Cambridge International A2

Accounting Prepared by :
Udayanga Wijekoon.Sc.
B.Sc. Accounting (Special)
OKI International School University of Sri Jayewardenepura,
Chartered Accountancy (S-I), CIMA (ML)

Accounting Standards
International Accounting Standards (IAS/IFRS)
International Accounting Standards are the standards created by the International Accounting Standards
Board (IASB) stating how particular types of transaction or other events should be reflected in the financial
statements of a business entity.
Following accounting standards and the conceptual framework for financial reporting should be studied
under Cambridge IAL Accounting syllabus.
IAS 01 Presentation of financial statements
IAS 02 Inventories
IAS 07 Statement of cash flows
IAS 08 Accounting policies, changes in accounting estimates and errors
IAS 10 Events after the reporting period
IAS 16 Property, plant and equipment
IAS 36 Impairment of assets
IAS 37 Provisions, contingent liabilities and contingent assets
IAS 38 Intangible assets

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Conceptual framework for financial reporting
Conceptual framework is a system of objectives and ideas that lead to the accounting authorities creating a
consistent set of rules.
Users of financial statements

Users Reasons for use

• to assess efficiency of the stewardship of management

Owners
• to assess performance in relation to payment of dividend

• to assess efficiency of their strategies by comparing with previous years or

Managers
with similar businesses

Investors • to assess past performance as a basis for future investment

• to assess performance as a basis of future wage and salary negotiations

Employees • to assess performance as a basis for continuity of employment and job
security

• to assess performance in relation to the security of their loan

to the business
Lenders
• to assess the performance in relation to payment of the interest (finance cost)
on the loan provided

Suppliers • to assess performance in relation to receiving payment of their liability

Customers • to assess performance in relation to the likelihood of continuity of trading

• to assess performance in relation to compliance with regulations and

Government
assessment of taxation liabilities
Public &
• to assess performance in relation to ethical trading
environmental bodies

Qualitative characteristics
The Conceptual Framework for Financial Reporting sets out the qualitative characteristics of the financial
statements that makes them useful to the users.
Fundamental qualitative characteristics
(1) Relevance – the information influences the economic decisions of users.
(2) Faithful representation – the information must be complete, neutral and free from errors.
Enhancing qualitative characteristics
(1) Comparability – the information enables comparisons with similar information about other entities
and with similar information about the same entity over time to identify and evaluate trends.
(2) Verifiability – the information is faithfully represented and can be verified, providing assurance to the
user that it is both credible and reliable.
(3) Timeliness – the information is provided to the users within a timescale suitable for their decision-making
purposes.
(4) Understandability – the information is readily understandable by users, which is facilitated through
appropriate classification, characterization and presentation of information.

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IAS 1 : Presentation of financial statements
The objective of the standard is to prescribe the basis for presentation of general-purpose financial
statements, to ensure comparability both with the entity's financial statements of previous periods and with
the financial statements of other entities.

The purpose of financial statements

Financial statements provide information, about the financial position, financial performance and cash flows
of an entity that is useful to a wide range of users in making economic decisions.

The components of the financial statements

A complete set of financial statements as set out in the standard, comprises:
1. a statement of financial position at the end of the period
2. a statement of profit or loss and other comprehensive income for the period
3. a statement of changes in equity for the period
4. a statement of cash flows for the period
5. accounting policies and explanatory notes
6. comparative information

Accounting concepts
The standard requires compliance with a series of accounting concepts:
• Going concern – the presumption is that the entity will not cease trading in the foreseeable future.
(This is generally taken to mean within the next 12 months)
• Accrual basis of accounting – with the exception of the statement of cash flows, the information is
prepared under the accruals concept; income and expenditure are matched to the same accounting
period.
• Consistency of presentation – the presentation and classification of items in the financial
statements should be retained from one period to the next unless a change is justified by a change in
circumstances or the requirement of a new IFRS.
• Materiality and aggregation – information is material if omitting, misstating or obscuring it could
reasonably be expected to influence decisions by the primary users of the financial statements. Each
material class of similar items should be presented separately in the financial statements.
• Offsetting – assets and liabilities, and income and expenditure may not be offset unless required or
permitted by an IFRS.
• Comparative information – there is a requirement to show the figures from the previous period for
all the amounts shown in the financial statements.

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Structure and content of financial statements
IAS 1 identifies in detail how the financial statements should be presented. It also sets out some general
principles that must be adopted in those statements:
• a clear identification of the financial statements (statement of profit or loss, statement of financial
position, etc.)
• the name of the entity (e.g. XYZ Limited)

• the period covered by the financial statements (year ended, etc.)

• the currency used (e.g. £s, $s)
• the level of rounding used (e.g. if the statements are presented in thousands, millions)

Current assets & non-current assets

An asset is classified as current when:
− the asset is held primarily for the purpose of trading
− the asset is expected to be realised, consumed, or sold within the entity’s normal operating cycle
− when the asset is expected to be realised within twelve months after the reporting period

Any other assets would then be classified as non-current.

Current liabilities & non-current liabilities

A liability is classified as current when:

− it is expected to be settled in the entity’s normal operating cycle

− the liability is held primarily for the purpose of trading

− the liability is due to be settled within twelve months after the reporting period

− the liability for which the entity does not have the right at the end of the reporting period to defer
settlement beyond twelve months.

Any other liabilities would then be classified as non-current.

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IAS 02 : Inventories
The term inventory refers to the stock of goods which a business holds in a variety of forms:
• raw materials - for use in a subsequent manufacturing process
• work in progress - partly manufactured goods
• finished goods - completed goods ready for sale to customers or goods that the business has bought for
resale to customers.

 Inventories should be valued at the lower of cost and net realisable value.

Cost should include all costs of purchase (including transport and handling), costs of conversion
(including manufacturing overheads) and other costs incurred in bringing the inventory to its present
location and condition.

costs of purchase (including transport and handling) xxx

costs of conversion (including manufacturing overheads) xxx
other costs incurred in bringing the inventory to its present location and condition xxx
Cost of inventories xxx

Net realisable value is the estimated selling price in the normal course of business, less the
estimated cost of completion and the estimated costs necessary to make the sale.

estimated selling price in the normal course of business xxx

estimated cost of completion xxx
estimated costs necessary to make the sale xxx
Net realisable value of inventories xxx

Any write-down to net realisable value should be recognised as an expense in the period in which the write-
down occurs.

Question 01

The Good Look Clothing Company carries a variety of inventory. At their year-end they produce the following
data:

Cost Price Net Realisable Value

Item
$ $
New dresses 1 000 1 000
Children’s clothes 2 000 3 000
Bargain fashions 1 200 900

Calculate the value of the inventories

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Calculation of the cost of inventories
The valuation of work in progress and finished goods of a manufacturing business consists of :

• direct materials which include the purchase price, including import duties, transport and handling costs,
less trade discounts and rebates
• direct labour
• direct expenses (for example royalties or licence fees)
• production overheads (costs to bring the product to its present location and condition)

The inventory value of work in progress and finished goods excludes:

− abnormal waste in the production process
− storage costs
− selling costs
− administrative overheads not related to production

Question 02

The XYZ Manufacturing Company manufactures wooden doors for the building trade. For the period under
review, it manufactured and sold 10000 doors. At the end of the trading period there were 1000 completed
doors ready for dispatch to customers and 200 doors which were 50% completed as regards direct material,
direct labour and production overheads. Costs for the period under review were:
$
Direct material used 20 000
Direct labour 5 000
Production overheads 8 300

Non-production overheads 10 000

Calculate the value of work in progress and finished goods.

Inventory valuation methods

IAS 2 allows two different methods to be used for valuing inventory:
• First in, first out (FIFO) - This assumes that the first items to be bought will be the first to be
used, although this may not match the physical distribution of the goods. The valuation of the
remaining inventory will therefore always be the value of the most recently purchased items.
• Average cost (AVCO) - Under this method a new average value (usually the weighted average
using the number of items bought) is calculated each time a new delivery of inventory is
received.

 Inventories which are similar in nature and use to the business will use the same valuation method. Only
where inventories are different in nature or use, a different valuation method be used.
 Once a suitable method of valuation has been adopted by a business then it should continue to use that
method unless there are good reasons why a change should be made. This is in line with the consistency.

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IAS 8 : Accounting policies, changes in accounting estimates and errors
Accounting policies
Accounting policies are defined as: ‘the specific principles, bases, conventions, rules and practices applied by
an entity in preparing and presenting financial statements.

In selecting and applying accounting policies, the standard requires that:

• when an accounting standard specifically applies to a transaction or event, then the policy
contained in that standard should be applied, OR
• when no specific standard applies, then management should use its judgement in developing
and applying an accounting policy that provides information to the users of the financial
statements that is relevant, reliable, prudent and complete.

An entity must apply accounting policies consistently for similar transactions. Changes in accounting policies
can only occur:
• if the change is required by an accounting standard or interpretation, OR
• if the change results in the financial statements providing more reliable and relevant
information that faithfully represents the effect of transactions on the financial statements.

 Any changes adopted must be applied retrospectively to financial statements. This means that the
previous figure for equity and other figures in the statement of profit or loss and statement of financial
position must be altered, subject to the practicalities of calculating the relevant amounts.

Changes in accounting estimates

As a result of the uncertainties in business activities, many items in financial statements can only be
estimated.
Eg : allowance for irrecoverable debts, obsolete inventory, the useful life of PPE and warranty obligations
The effect of a change in an accounting estimate, shall be recognized prospectively by;
− including it in profit or loss in the period of the change, if the change affects that period only or the
period of the change and future periods, if the change affects both

− to the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or
relates to an item of equity, it shall be recognised by adjusting the carrying amount of the related asset,
liability or equity item in the period of the change

Errors
Errors are defined as: ‘omissions from, and misstatements in, the entity’s financial statements for one or
more prior periods arising from a failure to use, or misuse, reliable information that was available when
those financial statements for those periods were authorized for issue; and could reasonably be expected to
have been obtained and taken into account in the preparation and presentation of those financial
statements.
The general principle is that the entity must correct material errors from prior periods retrospectively in
the first set of financial statements authorized for issue after their discovery. Thus, comparative
amounts from prior periods must be restated, subject to the practicalities of calculating the relevant
amounts.

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IAS 10 : Events after the reporting period
Events after the reporting period are events, either favourable or unfavourable, that occur between the end
of the reporting period, and the date on which the financial statements are authorized for issue.
The standard distinguishes between two types of events:

Adjusting events
An adjusting event is defined as an event after the reporting period that provides further evidence of
conditions (value or the existence of assets & liabilities) that existed at the end of the reporting period.
The financial statements should be changed to reflect adjusting events.
Examples :
• the settlement after the end of the reporting period of a court case that confirms that a present
obligation existed at the year end
• the determination, after the reporting period of the purchase price or sale price of a non-current
asset bought or sold before the year end
• inventories where the net realizable value falls below the cost price
• assets where a valuation shows that impairment has occurred
• trade receivables where a customer has become insolvent
• the discovery of fraud or errors which show the financial statements to be incorrect

Non-adjusting events
A non-adjusting event is defined as an event after the reporting period that is indicative of a condition
that arose after the end of the reporting period.
No adjustment is made to the financial statements for such events. If material, they are disclosed by way of
notes to the financial statements.
Examples :
• major purchase of assets
• losses of production capacity caused by fire, floods or strike action by employees
• announcement or commencement of a major reconstruction of the business
• changes in tax rates
• entering into significant commitments or contingent liabilities
• commencing litigation based on events arising after the reporting period
• major share transactions

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Specific cases

There are three situations in addition to the above that require consideration:
• Dividends declared or proposed after the reporting period are not recognised as a liability at the end of
the reporting period. They are non-adjusting events and are shown in a note to the financial statements.
• An entity shall not prepare its financial statements on a going concern basis if management determines
after the end of the reporting period either that it intends to liquidate the entity or to cease trading, or
that it has no realistic alternative but to do so.
• Entities must disclose the date when the financial statements were authorised for issue and who gave
that authorisation. If anyone had the power to amend the financial statements after issue then this fact
must also be disclosed.

Question 01
ABC PLC prepared its financial statements for the year ended 30 June 2024. During August 2024, before the
financial statements were approved, the following issues arose:
1. The company was informed that a customer had been declared bankrupt owing ABC PLC $ 38 000.
The debt related to sales in January 2024.
2. The directors discovered that an error in preparing the financial statements resulted in revenue
being understated by $ 150 000.
3. A fire at one of the company’s properties in July 2024 resulted in damage estimated at $ 125 000.

What action should the directors take in respect of these issues, all of which are material?

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IAS 16 : Property, plant and equipment

• Property, plant and equipment – tangible assets held for use in the production or supply of goods and
services, for rental to others and for administrative purposes, which are expected to be used for more
than one accounting period.

• Depreciation – the systematic allocation of the depreciable amount (cost less residual value) of a tangible
non-current asset over its useful life.

• Useful life – the period over which a tangible non-current asset is expected to be available for use, or the
number of production units expected to be obtained from the tangible non-current asset.

• Residual value – the estimated amount the entity expects to obtain for a tangible non-current
asset at the end of its useful life, after deducting the estimated costs of disposal.

• Carrying amount – the amount at which a tangible non-current asset is recognised in the
statement of financial position, after deducting any accumulated depreciation or accumulated
impairment losses.

Recognition of the property, plant and equipment in the financial statements

The standard states that an item of property, plant and equipment is to be recognised in the financial
statements when:
− it is probable that future economic benefits associated with the asset will flow to the entity, and
− the cost of the asset can be measured reliably.

Initial costs associated with property, plant and equipment

The standard provides that the following can be included as part of the initial cost of property, plant and
equipment in the statement of financial position:
• the initial purchase price after deducting discounts or rebates

• any import duties, taxes directly attributable to bring the asset to its present location and
condition
• the costs of site preparation

• initial delivery and handling costs

• installation and assembly costs

• professional fees (e.g. architects or legal fees)

The standard also provides guidance on which costs must be excluded as part of the cost in the
statement of financial position:
• any operating cost of testing the asset
• any general overhead costs
• the start-up costs of a new business or section of the business
• the costs of introducing a new product or service (e.g. advertising)

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Additional costs associated with property, plant and equipment
The standard recognises that, in addition to the initial purchase price of the asset, other amounts will
also be spent on it. The standard provides the following guidelines to assist with the treatment of such
expenditure:

• Day-to-day costs of servicing or repairing the asset should be charged as expenditure in the
statement of profit or loss.

• Where parts (e.g. the seats in an aeroplane) require replacement at regular intervals, these
costs can be recognised as part of the carrying amount of the asset – subject to the rules of
asset recognition above.

• Where the asset requires regular inspections in order for the asset to continue operating, the costs of
such inspections can also be recognised in the carrying amount, again subject to the rules of recognition
above.

Valuation of property, plant and equipment

An entity must adopt one of two models as its accounting policy for its valuation of each class of
tangible non-current assets:
• Cost model – the asset is carried at cost less accumulated depreciation and any accumulated
impairment losses.
• Revaluation model – the asset is included (carried) at a revalued amount. This is taken as its
fair value less any subsequent depreciation and impairment losses.

Revaluation of property, plant and equipment

• Revaluations are to be made regularly to make sure that the carrying amount does not differ materially
from the fair value of the asset at the date of the statement of financial position.
• Guidance is also given on the frequency of the revaluations:
− if changes are frequent, annual revaluations must be made
− where changes are insignificant, revaluations can be made every three to five years
• If a tangible non-current asset is revalued, then every asset in that class must be revalued.
• Any surplus on revaluation is transferred to the equity section of the statement of financial position as
part of the revaluation reserve.
Dr Asset account
Cr Revaluation reserve account
• Any loss on revaluation is recognised as a decrease in revaluation reserve.
Dr Revaluation reserve account
Cr Asset account

• If there is no revaluation reserve is left, any loss on revaluation is recognised as an expense in SOPL.
Dr Statement of profit or loss (As expense)
Cr Asset account

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Depreciation
Depreciation should be allocated on a systematic basis over the tangible non-current asset’s useful life.

Depreciation is to be included as an expense in the statement of profit and loss.

Land has an unlimited useful life and is not depreciated. It is carried in the statement of financial position at
cost.

Question 01
A company produces its financial statements for the year ended 31 March 2024. The balances on the non -
current asset accounts at 1 April 2023 were:
Cost ($) Accumulated Net book value
depreciation ($) ($)
Premises 400 000 0 400 000
Plant & machinery 135 000 75 000 60 000
Motor vehicles 42 000 33 000 9 000
Total 577 000 108 000 469 000

The following information was available:

− During the year, the land and buildings were revalued at $650 000. Plant and machinery were bought for
$ 50 000 as were new motor vehicles costing $ 21 000.
− During the year, plant and machinery that had cost $ 43 000 and had a net book value at the time of
disposal of $ 6 500 had been part of a trade-in on the new plant and machinery (the effective proceeds
on disposal had been $ 10 000). Motor vehicles costing $ 16 000 that had been depreciated by $ 12 400
were sold for $ 3 000.
− The company policy for depreciation is to charge 20% straight-line on all machines owned at the end of
the year and 25% straight-line on all motor vehicles owned at the end of the year. No depreciation is to
be charged on items disposed of during the course of the year or on the premises.

Prepare : Non-current asset schedule for the year ended 31 March 2024

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IAS 36 : Impairment of assets
• Impairment loss – the amount by which the carrying amount of an asset or cash generating
unit exceeds its recoverable amount.

• Recoverable amount – the higher of the asset’s fair value less costs of disposal (net selling price) and its
value in use.
• Fair value – Fair value is the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date.

• Value in use – the present value of the estimated future cash flows expected to be derived from an asset
or cash generating unit.

Indications of impairment
External sources Internal sources

− market value declines − obsolescence or physical damage

− negative changes in technology, markets, − asset is idle or is being held for disposal
economy or laws
− worse economic performance than expected
− increases in interest rates

− net assets of the company higher than market

capitalisation

 An indication of impairment indicates that the asset’s useful life, depreciation method, or residual value
may need to be reviewed and adjusted.

Recognition of an impairment loss

• An impairment loss is recognised whenever the recoverable amount is below the carrying
amount.
• The impairment loss is recognised as an expense in the statement of profit or loss, unless it
relates to a revalued asset. For revalued assets, the impairment loss is treated as a revaluation
decrease.
• Depreciation for future periods must be adjusted.

Question 01
An entity has three non-current assets in use at the date of its statement of financial position. Details of their
carrying values and recoverable amounts are set out below:

Asset Carrying amount ($) Fair value less costs to sell ($) Value in use ($)
1 30 000 10 000 50 000
2 15 000 12 000 14 000
3 20 000 15 000 9 000

Show the value of the assets to be recognised in the statement of financial position.

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IAS 37 : Provisions, contingent liabilities and contingent assets
Provision
Provision is a liability of uncertain timing or amount.
Recognition of a provision
A provision must be recognised if, and only if:
1. a present obligation exists as a result of a past event (legal or constructive obligation)
2. payment is probable (more than 50% likelihood of occurrence)
3. the amount can be estimated reliably

Recording of a provision
Dr Statement of profit or loss (As expense in SOPL)
Cr Provision account (As current liability in SOFP)

Contingent liability
Contingent liability is either a possible obligation that arises from past events but which depends on some
uncertain future event occuring not wholly within the control of the entity, or a present obligation where
payment is not probable or the amount cannot be reliably measured.
A possible obligation (a contingent liability) is disclosed in the notes to the financial statements, but
not recognised. However, where the possibility of payment is remote, no recognition or disclosure is
required.

Contingent asset
Contingent asset is a possible asset that arises from past events and whose existence will be confirmed only
by the occurrence of one or more uncertain future events not wholly within the control of the entity.
These should not be recognised in the financial statements, but should be disclosed in the notes to the
financial statements where an inflow of economic benefits is probable and the amount is material. Where
the inflow of economic benefits is possible or remote, there should be no recognition and no
disclosure.

Example:
A company manufactures shampoo. A customer is suing the company claiming that the shampoo has
caused burns to her head. The customer is claiming damages of $100 000. Lawyers have advised the
company that it is possible that the customer may win the legal case.
As the outcome of the case is uncertain (i.e. a possible successful claim for damages), the company
is not certain to be liable, i.e. this is a contingent liability. In these circumstances, the company should
not make a provision, but should disclose details of the case in its notes to the financial statements.
If the lawyer was of the opinion that it was probable that they would lose the legal case, a provision
for the damage. If the lawyer was of the opinion that it was probable that they would lose the legal case, a
provision for the damages should be made in the financial statements.

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IAS 38 : Intangible assets
An intangible asset is defined as an identifiable non-monetary asset without physical substance.
The three critical attributes of an intangible asset are:
1. it must be identifiable (the asset is either separate from the entity and can be sold or
transferred or arises due to contractual or other legal rights)
2. it must be controlled by the entity (power to obtain benefits from the asset)
3. the entity must be able to obtain future economic benefits from the asset such as revenue or
reduced costs.

Intangible assets can be acquired :

1. by separate purchase
2. as part of a business combination
3. by the exchange of assets
4. by internal generation (self-produced)

Examples of intangible assets

• research and development
• goodwill
• patents, copyrights and trademarks.

Recognition
The standard requires an entity to recognise an intangible asset, whether purchased or self-created
(at cost), if:
1. it is probable that the future economic benefits attributable to the asset will flow to the entity; and
2. the cost of the asset can be measured reliably

If an intangible asset does not meet both the definition of, and the criteria for, recognition, IAS 38 requires
the expenditure to be recognised as an expense when it is incurred.

Measurement of Intangible assets

• Initial measurement  Intangible assets are initially measured at cost.
• Measurement subsequent to acquisition  Similarly to PPE, an entity must choose either the cost model
or the revaluation model for each class of intangible asset.

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Classification based on useful life
Intangible assets are classified as having either an indefinite life or a finite life.
• Indefinite life - This is where there is no foreseeable limit to the period over which the asset is expected
to generate net cash inflows for the entity. An intangible asset with an indefinite useful life should not be
amortised.
• Finite life - This is where there is a limited period of benefit to the entity. In these circumstances, the cost
less residual value should be amortised on a systematic basis over that life, reflecting the expected
pattern of benefits.

Research and development costs

• Research costs – charge all costs to the statement of profit or loss.
• Development costs may be capitalised as an intangible asset only after the technical and commercial
feasibility of the asset for sale or use have been established. The entity must demonstrate how the asset
will generate future economic benefits.

• Internally generated brands, customer lists, etc. - These should not be recognised as assets.
• Computer software - If purchased, this may be capitalised. If internally generated, whether for sale or for
use, it should be charged as an expense until technical and commercial feasibility has been established.

• Other types of cost - The following items must be charged to expenses in the when incurred, not classed
as intangible assets:
− internally generated goodwill
− start-up costs
− training costs
− advertising and promotional costs
− relocation costs

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