them
appropriately and explain the reasons for your choice of classification.

Part B
Step 5 – Calculate the amounts to be recorded for the corporate bond
Calculate the interest expense and amortised cost of the bond using the effective interest method
(EIM). Paragraphs 5.7.10 and 5.7.11 of IFRS 9 indicate that interest on FVTOCI instruments
should be measured using the EIM, in the same way that you would if the instrument was
measured at amortised cost. You know from IFRS 9 that the amortised cost is the initial balance
less principal repayments less coupon payments plus interest accrued using the EIM. The
interest expense is calculated by applying the effective interest rate to the opening balance of the
bond each year. In this case, this calculation is quite straightforward as the effective interest rate
and coupon are the same.

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Step 6 – Prepare the journal entries required

The journal entries can be prepared for the year 30 June 20X7. Initial recognition of the
investment occurred on 30 June 20X6, so this journal is not required. Effectively, simply account
for it as if it was measured at amortised cost and then revalue it each period to fair value.
Changes in fair value are recognised in other comprehensive income (OCI).

Part C
Step 7 – Apply the requirements of IFRS 9 to the hedging relationship
Review para. 6.5.2 of IFRS 9, which defines the different types of hedging relationships.
The instrument being hedged in this case is a fixed rate government bond. There are no risks
relating to cash flow as these are fixed over the life of the bond. However, the fair value of the
bond will change as interest rates move. Accordingly, the interest rate swap is hedging against
interest rate risk as it impacts on the fair value of the bond, and is a fair value hedge.
Also review para. 6.5.8 of IFRS 9, which outlines how fair value hedges should be accounted for.
The gain or loss on the hedging instrument (the interest rate swap) is recognised in profit or loss.
The hedging gain or loss of the hedged item (the bond) is also recognised in profit or loss. In this
situation, where the bond is measured at FVTOCI and the interest rate risk is being hedged, the
hedging gains or losses are the portion of the change in fair value that has been recognised in
OCI.
From a practical perspective, Generous would prefer the fair value of the bond acquired to
follow its amortised cost profile and not be impacted by changes in interest rates (particularly
increasing interest rates that will reduce the value of the bond). Hedging this exposure with an
interest rate swap enables the movement in fair value to be offset against the change in fair value
of the swap.

Step 8 – Prepare the journal entries for the hedging relationship at 30 June
20X7 under fair value hedging
Interest rate swap – At 30 June 20X7, this has a fair value of $5,000. However, at 31 December
20X6, the swap had a fair value of ($7,000), and accordingly its value has increased by $12,000
during the six months. This gain on the swap will be recognised in profit or loss against the
change in value of the swap on the statement of financial position.
Government bond – At 30 June 20X7, this has a fair value of $10,070,000. This is a decrease of
$80,000 since inception, and $49,000 since 31 December 20X6. Of the $49,000 change in fair value,
$37,243 was recognised as part of the interest recognition process using the EIM, and $11,757 was
recognised in OCI as a revaluation of the bond to fair value. It is the $11,757 that represents the
hedging loss on the bond for the six months.
Because the government bond is now a hedged item, the loss for the six months of $11,757 will
now need to be recorded in profit and loss in order to offset against the gain made on the interest
rate swap (the hedging instrument).

Step 9 – Effectiveness testing

Paragraph 6.4.1 of IFRS 9 outlines the criteria for an effective hedging relationship.

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Part D
Step 10 – Apply the requirements of IFRS 9 to the asset portfolio
Paragraph 5.5.1 of IFRS 9 indicates that ECLs are only required to be recognised for financial
assets measured at amortised cost or FVTOCI. Accordingly, only the longer term part of the
portfolio needs to have the impairment provisions of IFRS 9 applied to it.
Paragraph 5.5.5 of IFRS 9 indicates that entities should recognise 12-month ECL (which is
ECL resulting from default events likely to occur in the next 12 months), unless a significant
increase in credit risk has occurred since initial recognition. To avoid assessing credit risk at each
reporting period, a simplification is available in para. 5.5.10 of IFRS 9 for financial instruments
that an entity has determined have a low credit risk. The background information indicates that
this is the case for the longer term part of the asset portfolio – accordingly, ECL can remain at
12-month ECL.

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Unit 10: Impairment of assets

Activity 10.1
Accounting for impairment loss for a CGU and
reversal of impairment loss

Solution
1. The impairment loss for the Dorado CGU at 30 June 20X2 is $350,000, which is allocated to
goodwill ($200,000), land ($20,000) and plant ($130,000).
2. Although the maximum impairment loss reversal is $283,750, the rules in IAS 36 permit only
a $10,000 reversal for land and $113,750 for plant to be recognised.

Recommended approach

Preliminary step – Review the Standard

IAS 36 paras 2, 63, 104–105, 114, 119, 122 and 123 are relevant to your task.

Task A: Calculate and allocate the impairment loss of the Dorado CGU
at 30 June 20X2

Step 1 – Identify indications of impairment/perform annual

impairment testing as CGU contains goodwill
The Dorado CGU must be tested annually for impairment as it contains goodwill.

Step 2 – Determine the CGU’s recoverable amount

The Dorado CGU’s recoverable amount was calculated to be $2,350,000 based on its value in
use (VIU).

Step 3 – Determine the carrying amount of the CGU

The Dorado CGU’s carrying amount at 30 June 20X2 was $2,700,000.

Step 4 – Determine if the CGU is impaired

Compare the CGU’s carrying amount to its recoverable amount. If the carrying amount of a CGU
exceeds its recoverable amount, the excess is an impairment loss.
The Dorado CGU is impaired as its carrying amount exceeds its recoverable amount.
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Step 5 – Calculate the impairment loss as at 30 June 20X2

The impairment loss for the Dorado CGU is $350,000, calculated as follows:

Dorado CGU impairment loss

Carrying amount of Recoverable amount Impairment loss

CGU assets of CGU (VIU)
$ $ $

Dorado 2,700,000 2,350,000 350,000

Step 6 – Determine the allocation of the impairment loss across

individual assets
The $350,000 impairment loss for the Dorado CGU is allocated across the individual assets
as follows:
•• First, it is allocated to goodwill (in accordance with IAS 36 para. 104).
• • The remaining impairment loss then is allocated pro rata to the remaining assets of the CGU
in proportion to their carrying amounts subject to the floor limit in IAS 36 para. 105.

As the land has a fair value less costs of disposal (FVLCOD) of $480,000 compared to the carrying
amount of $500,000, only $20,000 of the impairment loss can be allocated to this asset. This is
because of the requirements of IAS 36 para. 105, which establish $480,000 as the floor in this
situation. Therefore, the land cannot be reduced below its FVLCOD of $480,000.
The calculation of the impairment loss allocation is performed as follows:

Dorado CGU – allocation of impairment loss

Carrying Allocation Allocation of Revised

amount impairment carrying
loss amount
$ $ $

Goodwill 200,000 Allocated first to goodwill 200,000 –

Land 500,000 Allocated to satisfy the $480,000 20,000 480,000

floor limit

Plant (net of 2,000,000 Remaining impairment loss 130,000 1,870,000

accumulated allocated
depreciation)

Total impairment loss 2,700,000 350,000 2,350,000

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Task B: Calculate and allocate the maximum impairment loss reversal

at 30 June 20X3

Step 1 – Calculate the maximum impairment loss reversal at

30 June 20X3
The carrying amount of the Dorado CGU’s assets at 30 June 20X3 is as follows:

Asset $

Land 480,000

Plant (net of depreciation) *

1,636,250

Total 2,116,250
* The revised carrying amount at 30 June 20X2 after recognising the impairment loss was $1,870,000. As the plant had a
remaining useful life of eight years, the depreciation expense for the year ended 30 June 20X3 was $233,750 ($1,870,000
÷ 8 years). Accordingly, the carrying amount at 30 June 20X3 is $1,636,250 ($1,870,000 – $233,750).

The Dorado CGU’s recoverable amount at 30 June 20X3 is $2,400,000.

Therefore, the excess of the recoverable amount of the Dorado CGU over the carrying amount of
the total assets of the Dorado CGU is $283,750, calculated as follows:

Carrying amount of total

Excess of recoverable
Recoverable amount of assets of Dorado CGU
– = amount over carrying
Dorado CGU (net of accumulated
amount of total assets
depreciation)

$2,400,000 – $2,116,250 = $283,750

The $283,750 represents the maximum impairment loss reversal.

Step 2 – Allocate the maximum impairment loss reversal

IAS 36 para. 122 prohibits a reversal of an impairment loss for goodwill, so it is not possible
to reverse any write-down of goodwill. Accordingly, the $283,750 maximum impairment loss
reversal can only be allocated to the land and plant subject to the limits specified in IAS 36
paras 122–123.
This process can be performed in four steps, as follows.
Step A: Calculate the carrying amount at 30 June 20X3 if no impairment loss had been
recognised at 30 June 20X2

Asset

Land Plant

$500,000 cost $2,500,000 cost

Depreciation: $2,500,000 ÷ 10 years = $250,000 p.a.
Depreciation to 30.06.X3 is 3 years × $250,000 = $750,000

Carrying amount if impairment Carrying amount if impairment never occurred:

never occurred:
Cost $2,500,000 – Accumulated depreciation $750,000
$500,000
= $1,750,000

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Step B: Allocate the maximum impairment loss reversal to the individual assets
The maximum impairment loss reversal is allocated to the land and plant in proportion to their
actual carrying amounts at 30 June 20X3.

Allocation of impairment loss reversal

Asset Carrying Proportion Allocation Revised

amount of maximum carrying
impairment amount
loss reversal
$ $ $

Land 480,000 ($480,000 ÷ $2,116,250) × $283,750 64,359 544,359

Plant (net of 1,636,250 ($1,636,250 ÷ $2,116,250) × $283,750 219,391 1,855,641

accumulated
depreciation)

2,116,250 283,750 2,400,000

Step C: Establish the ceiling for an impairment reversal under IAS 36 para. 123
The Standard imposes a ceiling on the reversal of the impairment loss after the revised carrying
amount in Step B has been calculated. Would the pro rata allocation of the reversal of the
impairment loss cause the new carrying amount of any individual asset to exceed the lower of
that asset’s:
•• recoverable amount, and
•• carrying amount (after depreciation)

had no impairment loss been initially recognised?

A recoverable amount was able to be determined for the land but not for the plant.
The values are considered to determine whether a ceiling applies to the land and/or plant.

Asset

Land Plant

Carrying Recoverable Revised carrying Carrying Recoverable Revised carrying

amount if amount: amount after pro amount if amount: Not amount after pro
impairment $490,000 rata allocation: impairment determinable rata allocation:
never occurred: never occurred:
$544,359 $1,855,641
$500,000 $1,750,000
(from Step A) (from Step B) (from Step A) (from Step B)

The revised carrying amount of $544,359, after the The revised carrying amount of $1,855,641, after the
allocated reversal, would cause the land’s value to allocated reversal, would cause the plant’s value to
exceed its $490,000 recoverable amount (as this exceed its $1,750,000 carrying amount if impairment
value is lower than its $500,000 carrying amount if never occurred
impairment never occurred)

The ceiling applies so that the land can only be written The ceiling applies so that the plant can only be
up to a value of $490,000 written up to a value of $1,750,000

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Step D: Impairment loss reversal calculation
The impairment loss reversal is calculated as follows:

Asset

Land Plant

Ceiling value: Actual carrying amount at Ceiling value: Actual carrying amount at
30 June 20X3: 30 June 20X3:
$490,000 $1,750,000
$480,000 $1,636,250
(from Step C) (from Step C)

Impairment loss reversal: $10,000 Impairment loss reversal: $113,750

($490,000 – $480,00) ($1,750,000 – $1,636,250)

Although the maximum impairment loss reversal calculated in Step 1 was $283,750, only
$123,750 ($10,000 for land + $113,750 for plant) is permitted to be recognised.
The $123,750 impairment loss reversal is recognised in profit or loss in accordance with IAS 36
para. 119.

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Unit 11: Provisions (including employee

benefit entitlements), contingent liabilities
and contingent assets

Activity 11.1
Calculating employee benefit liabilities

Solution – Task A
Bruxus’ employee benefit liabilities at 30 June 20X3:

Employee benefit liabilities at 30 June 20X3

Leave type $

Annual 33,483

Long service 40,675

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Identify the employee benefit liabilities to be calculated

A liability must be calculated for annual leave, which is a short-term benefit, and for LSL, which
is another long-term benefit.

Step 2 – Review the Standard

Review the recognition and measurement requirements of IAS 19 in relation to short-term
benefits for the calculation of the liability for annual leave (IAS 19 paras 11–18) and other
long‑term benefits for the calculation of the LSL (IAS 19 paras 155–156).

Step 3 – Apply the Standard to calculate the annual leave liability

Annual leave is an accumulating absence and recognition occurs when the employee renders the
service that increases their entitlement to future compensated absences. Therefore, any annual
leave accrued at 30 June 20X3 must be recognised as a liability.
The liability is measured at the expected cost of the leave entitlement. As all employees are
expected to take their accrued annual leave in the next financial year, the cost to Bruxus will be
the current salary cost plus salary increase plus on-costs.
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Calculation of annual leave liability

Department Average Salary Salary On-costs1 Annual Number Average Liability2
annual increase after cost of staff annual
salary increase leave
$ % $ $ $ days $
CEO 230,000 15 264,500 26,450 290,950 1 6.5 7,274
Marketing 63,000 8 68,040 6,804 74,844 4 10.5 12,090
Finance 54,000 3 55,620 5,562 61,182 3 20 14,119
33,483

Notes
1. On-costs are 10% of salary costs.
2. Calculated as: Annual cost ÷ 260 days × number of staff × average annual leave days.

Step 4 – Apply the Standard to calculate the LSL liability

To calculate the LSL liability, first, calculate the ‘service value’. This is the employee’s salary at
reporting date plus any employee-related costs (e.g. taxes paid by employers based on employee
wages), multiplied by the proportion of LSL entitlement they have accrued through service
provided to the reporting date.

Calculation of service value

Department Average On-costs Average Average Entitlement Service

annual annual years of rate1 value
salary salary plus service
on-costs
$ % $ $

CEO 230,000 10 253,000 3 0.0154 11,689

Marketing 63,000 10 69,300 5 0.0154 5,336

Finance 54,000 10 59,400 8 0.0154 7,318

Note
1. Amount of LSL accumulated for each year of service, calculated as 1 ÷ 10 × 8 ÷ 52 (1 ÷ number of years of service
required for LSL × number of weeks of LSL ÷ number of weeks in the year).

Second, inflate the service value to the anticipated future cash flow when the LSL is taken. This is
based on the date when it is expected the LSL will be taken, not when the employee is entitled to
LSL. In this case, employees are expected to take LSL as soon as they are entitled.

Inflate the service value to the anticipated future cash flow when LSL is taken

Department Service value Salary increase per Growth in salary Anticipated future
year factor1 cash flow
$ % $

CEO 11,689 15 2.6600 31,093

Marketing 5,336 8 1.4693 7,840

Finance 7,318 3 1.0609 7,764

Note
1. (1 + growth rate)n, where n = years remaining.
CEO = (1 + 0.15)7
Marketing = (1 + 0.08)5
Finance = (1 + 0.03)2

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Third, discount the anticipated future cash flow to present value (PV) using the appropriate rate.

Discounted future cash flow

Department Anticipated future Discount rate Discount factor1 PV of anticipated

cash flow future cash flow
$ % $

CEO 31,093 4.90 0.71544 22,245

Marketing 7,840 4.69 0.79520 6,234

Finance 7,764 4.44 0.91678 7,118

Note
1. 1 ÷ (1 + discount rate)n, where n = years remaining.
CEO = 1 ÷ (1 + 0.0490)7
Marketing = 1 ÷ (1 + 0.0469)5
Finance = 1 ÷ (1 + 0.0444)2

Finally, multiply the PV of the anticipated future cash flow by the probability that the employee
will receive their LSL benefit (i.e. will still be employed when the LSL becomes payable) and by
the number of employees in each department.

LSL liability

Department PV of anticipated Probability Number of staff LSL liability

future cash flow
$ % $

CEO 22,245 30 1 6,674

Marketing 6,234 55 4 13,715

Finance 7,118 95 3 20,286

Total 40,675

$ $

30.06.X3 DTA 2,760

30.06.X3 Income tax expense 2,760

To record the movement in the DTA relating to the LSL liability

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Calculate the liability at year end and prepare the journal
entries
The journal entry restates the liability from 30 June 20X2 to 30 June 20X3 by recognising the
related expense. The movement in the short‑term employee benefits liability is impacted by the
$58,000 annual leave paid during the year as this was debited to the liability account.
A reconciliation of the movement in the short‑term employee benefits liability account during the
year ended 30 June 20X3 is as follows:

Movement in short-term employee benefits liability

Item $

Opening liability at 30.06.20X2 30,298

Less: Leave paid (58,000)

Add: Current year expense1 61,185

Closing liability at 30.06.20X3 33,483

1. The current year expense represents the balancing item to arrive at the closing liability balance of $33,483,
which was calculated in Step 3 of Task A.

The journal entry is shown in the solution.

Step 2 – Calculate the deferred tax impact and prepare the journal
entry
As the annual leave is an allowable deduction for tax purposes when the leave is paid, the
recording of a liability will give rise to a deferred tax balance as it represents future income tax
deductions.
The carrying amount of the liability is the amounts recorded in the statement of financial
position, being $33,483.
The tax base of the liability is the carrying amount less future deductible amounts, as the full
amount is deductible in the future and the tax base is nil.

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This will give rise to a DTA as follows:
Deductible
Carrying amount > Tax base = temporary
difference (DTD)

DTD × Tax rate % = DTA

The DTA balance would have been recorded in the 30 June 20X2 financial statements and,
therefore, it is only the movement in the DTA that needs to be recorded at 30 June 20X3.
The calculation of the movement in the DTA is shown in the following table:

Movement in DTA

Movement in liability Tax rate Movement in DTA

during year ended during year ended
30.06.X3 30.06.X3
$ % $

Annual leave liability 3,185 30 956

Note
The annual leave paid would result in an income tax deduction of $58,000, which will reduce the current tax liability
by $17,400 ($58,000 × 30%). This would be accounted for as part of the current tax liability calculated at 30 June 20X3,
which has been covered in the unit on income taxes.

The journal entry is shown in the solution.

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Activity 11.2
Provisions, contingent liabilities and
contingent assets

Solution

Part A: Impact of legal claims on Pinpoint’s 30 June 20X3 financial

statements
1. Claim against Pinpoint for patent infringement
Given the likelihood of success, a payment is probable (i.e. more likely than not), and IAS 37
para. 36 requires a provision to be recognised as the best estimate of the present obligation.
Accordingly, a provision for the full amount of the claim of $2 million should be made.
The $1,900,000 reimbursement from the insurance company is recognised as a receivable (i.e. net
of the excess) because it is virtually certain that, if a payment is made to the claimants, the
insurance company will reimburse $1,900,000.
For this legal claim, a net expense of $100,000 will be recorded in Pinpoint’s statement of profit
or loss and other comprehensive income for the year ended 30 June 20X3, as this represents the
excess on the insurance policy (IAS 37 para. 54).
Disclosures concerning this provision and the related insurance recovery receivable will be
required. If disclosure of this information is likely to prejudice the interests of Pinpoint in
defending the legal claim, then this information need not be disclosed; however, the notes to the
financial statements would still have to disclose the general nature of the dispute, together with
the fact that the information has not been disclosed and the reason why (IAS 37 para. 92).

2. Claim by Pinpoint against the National Enquirer

It is probable, but not virtually certain, that Pinpoint will receive an inflow. Therefore, a
contingent asset should be disclosed, in accordance with IAS 37 para. 34. In a note to the financial
statements, there is a requirement to provide a brief description of the nature of the contingent
asset and an estimate of its financial effect, being the $10 million claim for damages (IAS 37
para. 89).

Recommended approach
The steps outline a recommended approach for successfully completing Part A of this task.

Step 1 – Review the Standard

Review the definitions of a provision, contingent liability and contingent asset as defined in
IAS 37 para. 10. The criteria for recognising a provision are detailed in IAS 37 para. 14, the
required treatment of a contingent liability is in IAS 37 paras 27 and 28, and the required
treatment of a contingent asset is in IAS 37 paras 31 and 34.

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Financial Accounting & Reporting Chartered Accountants Program

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As the claim against Pinpoint is covered by the insurers, IAS 37 paras 53 and 54 are also relevant
regarding the recognition of reimbursements of expenditure required to settle a provision and
the net expense to be presented. Disclosures relating to provisions, contingent liabilities and
contingent assets are specified in IAS 37 paras 84–92.

Step 2 – Apply the Standard

1. Claim against Pinpoint for patent infringement
Apply the recognition criteria in IAS 37 para. 14 to the scenario in order to determine the correct
classification of the $2,000,000 legal claim. These recognition criteria are depicted in a decision
tree in Implementation guidance B, which is useful in determining the classification of the
legal claim.

Application of the recognition criteria

Recognition criteria Application to the scenario

Present obligation as a result of an obligating event As it is more likely than not that Pinpoint will be
required to settle the claim there is a present obligation
The alleged patent infringement is the obligating event

Probable outflow of economic benefit The solicitors believe there is a 60% chance of Pinpoint
not successfully defending the case; therefore, it is more
likely than not that a settlement of the claim will be
required

Reliable estimate The claim is for $2,000,000, which is therefore the best
estimate of the amount required to settle the claim

As the claim is covered by insurance, the probability of the reimbursement is assessed and
recognised in accordance with IAS 37 para. 53. A net expense of $100,000 should be presented
(IAS 37 para. 54) after netting the expected reimbursement against the likely damages.
Disclosures in the notes to the financial statements will also be required:
•• Provisions – details concerning the provision must include the nature of the obligation,
the likely timing of any outflow of economic benefits, and the amount of the expected
reimbursement which has been recognised as an asset (IAS 37 paras 84–85).
•• Prejudicial information – if disclosure of this information in paras 84–85 in relation to the
legal claim is likely to prejudice the interests of the entity then this information need not be
disclosed. However, the company must disclose the general nature of the dispute, together
with the fact that the information has not been disclosed and reason why (IAS 37 para. 92).

2. Claim by Pinpoint for defamation

The claim against the National Enquirer meets the definition of a contingent asset; there is a
possible asset arising from a past event, the outcome of which will only be confirmed when the
claim is settled.
To determine how the contingent asset is treated in the financial statements, its probability
is assessed. In this case, the lawyers have advised of a 75% chance of success. This means the
contingent asset is probable and is treated in accordance with IAS 37 para. 34, with disclosures
specified in para. 89.

Page 11-8 Suggested solutions to activities – Unit 11

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Part B – Impact of legal claims on Pinpoint’s 30 June 20X4 financial

statements
1. Claim against Pinpoint for patent infringement
As it is no longer probable that Pinpoint will have to make a payment, there is no longer a need
to include a provision in the financial statements at 30 June 20X4 and, similarly, no longer a need
to include a receivable for the reimbursement from the insurance company.
This has the result of a reversal of the $100,000 expense relating to the insurance excess through
the statement of profit or loss and other comprehensive income for the year ended 30 June 20X4.
A note to the financial statements must be included, under contingent liabilities (IAS 37 para. 86),
relating to the court case, as although the obligation is no longer probable, it is not remote.
In the note to the financial statements, there is a requirement to provide a brief description of the
nature of the contingent liability and, where practicable, an estimate of its financial effect and an
indication of the uncertainties relating to the amount or timing of any payment required (IAS 37
paras 86(a) and 86(b)).
In this note, the reimbursement that would be received from the insurance company should
there be a requirement of a payout should also be disclosed under IAS 37 para. 86(c).
However, if disclosure of this information is likely to prejudice the interests of Pinpoint in
fighting the legal claim, then this information need not be disclosed. However, the notes to the
financial statements would still have to disclose the general nature of the dispute, together with
the fact that the information has not been disclosed and the reason why (IAS 37 para. 92).

2. Claim by Pinpoint for defamation

In May 20X4, Pinpoint was successful in its claim against the producers of the National Enquirer.
Thus, there is no contingent asset disclosure to be made in the 30 June 20X4 financial statements.

Recommended approach
The steps outline a recommended approach for successfully completing Part B of this task.

Step 1 – Review the Standard

The references from Part A of the task are still relevant for Part B. Paragraph 59 is also relevant
for this reporting period.

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Step 2 – Apply the Standard

1. Claim against Pinpoint for patent infringement
The recognition criteria are assessed in the following table:

Application of the recognition criteria

Recognition criteria Relevance to the scenario

Present obligation as a result of an As it is only possible (no longer probable) that Pinpoint will be
obligating event required to settle the claim there is a possible obligation as a
result of a past event

Probable outflow of economic benefit The solicitors believe there is a 55% chance of Pinpoint winning
the case

Reliable estimate Not applicable, as there is no longer a probable outflow

As the claim against Pinpoint does not meet the three recognition criteria it should be classified
as a contingent liability and treated in accordance with IAS 37 para. 28, with disclosure
requirements specified in paras 86 and 92.
It is important to remember that as the claim against Pinpoint was provided for in 20X3, the
provision and related reimbursement should be reversed in the financial statements for the year
ended 30 June 20X4 (IAS 37 para. 59).

2. Claim by Pinpoint for defamation

The claim against the National Enquirer is now settled and is therefore no longer contingent.

Page 11-10 Suggested solutions to activities – Unit 11

Chartered Accountants Program Financial Accounting & Reporting

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Unit 12: Leases

Activity 12.1
Accounting for a lease by a lessee and lessor

Solutions
1. Journal entries for Brightwell
30 June 20X3

Date Account description Dr Cr

$ $

30.06.X3 Right-of-use asset 240,215

Lease liability 240,215

To record the lease liability and the right-of-use asset for the underlying asset being leased

Date Account description Dr Cr

$ $

Accumulated depreciation 40,703

fin31712_actsols

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Financial Accounting & Reporting Chartered Accountants Program

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Date Account description Dr Cr

$ $

To record the annual depreciation of the right-of-use asset over the six-year useful life of the underlying
asset (equipment) given the purchase option to take ownership of the asset ($244,215 ÷ 6)

In order to prepare the journal entries for the two years, you will need to:
i. Determine the amount to be recognised for the right-of-use asset (IFRS 16 para. 24)
ii. Prepare the lease repayment schedule for Brightwell by performing the calculations up to
30 June 20X4 (IFRS 16 para. 36).
iii. Determine the correct timeframe for depreciating the right-of-use asset (IFRS 16 para. 32).
The lease repayment schedule is determined as follows (note that the complete lease
payment schedule has been provided):

Lease repayment schedule – Brightwell

Date Opening Interest Liability Lease Closing

liability expense1 reduction payment liability
$ $ $ $ $

30.06.X3 240,215 – 60,000 60,000 180,215

30.06.X4 180,215 16,219 43,781 60,000 136,434

30.06.X5 136,434 12,279 47,721 60,000 88,713

30.06.X6 88,713 7,984 52,016 60,000 36,697

30.06.X7 36,697 3,303 36,697 40,000 –

Note 1: The interest expense has been calculated at 9% of the opening balance. No interest is allocated to the first
lease payment as the payments are in advance.

2. Deferred tax balance calculation at 30 June 20X4

Item $

Carrying amount of the right-of-use asset ($244,215 right-of-use asset – $40,703 203,512
accumulated depreciation)

Lease liability 136,434

Net lease asset 67,078

Tax base 0

Taxable temporary difference ($67,078 carrying amount of the net lease asset – $0 tax base) 67,078

Deferred tax liability ($67,078 TTD × 30%) 20,123

Page 12-2 Activities solutions – Unit 12

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IAS 12 does not specify how to determine the deferred tax relating to a lease. However, the
principles of calculating a temporary difference are applied.
Based on a practical interpretation of IAS 12:
•• The carrying amount of the lease can be determined by calculating the net lease asset or
net lease liability.
The $203,512 carrying amount of the right-of-use asset is calculated net of the
accumulated depreciation (as shown in the solution).
The $136,434 lease liability is determined from the lease payment schedule, or by
combining the effects of the journal entries relating to the lease liability in Task 1.
Accordingly, there is a net lease asset of $67,078.
•• The tax base of the lease can be determined by preparing a notional tax balance sheet.
This is because the definition of tax base in IAS 12 para. 5 states
The tax base of an asset or liability is the amount attributed to that asset or liability for tax
purposes.
The tax base is $0 as the lease is not recognised for tax purposes. Only the lease payments
and the initial direct costs are tax deductible. Accordingly, if a notional tax balance sheet
was being prepared, there would be $0 attributed to the right-of-use asset and the lease
liability.
Given there is a net lease asset, apply the appropriate asset rule (covered in Unit 4 under
’Tax base’ on p. 4-12)). Use the values of the carrying amount of the net lease asset and the
tax base to determine whether it is a deductible temporary difference or a taxable temporary
difference. As the $67,078 carrying amount of the net lease asset is greater than the $0 tax
base, there is a $67,078 taxable temporary difference.
To determine the deferred tax liability, the taxable temporary difference is multiplied by
Brightwell’s 30% tax rate.

3. Journal entries for Lease-Right

30 June 20X3

Date Account description Dr Cr

$ $

30.06.X3 Finance lease receivable 240,215

Cash 240,215

To record the net investment in the lease on its commencement with Brightwell and payment to
manufacturer for the equipment (IFRS 16 paras 67–68)

Date Account description Dr Cr

$ $

30.06.X3 Cash 60,000

Finance lease receivable 60,000

To record the lease payment made in advance on the commencement of the lease (IFRS 16 para. 76)

Unit 12 – Activities solutions Page 12-3

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Unit 13: Earnings per share (EPS)

Activity 13.1
Calculating basic EPS

Solution
The basic EPS for Wohtle for the year ended 30 June 20X2 is $1.18 per share.

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Access IAS 33 and review the following paragraphs relevant to this task.

Relevant IAS 33 paragraphs

Paragraph Relevance to task

10 Provides the formula for calculating basic EPS

12–14 Details adjustments to profit or loss for the impact of preference shares on issue

19–21 Specifies the calculation of the weighted average number of ordinary shares outstanding
using a time-weighting factor

26 Details the required adjustment to the weighted average number of ordinary shares for
changes in the number of ordinary shares during the period

Appendix A, A15 Specifies the treatment of partly paid ordinary shares as a fraction of a share to the extent
they are entitled to participate in dividends
fin31713_actsols

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Step 2 – Calculate profit or loss attributable to ordinary equity holders

Applying the relevant guidance from IAS 33 paras 12 and 14, adjust the profit after tax
attributable to ordinary equity holders of the parent entity for preference share dividends.

Calculation of profit or loss attributable to ordinary equity holders of the parent entity

Description Amount
$

Profit after tax attributable to ordinary equity holders of the parent entity 12,400,000

Less: Preference share dividends

– 31 December 20X1 ($3,500,000 × 10%) × 6 ÷ 12 (175,000)

– 30 June 20X2 ($3,500,000 × 10%) × 6 ÷ 12 (175,000)

Profit attributable to ordinary equity holders of the parent entity 12,050,000

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Step 3 – Calculate the weighted average number of ordinary shares

Applying the relevant guidance from IAS 33 paras 19 and 20, prepare a table of all movements in
ordinary shares during the period to calculate the weighted average number of ordinary shares
using time-weighting factors.

Weighted average number of ordinary shares

Details Period Days in Number of Cumulative Weighted

period shares shares average
number of
ordinary
shares

Ordinary shares 01.07.20X1– 168 10,000,000 10,000,000 4,602,740

15.12.20X1

Share buy-back 16.12.20X1– 16 (250,000) 9,750,000 427,397

31.12.20X1

Partly paid ordinary 01.01.20X2– 100 500,000 10,250,000 2,808,219

share issue (2⁄3 dividend 10.04.20X2
participation)*

Share issue 11.04.20X2– 81 500,000 10,750,000 2,385,616

30.06.20X2

365 10,223,972

*P
artly paid shares were treated as a fraction of an ordinary share to the extent that they were entitled to participate in
dividends during the period relative to a fully paid ordinary share. The partly paid shares were issued on 20 October
20X1 but were entitled to a 2⁄3 dividend participation from 1 January 20X2. The partly paid shares were therefore
included at 750,000 × 2⁄3 from 1 January 20X2.

Step 4 – Calculate basic EPS

Basic EPS (calculated to two decimal places)
Weighted average number of ordinary
Basic earnings ÷ = Basic EPS
shares

$12,050,000 ÷ 10,223,972 = $1.18

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Chartered Accountants Program Financial Accounting & Reporting

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Activity 13.2
Calculating diluted EPS

Solution
The diluted EPS for Best for the year ended 30 June 20X2 is $1.06 per share.

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Access IAS 33 and review the following paragraphs relevant to the task.

Relevant IAS 33 paragraphs

Paragraph/ Relevance to task

Illustrative
example

31 The adjustments to profit or loss and to the weighted average number of shares outstanding
for the impact of dilutive potential ordinary shares

33 The adjustments to profit or loss attributable to ordinary equity holders of the parent entity
for dividends, interest and other changes in income or expense that would arise if dilutive
potential ordinary shares were converted into ordinary shares

36–38 To calculate diluted EPS, the weighted average number of ordinary shares outstanding for
basic EPS is adjusted for the impact of dilutive potential ordinary shares

39 The conversion of dilutive potential ordinary shares is calculated on the basis most
advantageous to the holders

41 Potential ordinary shares are only treated as dilutive when their conversion to ordinary shares
would decrease basic EPS

44 In determining whether potential ordinary shares are dilutive, each issue is considered
separately, from the most dilutive to the least dilutive

45–47 Options are dilutive where the issue price is less than the average market price of shares. The
extent of dilution is limited to the difference between the number of shares on issue, less the
number of shares that would be issued at the average market price using the proceeds from
the conversion

52–53 Contingently issuable shares are included in the calculation of diluted EPS if the conditions
are met, or would be met if the period end were the end of the contingency period

Illustrative Provides an example of the calculation of the weighted average number of shares, including
example 9 the determination of the order in which to include dilutive instruments

Unit 13 – Suggested solutions to activities Page 13-5

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Step 2 – Calculate the earnings per incremental share from potential ordinary
shares
Determine the impact on earnings and the number of ordinary shares that would be issued,
assuming that all potential ordinary shares are converted to ordinary shares. Calculate the
earnings per incremental share for each category of potential ordinary shares.

Potential ordinary shares – incremental earnings

Description Increase in Increase in Earnings per

earnings number of incremental
ordinary share
$ shares $

Convertible notes 98,000 1 2,000,000 0.05

Convertible preference shares 120,000 2 40,000 3.00

Options Nil 121,212 3 Nil

Contingently issuable shares Nil 166,027 4 Nil

Notes
1. $2,000,000 × 7% × (1 – 0.30).
2. $1,000,000 × 12%.
3. The assumed proceeds from the options ($2,500,000) are regarded as having been received from the issue of ordinary
shares at the average market price ($2,500,000 ÷ $6.60 = 378,788 shares at average market price). The difference
between the number of shares issued and the number of shares that would have been issued at the average market
price (500,000 – 378,788 = 121,212) are the shares that are deemed to have been issued for no consideration.
4. The contingently issuable shares are included in accordance with IAS 33 para. 52, because the contingency (profit
before tax of $600,000 for the year to 31 August 20X2) would have been satisfied if the period end (30 June 20X2)
were the end of the contingency period (as the profit before tax to 30 June 20X2 was $650,000).
The number of contingently issuable shares included in the diluted EPS calculation is the number that would be
issuable, included from 1 September 20X1 (and weighted for the period), which was the date of the contingent share
agreement (200,000 × 303 ÷ 365).

Step 3 – Rank potential ordinary shares

The order in which to include the dilutive instruments in the diluted EPS calculation is
determined by the earnings per incremental share calculation, from lowest to highest; the lowest
representing the most dilutive. Therefore the ranking is:

Instrument Earnings per incremental share

Contingently issuable shares Nil1

Options Nil

Convertible notes $0.05

Convertible preference shares $3.00

1. These rank before the options as they would result in 166,027 ordinary shares being issued versus 121,212 for the
options, and therefore have a greater dilutive effect.

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Step 4 – Calculate diluted EPS

To calculate diluted EPS, each issue is considered separately, from the most dilutive to the least
dilutive.

Dilutive effect of potential ordinary shares

Earnings Ordinary EPS Dilutive

$ shares $ Yes/No

Basic EPS 14,364,000 11,400,000 1.2600

Contingently issuable shares Nil 166,027

14,364,000 11,566,027 1.2419 Yes

Options Nil 121,212

14,364,000 11,687,239 1.2290 Yes

Convertible notes 98,000 2,000,000

14,462,000 13,687,239 1.0566 Yes

Convertible preference shares 120,000 40,000

14,582,000 13,727,239 1.0623 No

As the convertible preference shares are anti-dilutive, since they cause the calculation to increase,
they are not included in diluted EPS.
Therefore, diluted EPS for Best for the year ended 30 June 20X2 is $1.06 per share (rounded from
$1.0566).

Unit 13 – Suggested solutions to activities Page 13-7

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30.06.X6 Employee benefits liability 13,907

30.06.X6 Bank 45,000

Record cash-settled SBP transaction

Year 4

Date Account description Dr Cr

$ $

30.06.X7 Employee benefits expense 8,680

30.06.X7 Employee benefits liability 47,320

30.06.X7 Bank 56,000

Record cash-settled SBP transaction

fin31714_actsols

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Financial Accounting & Reporting Chartered Accountants Program

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Year 5

Date Account description Dr Cr

$ $

30.06.X8 Employee benefits expense 5,400

30.06.X8 Employee benefits liability 54,600

30.06.X8 Bank 60,000

Record cash-settled SBP transaction

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standard

Review IFRS 2 for guidance on accounting for cash-settled SBP transactions, specifically
paras 30–33.
IFRS 2 Implementation guidance IG Example 12 provides an example of accounting for cash-
settled SBP transactions.

Step 2 – Calculate the expense and liability for the SARs for the first year
Calculate the expense and liability to be recognised at 30 June 20X4. The services provided
by the managers and the liability incurred are measured at the fair value of the liability (IFRS 2
para. 30). As the managers have to complete three years of service, the expense and liability are
recognised over the three-year period (IFRS 2 para. 32).
The expense to be recognised for year ending 30 June 20X4 is calculated as:
Number of
Number Expense
managers Fair value Proportion
of SARs Opening for SARs for
for whom it of shares at of vesting
× granted × × – liability for = year ending
is expected reporting period
to each SARs 30 June
that SARs date completed
manager 20X4
will vest

(50 – 4 – 6) × 200 × $12.00 × ⁄3

1
– $0 = $32,000

There is no opening liability; therefore, $32,000 is the liability for SARs balance at 30 June 20X4.

Step 3 – Prepare the journal entry

The journal entry is shown in the solution.

Step 4 – Calculate the expense and liability for the SARs for the second year
The liability is remeasured to fair value at each year end until the liability is settled. Any changes
in fair value are recorded in profit or loss for the period (IFRS 2 para. 30).
The expense to be recognised for year ending 30 June 20X5 is calculated as:
Number of Number Expense
Fair value Proportion
managers for of SARs Opening for SARs for
of shares at of vesting
whom it is × granted × × – liability for = year ending
reporting period
expected that to each SARs 30 June
date completed
SARs will vest manager 20X5

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(50 – 4 – 3 – 2) × 200 × $16.10 × 2

⁄3 – $32,000 = $56,013

The current year expense is added to the prior year liability; therefore, $88,013 ($56,013 + $32,000)
is the liability for SARs balance at 30 June 20X5.

Step 5 – Prepare the journal entry

The journal entry is shown in the solution.

Step 6 – Calculate the expense and liability for the SARs for the third year
The liability at 30 June 20X6 must reflect the fair value of the outstanding liability. The SARs that
were exercised on 30 June 20X6 should not be included in the liability.
The expense to be recognised for year ending 30 June 20X6 is calculated as:
Number Expense
Fair value Proportion
Number of of SARs Opening for SARs for
of shares at of vesting
managers holding × granted × × – liability for = year ending
reporting period
unexercised SARs to each SARs 30 June
date complete
manager 20X6

(50 – 4 – 3 –2 – 15) × 200 × $19.60 × 3

⁄3 – $88,013 = $13,907

The current year expense is added to the prior year liability; therefore, $101,920 ($13,907 +
$88,013) is the liability for SARs balance at 30 June 20X6.
In addition, 15 managers exercised their SARs on 30 June 20X6 and cash paid out for each SAR
equals the intrinsic value. The cash payment is $45,000 (15 × 200 × $15.00) and this amount will be
expensed, as the liability of $101,920 reflects the outstanding liability at 30 June 20X6.

Step 7 – Prepare the journal entry

The journal entry is shown in the solution.

Step 8 – Calculate the expense and liability for the SARs for the fourth year
The liability at 30 June 20X7 must reflect the fair value of the outstanding liability. The SARs that
were exercised on 30 June 20X7 should not be included in the liability.
The expense to be recognised for year ending 30 June 20X7 is calculated as:
Number Expense
Fair value Proportion
Number of managers of SARs Opening for SARs for
of shares at of vesting
holding unexercised × granted × × – liability for = year ending
reporting period
SARs to each SARs 30 June
date complete
manager 20X7

(50 – 4 – 3 –2 – 15 – 14) × 200 × $22.75 × ⁄3

3
– $101,920 = ($47,320)

The current year expense is added to the prior year liability; therefore, $54,600 (($47,320)
+ $101,920) is the liability for SARs balance at 30 June 20X7.
In addition, 14 managers exercised their SARs on 30 June 20X7 and cash paid out for each SAR
equals the intrinsic value. The cash payment is $56,000 (14 × 200 × $20.00).

Step 9 – Prepare the journal entry

The journal entry is shown in the solution.

Step 10 – Calculate the expense and liability for the SARs for the final year
The remaining SARs were exercised on 30 June 20X8, and therefore no liability is outstanding
at 30 June 20X8. The liability is currently recorded at $54,600 and this can be derecognised.

Unit 14 – Suggested solutions to activities Page 14-3

Financial Accounting & Reporting Chartered Accountants Program

ACT
Twelve managers exercised their SARs on 30 June 20X8 and cash paid out for each SAR equals
the intrinsic value. The cash payment is $60,000 (12 × 200 × $25.00).

Step 11 – Prepare the journal entry

The journal entry is shown in the solution.

Page 14-4 Suggested solutions to activities – Unit 14

Chartered Accountants Program Financial Accounting & Reporting

ACT

Unit 15: Business combinations

Activity 15.1
Accounting for a business combination

Solution
A. Journal entries recorded by Starc as a result of the acquisition of TBS at 1 April 20X2:
Acquisition of the investment in TBS
Date Account description Dr Cr
$ $
01.04.X2 Investment in TBS 4,297,160
Cash 1,100,000
Deferred consideration payable 357,160
Share capital 2,840,000
To record the acquisition of the investment in TBS

Share issue costs

Date Account description Dr Cr
$ $
01.04.X2 Share capital 20,000
Cash 20,000
To record the share issue costs related to acquisition of the investment in TBS
fin31715_actsols

Unit 15 – Suggested solutions to activities Page 15-1

Financial Accounting & Reporting Chartered Accountants Program

ACT
B. The value of goodwill at 30 June 20X2 is $446,160 and at 30 June 20X3 is $439,160, calculated
as follows:

Goodwill calculation as at 30 June 20X2 and 30 June 20X3

30 June 20X2 30 June 20X3
Item $ $ $ $
Consideration transferred 4,297,160 4,297,160
Fair value of NCI 980,000 980,000
5,277,160 5,277,160
Assets acquired
Book value of net assets 4,740,000 4,740,000
Fair value adjustments (all amounts are
net of tax, where applicable)
Plant and equipment (($1,200,000 – 196,000 196,000
$920,000) × (1 – 30%))
Recognition of contingent liability (105,000) (98,000)
20X2: ($150,000 × (1 – 30%)) = (105,000)
20X3: ($140,000 × (1 – 30%)) = (98,000)
FVINA 4,831,000 4,838,000
Goodwill acquired 446,160 439,160

C. Journal entries to be recorded by Starc in the 12 months to 1 April 20X3 (ignoring tax effect
entries):
Interest expense on deferred consideration
Date Account description Dr Cr
$ $
30.06.X2 Interest expense 10,710
Deferred consideration payable 10,710
To record the interest expense on the deferred consideration to 30 June 20X2

Date Account description Dr Cr

$ $
01.04.X3 Interest expense 32,130
Deferred consideration payable 32,130
To record the interest expense on the deferred consideration from 1 July 20X2 to 1 April 20X3

Payment of the deferred consideration

Date Account description Dr Cr
$ $
01.04.X3 Deferred consideration payable 400,000
Cash 400,000
To record the payment of the deferred consideration to the former shareholders of TBS

Page 15-2 Suggested solutions to activities – Unit 15

Chartered Accountants Program Financial Accounting & Reporting

ACT

Recommended approach
The steps outline a recommended approach for successfully completing the tasks.

Task A
Step 1 – Identify the journal entries required
Journal entries will be recorded in Starc’s general ledger for the investment in TBS and for the
share issue costs associated with the acquisition.

Step 2 – Apply the Standards

Consider each item of consideration to establish at what value it should be included in the cost of
investment in accordance with IAS 39 paras 43 and AG64.

Cost of investment in TBS – 1 April 20X2

Description $
Cash – payable at acquisition 1,100,000
Deferred consideration 1
357,160
Shares issued2 2,840,000
Investment in TBS at initial recognition 4,297,160

Notes
1. To measure the fair value of the deferred consideration, it is discounted using a discount rate reflecting the acquirer’s
incremental borrowing rate (in this case 12%). Therefore, the fair value of the deferred payment is calculated as:
$400,000 × present value of a single dollar at 12% for one year = $400,000 × 0.8929 (1 ÷ 1.12) = $357,160.
2. The shares are valued at their fair value, calculated as: 1 share in Starc × 800,000 ÷ 2 shares acquired in TBS × $7.10 fair
value = $2,840,000.

The $20,000 in share issue costs are accounted for as a deduction from equity under IAS 32
para. 35. As they are not part of the fair value of the consideration given, they are not netted
against the $2,840,000 in determining the amount initially recognised for the investment.

Step 3 – Prepare the journal entries

Prepare the journal entry to record the acquisition of TBS in Starc’s accounting records based on
the amounts calculated in Step 3 together with the journal entry for the share issue costs.
The journal entries are shown in the solution.

Task B
Step 1 – Review the Standard
Calculating goodwill under IFRS 3 utilises the concept of consideration transferred.
Review IFRS 3 paras 37–40 to recap on what should be included in the consideration transferred
and paras 51–52 regarding what is part of the business combination.
Review the definition of ‘goodwill’ in IFRS 3 Appendix A.
Review IFRS 3 paras 45–50 detailing the measurement period when adjustments are made to
provisional amounts recognised at the acquisition date.

Unit 15 – Suggested solutions to activities Page 15-3

Financial Accounting & Reporting Chartered Accountants Program

ACT

Step 2 – Apply the Standard

The consideration transferred is $4,297,160.
Goodwill acquired on the acquisition of TBS is calculated as ((fair value of consideration + fair
value of NCI at acquisition) – (FVINA)). The tax effect of any fair value adjustments should be
taken into account.
The goodwill calculation at 30 June 20X2 is calculated based on the exit price applicable to the
contingent liability at the acquisition date. The plaintiff has claimed $380,000 in damages but the
lawyers believe TBS will successfully defend the case. The 30% chance of losing the case indicates
that TBS would have only disclosed a contingent liability in its financial statements as the
probability of an outflow is 50% or lower (IAS 37 para. 10(b)(i)). Accordingly, the after tax effect
of the $150,000 exit price value is subtracted in calculating the FVINA.
The goodwill at 30 June 20X3 reflects the settlement of the contingent liability within the
measurement period. As the measurement period shall not exceed one year from the date of
acquisition (i.e. to 31 March 20X3), any new information obtained about facts and circumstances
that existed at 1 April 20X2 and would have changed the measurement of goodwill are adjusted
for in accordance with IFRS 3 para. 45. As a result, an adjustment needs to be made to the FVINA
for the contingent liability as the settlement of the lawsuit occurred within the measurement
period.

Step 3 – Perform the calculation

The goodwill calculation for the two years are shown in the solution.
[Note that in Unit 16 the consolidation journal entries will be covered including those relating to
the measurement period adjustment.]

Task C
Step 1 – Consider any transactions/accounting entries in the year to 1 April 20X3
Items that directly affect Starc need to be recorded in Starc’s records, as follows:
Interest expense on deferred consideration
This represents the unwinding of the discount of $42,840 on the deferred consideration payable
($400,000 – $357,160), which is recognised as interest expense. Three months of this interest
($10,710) would have been expensed in Starc’s 30 June 20X2 financial statements, with the
remaining nine months worth of interest ($32,130) expensed in the year ended 30 June 20X3.
Payment of the deferred consideration
The deferred consideration of $400,000 was paid on 1 April 20X3.

Step 2 – Prepare the journal entries

The journal entries are shown in the solution.

Page 15-4 Suggested solutions to activities – Unit 15

Chartered Accountants Program Financial Accounting & Reporting

ACT

Unit 17: Equity accounting

Activity 17.1
Accounting for an investment in an associate
under the equity method of accounting

Solution
The journal entries as at 30 June 20X3 applying the equity method of accounting in the
consolidated financial statements of Benaud are as follows:

Journal 1
Date Account description Dr Cr
$ $

30.06.X3 Dividend revenue 120,000

30.06.X3 Investment in TOBA 120,000

To record the elimination of dividends received by Benaud during the 20X3 year

Journal 2
Date Account description Dr Cr
$ $

30.06.X3 Investment in TOBA 80,000

30.06.X3 Share of TOBA’s revaluation surplus 80,000

To record the share of TOBA’s post-acquisition revaluation surplus

Journal 3
Date Account description Dr Cr
$ $

30.06.X3 Investment in TOBA 166,400

30.06.X3 Retained earnings brought forward 24,800

30.06.X3 Share of TOBA’s profit after tax 141,600

To record the recognition of Benaud’s 40% share of TOBA’s post-acquisition retained earnings and profit after
tax for the 20X3 year
fin31717_actsols

Unit 17 – Suggested solutions to activities Page 17-1

Financial Accounting & Reporting Chartered Accountants Program

ACT

Recommended approach
The steps outline a recommended approach for successfully completing this task.

Step 1 – Review the Standards

Review IAS 28 for guidance on accounting for an associate. The following paragraphs are
relevant:
•• Paragraph 3 defines the equity method.
•• Paragraphs 2, 4 and 44 explain whether the equity method is applied in the investor’s general
ledger or on the consolidation worksheet with consolidation journal entries.
•• Paragraph 10 explains how the equity method affects the carrying amount of the investment.
•• Paragraphs 26–39 explain in detail the procedures involved in applying the equity method.

Step 2 – Identify the approach to apply the equity method of accounting for the
investment
Establish the approach to prepare the journal entries as at 30 June 20X3 to apply the equity
method of accounting:
•• Calculate goodwill or any negative goodwill included in the cost of the investment.
•• Prepare all necessary equity accounting journal entries and adjustments.
•• Calculate the equity carrying amount at 30 June 20X3.

Step 3 – Calculate goodwill or any negative goodwill in the cost of the

investment
Apply the requirements of IAS 28 to calculate goodwill or any negative goodwill in the cost of
the investment at the acquisition date. Goodwill arising is included in the carrying amount of
the investment; however, if there is any negative goodwill in the cost of the investment it will be
included as income in the period of acquisition via an equity accounting journal entry.
Perform the calculation by comparing the investment cost with Benaud’s share of the net fair
value of TOBA’s identifiable assets and liabilities.

Calculation of the value of goodwill included in Benaud’s investment cost for TOBA

Description $

Book value of net assets at acquisition 5,800,000

Add: fair value adjustment on machinery ($300,000 net of tax effect 30%) 210,000

Fair value of identifiable net assets 6,010,000

× 40% interest 2,404,000

Cost of investment in TOBA 2,500,000

Goodwill 96,000

Goodwill arising on the acquisition of TOBA is $96,000. IAS 28 paras 32(a) and 42 state that any
goodwill is included in the carrying amount of the investment; that is, it is not recognised as a
separate asset. As such, no equity journal entry will be required in regard to the $96,000.

Step 4 – Prepare all necessary equity accounting journal entries and

adjustments
A number of issues must be addressed through the equity accounting journal entries.
It is important to note that the equity accounting journal entries are notional entries (i.e. recorded
on the consolidation worksheet only), as Benaud prepares consolidated financial statements

Page 17-2 Suggested solutions to activities – Unit 17

Chartered Accountants Program Financial Accounting & Reporting

ACT
(IAS 28 para 44). Note: The equity method is applied in an investor’s separate financial
statements if it is not a parent in a consolidated group.
The equity accounting journal entries need to reflect:
•• The 20X3 dividend received from TOBA.
•• The post-acquisition revaluation surplus.
•• The post-acquisition retained earnings, including current year profit as adjusted for intra-
group transactions, and depreciation based on fair value of the machinery at the acquisition
date.

Benaud’s share of the 20X3 dividend is $120,000 (40% × $300,000), which needs to be eliminated.
The journal entry is presented in the solution.
As the 20X2 dividend is reflected in the post‑acquisition opening retained earnings it does not
require adjustment.
Benaud’s share of the post-acquisition movement on the revaluation surplus is $80,000
(($2,000,000 – $1,800,000) × 40%). The journal entry is presented in the solution.
To calculate the post-acquisition opening retained earnings and current year profit, adjustment
needs to be made for:
•• The unrealised profit on inventory sold by TOBA to Benaud.
•• The depreciation based on the fair value of the machinery at the acquisition date.

A table can be used for these calculations:

Post-acquisition opening retained earnings and profit after tax

Description Post-acquisition Current year profit

opening retained after tax
earnings
$ $

Opening retained earnings1 1,110,000

Less: pre-acquisition retained earnings (950,000)

Post-acquisition opening retained earnings 160,000

Current year profit after tax 340,000

After-tax effect of fair value adjustments

Depreciation on machinery2 (42,000) (42,000)

After-tax effect of unrealised profits on inter-entity

transactions

Unrealised profit in inventory at 01.07.X2, realised in 20X33 (56,000) 56,000

Adjusted opening retained earnings 62,000

Adjusted current year profits 354,000

40% interest 24,800 141,600

Notes
1. $950,000 opening retained earnings at 1 July 20X1 + $560,000 profit for 20X2 – $400,000 dividend for 20X2 (IAS 28
para. 10).
2. $300,000 × 20% = $60,000 × (1 – 30%) = $42,000 (IAS 28 para. 32).
3. $400,000 – ($400,000 ÷ 1.25) = $80,000 × (1 – 30%) = $56,000 (IAS 28 para. 28).

Benaud’s 40% interest is used for the journal entry to record the post-acquisition movement
in retained earnings for TOBA. The journal entry is presented in the solution.

Unit 17 – Suggested solutions to activities Page 17-3

[This page has deliberately been left blank]

Page 17-4

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