Course Notes

ACCA SBR
Strategic Business Reporting
Exams from September 2024
ii Course Notes ACCA SBR

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ACCA SBR Course Notes iii

Contents
Page

1 Paper aim vi
2 The Strategic Business Reporting syllabus vi
3 Exam format vii
4 UK and International versions of the exam paper vii
5 Examiner articles and webinars viii

A: Fundamental ethical and professional principles 1

1 Professional behaviour and compliance with accounting standards 1

2 Ethical requirements of corporate reporting and the consequences of unethical behaviour 3
3 Ethics in contemporary scenarios 4
4 Related party relationships and transactions 6

B: The Financial Reporting framework 11

1 The Conceptual Framework for Financial Reporting 11

2 The use of other comprehensive income 18
3 Practice Statement: Making materiality judgements 19

C1: Revenue 23

1 IFRS 15 Revenue from contracts with customers 23

C2: Non-current assets 35

1 IAS 16: Property, Plant and Equipment 35

2 IAS 38: Intangible Assets 37
3 IAS 40: Investment Property 38
4 IAS 36: Impairment of Assets 39
5 IFRS 5: Non-current Assets Held for Sale and Discontinued Operations 42

C3: Financial instruments 47

1 IAS 32 – Financial Instruments: Presentation 47

2 Recognition and measurement 50
3 Impairment of financial assets 56
4 Hedge accounting 59

C4: Leases 63

1 Introduction 63
2 Identifying a lease 63
3 Accounting treatment of leases by the lessee 64
4 Lessor accounting 69
5 Sale and leaseback 73

C5: Employee benefits 77

1 Introduction 77
2 Post-employment benefits 77
3 The role of the actuary 81
4 The 'asset ceiling' test 83
5 Termination benefits 84
iv Course Notes ACCA SBR

C6: Income taxes 87

1 IAS 12 – Income taxes 87

2 Recognition of deferred tax 90
3 Taxable temporary differences 91
4 Deductible temporary differences 93
5 Share-based payments 96
6 Leases 96
7 Presentation 97
8 Disclosure 97

C7: Provisions, contingencies and events after the reporting date 99

1 IAS 37 – Provisions 99
2 Specific types of provision 100
3 Contingent liabilities 103
4 Contingent assets 103
5 Events after the reporting period 104

C8: Share-based payment 107

1 IFRS 2 – Share-based payments: introduction 107

2 Equity-settled share-based payment transactions 108
3 Accounting for cash-settled share-based payment transactions 109
4 Transactions with a choice of settlement 110
5 Vesting conditions 111
6 Deferred tax and share-based payments 113

C9: Fair value measurement 117

1 IFRS 13 Fair Value Measurement 117

C10: Reporting requirements of small and medium-sized entities (SMEs) 121

1 The IFRS for SMEs 121

C11: Other reporting issues 123

1 IAS 20: Accounting for Government Grants and Disclosure of Government Assistance 123
2 IAS 41 Agriculture 124
3 IAS 34 Interim financial reporting 124
4 IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors 125
5 IFRS 1 First-time adoption of international financial reporting standards 126

D1: Group accounting – revision of basic groups 129

1 Introduction 129
2 Subsidiaries 130
3 Further detail on goodwill 138
4 Requirements for a group to prepare consolidated financial statements 139
5 Associates 140
6 Joint arrangements – IFRS 11 141
7 Disclosure of interests in other entities – IFRS 12 143
8 Definition of a business 143
ACCA SBR Course Notes v

D2: Group statements of cashflow 149

1 Indirect method statement of cash flows: proforma 149

2 Consolidated statement of cash flows 152
3 Acquisition and disposal of subsidiaries 155
4 Acquisitions and disposals of associates and joint ventures 163

D3: Changes in group structure 167

1 Introduction 167
2 Step acquisitions and disposals where control is retained 167
3 Step acquisitions where control is gained 172
4 Disposals where control is lost 175
5 Subsidiaries acquired exclusively with a view to resale 179

D4: Foreign transactions and entities 185

1 Functional currency and presentation currency 185

2 Group accounting – translation of foreign operations 187
3 Associates and joint arrangements 196
4 Disposal of foreign operations 196

E: Interpreting financial statements 203

1 Introduction 203
2 Business model 204
3 Approach to interpreting financial statements 205
4 The key ratios 205
5 Earnings per Share: IAS 33 209
6 The impact of environmental, social and ethical factors on performance measurement 211
7 Developments in sustainability reporting 212
8 Integrated Reporting 216
9 IFRS 8 Operating Segments 219
10 Practice Statement: Management commentary 221
11 Specialised, not-for-profit and public sector entities 223
12 Appendix (home study) 223

F: The impact of changes in accounting regulation 229

1 Introduction 229
2 Cryptocurrency and other digital assets 229
3 Accounting for the effects of a natural disaster or global event 231
4 Accounting for the effects of climate change 234
5 Going concern assessments 235

G: Question 1 exam technique 237

1 Exam format – question 1 237

2 Adjusting the draft financial statements 238
3 Exam technique 248
vi Course Notes ACCA SBR

1 Paper aim
This paper follows on from the basic accounting techniques covered in Knowledge Module Financial
Accounting (FA) and Skills Module Financial Reporting (FR).

2 The Strategic Business Reporting syllabus

Full details of the Strategic Business Reporting (SBR) syllabus can be found on the ACCA website at
https://www.accaglobal.com/uk/en/student/exam-support-resources/professional-exams-study-
resources/strategic-business-reporting/syllabus-and-study-guide.html
These course notes cover the syllabus and include all you need to know to pass the SBR exam.
These notes are supported by a question bank, and two exams.
The syllabus includes the following section:

First Intuition has confirmed with the ACCA that this syllabus area relates to your ability to use the
ACCA software to complete the exams. There is no additional learning and therefore no additional
material on this in these notes. However, we do recommend that you complete two of the exams on
the ACCA practice platform as part of this course in order that you are prepared to demonstrate the
above skills when you sit your exam.
ACCA SBR Course Notes vii

3 Exam format
The syllabus is assessed by a three-hour fifteen-minute examination. It examines professional
competences within the business reporting environment.
The paper will comprise two sections:
Marks
Section A 2 compulsory questions 50
Section B 2 compulsory questions of 25 marks each 50
100

Section A
Section A will consist of two scenario-based questions that will total 50 marks. The first question will
be worth 30 marks and the second question will be worth 20 marks. The first question will examine
group accounting (syllabus area D). Candidates will need to discuss issues in group accounting and use
a spreadsheet to adjust a consolidated financial statement. The question is also likely to require
consideration of some other financial reporting issues (syllabus area C). The second question in Section
A will require candidates to consider the reporting implications and the ethical implications of specific
events in a contemporary scenario.

Section B
Students will be required to answer a further two questions, each worth 25 marks. These discursive
questions will be scenario-based and could contain computational elements. Section B could deal with
any aspect of the syllabus but will always include either a full question, or part of a question, that
requires the candidate to consider stakeholder perspectives.
Two professional marks will be awarded in Question 2 and two in Question 4. Further guidance will be
given in the questions clarifying what these professional marks will be awarded for.

4 UK and International versions of the exam paper

There are two versions of the syllabus, study guide and exam paper: the International version and the
UK version. The two versions are very similar.
Both the UK version and International version examine International Financial Reporting Standards
(IFRS Standards) throughout.
The exam structure (in terms of the number of questions and the mark allocation) is virtually identical.
The only significant difference between the UK and International versions is that the UK version
examines reporting requirements for small entities in the UK, including the principal differences
between UK GAAP and IFRS Standards. The International version examines reporting requirements
for small entities under IFRS Standards (the IFRS for SMEs).
viii Course Notes ACCA SBR

5 Examiner articles and webinars

The SBR examining team publishes articles on the ACCA website. There are two types of articles:
 Exam technique: https://www.accaglobal.com/sg/en/student/exam-support-
resources/professional-exams-study-resources/strategic-business-reporting/cbe-exam-
technique.html.
 Technical articles: https://www.accaglobal.com/uk/en/student/exam-support-
resources/professional-exams-study-resources/strategic-business-reporting/technical-
articles.html.
The exam technique articles are a really useful insight into how to approach the SBR exam and how it
will be marked.
The technical articles are grouped by syllabus area and it is very important that you read them all as
quite often an article will form the basis of a future exam question. The articles will also give you a
good understanding of the accounting principles underpinning each syllabus area.
There are also some technical articles that cover multiple syllabus sections. These articles will help you
to approach scenario-based questions that test more than one area of the syllabus.
 1

Fundamental ethical and

professional principles

1 Professional behaviour and compliance with accounting standards

EXAM SMART
Ethics will be tested in Question 2 of the exam. This question will require you to consider the
reporting implications and the ethical implications of specific events in a contemporary
scenario.

1.1 Fundamental principles

Professional accountants have a duty to prepare financial statements which fairly present the affairs of
a business to the various users of financial reports. The ACCA wants its members to act ethically and so
has produced its own ethical code which outlines five principles of ethical behaviour (memory aid:
‘OPPIC’):
 O bjectivity: do not allow bias or conflicts of interest or undue influence of others to override
professional or business judgement
 P rofessional competence and due care with training, both pre-qualification and post-
qualification. Essentially, this means that accountants should follow the relevant accounting
standard and apply the concept of substance over form
 P rofessional behaviour – comply with relevant laws and regulations and do not do anything
that would discredit the profession
 I ntegrity: be straightforward and honest
 C onfidentiality: do not disclose confidential information to third parties without permission
and do not use confidential information for personal gain
 2 Course Notes ACCA SBR

While you do not need to learn the definition of these principles, you will need to apply them in the
scenario given.

1.2 Threats
You are likely to have to spot threats to the above ethical principles in your exam. The following
threats are identified in the ACCA’s Code of Ethics and Conduct.
Threat Description
Self-interest This may occur as a result of financial or other interests of directors and those
involved in preparing the financial statements or their close family members.
Examples include:
 Profit-related pay
 Owning shares in the company
 Inappropriate personal use of company assets.
Self-review This may occur when a previous judgement needs to be re-evaluated by those
responsible for the judgement. Examples include:
 Business decisions being made by the person who prepared the data
 Determining the appropriate accounting treatment for an investment
after performing the feasibility study for the acquisition.
Advocacy This may occur when a director or accountant promotes a position or opinion
to the extent that objectivity is compromised. An example would be preparing
over-optimistic forecasts in order to raise new finance.
Familiarity A close relationship could make a director or accountant too sympathetic to
the needs of others. Examples include:
 A Finance Director being a close friend of the Chief Executive Officer
(CEO), making them more likely to follow the wishes if the CEO than the
requirements of accounting standards
 Accepting a gift or preferential treatment (unless the value is trivial)
 Long association with business contacts.
Intimidation A director or accountant may be deterred from acting objectively by actual or
perceived threats. Examples include:
 Threat of dismissal
 A dominant personality.

LECTURE EXAMPLE A.1: ACCOUNTING AND ETHICAL IMPLICATIONS

A bonus is awarded to the directors of Goodchild if the operating cash flow exceeds a predetermined
target in the year. In previous years, Goodchild’s accounting policy was to present dividends paid as an
operating cash flow. However, the directors are proposed to change the accounting policy to present
dividends paid as a financing cash flow.
Required
Discuss the accounting and ethical implications of the above situation.
ACCA SBR Course Notes 3

SOLUTION

2 Ethical requirements of corporate reporting and the consequences of

unethical behaviour
Part of the accountant’s ethical responsibility lies in the preparation of financial statements which
fairly reflect the performance and position of the entity. Preparers of financial statements therefore
have an ethical duty to keep up to date with developments in IFRS Standards. This also ties into the
professional competence aspect of the ACCA Code of Ethics.
They also need to ensure that they have enough dedicated time and resources to complete the
financial statements in an appropriate manner.
There may be threats to the integrity and objectivity of the preparers of financial statements if:
 They are on profit-related pay
 The company is preparing for a stock exchange listing
 The company is in difficulties
 There are insufficient resources (time/expertise) to prepare the financial statements
When faced with these threats, the accountant needs to determine whether there are any safeguards
which could help to reduce the threat to an acceptable level.
Questions often contain a scenario in which management/the company want to manipulate the
financial statements to show the company’s financial position or performance in a better light.
Typically, students are asked to discuss how such behaviour is inconsistent with their responsibilities
as members of the accounting profession.
Users of financial statements (stakeholders) are entitled to assume that accountants behave in an
ethical way when preparing accounts. Any inappropriate actions would amount to a breach of this
trust. The reputation of the accounting profession depends upon accountants’ integrity.
Recent questions have asked students to discuss the following:
 accounting and ethical implications arising from a proposed change of accounting policy relating
to a pension scheme;
 ethical issues arising from an entity’s proposed treatment of foreign exchange differences;
 potential ethical conflicts that might arise in preparing a statement of cash flows where a
company needs a significant injection of capital;
 the ethical issues of lease classification
 4 Course Notes ACCA SBR

3 Ethics in contemporary scenarios

3.1 Ethics in a digital age
A contemporary accountant is faced with new digital technologies. This means that the ethical
principles may become increasingly at risk e.g.
 Professional competence and due care – the accountant will be faced with new problems that
have not been seen before. This lack of knowledge and expertise needs to be addressed by the
accountant learning new information very quickly and applying judgement to it.
 Objectivity – this may be compromised as a result of intimidation (e.g. by a hacker’s threats).
 Confidentiality – an increasing amount of data is now stored digitally increasing a risk of breach
of client confidentiality.
 Integrity – this could be compromised if an accountant is unwilling to acknowledge and address
their lack of knowledge and expertise of digital developments. The accountant should be
straightforward and honest about the way it obtains consent to use customers’ data.
Examples of digital developments to consider are:

Cybersecurity Platform-based business

models e.g. eBay

Big data and Cryptocurrencies e.g.

Digital developments
analytics bitcoin

Distributed ledger
technology e.g. Artificial intelligence
blockchain

3.2 Ethics and sustainability reporting

Sustainability reporting (on the environmental, social and governance impacts of a company’s
activities) has become an increasingly important part of corporate reporting and it is important that
the accountant acts ethically and professionally in complying with sustainability standards.
Ethical principle How it may be compromised in sustainability reporting
Objectivity The accountant may be under pressure from the directors to adopt ‘greenwashing’
when preparing sustainability disclosures in its annual report.
Professional Sustainability reporting is rapidly evolving, and the accountant may not keep up to
competence and date with the latest sustainability standards resulting in reports that do not comply
due care with these standards.
Professional The accountant may be reluctant to admit to their lack of knowledge of current
behaviour sustainability standards resulting in non-compliance with sustainability standards,
thereby discrediting their profession.
ACCA SBR Course Notes 5

Ethical principle How it may be compromised in sustainability reporting

Integrity The accountant may be deliberately dishonest in their sustainability reporting by
overstating positive impacts and understating negative impacts.
Confidentiality The accountant should consider their responsibility to external stakeholders and
whether it would be compromised by remaining quiet or being overly transparent
when preparing or reviewing a sustainability report.

ILLUSTRATION: ETHICAL DILEMMA IN THE CONTEXT OF SUSTAINABILITY REPORTING

You are an accountant who has worked for many years for a large listed multinational corporation,
Stonham Co. You are responsible for preparing the company’s first sustainability report. Stonham Co
claims on its website to prioritise sustainability and has publicly committed to being transparent in its
reporting practices but you are aware from company meetings that some directors prioritise financial
performance over sustainability performance.
Stonham Co has several subsidiaries that operate independently. You discover that some subsidiaries
do not have proper systems to collect sustainability data, do not dedicate sufficient resources to
sustainability reporting and management shows little interest in the parent’s sustainability goals.
You approach a divisional head to discuss the issues, but they become angry and are adamant that you
do not understand the culture in their country and that no changes are required.
Required:
Discuss the ethical issues that the accountant of Stonham Co is facing and the actions they should take.
SOLUTION
Ethical issues
Intimidation threat: The accountant may be deterred from disclosing the weaknesses in sustainability
practices of certain subsidiaries due to pressure from the divisional head, particularly as the
accountant is aware that some directors prioritise financial performance over sustainability
performance.
Self-interest threat: The accountant may feel that their job or career progression at Stonham Co could
be under threat if they disclose the weaknesses in sustainability practices of the affected subsidiaries.
Advocacy threat: The accountant may not act on the negative findings for fear that Stonham Co may
suffer reputational damage as a result.
Familiarity threat: The accountant’s long-standing employment at Stonham Co may mean that their
close relationship with colleagues, divisional heads and directors results in personal loyalty over-riding
objectivity when preparing the sustainability report.
Actions
Integrity: The accountant should inform both the relevant subsidiaries and the directors of Stonham
Co of the issues.
Objectivity: The accountant has a duty to resist the threat of intimidation. There is a cultural issue with
the subsidiaries not adhering to the stated company claim to prioritise sustainability responsibility. If
the accountant feels that the senior management at the subsidiary and Stonham Co’s directors will not
act on the issues, they should consult the audit committee.
Professional competence and due care: The accountant should consider suggesting to the board that
senior management of the affected subsidiaries attend training on sustainability reporting.
Professional behaviour: As Stonham Co is a listed company, listing regulations may require the
accountant to disclose these issues to the stock exchange.
 6 Course Notes ACCA SBR

4 Related party relationships and transactions

A related party is a person or entity that is related to the reporting entity.
The objective of IAS 24 Related Party Disclosures is to ensure that an entity’s financial statements
contain the disclosures necessary to draw attention to the possibility that its financial position and
profit or loss may have been affected by the existence of related parties and by transactions and
outstanding balances with these parties.

4.1 Why do we need a standard?

When we look at a set of financial statements, we tend to assume that the figures in those statements
are based on transactions with other companies that have no connection with that company. This
would mean, for example, that an assumption would be made that all sales and purchases are on an
“arm’s length basis”.
For example, if a company makes many of its purchases from a parent company which charges an
artificially low price for its goods, then the subsidiary’s profits are overstated in comparison with those
of similar companies that make purchases from third parties, at market prices.
Disclosing the existence of related party relationships and information about transactions and
outstanding balances helps users to understand the potential effect of the relationship on the financial
statements.
IAS 24 explains that the existence of a related party relationship can affect the performance of a
company even if there are no actual transactions between the related parties. For example, a parent
may instruct a subsidiary not to engage in a particular activity.
IAS 24 defines a related party transaction as a transfer of resources, services or obligations between a
reporting entity and a related party, regardless of whether a price is charged.
Note: this means that all related party transactions must be disclosed, even if the transaction has
taken place ‘at arm’s length’.

4.2 Related parties

A person (or close member of that person’s family) is a related party of the reporting entity if they:
 have control or joint control over the reporting entity;
 have significant influence over the reporting entity;
 are a member of the key management personnel of the reporting entity or of a parent of the
reporting entity.
An entity is a related party of the reporting entity if:
 They are members of the same group (e.g. a parent-subsidiary or parent-associate or parent-
joint venture relationship would be a related party relationship and two subsidiaries of the
same parent company would also be related parties because they are under common control.)
 One is an associate or a joint venture of the other
 Both entities are joint ventures of the same third party (or one is an associate and the other is a
joint venture of the same third party)
 The entity is a post-employment benefit plan for the benefit of employees
 The entity is controlled or jointly controlled by any of the persons identified above
 A person (or close family member) with control or joint control of the reporting entity has
significant influence over the entity or is key management personnel of the entity.
ACCA SBR Course Notes 7

The following are not necessarily related parties:

 Two entities simply because they have a director/key manager in common
 Two joint venturers simply because they share control of a joint venture
 Providers of finance (e.g. bank), trade unions and public utilities
 Government departments and agencies.
 Customers, suppliers, franchisors, distributors or agents with whom the entity is transacting a
large volume of business.

4.3 Disclosure
IAS 24 requires disclosure of:
 The name of the entity's parent and, if different, the ultimate controlling party irrespective of
whether there have been any transactions;
 Where there have been transactions between related parties:
(i) nature of the related party relationship
(ii) information about the transactions. As a minimum, this includes:
 Amount of the transaction
 Amount of outstanding balances
 Provisions for doubtful debts and bad debt expenses
 Key management compensation, in terms of:
– Short-term employee benefits
– Post-employment benefits/pensions
– Other long-term benefits
– Termination benefits
– Share-based payments (e.g. share options)
Note: these remuneration figures will be totals and will not disclose what individual directors earn.
(However, local legal requirements may demand this.)
 8 Course Notes ACCA SBR

LECTURE EXAMPLE A.2: RELATED PARTIES

Pebble is a company that complies with the minimum requirements of IAS 24. The following
transactions relate to the current year.
(1) Pebble sells goods on credit to Chalk, which is a company owned by the son of Mr Granite.
Mr Granite is a director of Pebble. At the year end, there was a trade receivable of $100,000
owing from Chalk to Pebble. It was decided to write off $30,000 of this receivable, and make full
provision against the remainder. Debt collection costs incurred by Pebble during the year were
$4,000.
(2) During the year, Pebble purchased goods from Marble for $600,000, which was deemed to be
an arm's length price. Pebble owns 40% of the ordinary share capital of Marble.
(3) At the year end an amount of $90,000 is due to one of Pebble's distributor companies, Slate.
(4) During the year a house owned by Pebble, with a carrying amount of $200,000 and a market
value of $450,000, was sold to one of its directors, Mrs Boron, for $425,000. Pebble guaranteed
the loan taken out by Mrs Boron to purchase the property.
Required:
Explain whether related party relationships exist and what disclosures, if any, would be required by IAS
24 in the current year financial statements of Pebble, in respect of each of the following transactions.
SOLUTION
ACCA SBR Course Notes 9

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the five principles of ethical behaviour?
Can you explain the five main threats to ethical behaviour?
Can you discuss the ethical requirements of corporate reporting?
Do you understand the consequences of unethical behaviour?
Do you understand the various ways in which digital technologies may make it more
difficult for accountants to uphold ethical principles?
Do you understand the definition of a related party and the reasons why it is
important to disclose related party relationships and transactions?
Can you identify related party relationships and transactions?
Can you specify the disclosure requirements for related party transactions?
10 Course Notes ACCA SBR

Chapter A – Lecture example solutions

Lecture example A.1
Accounting implications
IAS 7 Statement of Cash Flows allows dividends paid to either be presented in ‘operating activities’ or
‘financing activities’. Therefore, the proposed change to Goodchild’s accounting policy does not
contravene IAS 7.
However, IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors only permits changes
in accounting policies if the change is required by an IFRS (not the case here) or if it results in more
reliable and relevant information in the financial statements. Here, the motivation for the change
appears to be to maximise the directors’ bonus rather than to present more relevant and reliable
information. Therefore, it does not appear to be acceptable.
Ethical implications
There is a self-interest threat here as the directors receive a bonus if the operating cash flow exceeds a
predetermined target. Therefore, there is a potential incentive to overstate operating cash flows to
maximise the bonus. The proposed change in accounting policy would increase the amount of
operating cash flow and therefore, result in a higher bonus
The ethical principle of objectivity is potentially compromised here as it would appear that the
directors are acting in their own best interests rather than the interests of the shareholders.
Conclusion
Unless the directors can demonstrate that the change in accounting policy would result in more
relevant and reliable information in the financial statements, Goodchild should continue to recognise
dividends paid in ‘operating activities’.

Lecture example A.2

(1) Chalk is owned by one of the close members of the family of a member of Pebble’s key
management personnel, so it is a related party of Pebble. Disclosure should be made of the
nature of the relationship, any transactions during the period and the fact that the $100,000
balance has been written off during the period. The bad or doubtful debt expense should also
be disclosed.
There is no requirement to disclose the debt collection costs of $4,000, or the names of Chalk,
the director of Pebble or his son.
(2) Marble is very probably a related party of Pebble because Pebble’s 40% shareholding in it
appears to provide Pebble with significant influence over Marble. Despite being an arm's length
price, the value of the transaction should be disclosed (aggregated with similar transactions
during the year if appropriate).
The company should only disclose that related party transactions were made on terms
equivalent to those that prevail in arm's length transactions if these terms can be substantiated.
The nature of the relationship should be disclosed, but no names need to be disclosed.
(3) The distributor is not a related party of Pebble; thus, no separate disclosure is required.
(4) Mrs Boron is a member of the key management personnel of Pebble, so is one of its related
parties. The nature of the relationship, details of the amount and nature of the transaction
should be disclosed, along with the fact that Pebble is guaranteeing the loan of a related party.
Any amount of the sale price still owed to Pebble at the year-end should be disclosed.
 11

The Financial Reporting

framework

1 The Conceptual Framework for Financial Reporting

The IASB’s Conceptual Framework for Financial Reporting was revised in March 2018. Some chapters
are almost unchanged:
The objective of general-purpose financial reporting
Qualitative characteristics of financial information
Concepts of capital and capital maintenance.
The remaining chapters are either new or substantially revised.

1.1 Introduction
The objective of a conceptual framework is to enable standard-setters to achieve a consistent and
coherent set of fundamental principles which will help users of financial statements to form more
complete assessments of companies’ performance.
The IASB’s Conceptual Framework helps:

 The IASB to develop IFRS Standards that are based on consistent concepts;
 Preparers of financial statements to develop consistent accounting policies when no standard
applies to a particular transaction or other event, or when a standard allows a choice of
accounting policy; and
 All parties to understand and interpret the standards
The Conceptual Framework is not a standard and does not override any requirement in a standard.
IAS 1 Presentation of Financial Statements aims to provide a framework within which an entity
presents fairly the effects of transactions and other events in a set of financial statements.
12 Course Notes ACCA SBR

In order to achieve fair presentation, an entity must comply with IFRS Standards, but in the absence of
a relevant accounting standard for a particular transaction or event, an entity should refer to the
definitions, recognition criteria and measurement concepts in the Conceptual Framework.

1.2 The objective of general-purpose financial reporting

The objective of general-purpose financial reporting is to provide financial information about the
reporting entity that is useful to its primary users so that they can make decisions about providing
resources to the entity. These are:
 Existing and potential investors
 Lenders
 Other creditors
Many of these users cannot require reporting entities to provide information directly to them and
must rely on general purpose financial statements for much of the financial information they need.
Users of the financial statements need information about:
 an entity’s economic resources (assets); claims against it (liabilities); and changes in these
resources and claims; and
 how efficiently and effectively management have used the entity’s economic resources
(stewardship)
General purpose financial reports cannot provide all the information that these primary users need.
Other users (e.g. regulators and members of the public) may find financial statements useful, but they
are not primarily intended for these other users.

1.3 Qualitative characteristics of financial information

Fundamental qualitative characteristics
The fundamental qualitative characteristics of information are relevance and faithful representation.
Relevance – relevant financial information makes a difference to the decisions of the user. Financial
information can make a difference to decisions if it has:
 Predictive value – it can be used to predict future outcomes
 Confirmatory value – it provides feedback about previous evaluations (it confirms whether past
predictions were reasonable)
Materiality is a threshold quality of information. Information is material if omitting, misstating or
obscuring it could reasonably be expected to influence decisions that primary users of general
purpose reports might make on the basis of those reports. (The IASB’s Practice Statement: Making
Materiality Judgements is covered later in this chapter.)
Faithful representation – information in the financial statements faithfully represents the transactions
and other events it purports to represent. A faithful representation will be:
 Complete
 Neutral/unbiased
 Free from error
ACCA SBR Course Notes 13

Enhancing qualitative characteristics

Information that is relevant and faithfully represented can be improved by the following:
 Comparability – Comparability should enable users to identify similarities and differences
between items, both between different periods for the same entity and between different
entities. Comparability is facilitated by the existence and disclosure of accounting policies. The
requirement to restate comparatives and record prior year adjustments for changes in
accounting policies assists with comparisons between different periods.
However, the exercise of judgement, use of accounting estimates and choice of accounting
treatments in some accounting standards can reduce comparability between entities.
Comparability between entities can be even more problematic for alternative performance
measures (APMs) (e.g. earnings before interest depreciation and amortisation ‘EBITDA’)
because they are not defined by accounting standards so there is a risk of inconsistencies in the
definition and calculation of the APMs.
Comparability can also be tricky for the management commentary as the IASB provides non-
mandatory guidance only so its format and content are likely to vary between entities
depending on the perspectives of management and the individual circumstances of individual
entities.
 Verifiability – Verifiable information which enables users to determine whether a particular
accounting treatment is a faithful representation. Verification of figures in financial statements
can be direct (e.g. by counting cash) or indirect through checking inputs to a model or formula
and recalculating outputs (e.g. verifying the carrying amount of inventory by checking quantities
and costs then recalculating the end figure using the first-in first-out method).
 Timeliness – To be useful, information must be provided to users within a reasonable time.
 Understandability – Information should be presented in such a way that it is understandable by
users with reasonable business knowledge. This can present management with a problem
because clearly not all users have the same (financial) abilities and knowledge. However, useful
information should not be omitted from the financial statements simply because it may be too
complex for some users to understand.

1.4 Financial statements and the reporting entity

A reporting entity is an entity that is required, or chooses, to prepare financial statements.
A reporting entity does not have to be a legal entity and can comprise only a portion of an entity or
two or more entities.
For example, if one entity (a parent) controls another entity (a subsidiary) the parent and the
subsidiary together form a single economic entity.
 Consolidated (group) financial statements are prepared to provide information about the group
as a single reporting entity.
 These normally provide more useful information to users than the two individual sets of
financial statements for the parent and the subsidiary.
Financial statements provide information about transactions and other events from the perspective of
the reporting entity as a whole, not from the perspective of any particular group of users.

Going concern assumption

It is assumed that the company preparing the financial statements is a going concern i.e. the financial
statements are being prepared on the assumption that an entity will continue in operation for the
foreseeable future. This is sometimes referred to as the underlying assumption.
14 Course Notes ACCA SBR

1.5 The elements of financial statements

Financial statements show the reporting entity’s:
 Economic resources: assets
 The claims against it: liabilities and equity
 Changes in economic resources and claims: income and expenses, contributions from owners
(e.g. capital) and distributions to owners (e.g. dividends)
Element Definition
Asset A present economic resource controlled by the entity as a result of past events.
An economic resource is a right that has the potential to produce economic benefits
Liability A present obligation of the entity to transfer an economic resource as a result of past
events.
Equity The residual interest in the assets of the entity after deducting all its liabilities
i.e.: EQUITY = NET ASSETS = SHARE CAPITAL + RESERVES
Income Increases in assets, or decreases in liabilities, that result in increases in equity, other than
those relating to contributions from holders of equity claims
Expenses Decreases in assets, or increases in liabilities, that result in decreases in equity, other than
those relating to distributions to holders of equity claims

EXAM SMART
These definitions – and the recognition criteria below – are very important in the context of
your exam. You could be asked to discuss or advise on the financial reporting treatment of
an unusual transaction or event and/or a transaction for which there is no applicable IFRS.
One obvious way of doing this is to apply the principles in the Conceptual Framework.
You may also be asked to compare the principles in the Conceptual Framework with the
requirements of specific IFRS Standards.

1.6 Recognition and derecognition

1.6.1 Recognition
Recognition means including an item in the financial statements.
An entity recognises an item in the financial statements if:
 it meets the definition of an element; and
 it provides useful information:
– relevant information about the item; and
– a faithful representation of the item.

1.6.2 Derecognition
Derecognition (removing all or part of an item from the financial statements) normally occurs when:
 the entity loses control of an asset; or
 the entity no longer has a present obligation for a liability.
ACCA SBR Course Notes 15

The aim is to faithfully represent:

 any assets or liabilities retained after the transaction or event that led to the derecognition;
and
 the change in the entity’s assets and liabilities as a result of the transaction or event.
This aim is normally achieved by:
 derecognising the transferred component of assets and liabilities;
 continuing to recognise the retained component of assets and liabilities;
 where necessary for faithful representation:
– separate presentation of any retained component in the statement of financial position
– separate presentation in the statement of financial performance of any income or
expenses recognised as a result of derecognition of the transferred component
– provision of explanatory information.

ILLUSTRATION: DERECOGNITION

Grievson sells goods to Campbell for $20,000. Grievson allows Campbell to pay in two equal
instalments of $10,000 after 30 days and 60 days respectively. However, if Campbell pays the first
instalment within 10 days, they will receive a 5% prompt payment discount on the first instalment. At
the date of the sale, Campbell is expected to pay the first instalment within 10 days so the revenue
and receivable are recorded at $19,500 ([$10,000 × 95%] + $10,000).
However, Campbell ends up paying the first instalment 30 days after the sale so does not qualify for
the 5% prompt payment discount and has to pay $10,000. This payment is recorded as follows:
To record this payment, Grieveson:
(1) Derecognises the transferred component of the asset (the element of the trade receivable
relating to the first instalment) – $9,500
(2) Continues to recognise the retained component of the asset (the element of the trade
receivable relating to the second instalment) – $10,000
(3) Recognises in the statement of profit or loss income recognised as a result of the derecognition
– the extra revenue of $500 earned by Campbell not taking up the 5% prompt payment
discount.

In some cases, an entity might appear to transfer an asset or liability but that asset or liability should
remain in the entity’s statement of financial position e.g.
 apparent transfer of an asset but retention of significant positive or negative variations in the
amount of economic benefits that may be produced by the asset; or
 transfer of an asset to an agent whilst the transferor still controls the asset.
Prior to the March 2018 revision, no guidance on derecognition was included in the Conceptual
Framework.
16 Course Notes ACCA SBR

LECTURE EXAMPLE B.1: DERECOGNITION

Quartz sold an investment property to a Limestone, a financial institution. The sales price was
$4 million and the fair value of the property was $5 million. Under a contractual agreement between
Quartz and the financial institution, Quartz has an obligation to repurchase the property after one year
for $4.32 million.
Required:
Explain how Quartz should account for the above transaction.
SOLUTION

1.7 Measurement
In order to recognise an element in the financial statements, an entity selects a measurement basis.
This may be either:
 Historical cost – elements in the statement of financial position are measured at their historical
cost i.e. the amount of cash that was paid to acquire or create them (asset), or the cash that will
be paid to settle them (liability); or
 Current value: historical cost amounts are updated to reflect conditions at the measurement
date (normally the year end)
ACCA SBR Course Notes 17

CURRENT VALUE

FAIR VALUE VALUE IN USE CURRENT COST

The price that would be Present value of the cash flows, or The cost of an
received to sell an asset, or other economic benefits that an equivalent asset at the
paid to transfer a liability, entity expects to derive from the use measurement date (or
in an orderly transaction of an asset and its ultimate disposal. consideration that
between market (Fulfilment value is the present value would be received for
participants at the of cash/economic resources that an a liability).
measurement date (see entity expects to transfer to meet a
IFRS 13) liability.)

Selecting a measurement basis

The information provided must be useful to users (relevant and faithfully represented). An entity
should consider:
 Characteristics of the asset or liability being measured (e.g. does it change value rapidly?)
 How the asset or liability contributes to future cash flows (e.g. will it continue to be used in the
business or will it be sold?)
 Whether there is measurement uncertainty (e.g. can current value be determined by using
market prices or must it be estimated in some other way?)

1.8 Presentation and disclosure

A reporting entity communicates by presenting and disclosing information in its financial statements.
Effective communication in financial statements requires:
 Focusing on objectives and principles rather than on rules (entity specific disclosure is more
useful than standardised descriptions; duplication of information in different parts of the
financial statements can make them harder to understand).
 Classifying information in a manner that groups similar items and separates dissimilar items
(e.g. assets and liabilities should not normally be offset).
 Aggregating (adding together) information in such a way that it is not obscured either by
unnecessary detail or excessive summarisation.
A balance is needed between:
 giving entities the flexibility to provide relevant information; and
 requiring information that is comparable over time and between different entities

1.9 Concepts of capital and capital maintenance

It is possible to think of an entity’s profit as the difference between its capital at the beginning and end
of a period.
“Capital” could be defined in terms of:
 Financial capital – shareholders’ funds, represented by the share capital and reserves of a
statement of financial position – an entity only makes a profit if its shareholders’ funds increase
after taking inflation into account.
18 Course Notes ACCA SBR

 Physical/Operating capital – the physical assets and liabilities needed to keep the company
running – in times of rising prices, an entity can only earn a profit if its physical productive
capacity increases during the year.
Capital maintenance is a concept that is intended to ensure that excessive dividends are not paid in
times of rising prices, (i.e., that an entity’s capital is maintained).

2 The use of other comprehensive income

Income and expenses are classified and included either in the statement of profit or loss or in other
comprehensive income (OCI).
The Conceptual Framework does not include a definition of profit or loss. Whether an item is included
in profit or loss or in other comprehensive income depends on the requirements of individual
standards; there are no consistent principles. This has led to problems:
 Other comprehensive income (OCI) is often not fully understood by users of the financial
statements.
 OCI is used inconsistently in IFRS Standards. Some believe that OCI has become a home for
controversial items, such as unrealised gains and losses on remeasurement of assets.
 Some users may ignore OCI, because the gains and losses reported there are not caused by the
operating activities of the entity (and do not help them to predict future performance). This
means that users may not appreciate the significance of losses reported in OCI.
Reclassification is the ‘recycling’ of gains and losses which were recognised in OCI/reserves in previous
periods to profit or loss in the current period. Some items are reclassified while others (e.g. gains and
losses on revaluation of property, plant and equipment) are not. Again, this is set out in individual
standards, rather than in the Conceptual Framework. There is no overall principle.
An argument for reclassification:
 It ensures that profit or loss includes all relevant gains and losses. No items of income and
expenses are excluded from profit or loss permanently.
Arguments against reclassification:
 It results in profits or losses being recorded in a different period from the change in the related
asset or liability. This is inconsistent with the Conceptual Framework’s definition of income and
expenses (as these result from increases and decreases in assets and liabilities).
 It creates complexity in financial reporting and may confuse users as some gains and losses are
effectively recognised twice: once in OCI and later in profit or loss
 It may lead to earnings management.
The 2018 Conceptual Framework explains that:
 In principle all income and expenses are presented in the statement of profit or loss.
 In exceptional circumstances, income or expenses arising from a change in the current value of
an asset or liability are included in other comprehensive income (OCI). This is to ensure that the
statement of profit or loss provides relevant information and a faithful representation.
 In principle, income and expenses included in OCI in one period are subsequently reclassified or
‘recycled’ to profit or loss, if doing so results in more relevant information and a faithful
representation of financial performance for the period.
 Items are not reclassified if there is no clear basis for identifying the period in which
reclassification should take place or the amount that should be reclassified.
ACCA SBR Course Notes 19

EXAM SMART
This is the most important chapter of the SBR notes. The SBR examining team recommend
the following exam technique:
 Always attempt all parts of all questions.
 If you cannot think of the relevant IAS or IFRS, apply the accounting principles of the
Conceptual Framework.
 Credit will be awarded to an answer that discusses a scenario using the Conceptual
Framework even if it does not match the suggested solution.
This is particularly important in answering Section B of the paper which candidates typically
find harder than Section A.

3 Practice Statement: Making materiality judgements

This provides guidance to help management apply the concept of materiality when preparing general
purpose financial statements. It is not a standard and therefore the guidance is not compulsory, but
does represent best practice.

3.1 General characteristics of materiality

Conceptual Framework definition:
Information is material if omitting, misstating or obscuring it could reasonably be expected to
influence decisions that the primary users of a specific reporting entity’s general-purpose financial
statements make on the basis of those financial statements.
 it is entity-specific
 it is an aspect of relevance
 it is based on the nature and/or the magnitude of items
Further points:
 The need for materiality judgements is pervasive (affects all items) in the preparation of
financial statements.
 Requirements in IFRS Standards must be applied if their effect is material, but an entity should
not make immaterial departures from IFRS Standards in order to achieve a particular
presentation in the financial statements.
 Management must use judgement in deciding whether an item is material; it should consider
the entity’s specific circumstances and how the information meets the information needs of
primary users (what types of decisions they make; what information they need to make those
decisions).
20 Course Notes ACCA SBR

3.2 Suggested four-step approach

STEPS
Step 1: Identify information that might be material. Consider:
 requirements of IFRS Standards
 primary users’ common information needs
Step 2: Assess: is the information material? Consider:
 Quantitative factors (e.g. is the item material in the context of the entity’s
profit/revenue/assets?)
 Qualitative factors: characteristics of an entity’s transactions that make information more likely
to influence decisions made by users:
– Entity specific: e.g. related party involvement; unusual transactions/events; unexpected
variations/unexpected changes in trends
– External: e.g. the entity’s geographical location, industry sector or state of the economy
in which it operates.
Step 3: Organise the information in the draft financial statements.
To be useful, information must be understandable. Classifying and presenting information clearly and
concisely makes information understandable, for example:
 Emphasise material matters
 Adapt information to the entity’s own circumstances
 Describe transactions/events as simply and directly as possible
 Highlight relationships between different pieces of information
 Use formats appropriate for the type of information (tabular or narrative)
 Maximise comparability
 Avoid/minimise duplication of information
An entity should consider how information is presented in the financial statements (e.g. should items
be separate line items in the primary financial statements or should they be disclosed in the notes?)
Material items that have different natures or functions should not be aggregated.
Providing an excessive amount of immaterial information may obscure material information.
Step 4: Review the draft financial statements
 An entity should assess materiality on an individual and on a collective basis: an item might not
be material on its own, but is it material when considered with other information?

EXAM SMART
A recent amendment to IAS 1 requires entities to disclose all material accounting policies.
An accounting policy is probably material if it relates to a material transaction or event and
 there was a change in accounting policy during the period
 it was chosen from one or more allowed options
 it was developed in the absence of an applicable IFRS Standard
 it relates to an area where significant judgements/assumptions are required
 the accounting treatment of the transaction is complex
ACCA SBR Course Notes 21

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the objective of general purpose financial reporting, including the
main information needs of primary users?
Can you explain the qualitative characteristics of useful financial information and
discuss whether specific information actually possesses those qualities?
Can you understand and explain the definition of a reporting entity?
Do you understand the definitions of the elements of financial statements?
Can you explain and apply the criteria for recognising and derecognising an item in the
financial statements?
Can you explain the different measurement bases: historical cost and the three ways
of measuring current value (fair value, value in use, and current cost)?
Can you discuss the issues around the classification of income and expenses in the
statement of profit and loss and other comprehensive income, including the
arguments for and against reclassification of items?
Do you understand the general characteristics of materiality and the four-step
approach to identifying information that might be material to the financial
statements?
22 Course Notes ACCA SBR

Chapter B – Lecture example solutions

Lecture example B.1
As Quartz has an obligation to repurchase the property, Limestone does not obtain control of the
property. This is because Limestone is limited in its ability to direct the use of, and obtain substantially
all of the remaining benefits of the asset, even though it has physical possession of the asset. As
Quartz does not lose control of the property, the property should not be derecognised.
This is evidenced by the following:
 Limestone will only have physical possession of the property for one year.
 Limestone will not benefit from any increases in market value of the property as the repurchase
price is fixed (at $4.32 million) and is likely to be below market value.
 The sale proceeds are 20% below market value.
The substance of the transaction is that of a financing arrangement. The sale is to a financial
institution. The repurchase price of $4.32 million is greater than the sales price which represents a
lender’s return of $0.32 million on the amount paid out. Therefore, the transaction should be
accounted for as follows:
 Continue to recognise the property in Quartz’s statement of financial position.
 Record the sales proceeds of $4 million as a financial liability.
 Recognise $0.32 million as a finance cost in profit or loss and increase the financial liability by
the same amount.
 Derecognise the financial liability of $4.32 million on the repurchase date.
 23

C1

Revenue

1 IFRS 15 Revenue from contracts with customers

This is an important standard which deals with all contracts with customers except leases and financial
instruments. A contract is defined as an agreement between two or more parties that creates
enforceable rights and obligations. In essence, revenue will be recognised and measured using a 5-step
model.
24 Course Notes ACCA SBR

Step 1:
Identify the contract with the
customer

Step 2:
Identify the separate
performance obligations

Step 3:
Determine the transaction price

Step 4:
Allocate the transaction price to
the performance obligations

Step 5:
Recognise revenue as each
performance obligation is
satisfied

1.1 Step 1: Identify the contract with the customer

This contract could be for goods and services (e.g. a computer sale along with a one-year warranty). A
contract with a customer is within the scope of IFRS 15 only when:
 The parties have approved the contract and are committed to carrying it out.
 The rights and payment terms regarding the goods and services to be transferred can be
identified.
 The contract has commercial substance.
 It is probable that the entity will collect the consideration to which it will be entitled.
ACCA SBR Course Notes 25

1.2 Step 2: Identify the separate performance obligations

The “performance obligation” is the promise to provide goods or services to a customer.
A company would account for a performance obligation separately only if the promised good or
service is “distinct”:
 the customer can benefit from the good or service on its own; (if it could be sold separately);
and
 the entity’s promise to transfer the good or service to the customer is separately identifiable
from other promises in the contract.
For example, the sale of a mobile phone with a standard two-year rental contract would comprise two
performance obligations: (1) the sale of the phone; and (2) the sale of the line rental. These
arrangements are known as “bundle arrangements”.

1.3 Step 3: Determine the transaction price

The transaction price is the amount of consideration to which the entity expects to be entitled.
An entity should consider the effect of variable consideration (e.g. where there are discounts,
incentives, penalties or where a product is sold with a right of return). Estimates should be based on
probabilities and weighted averages, including estimates of contingent amounts, or on the single most
likely amount (where appropriate).
The transaction price should also take into account the time value of money, if material (for example,
where a transaction includes a significant financing component).

ILLUSTRATION: PRODUCT SOLD WITH RIGHT OF RETURN

Balham makes toys. Each toy costs $100 to make and sells for $150 each. Balham has just sold 50 toys
to a customer, who paid the full amount of the sale ($7,500) in cash up front and took delivery of the
toys on the same date.
The customer has been given 30 days to return the toys. Historically, this customer has returned 10%
of the goods purchased within the 30-day return period.
Balham recognises revenue for the 90% of the products sold which are not expected to be returned =
90% × $7,500 = $6,750. For the 10% of goods expected to be returned, a refund liability of 10% ×
$7,500 = $750 is set up. This liability is extinguished and recorded as revenue when the return period
expires.
Balham derecognises the inventories sold, but also recognises an asset of 10% x 50 goods @ cost of
$100 = $500 as well as a corresponding credit to cost of sales, for its right to recover the products
from the customer on settling the refund liability.
26 Course Notes ACCA SBR

LECTURE EXAMPLE C1.1: DISCOUNTING

Green sells goods to Mae for $300,000 on 1 January 2020, payable in three annual instalments of
$100,000 each commencing on 31 December 2020. The appropriate discount is 10%. The cumulative
10% three-year discount factor is 2.487.
Required:
Explain, with suitable calculations, how Green should account for the above transaction in its financial
statements for the year ended 31 December 2020.
SOLUTION

1.4 Step 4: Allocate the transaction price to the performance obligations

The transaction price should be allocated to the performance obligations in proportion to the
stand-alone selling price of the good or service.

1.5 Step 5: Recognise revenue as each performance obligation is satisfied

A performance obligation is satisfied as or when the customer obtains control of the promised good or
consumption of the service.
(i) Identify whether control passes at a point in time or over time
(ii) If over time, recognise revenue by using a method that reflects the entity’s performance
in transferring control of goods or services. Appropriate methods include:
– Output methods: based on the value to the customer e.g. based on surveys of
work completed to date.
– Input methods: based on the entity’s efforts or inputs e.g. the proportion of total
costs incurred to date.
(iii) If at a point in time, determine when control passes, i.e. when the customer has the
ability to direct the use of the asset and obtain substantially all the benefits from the
asset.
ACCA SBR Course Notes 27

ILLUSTRATION: 5-STEP MODEL

David enters into a 12-month contract with a satellite TV broadcaster, TVco. He pays a monthly fixed
fee of $100 and receives a full package of movies, sport and music channels.
He received a ‘free’ set-top box at the inception of the plan.
TVco sells the same set-top boxes for $300 and the same monthly payment plans without the box for
$80/month.
To calculate how much revenue to recognise, TVco should:
(1) identify the contract: which here is the 12-month plan with David.
(2) identify all performance obligations from the contract with David. Here, there are two
performance obligations:
(i) Obligation to deliver a set-top box
(ii) Obligation to deliver the TV channels for 1 year
(3) The transaction price is $1,200, calculated as monthly fee of $100 × 12 months.
(4) TVco needs to allocate that transaction price of $1,200 to individual performance obligations
under the contract based on their relative stand-alone selling prices.
Performance obligation Stand-alone selling price % on total Revenue
Set-top box $300 23.8% $285.60
Channels (80 × 12) = $960 76.2% $914.40
Total $1,260 100.0% $1,200.00
(5) Recognise the revenue when TVco satisfies the performance obligations. Therefore:
When TVco delivers the set-box to David, it needs to recognise the revenue of $285.60 immediately;
When TVco broadcasts the programmes over the next 12 months, it needs to recognise the
corresponding revenue of $914.40. It’s practical to spread this ($914.40/12 = $76.20 per month) as the
billing happens.

ILLUSTRATION: PERFORMANCE OBLIGATION SATISFIED OVER TIME

On 1 January 2020, Collins enters into a two-year contract with a customer to build a factory on the
customer’s land for a fixed price of $450,000. At the year end of 31 December 2020, Collins has
incurred $100,000 of the total expected costs of $300,000. A survey at 31 December 2020 values the
work completed to date at $180,000.
If Collins wishes to use an output method to measure progress towards satisfaction of its performance
obligation, it would recognise revenue of $180,000 (the value of work completed) in the year ended
31 December 2020.
If Collins wishes to use an input method to measure progress towards satisfaction of its performance
obligation, it would recognise revenue of $150,000 based on the proportion of total costs incurred to
date ($450,000 × $100,000/$300,000).
Another possibility would be to recognise revenue on the basis of time elapsed of $225,000 ($450,000
× ½) but this is likely to be a less accurate measure of work completed that the two methods described
above.
28 Course Notes ACCA SBR

1.6 Warranties

Standard warranty Warranty provides

(product complies with customer with service (in
Extended warranty
agreed-upon addition to assurance
specifications) (customer has option to that product complies
purchase this separately) with agreed-upon
(no option to purchase
separately) specifications)

Recognise a provision Treat as a separate Treat as a separate

based on estimated performance obligation performance obligation
repair costs under IAS 37 under IFRS 15 under IFRS 15

Where the warranty (or part of the warranty) is treated as a separate performance obligation, the
transaction price is allocated between the sale of the product and the separate performance
obligation under the warranty per Step 4 above.

ILLUSTRATION: WARRANTIES

Creeting is a manufacturer. When it sells Product X, Creeting provides its customer with a warranty. The
warranty provides assurance that the product complies with agreed-upon specifications and will operate
as promised for 12 months from the purchase date. For no extra cost, the warranty also offers the
customer to up to 15 hours of training on how to operate Product X.
Creeting often sells Product X without the 15 hours of training.
The training part of the warranty provides the customer with a service in addition to the assurance
that Product X complies with agreed-upon specifications. Therefore, this promised service is a
separate performance obligation in its own right.
The part of the warranty that provides the customer with assurance that Product X will function as
intended for 12 months, does not provide a customer with a good or service in addition to that
assurance. Therefore, it should be accounted for under IAS 37. This will result in recognition of a
provision and a corresponding expense measured at the best estimate of the expected repair costs
under the warranty.
There are two separate performance obligations here:
 To transfer Product X to its customer;
 To provide training to its customer.
Therefore, the transaction price must been be allocated to the two performance obligations (the
product and the training). Creeting will then recognise revenue when (or as) the performance
obligations are satisfied. For Product X, this is likely to be on delivery to the customer. For the training,
this is likely to be over the 12-months of the contract as the training services are provided.
ACCA SBR Course Notes 29

1.7 Principals and agents

A principal supplies its own goods and services whereas an agent receives a fee or commission for
arranging the provision of goods or services by the principal (e.g. a travel agent selling British Airways
flights).
The presumption is that if an entity controls the good or service before transfer to the customer, the
entity is the principal. This is not a definitive conclusion as may be the case when an entity obtains
legal title of a product momentarily. Indicators that an entity is an agent (and therefore does not
control the good or service before it is provided to a customer) include the following:
 another party is primarily responsible for fulfilling the contract
 the entity does not have inventory risk before or after the goods have been ordered by a
customer, during shipping or on return
 the entity cannot determine prices for the other party’s goods or services
 the entity’s consideration is in the form of a commission
A principal will recognise the gross amount of the consideration whereas the agent will only recognise
the commission earned on the goods/services.

LECTURE EXAMPLE C1.2: PRINCIPAL VERSUS AGENT

Needham operates a website which allows customers to buy goods from a range of suppliers. The
suppliers deliver goods directly to the customers. When a good is purchased via the website, under
Needham’s contracts with its suppliers, Needham is entitled to a commission of 10% of the sales
prices.
Needham’s website facilitates payment between the customer and supplier at prices set by the
supplier. Payment is required from customers before the order is processed and all orders are non-
refundable. Needham has no further obligations after arranging for the goods to be provided to the
customer.
Required:
Discuss whether Needham is a principal or an agent.
SOLUTION
30 Course Notes ACCA SBR

1.8 Contract costs

IFRS 15 notes that there are 2 types of contract cost, which must be capitalised:
(1) The costs of obtaining a contract, such as selling and marketing costs, bid and proposal costs,
sales commissions, and legal fees. Costs to be capitalised are those costs that entities would not
have incurred had the contract not been obtained. In addition, for such costs to be recognised
as an asset, the entity must expect to recover these costs. This excludes costs that would have
been incurred regardless of whether the contract was obtained or not (such as due diligence
costs or the costs of travelling to a tender).
(2) The costs of fulfilling a contract if they do not fall within the scope of another standard (such as
IAS 2 Inventories) and:
 the costs relate directly to the contract; and
 they generate or enhance resources of the entity (e.g. cost of machinery or other assets
that will be used to perform the contract); and
 the entity expects them to be recovered.
The capitalised costs of obtaining and fulfilling a contract are amortised to the statement of profit or
loss as revenue is recognised.

1.9 Non-refundable up-front fees

An entity will need to assess if non-refundable fees (such as gym membership fees) relate to a
separate performance obligation. When the upfront fee represents an advance payment for future
goods or services, such fees would be recognised as revenue only when those future goods or services
are provided, using the 5-step approach outlined earlier.
An upfront fee should be recognised as revenue when future goods or services are provided. So, an
upfront admin fee for joining a gym should NOT be recognised immediately, but instead should be
deferred and spread over, say the first year of the gym membership, if there is an initial 1-year
membership period.

1.10 Consignment inventories

These are in effect a ‘sale and return’ arrangement. They arise when a seller delivers a product to
another party (such as a dealer or a distributor) for sale to end customers, but retains control of that
product. Consignment inventories are common in the motor trade and book industries.
Indicators that a consignment arrangement exists include:
 The product is controlled by the seller until a specified event occurs (e.g. the sale of the product
to a third party)
 The seller can require the return of the product or transfer the product to a third party (such as
another dealer); and
 The dealer does not have an unconditional obligation to pay for the product (although it might
be required to pay a deposit).
The original seller should not recognise revenue upon delivery of a product to another party if the
delivered product is held on consignment. Revenue is only recognised when control passes to the
dealer or distributor.

1.11 Sale and repurchase agreements

In a sale and repurchase agreement, an entity sells an asset but retains the right to repurchase the
asset at some point in the future.
ACCA SBR Course Notes 31

There are three main types of sale and repurchase agreement:

 The seller has the right to repurchase the asset (a call option)
 The seller has an obligation to repurchase the asset (a forward)
 The seller has an obligation to repurchase the asset if the customer requests it (a put option)

Call option or forward

Control never transfers to the customer, because the customer only has a limited ability to direct the
use of the asset and cannot obtain substantially all of the remaining benefit from holding the asset.
Therefore no sale has occurred. The seller does not recognise revenue, but instead treats the
arrangement as either:
 a financing arrangement (loan) – where the exercise price (repurchase price) is equal to or
greater than the original selling price; or
 a lease – where the exercise price is less than the original selling price.

Put option
The financial reporting treatment depends on whether the arrangement creates an obligation for the
seller to repurchase the asset, i.e. the exercise price is greater than the expected market value of the
asset (because there is then a financial incentive for the customer to exercise the option). There are
two possibilities:
(i) Exercise price equal to or greater than the original selling price = an obligation to
repurchase exists → treat as a financing arrangement: a loan. Any excess of the exercise
price over the original selling price is treated as a finance cost. The selling entity
continues to recognise an asset and no revenue is recognised.
(ii) Exercise price less than the original selling price = an obligation to repurchase exists →
treat as a lease in accordance with IFRS 16 (see Chapter C3). The customer is paying the
selling entity to use a specified asset for a period of time; the selling entity is a lessor.
If the exercise price is less than expected market value of the asset the customer has no financial
incentive to exercise the option = no obligation to repurchase exists → treat as a sale with right of
return (see Section 1.3 above)

ILLUSTRATION: SALE AND REPURCHASE AGREEMENT

On 1 April 20X5, Alwyn,a property developer, sold a building to Dring for $9.5 million. At that date, the
building had a carrying amount of $6.5 million.
Under the terms of the contract, Alwyn has an obligation to repurchase the asset for $12 million on
31 March 20X7 if Dring requests this.
It is estimated that the market value of the building will be $11 million at 31 March 20X7.
How should the building be treated in the financial statements of Alwyn for the year ended 31 March
20X6?

SOLUTION
This is a sale and repurchase agreement with a put option.
Dring will exercise the repurchase right if it has an economic incentive to do so.
 The repurchase price of $12 million is significantly higher than the original selling price of
$9.5 million.
32 Course Notes ACCA SBR

 At the repurchase date, the estimated market value of the building is $11 million – also higher
than the original selling price.
 Therefore, Dring has a significant economic incentive to exercise the repurchase right and an
obligation exists.
Alwyn should not recognise a sale as control of the building has not transferred to Dring. Instead, the
sale and repurchase agreement should be treated as a financing arrangement:
 Alwyn should continue to recognise the building as an asset
 Alwyn should also recognise a loan (a financial liability) of $9.5 million
 The excess of the exercise price over the original selling price should be treated as a finance
cost.

1.12 Contract modifications

A contract modification is a change in the scope or the price of a contract (or both).
A modification is treated as a separate contract if:
 The scope of the contract increases because of the addition of distinct goods and services; and
 The price increases by an amount that reflects the stand-alone selling price of these additional
goods and services.
If these conditions are not met, the accounting treatment depends on whether:
 The remaining goods are distinct from those transferred to the customer before the
modification; or
 The remaining goods and services are not distinct from those transferred to the customer
before the modification.
Note: You may find it helpful to look back at the meaning of distinct (see Step 2 of the five-step
process, earlier in this chapter).

Remaining goods distinct from those transferred before the modification

This is treated as the termination of the existing contract and the creation of a new contract.
The transaction price for the new contract is the total of:
 The original consideration not yet recognised; and
 The additional consideration promised from the modification

Remaining goods and services not distinct from those transferred before the
modification
This is treated as part of the original contract (because there is a single performance obligation).
The modification changes the contract price and the stage of contract completion. There is an
adjustment to the cumulative amount of revenue recognised at the modification date.
ACCA SBR Course Notes 33

LECTURE EXAMPLE C1.3: CONTRACT MODIFICATION

Wright enters into a contract to supply a customer with 500 units of a cleaning product for $80 each
over a period of nine months. Control of each unit passes to the customer when it is delivered. Two
months into the contract, after Wright has supplied 350 units, it agrees to supply an additional 250
units, so that the entity is contracted to supply 750 units in total.
The stand-alone selling price of each unit is $80. Wright and the customer agree that the additional
250 units will be supplied at a price of $72 each.
At the year-end, Wright has transferred 400 units.
Required:
Explain how Wright should treat the contract modification in its financial statements and calculate the
amount of revenue to be recognised in the financial statements for the year.
SOLUTION

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain and apply the five-step model for recognising revenue, including
whether revenue should be recognised (a) at a point in time or (b) over time?
Do you understand how to deal with warranties, how to identify whether an entity is
acting as an agent or a principal and how to deal with consignment inventories, sale
and repurchase agreements and contract modifications?
34 Course Notes ACCA SBR

Chapter C1 – Lecture example solutions

Lecture example C1.1
On 1 January 2020, Green records revenue and a receivable of $248,700 ($100,000 × 2.487). In the
year ended 31 December 2020, Green unwinds one year of discounting. This results in interest income
of $24,870 (10% × $248,700). This interest income of $24,870 should be shown separately from the
revenue figure of $248,700 in Green’s statement of profit or loss for the year ended 31 December
2020.
Mae pays the first instalment of $100,000 on 31 December 2020. Therefore, Green’s statement of
financial position as at 31 December 2020 will include a receivable of $173,570 ($248,700 + £24,870 –
$100,000).

Lecture example C1.2

Needham is acting as an agent for the following reasons:
 The supplier (not Needham) is primarily responsible for fulfilling the customer order as
Needham is not obliged to provide the goods if the supplier fails to transfers the goods to the
customer.
 Needham does not bear any inventory risk as it does not deal directly with the inventories at
any point in time.
 The supplier (not Needham) establishes the sales price for the goods.
Therefore, Needham is the agent and should recognise the 10% commission as revenue. Each supplier
is a principal in this scenario and would recognise the full sales price as revenue and the commission
earned by Needham as an expense.

Lecture example C1.3

The units of the cleaning product are distinct goods (the customer can benefit from each unit on its
own), which might suggest that the supply of the additional units should be treated as a separate
contract.
However, the additional units are not being supplied at the stand alone price. Therefore the
modification is not accounted for as a separate contract, but as a termination of the existing contract
and the creation of a new contract.
We need to arrive at a transaction price for the new contract. This is the total of:
 The original consideration not yet recognised; and
 The additional consideration promised from the modification
$
Original consideration not yet recognised (150 × $80) 12,000
Additional consideration from the modification (250 × $72) 18,000
30,000

Therefore the price per unit is $75 (30,000/400).

The amount of revenue to be recognised for the year is:
$
Original contract (350 × $80) 28,000
New contract (50 × $75) 3,750
31,750
 35

C2

Non-current assets

1 IAS 16: Property, Plant and Equipment

1.1 Definition
Property, plant and equipment (PPE) are tangible items that are held by an entity for use in the
production or supply of goods or services and are expected to be used during more than one period.

1.2 Measurement at recognition

IAS 16 states that the cost of an item of property, plant and equipment should be recognised when
two conditions have been fulfilled:
(1) It is probable that future economic benefits associated with the item will flow to the entity
(2) The cost of the item can be measured reliably
All items of PPE are recognised at cost, where “cost” is the purchase price, excluding recoverable VAT,
including import duties and after deducting trade discounts. “Cost” also includes:
 “Directly attributable costs” of bringing the asset to the location and condition necessary for it
to be capable of operating in the manner intended by management. “Directly attributable”
essentially means “additional, necessary” costs and would include the cost of site preparation,
initial delivery costs, installation and assembly costs, costs of testing whether the asset is
functioning properly and legal fees. Testing may involve producing samples: any resulting sale
proceeds are recognised in profit or loss.
 Estimated cost of dismantling and removing the item and restoring the site on which it is
located (see Chapter C7 - IAS 37 Provisions, Contingent Liabilities and Contingent Assets).

1.3 Borrowing costs

IAS 23 Borrowing Costs states that the capitalisation of finance costs, including interest, is required for
any “qualifying asset” – i.e. an asset which takes a substantial period of time to get ready for its
intended use.
36 Course Notes ACCA SBR

Interest can be capitalised out of borrowings taken out specifically for the purchase of the asset (using
the actual interest rate incurred) or out of general borrowings (where the weighted average interest
rate is used).
Capitalisation commences when:
 expenditures for the asset are being incurred;
 borrowing costs are being incurred;
 and construction activities are in progress.
Capitalisation is suspended while development is interrupted and ceases when substantially all the
activities necessary to prepare the qualifying asset for its intended use or sale are complete.

1.4 Subsequent expenditure

Parts of some items of property, plant and equipment may require replacement at regular intervals.
For example, a furnace may require relining after a specified number of hours use.
Subsequent costs are capitalised when the cost of replacement is incurred, providing the recognition
criteria are met. They should then be treated separately for the purpose of calculating deprecation.
Day-to-day servicing costs, for example repairs and maintenance, are not capitalised. These costs are
expensed in the statement of profit or loss when incurred.

1.5 Measurement after recognition

After initial recognition, the entity must choose either the cost or revaluation model (to fair value) as
its accounting policy.

1.6 Fair value

IAS 16 and IFRS 13 Fair Value Measurement define fair value as ‘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’.
In practice, the fair value of an asset is normally its market value.
Where an item of property, plant and equipment is revalued, all other assets in the same class should
also be revalued.
Revaluations should be made with “sufficient regularity” to ensure that the carrying amount does not
differ materially from its fair value.
Depreciation should then be charged on the revalued amount.
Any excess depreciation (i.e. the difference between the old depreciation charge and the new charge
based on the revalued amount) can be transferred from the revaluation surplus to retained earnings
each year. (Note that this reserve transfer is optional.)
On the disposal of the asset, any remaining balance in the revaluation surplus should be transferred to
retained earnings.

1.7 Depreciation
All non-current assets (apart from land) should be depreciated over their useful lives down to their
residual value.
Depreciation charge = Cost/value – residual value
Remaining useful life
ACCA SBR Course Notes 37

Other points to note:

 The depreciation method should reflect the expected pattern of consumption of the asset’s
future economic benefits.
 Where an asset has one or more components with different useful lives, these components are
depreciated separately.
 The useful life and depreciation method of property, plant and equipment should be reviewed
at least at each financial year end.

2 IAS 38: Intangible Assets

2.1 Definition
An intangible asset is an identifiable non-current asset without physical substance. Examples include
patents, software and brands. This is a controversial area of accounting as many companies want to include
such “assets” on the statement of financial position, but the recognition rules often prohibit this.
An intangible asset may be recognised in the financial statements if:
 It is probable that the entity will receive probable future economic benefits from the asset, and
 The cost of the asset can be measured reliably
These rules mean that any internally-generated intangible such as a brand or customer list will not be
permitted on the statement of financial position because of the inability to determine its “cost”.
Note that advertising costs cannot be recognised as an intangible asset and must be expensed instead,
as there is no guarantee that future economic benefits will arise from the expenditure.

2.2 Measurement at recognition

 Intangible assets purchased separately (e.g. a purchased licence to operate a radio station) –
should be recognised at cost, including any directly attributable costs.
 Intangible assets acquired as part of a business combination – recognised at fair value at the
date of acquisition.
 Internally generated goodwill (e.g. reputation) – NOT recognised on the statement of financial
position.

2.3 Measurement after recognition

(a) Cost model - cost less accumulated amortisation and impairment losses
(b) Revaluation model – only to be used if the asset is traded in an active market. This is likely to be rare.

2.4 Amortisation
The rules for intangible assets are almost identical to those for a tangible asset. The following points
are also relevant:
 The residual value is normally assumed to be zero.
 Amortisation begins when the asset is available for use.
 Methods based on expected revenue are normally inappropriate.
Some intangibles are considered to have an indefinite useful life. An “indefinite useful life” is one
when there is no foreseeable limit to the period over which the asset is expected to generate net
cash inflows for the entity. The term indefinite does not mean infinite.
These assets are not amortised, but are tested for impairment annually.
38 Course Notes ACCA SBR

2.5 Research and development costs

 Research costs = those costs that are incurred to “gain new scientific or technical knowledge
and understanding”.  always expensed in the statement of profit or loss (SPL).
 Development costs = those costs which are incurred in the “application of research findings to a
plan/design for the production of new or substantially improved materials, products or
processes prior to commercial production or use”.
These costs MUST be recognised if all of the following criteria are met:
– Probable future economic benefits
– Intention to complete the asset and use or sell it
– Resources available to complete the development and to use or sell the asset
– Ability to use or sell the asset
– Technical feasibility of completing the asset
– Expenditure can be measured reliably.

3 IAS 40: Investment Property

It is possible for a company to own more than one property. It might occupy one for its day-to-day
activities and operations and another which it can rent out for its rental income and/or capital
appreciation – an investment property.
Note that land can be considered an investment property if it is held for capital appreciation, even
land which is held for “indeterminate use”.
Investment properties include properties/land held by the owner or held under a lease.
Investment properties EXCLUDE:
 owner-occupied properties
 properties intended for sale in the ordinary course of business; and
 properties to which the entity provides ancillary services (e.g. serviced offices), unless the
services are insignificant in relation to the whole arrangement.
Initially, an investment property should be measured at cost. At each subsequent year end, it can
either:
 Value the property as a normal non-current asset at depreciated cost or
 It can choose the fair value model, whereby the property is revalued each year end, with any
gain or loss recognised in the statement of profit or loss. Under this model, the asset is not
depreciated.
Whichever policy it chooses should be applied to all of its investment properties.
ACCA SBR Course Notes 39

3.1 Change of use

If a company changes the use of an investment property to a conventional property (perhaps because
it reoccupies the property itself), then the deemed new cost of the property is taken to be its fair value
at the date of the change in use. This is the new “cost” that is depreciated.
If a conventional (owner-occupied) property becomes an investment property that will be carried at
fair value, the entity applies IAS 16 up to the date of the change (i.e. it depreciates the asset up to the
date of change in use), then treats any difference between its carrying amount and its fair value as a
revaluation through the revaluation surplus, with subsequent revaluations going through the profit or
loss in accordance with IAS 40.
Note that transfers can only occur when a property meets, or ceases to meet, the definition of
investment property and that there must be evidence of the change in use. A change in management’s
intentions, on its own, is not evidence of an actual change in use.

4 IAS 36: Impairment of Assets

4.1 Impairment
At the end of each reporting period an entity should assess whether there is any indication that an asset
may be impaired. If an indication of impairment does exist, then the recoverable amount of the asset
must be determined.
An asset is impaired if its carrying amount is greater than its recoverable amount, where recoverable
amount is the higher of:
 Fair value less costs of disposal = net proceeds from the sale of the asset at an arm’s length
transaction and
 Value in use = the present value of the future cash flows that the asset is expected to generate,
including any disposal proceeds at the end of the asset’s life, discounted at a pre-tax rate
The assumptions used in arriving at the recoverable amount need to be ‘reasonable and supportable’.
Indicators of impairment include:
External sources
 Significant fall in the market value of the asset
 An adverse effect on the business in the technological, market, economic or legal environment
in which the entity operates (e.g. a recession)
 Increased market interest rates that reduce the value in use
Internal sources
 Evidence of obsolescence or physical damage.
 The asset is not used as much in the business as it once was
 Internal evidence that the asset’s performance will be worse than expected.
40 Course Notes ACCA SBR

ILLUSTRATION: VALUE IN USE

Gerard Co has some computerised equipment with a carrying amount of $4 million on 31 October
2018.
Whilst searching the internet, Gerard discovers that the manufacturer of the equipment is now selling
the same system for $3 million.
The projected cash flows from the equipment are:
Year ended 31 October $m
2019 1.3
2020 2.2
2021 2.3
The residual value of the equipment is assumed to be zero. The company uses a discount rate of 10%.
The directors think that the fair value less costs to sale of the equipment is $2.5 million.
SOLUTION
Value in use =
Year ended 31 October Cash flows Discounted (10%)
$m $m
2019 1.3 1.2
2020 2.2 1.8
2021 2.3 1.7
Value in use 4.7
Fair value less costs of disposal 2.5
Recoverable amount: value in use (higher) 4.7
The recoverable amount is higher than the carrying amount of $4 million and therefore the equipment
is not impaired.

4.2 Cash-generating units (CGUs)

It is often not possible to estimate the recoverable amount of an individual asset. In such
circumstances, an entity should determine the recoverable amount of the group of assets (cash-
generating unit) to which it belongs.
A cash-generating unit is the smallest identifiable group of assets for which independent cash inflows
can be identified and measured.
For example, the Oxford Street branch of Marks & Spencer would be considered a CGU, as would
Disneyland in Paris.

4.3 Goodwill
A subsidiary in a group of companies will probably have an element of goodwill attached to it, relating
to the original purchase by the parent company. This goodwill will not generate cash flows
independently of other assets. It must be allocated to the CGUs that are expected to benefit from the
combination.
When goodwill is created in a business combination, it may or may not be possible to allocate it to a
particular CGU. It may, for example, only be possible to allocate it to a group of CGUs.
ACCA SBR Course Notes 41

Where a parent has measured non-controlling interest as their proportionate share of the subsidiary’s
net assets, this means that the NCI’s share of goodwill has not been included in the group’s assets. To
calculate the impairment loss, the goodwill figure must be ‘grossed up’ to include 100% of the
subsidiary’s goodwill.

ILLUSTRATION: IMPAIRMENT OF GOODWILL (PROPORTIONATE METHOD)

X owns 80% of the equity shares of Y. The carrying amount of Y’s assets is $100 million. Goodwill
relating to Y is $20 million. It is the policy of the X Group to measure non-controlling interest at their
proportionate share of the subsidiary’s assets.
The recoverable amount of Y is $110 million.
$m
Net assets excluding goodwill 100
Goodwill: original: 20
Plus: “notional goodwill” needed to gross up goodwill (20/80 × 20) 5
Total carrying amount 125

Recoverable amount 110

Impairment 15

Total goodwill (including the NCI’s goodwill) is written down to $10 million.
But because only the group share of the goodwill is included in the group financial statements, only
the group share of the impairment loss is recognised:
Dr Profit or loss $12 million (80% × $15 million)
Cr Goodwill $12 million

4.4 Recognition of impairment losses (i.e. what to “debit” and “credit”)

Impairment losses are treated in the following way:
 Assets carried at historical cost (i.e. those that have never been revalued in the past)
Dr Profit or loss
Cr Non-current asset
(For a CGU: Dr Profit or loss
Cr (1) Goodwill
(2) PPE and intangibles on a pro-rata basis)
 Revalued assets
Dr Revaluation surplus/OCI re: the asset (down to nil)
Dr Profit or loss (any balance)
Cr as above
The carrying amount of an asset should not be reduced below its recoverable amount (or zero).
After the impairment has taken place, the depreciation/amortisation charge should be adjusted to
allocate the remaining carrying amount over the remaining useful life.
42 Course Notes ACCA SBR

ILLUSTRATION: RECOGNISING AN IMPAIRMENT LOSS

An asset was purchased for $1,000 at 1 January 2010. It has a useful economic life of 10 years.
At 31 December 2012, the carrying amount is therefore: $1,000 – three years of depreciation of $100 =
$700.
The asset is revalued at this date to $840, creating a revaluation surplus of $140.
For the year ended 31 December 2013, the asset would now be depreciated by $840/7 years = $120,
leading to a carrying amount at 31 December 2013 of $720.
This new depreciation charge is $20 higher than the “old” charge, meaning that the company would
put through a transfer through reserves each year of:
Dr Revaluation surplus $20 (bringing this surplus down to $120 in 2013 and $100 in 2014)
Cr Retained earnings $20
At 31 December 2014 (when the carrying amount is $600), the company performs an impairment
review and discovers that the recoverable amount is $440, meaning that the asset is impaired by $160.
The double entry to record this would be:
Dr Revaluation surplus $100 (to bring this down to nil)
Dr Profit or loss $60
Cr Asset $160

4.5 Reversal of past impairments

An entity should assess at each year end whether there is any reversal of any past impairments for
assets other than goodwill.
For individual assets and CGUs, the reversal is recognised in the statement of profit or loss, except
where reversing a loss recognised on assets carried at revalued amounts, which are treated in
accordance with the applicable IFRS.
Note that the carrying amount of an asset cannot be increased above the lower of:
(a) Its recoverable amount (if determinable); and
(b) Its depreciated carrying amount had no impairment loss originally been recognised.
Previous impairments to goodwill cannot be reversed.
For example, carrying on from the illustration above, the depreciation charge for 2015 would be 440/5
remaining years = 88, giving a carrying amount at 31 December 2015 of 440 – 88 = 352.
If, at 31 December 2015, the company decided that the asset is now worth 450, it should:
Dr Asset (450 – 352) 98
Cr Profit or loss 48 – see below
Cr Revaluation surplus/OCI 50
Had the original asset never been revalued or impaired, it would have a depreciated carrying amount
at 31 December 2015 of $1,000 less six years of depreciation of $100 = $400. Therefore, the credit to
the statement of profit or loss should be the difference between the carrying amount of 352 and 400 =
48. The remaining reversal simply goes to the revaluation surplus.

5 IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

IAS 36 Impairment of Assets and IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations
are often examined together. If an asset is going to be sold after the year end, IFRS 5 is relevant. If the
asset is likely to be sold for less than its current carrying amount, then IAS 36 will also be relevant.
ACCA SBR Course Notes 43

IFRS 5 requires entities to disclose information about:

 Non-current assets that are held for sale; and
 Discontinued operations.

Non-current assets held for sale

An asset is “held for sale” if the entity plans to recover its value by selling it, rather than using it in the
business. To be classified as 'held for sale', the following criteria must be met:
 Seeking the entity must be actively seeking a buyer
 Available the asset must be available for immediate sale in its present condition
 Likely the sale must be highly probable (e.g. at a reasonable price)
 Expected the sale is expected to be completed within one year
Once an asset is classified as “held for sale”:
 Update the carrying amount of the asset in accordance with IFRS Standards (normally IAS 16).
Depreciate up to date of classification and revalue (if using the revaluation model).
 Next: revalue at lower of carrying amount and fair value less costs to sell – this is similar to
performing an impairment review. Any loss is recognised in profit or loss.
 Transfer the asset from non-current assets to current assets.
 Depreciation should cease from the date of classification.
 Any subsequent downwards movement in fair value less costs to sell is recognised as a further
loss in profit or loss.
 However, if fair value less costs to sell increases in the future (a bit like a revaluation), this
increase cannot exceed cumulative impairment losses to date.

ILLUSTRATION: ASSET THAT HAS NOT PREVIOUSLY BEEN REVALUED

Sam, a limited liability company, has a non-current asset with a carrying amount of $43,200.
On 1 January 2016, Sam decides to sell the asset and classifies it as “held for sale”.
The fair value less costs to sell is $21,000.
The asset is eventually sold on 30 March 2016 for $18,000.
How should the transaction be accounted for?
SOLUTION
(1) At 1 January 2016, the asset is classified as “held for sale” and is therefore valued at the lower
of carrying amount ($43,200) and fair value less costs to sell ($21,000).
There is therefore an impairment loss of $22,200, which is charged to the statement of profit or
loss.
No more depreciation is charged on the asset.
(2) On disposal:
$
Proceeds 18,000
Carrying amount 21,000
Loss on disposal (3,000)
44 Course Notes ACCA SBR

5.1 Disposal groups

An entity may decide to dispose of a group of assets instead of a single asset. For example, a company
might decide to sell all of the assets relating to the sales office, which is being closed down.
The accounting treatment for a disposal group is identical to that for a single asset, except that the
entity must show separately the assets held for sale and the liabilities held for sale (i.e. they must not
be offset).

5.2 Discontinued operations

A discontinued operation is a component of an entity that, at the year end, either has been disposed
of or is classified as held for sale and:
(a) Represents a separate major line of business or geographical area of operations, or
(b) Is part of a single coordinated plan to dispose of a separate major line of business or
geographical area of operations, or
(c) Is a subsidiary acquired exclusively with a view to resale.
A component of an entity is one that has operations and cash flows that can be clearly distinguished,
operationally and for financial reporting purposes, from the rest of the entity.
This means that if a department store such as John Lewis were to shut down its Bristol store, then this
would NOT be considered a discontinued activity as John Lewis would still continue to operate other
stores around the country.
Therefore, when an entity has a disposal group (which is largely reflected in the statement of financial
position), it may also have discontinued operations (which are largely shown in the statement of profit
or loss).
Essentially, the results of the entity need to be split, on the statement of profit or loss, between those
that relate to the continuing activities of the business and those that are now discontinued.:
 On the face of the SPL - a single amount comprising the total of:
– The post-tax profit or loss of discontinued operations, and
– The post-tax gain or loss recognised on the remeasurement to fair value less costs to sell
or on the disposal of assets/disposal groups comprising the discontinued operation.
 Either on the face of the SPL or in the notes:
– The revenue, expenses, and pre-tax profit or loss of discontinued operations, and the
related income tax expense;
– The gain or loss recognised on the measurement to fair value less costs to sell or on the
disposal of assets/disposal groups comprising the discontinued operation and related
income tax expense;
ACCA SBR Course Notes 45

ILLUSTRATION: DISCONTINUED OPERATIONS

Angus, a limited company, has committed itself to a plan of action to sell an 80%-owned subsidiary,
Frasier before its year-end of 31 March 2014. The sale is expected to be completed on 1 July 2014 and
the financial statements of the group were signed on 15 May 2014.
Frasier had net assets at the year end of $5 million and the carrying amount of related goodwill is
$1 million.
At 15 May 2014 Angus was negotiating the consideration for the sale of Frasier but no contract has
been signed or public announcement made as of that date.
Angus expected to receive $4.5 million for the company after selling costs, which it considers to be
Frasier’s recoverable amount.
Required:
How should the sale of Frasier be dealt with in the Angus group financial statements at 31 March 2014?
SOLUTION
IFRS 5 requires an asset or disposal group to be classified as held for sale where it meets the criteria
outlined earlier in this chapter.
The proposed sale of Frasier appears to meet these conditions. Although the sale had not taken place
by the time that the 2014 financial statements were approved, negotiations were in progress and the
sale is expected to take place on 1 July 2014, well within a year after the decision to sell. Angus had
committed itself to the sale before its year-end of 31 March 2014.
Where a subsidiary is held for sale it continues to be included in the consolidated financial statements,
but it is presented separately from other assets and liabilities in the statement of financial position
and its assets and liabilities should not be offset.
If Frasier represents a separate major line of business or geographical area of operations it will also
qualify as a discontinued operation, which means that on the face of the statement of profit or loss
and other comprehensive income the group must disclose a single amount comprising the total of its
post-tax loss for the year.
Frasier must be reviewed for impairment immediately before its classification as 'held for sale':
$000
Net assets at 31 March 2014 5,000
Goodwill 1,000
Total carrying amount 6,000

Fair value less costs to sell 4,500

IFRS 5 requires items held for sale to be measured at the lower of carrying amount and fair value less
costs to sell and therefore Frasier will be carried at the fair value less costs to sell of $4.5 million in
the statement of financial position, with an impairment of $1.5m ($6m – $4.5m) recorded.
This impairment of $1.5m should be taken against goodwill ($1,000k), and net assets (the balance of
$500k):
Dr Profit or loss $1,500k
Cr Goodwill $1,000k
Cr Net assets $500k
46 Course Notes ACCA SBR

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand how to recognise and measure property, plant and equipment and
intangible assets, at the time they are originally acquired or developed and in
subsequent periods?
Can you explain what is meant by investment property, how to recognise and measure
it and the ways in which this differs from accounting for other tangible assets?
Can you identify situations in which an asset may be impaired?
Do you understand the definition of recoverable value and how to determine it,
including the calculation of value in use?
Do you know how to recognise and measure an impairment loss for (a) a single asset
and (b) a cash generating unit (CGU)?
Can you explain how to account for a reversal of a past impairment?
Can you list and explain the criteria that must be met before an asset can be classified
as ‘held for sale’?
Do you understand how to measure an asset that is held for sale and how it is
accounted for and presented in the financial statements?
Do you understand the definition of a discontinued operation and can you explain how
to present a discontinued operation in the financial statements?
 47

C3

Financial instruments

1 IAS 32 – Financial Instruments: Presentation

KEY TERM
Financial instrument: A financial instrument is defined as any contract that gives rise to
both a financial asset of one entity and a financial liability or equity instrument of another
entity.

1.1 Classification
Financial instruments fall into three categories:
(1) Financial assets: e.g.
 An equity instrument of another entity (e.g. shareholding in another company);
 Cash or a contractual right to receive cash or another financial asset from another entity,
e.g. trade receivables, loan receivable;
 A derivative standing at a gain.
(2) Financial liability: e.g.
 A contractual obligation to deliver cash or another financial asset to another entity; e.g.
trade payables, loan payable, debenture loans, redeemable preference shares.
 A derivative standing at a loss.
(3) Equity instrument. A contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities; e.g. a company’s own ordinary shares, share options, irredeemable
preference shares.
48 Course Notes ACCA SBR

1.2 Derivatives
IFRS 9 defines a derivative as a financial instrument which has the following characteristics:
(1) It requires little or no initial investment,
(2) It derives its value from some underlying item, e.g. a contract to purchase wheat at
$1,000/tonne on 31 December 2015. The value of this contract is “derived” from the stock
market for wheat.
(3) It is settled at some future date.
A contract is not considered to be a derivative where its purpose is to take physical delivery of a product. (A
contract to take physical delivery of a product is not normally recognised until the date of sale or purchase.)
A derivative can either be classified as a financial asset (if standing at a gain) or a financial liability (if
standing at a loss).

1.3 Preference shares

One of the fundamental principles of IAS 32 is that a financial instrument should be classified
according to its substance rather than its legal form.
A potential problem arises in the presentation of preference shares. Preference shares are shares in a
company which give their holders an entitlement to a fixed dividend but which do not usually carry
voting rights.
Because of this entitlement, it could be argued that the issuing company has an obligation to pay this
dividend, and that the instrument, in substance, has similar characteristics to debt. This is particularly
the case if the preference shares are redeemable i.e., they have to be repurchased by the issuing
company at some future date.
Therefore, redeemable preference shares are very often categorised as “liabilities” and not “equity”
(or shares).
A further complication can be added if the preference shares are “cumulative” meaning that any
dividends not paid in any year must be paid in future years. This feature means that cumulative
preference shares (redeemable and non-redeemable) are very likely to be categorised as a liability.

1.4 Compound instruments

Compound instruments are those which show characteristics of both equity and financial liabilities. If
this is the case, then we “split” the components on the statement of financial position.
The most common example of a compound instrument is convertible debt – debt that the holder has
the option of converting into shares at some point in the future.

LECTURE EXAMPLE C3.1: COMPOUND INSTRUMENTS

A company issued 4,000 convertible bonds on 1 January 2004. The bonds are redeemable in four
years' time at their par value of $100 per bond.
The bonds pay interest annually in arrears at an interest rate (based on nominal value) of 5%.
Each bond can be converted at the maturity date into five $1 shares.
The prevailing market interest rate for four-year bonds that have no right of conversion is 8%.
The annuity factor for four years at 8% is 3.312. The present value of $1 receivable in four years’ time
at 8% is 0.735.
ACCA SBR Course Notes 49

Required:
Show the accounting treatment of the bond at inception and as at 31 December 2004.
SOLUTION

Non-current liabilities $
Financial liability component of convertible debt
Equity
Equity component of convertible debt
(W1) Initial recording:

Dr Cash
Cr Financial liability (W2)
Cr Equity

(W2) Fair value of equivalent non-convertible debt

$
Present value of principal payable at the end of 4 yrs
Present value of interest payable annually in arrears for 4 yrs

Solutions to the Lecture examples may be found at the end of the chapter

EXAM SMART
Exam questions may ask you to explain or advise on whether a particular financial
instrument (usually a class of shares) should be classified as debt or equity in the financial
statements of the issuer.
You can gain marks by applying the definitions of financial liabilities and equity, even if your
final answer is not the same as the Examiner’s. Things to think about:
 Is the issuer required to pay cash or to transfer another financial asset (e.g. to repay a
loan, to redeem shares)?
 Has the issuer promised a particular return to the holder regardless of its own profit
(e.g. it has to pay a fixed amount of interest on loan notes or preference shares)?
If either of these applies, then the issuer has an obligation and therefore there is a liability.
50 Course Notes ACCA SBR

2 Recognition and measurement

2.1 Recognition
Per IFRS 9, Financial assets and liabilities are required to be recognised in the statement of financial
position when the entity becomes a party to the contractual provisions of the instrument.
In practical terms, this usually means:
Type of financial instrument Recognition
Trade receivable/payable On delivery of goods or performance of service
Loans (bonds, loan notes, debentures) On issue/purchase
Shares On issue/purchase
Derivatives On the commitment date (rather than the settlement date)

2.2 Derecognition
Derecognition occurs when the contractual rights to the cash flows to the financial asset expire (e.g.
because a customer has paid their debt) or is sold, based on whether the entity has transferred
substantially all the risks and rewards of ownership of the financial asset.
For financial liabilities, derecognition occurs when the obligation is paid off, cancelled or expires.

ILLUSTRATION: DERECOGNITION

Webster holds a government bond. On 1 January 2019, Webster sells the bond to a bank for its market
value of $5,000 and agrees to repurchase the bond on 1 January 2020 for $5,200 ($5,000 + 4%
interest).
Even though Webster has sold the bond (a financial asset), it should not derecognise the bond as it has
retained substantially all the risks and rewards of ownership. The bank is not taking on the risks and
rewards of ownership as it will only receive a guaranteed lender’s return on the bond and will not
benefit from or lose out from any increase or decrease in the bond’s market value. Therefore, Webster
should continue to recognise the bond as a financial asset and record the sales proceeds as a financial
liability. The difference between the sale and repurchase price should be recorded as an interest
expense and be added to the carrying amount of the financial liability.

2.3 Measurement: financial assets

Subsequent
Type of financial asset Explanation Initial measurement measurement
Investments in debt Business model: Fair value PLUS Amortised cost
instruments  Held to collect transaction costs
e.g. buy bonds, loan notes, contractual cash
debentures (lend money) flows; and
 Cash flows are solely
principal and interest
ACCA SBR Course Notes 51

Subsequent
Type of financial asset Explanation Initial measurement measurement
Business model: Fair value PLUS Fair value through other
 Held to collect transaction costs comprehensive income
contractual cash (with reclassification to
flows and to sell; and P/L on derecognition)
 Cash flows are solely [Note: interest calculated
principal and interest on amortised cost basis is
recognised in P/L]
Investments in equity Purchases of ordinary Fair value Fair value through profit
instruments i.e. buy shares shares unless election (transaction costs are or loss
below is taken recognised as an
expense in P/L)
If not ‘held for trading’ Fair value PLUS Fair value through other
(held for trading = for transaction costs comprehensive income
short-term profit making), (no reclassification to P/L
the entity can make an on derecognition)
irrevocable election on
initial recognition
E.g. investment in
ordinary shares which the
investor intends to hold
for the long-term
Derivatives standing at a The agreed rate under the Fair value Fair value through profit
gain derivative is more (transaction costs are or loss
favourable than the rate recognised as an
under an equivalent expense in P/L)
contract at the year end

EXAM SMART
Investments in subsidiaries, associates and joint ventures are outside the scope of IFRS 9.
Therefore, the above table refers to small shareholdings that do not give the investor
significant influence, joint control or control. The one exception is recognition of the
investment in the subsidiary, associate or joint venture in the parent’s separate financial
statements which IAS 27 Separate Financial Statements allows the parent to measure in one
of three possible ways:
 At cost; or
 In accordance with IFRS 9 (at fair value through P/L if no election; or at fair value
through OCI if election taken up); or
 Using the equity method.
52 Course Notes ACCA SBR

ILLUSTRATION: AMORTISED COST

Gav Co purchased 5% debentures in Zurich Co on 1 January 2009 (their issue date) for $500,000 as an
investment. Gav intends to hold them for six years, at which point Zurich will have to repay Gav
$560,000. Transaction costs of $5,000 were incurred on purchase. The effective rate of interest of the
bond is 6.5%.
Initial measurement:
Dr Financial asset $505,000 (adding the transaction costs of $5,000, as this is a financial asset)
Cr Cash $505,000
Subsequent measurement:
Using the rationale on the previous page, the financial asset should be held at amortised cost:
Year end Asset Effective Interest received
31 December b/f interest @ 6.5% (@5% coupon) Asset c/f
$000 $000 $000 $000

2009 505 32.8 (25) 512.8

2010 512.8 33.3 (25) 521.1
2011 521.1 33.9 (25) 530.0
2012 530.0 34.5 (25) 539.5
2013 539.5 35.1 (25) 549.6
2014 549.6 35.7 (25) 560

Dr Fin asset Dr Cash The year end

Cr P/L : finance income Cr Fin asset balance is
the “amortised
cost”

ILLUSTRATION: FAIR VALUE THROUGH PROFIT OR LOSS

Gav Co purchased 30,000 shares in Jersey Co on 1 November 2011 for $2.00 each as a short-term
investment. Transaction costs on purchase or sale are 1% purchase/sale price. The share price at the
year end, 31 December 2011, was $2.20.
Initial recording: 1 November 2011
Dr Financial asset – shareholding $60,000 (excluding. transaction cost)
Cr Cash $60,000
At the year end: 31 December 2011
The financial asset will be held at fair value ($2.20), (potential transaction costs are ignored):
30,000 × $2.20 = $66,000
Therefore, Dr Financial asset $6,000
Cr Profit or loss – gain $6,000
ACCA SBR Course Notes 53

ILLUSTRATION: FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

Pestell anticipates capital expenditure in a few years and so invests its excess cash in financial assets so
it can fund the capital expenditure when required. Pestell holds the financial assets to collect the
contractual cash flows of the interest and principal, and, when an opportunity arises, Pestell sells
financial assets to re-invest in financial assets with a higher return. As part of this policy, on 1 January
2020, Pestell purchased 5% bonds with a nominal value of $100,000 at a discount of 10%. The bonds
are redeemable on 31 December 2024. The annual rate of return on the bonds is 7.5%.
Due to a decrease in market interest rates, the fair value of these bonds at 31 December 20X0
increased to $103,000.
The bonds are investments in debt with a business model to collect contractual cash flows (of interest
and the principal) and to sell. Therefore, they should be measured initially at fair value plus transaction
costs (none here) and subsequently at fair value through other comprehensive income.
Interest Change in
Effective interest received @5% fair value Asset c/f
Year end Asset @ 7.5% × b/f coupon × (balancing (fair
31 December b/f balance nominal value figure) value)
$ $ $ $ $
2020 90,000 6,750 (5,000) 11,250 103,000
The effective interest income of $6,750 would be recorded in profit or loss, the gain from the change
in fair value of $11,250 in other comprehensive income and the asset of $103,000 in the statement of
financial position.

ILLUSTRATION: DERIVATIVES

On 1 September 2018 a company entered into a speculative forward contract to buy titanium for
$400,000 on 31 January 2019. This is a derivative financial instrument.
The initial cost of the contract was nil.
At 31 December 2018 (the year end), due a to fall in expected supply, a forward contract for delivery
of an equivalent quantity of titanium on 31 January 2019 would have cost $450,000.
Initial recognition
$000 $000
Dr Financial asset NIL
Cr Cash NIL
At the year end
$000 $000
Dr Financial asset (450,000 – 400,000) 50
Cr Profit or loss – gain 50
54 Course Notes ACCA SBR

2.4 Measurement: Financial liabilities

Initial measurement Subsequent measurement
Most financial liabilities Fair value LESS transaction Amortised cost
e.g. trade payables, loans [including costs
issue of bonds, loan notes, debentures],
preference shares classified as a liability
Financial liabilities at fair value through Fair value (transaction costs Fair value through profit or loss *
profit or loss are recognised as an expense
 ‘Held for trading’ (short-term profit in P/L)
making)
 Derivatives standing at a loss
 Designated on initial recognition at
‘fair value through profit or loss’ to
‘avoid an accounting mismatch’
(e.g. loans to finance investment
properties held under the fair value
model)
 A group of FL (or FA and FL)
managed and performance
evaluated on a fair value basis (e.g.
financial services company)
Financial liabilities arising when Consideration received Measure financial liability on
transfer of asset does not qualify for e.g. for debt factoring with same basis as transferred asset
derecognition recourse, the proceeds (amortised cost or fair value)
e.g. debt factoring with recourse received from the factor
Financial guarantee contracts and Fair value LESS transaction Higher of:
commitments to provide a loan at a costs  Amount initially recognised
below market interest rate e.g. for parent’s guarantee of less amounts amortised to
e.g. a parent guarantees a subsidiary’s subsidiary’s loan, fair value P/L (IFRS 15)
loan will take into account the  Impairment loss allowance
e.g. an entity commits to make a loan to likelihood of default (see later in this chapter)
another party at an interest rate which e.g. for parent’s guarantee of
is lower than the rate the entity would subsidiary’s loan, amount initially
have to pay to borrow the money in recognised will be amortised
order to make the loan over the term of the loan

* Changes in fair value due to the liability’s credit risk are recognised separately in other
comprehensive income.

EXAM SMART
Often, in exam questions, you will be told that the entity has accounted for a financial
instrument in a certain, probably incorrect, way. You will need to correct the entries.
ACCA SBR Course Notes 55

ILLUSTRATION: CORRECTING ERRORS MADE BY THE COMPANY

Company X has issued a 5% bond for $100,000 which has to be repaid in 2 years for $106,200. The
effective rate of interest on the bond is 8%. Company X has recorded the annual interest payment of
$5,000 in profit or loss as an expense.
To correct this error, an amortised cost table may help:
Liability Effective Interest @ Interest paid (@ 5%
Year b/f 8% coupon) Liability c/f
$000 $000 $000 $000
2016 100 8 (5) 103
2017 103 8.2 (5) 106.2

Dr P/L : finance cost Dr Fin liability The year end

Cr Fin liability Cr Cash balance is
the “amortised
cost”
Therefore, the correct interest charge in profit or loss in year 1 is $8,000, not $5,000. So we will need
the following correcting entry:
Dr Profit or loss: finance cost $3,000
Cr Financial liability $3,000

2.5 Reclassification of financial assets

An entity may only reclassify a financial asset if it changes its business model for managing financial
assets. When this happens, it must reclassify all financial assets affected by the change.
A financial liability cannot be reclassified.

2.6 Modification of financial liabilities

The terms of a financial liability (e.g. a debt instrument or a loan) may change.
 If the terms are substantially different, the original liability is derecognised and a new liability is
recognised and measured at fair value.
 Otherwise, the original liability is not derecognised. It is restated to the present value of the
revised cash flows. The difference is recognised in profit or loss.
To assess whether the terms of a modified liability are substantially different from those of the original
liability, we compare:
 the present value of the cash flows under the new terms (discounted at the original effective
interest rate);and
 the present value of the cash flows under the old terms.
The new liability is substantially different from the old liability if the difference between the two
amounts is 10% or more.
56 Course Notes ACCA SBR

ILLUSTRATION: MODIFICATION OF A FINANCIAL LIABILITY

On 1 January 20X3 Fraser took out a loan of $8 million. The loan is repayable in 4 years’ time, on
31 December 20X6.
Interest of 4% was paid annually in arrears. Fees of $280,000 were incurred. The effective rate of
interest on the loan is 5%.
At 31 December 20X3, after the interest has been paid, the carrying amount of the loan is $7,786,000
million and this is the same as the present value of the remaining cash flows.
On 31 December 20X3 the loan is renegotiated.
The par value of the loan is still $8 million (equal to its fair value). The loan is now repayable 2 years
later, on 31 December 20X8. The coupon rate of interest increases to 6% and fees of $500,000 are
payable.
The present value of the cash flows under the new terms, including the fees, calculated at the original
effective interest rate of 5%, are $8.85 million.
To assess whether the terms of the renegotiated loan are substantially different, we compare the
present value of the new cash flows with the present value of the original (remaining) cash flows:
$8.85 million less $7.786 million = $1,064,000. This is 13.6% of $7.786 million, so the two loans are
substantially different.
We derecognise the original loan and recognise the new loan at fair value:
Dr Financial liability (original loan) $7,786,000
Dr Profit or loss $214,000
Cr Financial liability (new loan) $8,000,000
The fees are also expensed to profit or loss.
Suppose that the terms of the new loan had been different and no transaction fees had been payable.
In this case, the difference would have been less than 10% (i.e. not substantially different from the old
loan): $8.35 million less $7.786 million =$564,000: $7.2%.
The loan is modified, rather than derecognised. It is restated to the present value of the revised cash
flows and the difference is recognised in profit or loss:
Dr Profit or loss ($8.35 million less $7.786 million) $564,000
Cr Financial liability (new loan) $564,000

3 Impairment of financial assets

Until recently, IAS 39 (the previous standard on financial instruments) required companies to wait until
a critical event occurred which would have led to the “bad debt” of a receivable.
While the incurred loss model was simple to understand, it meant that companies were not allowed
to record an impairment until the “critical event” (e.g. the liquidation of a customer) actually occurred.
Under the current rules in IFRS 9, it is not necessary for a critical event to have occurred before credit
losses are recognised. Instead, expected credit losses should always be recognised (at their present
value). The amount of expected credit losses should be updated at each reporting date.

3.1 The three stages

The rules on impairment apply to financial assets carried at amortised cost e.g. a bank lending money
to its customers and to assets carried at fair value through OCI.
ACCA SBR Course Notes 57

There are three stages at which the expected credit losses need to be reviewed, as shown in the
diagram and the Illustration below.

Stage 1 Stage 2 Stage 3

Initial recognition Credit risk

Objective
(and increases
evidence of
subsequently if significantly
When? impairment
no significant (rebuttable exists at the
deterioration in presumption if >
reporting date
credit risk) 30 days past due)

Credit losses 12-month Lifetime expected Lifetime expected

recognised expected credit credit losses credit losses
losses

Interest Gross carrying Gross carrying Net carrying

calculated amount amount amount

ILLUSTRATION: IMPAIRMENT OF FINANCIAL ASSETS

On 1 January 20X1, Standard Co makes a loan of $10 million to Flag Co. Interest of 5% is payable on
31 December each year. The loan is repayable on 31 December 20X4.
Stage 1:
At 31 December 20X1, there has been no increase in credit risk.
The company recognises an allowance for losses and measures this as an amount equal to the present
value of the expected credit losses that would result if the default occurs in the next 12 months.
The probability of the default occurring in the next twelve months is 2%. The present value of the
expected credit losses (cash shortfalls) over the life of the loan if the default occurs in the next
12 months is $100,000.
Standard Co recognises an allowance for expected credit losses of $2,000 ($100,000 × 2%).
Interest revenue is $500,000 ($10 million × 5%). It is calculated on the gross carrying amount of the
loan receivable of $10 million.
Stage 2:
At 31 December 20X2, the credit risk of the loan has increased significantly.
Standard Co measures the loss allowance at an amount equal to the expected credit losses that result
from all possible default events over the remaining life of the asset.
The probability of the default occurring over the remaining life of the loan is 30%. The present value of
expected credit losses from default events over the life of the loan are expected to be $900,000.
The allowance for expected credit losses is $270,000 ($900,000 × 30%).
58 Course Notes ACCA SBR

The increase of $268,000 ($270,000 – $2,000) is recognised in profit or loss.

Interest revenue is $500,000 ($10 million × 5%). It is calculated on the gross carrying amount of the
loan receivable of $10 million.
Stage 3:
At 31 December 20X3, there is objective evidence that the loan is credit impaired.
The estimated present value that is expected to be recovered (less costs) is $7.5 million.
The gross carrying amount of the loan is $10.5 million (the loan of $10 million plus the unpaid interest
of $0.5 million).
Standard Co recognises an allowance equal to the present value of the amount that will not be
recovered (lifetime expected credit losses).
Lifetime expected credit losses are $3 million (gross carrying amount of the loan $10.5 million –
amount expected to be recovered $7.5 million).
The increase in expected credit losses of $2.73 million ($3 million - $270,000) is recognised in profit or
loss.
As Stage 3 is not reached until the last day of the reporting period (31 December 20X3), interest
revenue in 20X3 is still calculated on the gross carrying amount. Interest revenue is therefore $500,000
($10 million × 5%).
However, in the year ended 31 December 20X4, interest revenue is calculated on the net carrying
amount of $7.5 million i.e. the gross carrying amount ($10.5 million) less the loss allowance
($3 million). This results in interest revenue of $375,000 ($7.5 million × 5%). Effectively, interest is
calculated on the present value of the loan expected to be recovered.

3.2 Simplified approach for trade receivables

Simplified rules have been introduced for companies with “traditional” trade receivables.
Where there is no significant financing component, companies should recognise lifetime credit losses
from initial recognition.
Where there is a significant financing component, the company can choose either to apply the 3-stage
approach or to recognise lifetime credit losses from initial recognition.
IFRS 9 states that “lifetime expected credit losses” should be calculated using a “provision-matrix”,
updating the rates each year to reflect current conditions and reasonable, supportable forecasts about
future expectations.
Age of Debt Amount outstanding Risk of default Allowance
0 to 30 days $100,000 2% $2,000
30 to 60 days $50,000 10% $5,000
60 days + $30,000 40% $12,000
$19,000

3.3 Purchased or originated credit-impaired financial assets

Credit-impaired financial assets are those for which one or more events that have a detrimental
impact on the estimated future cash flows have already occurred (for example, the issuer or borrower
is in serious financial difficulty, or the amount owing is overdue).
Purchased or originated credit impaired financial assets are financial assets that are credit-impaired on
initial recognition.
ACCA SBR Course Notes 59

In this case, the financial asset is originally recognised as a single figure without a separate allowance
for credit losses. This is because the losses are already reflected in the fair value at which the financial
asset is initially recognised.
However, any subsequent changes in lifetime credit losses are recognised as a separate allowance.

4 Hedge accounting
Companies enter into “hedges” as a means to manage the risks that they face. A hedging instrument
(such as a forward contract which fixes the price of a future purchase or sale) aims to reduce the
variability in the value of a hedged item (an asset or liability), by making a gain where the asset suffers
a loss and vice versa.
A hedging relationship qualifies for hedge accounting only if all of the following criteria are met:
 The hedging relationship consists only of eligible hedging instruments and eligible hedged items.
 At the inception of the hedging relationship there is formal designation and documentation of
the hedging relationship and the entity’s risk management objective for undertaking the hedge.
This effectively makes hedge accounting a “choice” as, if a company does not formally
document a hedge, it cannot use hedge accounting.
 The hedging relationship meets all of the hedge effectiveness requirements:
 There is an economic relationship between the hedged item and the hedging instrument
(i.e. values generally move in the opposite direction)
 The effect of credit risk does not dominate the value changes that result from that
economic relationship i.e. credit risk isn’t a significant factor influencing FV movements
of the hedging instrument
 The hedge ratio applied is the same for the hedged item and the hedging instrument (i.e.
if an entity is only hedging 85% of the movement in a hedged item it must use only 85%
of the overall movement in the hedging instrument)
A consequence of hedge accounting is reduced volatility in profit or loss, as shown in the following
illustrations.
There are two types of hedge that you are likely to see in SBR:
(1) Fair value hedges – these reduce the risk of exposure to changes in the fair value of an asset (or
liability) that is already owned by the company. These changes could affect the statement of profit
or loss e.g. hedging the fair value of fixed rate debentures due to changes in interest rates.
All gains and losses on both the hedged item and hedging instrument are recognised
immediately in the statement of profit or loss - see illustration below.
(2) Cash flow hedges – these reduce the risk of exposure to changes in future cash flows that a
company will make relating to the purchase of an asset they don’t yet own. e.g. the future
purchase of oil. Depending on the future price of oil, a company’s future cash flows and
expenses will change. The hedge is accounted for as follows:
 The gain or loss on the effective portion of the hedge (i.e. up to the value of the loss or
gain on the cash flow that is being hedged) is recognised in reserves/OCI (and transferred
to the statement of profit or loss when the cash flow is recognised in the statement of
profit or loss).
 Any excess (i.e. the ineffective portion) is recognised immediately in the statement of
profit or loss.
60 Course Notes ACCA SBR

ILLUSTRATION: FAIR VALUE HEDGE

A company owns 20,000 tonnes of wheat, which cost $440,000 on 1 December 2011.
To hedge against fluctuations in the price of wheat, the company enters a futures contract (which
obliges the company to purchase or sell wheat in the future) to sell 20,000 tonnes of wheat on
31 March 2012 at the fixed price of $22/tonne.
The market price and the futures price of wheat on 31 December 2011, its year end, is $24/tonne.
How should this be accounted for?
SOLUTION
Without hedge accounting
The futures contract (which is designed to reduce risk) is a derivative/financial instrument which needs
to be remeasured to fair value at the year end, with any gain or loss recognised in the statement of
profit or loss (using the rules from earlier in this chapter).
Dr Statement of profit or loss (20,000 tonnes × (24–22) $40,000 (the company is going to sell the
wheat for less than the current futures price)
Cr Financial liability $40,000
The inventory (wheat) remains at its original cost of $440,000.

With hedge accounting

The loss of $40,000 on the futures contract is recognised in the statement of profit or loss as above.
The inventories are also revalued to fair value:
Fair value at 31 December 2011 (20,000 tonnes × $24) $480,000
Cost $440,000
Gain $40,000

This gain is also recognised in the statement of profit or loss:

Dr Inventory $40,000
Cr Statement of profit or loss $40,000
The net effect on the statement of profit or loss is now nil compared to a loss of $40,000 without
hedging. This is because the loss on the liability (the derivative) has been exactly counteracted with
gain on the asset (wheat).
In other words, the hedge is 100% effective as the loss on the derivative (futures contract) of $40,000
is exactly the same as the gain on the hedged item (inventory) of $40,000.

ILLUSTRATION: CASH FLOW HEDGE

A company enters into a contract to buy 10 units of inventory in 6 months for the market price at that
time, but management is worried that this price is going to rise. The current market price is $90/unit.
It enters into a forward contract (a “hedging instrument”) to buy the inventory (the “hedged item”) in
6 months at a fixed price of $91/unit ($ i.e. $910).
At the year-end, in 3 months’ time, the actual market price of the inventory is $98.5/unit and the
forward price is $100/unit.
This would result in a gain of $90 (10 units × ($100 - $91)) on the forward contract.
ACCA SBR Course Notes 61

Without hedge accounting, the derivative/forward contract would be recorded at fair value at the
year end, with the movement going through profit or loss:
Dr Financial asset $90
Cr Profit or loss $90
With hedge accounting, instead of crediting profit or loss $90, the credit is to reserves/other
comprehensive income with the EFFECTIVE part of the hedge.
To work this out, you could argue that the company made a “loss” of $85 (10 units × ($98.5 – $90) on
its cashflow commitment. This “loss” would go unrecognised in the financial statements. However,
under hedge accounting, it can recognise the effective portion of the hedge in reserves/OCI and the
ineffective portion in profit or loss:
The “ineffective” portion is the amount by which the change in the fair value of the hedging
instrument > change in the fair value of the cashflows of the hedged item - profit or loss
The “effective” portion is the amount by which the change in the fair value of the hedging instrument
is less than or equal to the change in the fair value of the cashflows of the hedged item - Cash flow
hedge reserve/OCI
So, here, the change in the fair value of the hedging instrument (the forward contract) = $90
the change in the fair value of the cashflows = $85
Dr Financial asset $90 (as before)
Cr OCI/reserves (with the effective portion) $85
Cr Profit or loss (with the ineffective portion) $5

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand the definitions of: a financial asset; a financial liability; and an
equity instrument?
Do you know how to measure and record a financial instrument on initial recognition?
Do you understand how to measure a financial asset at: amortised cost; fair value
through profit or loss; and fair value through other comprehensive income, and can
you determine which of these methods should be used to measure a given financial
asset?
Do you understand how to recognise and measure a financial liability?
Do you understand the definition of a derivative and how to recognise and measure
derivatives in the financial statements?
Can you explain the three-stage model of reviewing a financial asset for impairment
and can you apply the model to account for a financial asset that is impaired?
Can you identify when a hedging relationship meets the criteria for hedge accounting?
Can you explain and apply the hedge accounting rules to report a hedged item and a
hedging instrument?
62 Course Notes ACCA SBR

Chapter C3 – Lecture example solution

Lecture example C3.1
$
Non-current liabilities
Financial liability component of convertible debt 360,240
Equity
Equity component of convertible debt 39,760 (bal)
400,000
(W1) Initial recording: Dr Cash (4,000 × $100) $400,000
Cr Financial liability 360,240 (W2)
Cr Equity 39,760 (bal)
(W2) Fair value of equivalent non-convertible debt
$
Present value of principal payable at the end of 4 yrs (4,000 × $100 × 0.735) 294,000
Present value of interest payable annually in arrears for 4 yrs
(5% × 400,000 × 3.312) 66,240
360,240
The financial liability will then be measured at amortised cost:
Effective Interest paid
Year Liability b/f interest @ 8% (@5% coupon) Liability c/f
$ $ $ $

2004 360,240 28,819 (20,000) 369,059

2005 369,059
 63

C4

Leases

1 Introduction
IFRS 16 Leases was issued in January 2016 and replaces IAS 17. Under IAS 17, all leases were classified
as either finance leases or operating leases. Under IFRS 16, a lessee accounts for almost all leases by
recognising an asset and a liability in the statement of financial position. The accounting treatment is
almost exactly the same as for a finance lease under IAS 17.

KEY TERMS
Lease – a contract that conveys the right to use an asset (the underlying asset) for a period
of time in exchange for consideration.
Lessee – the entity that obtains the right to use an underlying asset in exchange for
consideration
Lessor – the entity that provides the right to use an underlying asset in exchange for
consideration
Right of use asset – represents the lessee’s rights to use an underlying asset for the lease
term

2 Identifying a lease
A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a
period of time in exchange for consideration.
“Control” of an asset exists where the customer has the right to obtain substantially all of the
economic benefits from its use and the right to direct its use
A customer does not have the right to use an identified asset if the supplier has the practical ability to
substitute an alternative asset and would benefit economically from doing so.
64 Course Notes ACCA SBR

ILLUSTRATION: IDENTIFYING A LEASE (1)

Toton provides Chewton with five trucks for a period of five years. The trucks are specified in the
contract. The other terms of the contract are:
 Chewton determines when, where, and which goods are transported using the trucks.
 The trucks are kept at Chewton’s premises when they are not in use.
 Chewton can use the trucks for another purpose (e.g. storage), if it chooses.
Conclusion: this is a lease. There are identified assets, and Chewton controls their use.

ILLUSTRATION: IDENTIFYING A LEASE (2)

Toton agrees to transport a specified quantity of goods for Chewton using a specified type of truck for
a period of five years. This is equivalent to Chewton having the use of five trucks for five years.
 The contract states the nature and quantity of the goods to be transported.
 Toton has a large number of similar trucks that can be used to meet the requirements of
the contract.
 The trucks are kept at Toton’s premises when they are not in use.
Conclusion: this is not a lease. The trucks used to transport goods for Chewton are not identified
assets, as Toton has the practical ability to substitute alternative assets. Toton benefits economically
from using whichever trucks are available and in the most convenient location to carry out the work.
This is simply a contract for the provision of a delivery service.

3 Accounting treatment of leases by the lessee

3.1 At the commencement of the lease
Dr Right of use asset (PPE)
Cr Lease liability
[Cr Cash *]
* With any payments made at the commencement date of the lease (e.g. a deposit or the first
instalment if instalments are paid in advance)

3.1.1 Measurement of the lease liability

The lease liability is effectively a “loan”, reflecting the substance of the transaction i.e. you have
borrowed in order to fund the purchase of a non-current asset.
The lease liability is initially measured at the present value of the future lease payments.
The discount rate used for the calculation should be the rate implicit in the lease. If this cannot be
readily determined, the lessee’s incremental borrowing rate should be used.
Lease payments include:
 fixed payments less any lease incentives receivable
 variable lease payments (payments that depend on an index or a rate)
 amounts expected to be payable under residual value guarantees
 options to purchase the asset that are reasonably certain to be exercised, plus
 any termination penalties that are expected to be incurred.
ACCA SBR Course Notes 65

Future lease payments exclude payments made at or before the commencement date e.g.:
 a deposit
 the first instalment if instalments are paid in advance.
If instalments are paid in arrears, all instalments will qualify as future lease payments and therefore, all
instalments will be included in the initial lease liability (at their present value).

3.1.2 Measurement of the right of use asset

The right of use asset is initially recognised at cost. The initial cost comprises:
Right-of-
use asset
$
Initial measurement of lease liability (present value of future lease payments) X
Payments made at/before the commencement date (e.g. deposit, first instalment if paid
in advance) less any lease incentives received X
Initial direct costs (incremental costs of obtaining the lease) (e.g. legal costs) X
Estimated costs of removing/dismantling the asset at the end of the lease X
X

If all of the above are present, this will result in the following double entry:
Dr Right of use asset (PPE)
Cr Lease liability
Cr Cash (e.g. deposit, first instalment in advance, initial direct costs)
Cr Provision (estimated removal/dismantling costs)
The asset will be normally depreciated over:

Shorter of:

The asset’s useful

The lease term
life *

* If there is a reasonable certainty that the lessee will obtain ownership by the end of the lease term
then the asset should always be depreciated over its useful life.

3.2 Subsequent measurement of the lease liability

As the company makes its regular lease payments, the lessee measures the lease liability as:
 the carrying amount at the commencement of the lease; plus
 interest on the lease liability; less
 the lease payments made.
66 Course Notes ACCA SBR

ILLUSTRATION: LEASE ACCOUNTING (INSTALMENTS PAID IN ADVANCE)

Simpson makes up its accounts to 31 December each year. It enters into an agreement to lease a
machine under the following terms:
Inception of lease: 1 January 2020
Term: 5 years at $100,000 per annum payable in advance
PV of future lease payments: $345,000
Useful life: 6 years
Interest rate implicit in the lease 6.2%
Required:
Prepare the relevant extracts in respect of the above lease for the year ended 31 December 2020.
SOLUTION
$
Statement of profit or loss (extract)
Depreciation (W2) 89,000
Finance costs (W1) 21,390
Statement of financial position (extract)
Non-current assets
Property, plant and equipment (W2) 356,000
Non-current liabilities
Lease liability (W1) 266,390
Current liabilities
Lease liability (366,390 – 266,390) 100,000

(W1) Lease liability

Year Liability b/f Instalment Balance Interest @ 6.2% Liability c/f
$ $ $ $ $
2020 345,000 (0) 345,000 21,390 366,390
2021 366,390 (100,000) 266,390 16,516 282,906

Non-current Total lease

lease liability liability

Note: The instalment paid on 1 January 2020 has already been excluded from the initial liability so
does not need to be deducted.
(W2) Depreciation
Depreciation based on shorter of lease term and useful life = 5 years
The initial right of use asset is recorded at the present value of future lease payments plus the first
instalment paid in advance: $345,000 + $100,000 = $445,000.
Therefore, depreciation charge = $445,000 / 5 years = $89,000.
Therefore, carrying amount = $445,000 ‒ $89,000 = $356,000.
ACCA SBR Course Notes 67

3.3 Separating lease and non-lease components

A contract may consist of a lease component and a non-lease component (i.e. a service component).
Example: A leases a vehicle to B and also agrees to maintain the vehicle throughout the lease term.
The lessee either:
 allocates the consideration to each component of the contract based on the stand-alone price
of each; or
 elects to account for the contract as a single lease (the election is made for each class of
underlying asset).

ILLUSTRATION: ALLOCATING CONSIDERATION

Langley leases an item of plant from Kimberley for three years and Kimberley also agrees to maintain
the plant during that time. The maintenance agreement is a contract for services, rather than a lease.
Langley agrees to pay Kimberley a total of $360,000 in three annual instalments of $120,000. The rate
of interest implicit in the lease is 10%.
Langley decides to allocate the consideration paid to Kimberley between the lease and non-lease
elements of the contract.
If Langley had leased the plant without the maintenance contract, it would have paid total
consideration of $300,000, in three annual instalments of $100,000. A contract to maintain plant that
Langley already owned would have cost $20,000 each year.
Langley recognises a lease liability of $248,700 ($100,000 × 2.487) at the inception of the contract and
also recognises a right-of-use asset.
The annual maintenance payments of $20,000 are expensed to profit or loss.

3.4 Remeasurement of a lease liability

If there are changes to the lease payments, the lessee must remeasure the lease liability. Both the
carrying amount of the lease liability and the carrying amount of the right-of-use asset are adjusted.
The lease liability is remeasured by discounting the revised lease payments using a revised discount
rate if:
 the lease term changes; or
 the entity changes its assessment of an option to purchase the underlying asset
68 Course Notes ACCA SBR

ILLUSTRATION: REMEASUREMENT

On 1 January 2014, Heanor enters into a five-year lease, with an option to extend for a further two
years. Lease payments are $20,000 per annum during the initial five-year period, payable at the end of
each year. The rate of interest implicit in the lease is 10%. There are no initial direct costs or lease
incentives.
At the inception of the lease, it is extremely unlikely that Heanor will exercise the option to extend the
lease, so the lease term is determined to be five years.
At the inception of the lease Heanor records a right-of-use asset and a lease liability of $75,820
($20,000 × 3.791).
At 31 December 2015, the lease liability is $49,742 (W1 below) and the right-of-use asset is $45,492
(75,820 – two years of depreciation = 2 × $15,164 i.e. $30,328).
(W1) Lease liability
Year Liability b/f Interest @ 10% Instalment Liability c/f
$ $ $ $
2014 75,820 7,582 (20,000) 63,402
2015 63,402 6,340 (20,000) 49,742
On 1 January 2016, Heanor’s circumstances change and as a result there is now an economic incentive
to extend the lease for the additional two years, so that this is now virtually certain to happen. Lease
payments for the additional two years are $25,000 per annum, still payable at the end of each year. As
a result, the rate of interest implicit in the lease increases to 12%.
On 1 January 2016 the lease liability is remeasured as the present value of the three remaining
payments of $20,000 plus the two additional payments of $25,000, all discounted at the revised
interest rate:
$
Present value of remaining payments (20,000 × 2.402) 48,040
Present value of additional payments (25,000 × 0.636) + (25,000 × 0.567) 30,075
78,115

The following adjustment is made:

Dr Right-of use asset (78,115 – 49,742) $28,373
Cr Lease liability (78,115 – 49,742) $28,373
At 31 December 2016, the carrying amount of the lease liability is $67,489 (W2) and the carrying
amount of the right-of-use asset is $59,092 (W3).
(W2) Lease liability
Year Liability b/f Interest @ 12% Instalment Liability c/f
$ $ $ $
2016 78,115 9,374 (20,000) 67,489
ACCA SBR Course Notes 69

(W3) Right-of-use asset

$
1.1.2014 Initial asset 75,820
Depreciation (2/5) (30,328)
31.12.2015 Carrying amount 45,492
1.1.2016 Adjustment (78,115 – 49,742) 28,373
73,865
Depreciation (1/5) (14,773)
31.12.2016 Carrying amount 59,092

3.5 Short life and low value assets

If the lease is for a period of 12 months or less or the underlying asset is of a low value when new then
a simplified treatment is allowed.
The lessee can choose to recognise the lease payments as an expense in the statement of profit or loss
on a straight-line basis:
 No right of use asset or lease liability is recognised in the statement of financial position.
 The annual lease expense = total cost/life of lease.
Examples of low value assets include: tablets, small PCs, telephones and small items of furniture.
Note: IFRS 16 explicitly states that cars are not low value assets.

ILLUSTRATION: LOW VALUE ASSETS

Twyford enters into a non-cancellable four-year lease for a number of mobile telephones, paying a
(non-refundable) $4,000 deposit followed by an annual charge of $3,000 for four years.
The total cost of the lease is spread over the four years i.e. $4,000 deposit + (4 × $3,000) = $16,000
over four years = $4,000 per annum:
Year 1:
Dr SPL: Lease expense $4,000
Dr SFP: Prepayments $3,000
Cr Cash $7,000
Years 2, 3 & 4:
Dr SPL: Lease expense $4,000
Cr Cash $3,000
Cr Prepayments $1,000

4 Lessor accounting
4.1 Lease classification
A lessor must classify each of its leases as either an operating lease or a finance lease.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership
of an underlying asset (to the lessee). Title may or may not be eventually be transferred.
70 Course Notes ACCA SBR

IFRS 16 identifies five situations which would normally lead to a lease being classified as a finance lease:
(a) The lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
(b) The lessee has the option to purchase the asset at a price sufficiently below fair value at
exercise date, that it is reasonably certain the option will be exercised;
(c) The lease term is for a major part of the asset’s economic life even if title is not transferred;
(d) The present value of the lease payments amounts to substantially all of the asset’s fair value at
inception;
(e) The leased asset is so specialised that it could only be used by the lessee without major
modifications being made.
An operating lease is defined as a lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset (to the lessee).

4.2 Lessor accounting for a finance lease

The approach to lessor accounting for a finance lease is quite logical and is essentially the opposite of
lessee accounting – where the lessee has a lease liability, the lessor has a receivable and whereas the
lessee has interest payable, the lessor has interest receivable.
Similarly, the lessor does not have the non-current asset on its statement of financial position – that
asset belongs in substance to the lessee.
IFRS 16 states that lessors should recognise a receivable at an amount equal to the net investment in
the lease.
The net investment in the lease is the sum of:
 Present value of future lease payments receivable by the lessor; plus
 Present value of any unguaranteed residual value accruing to the lessor.
The above amounts are discounted at the interest rate implicit in the lease.
Similar to lessee accounting, the present value of future lease payments excludes payments received
at the commencement date of the lease (e.g. deposit and first instalment in paid in advance).
The lessor recognises finance income over the lease term.
Note that the “lessor” could be a manufacturer or dealer whose trade is the leasing out of assets. They
would also have to include “revenue” and “cost of sales” in their accounts:
Dr SFP: Net investment in lease/Lease receivable X
Cr Revenue X
Where “X” is the lower of the fair value of the asset or present value of lease payments
Dr Cost of sales Y
Cr Inventory/Bank Y
Where “Y” is cost of manufacture or price paid if bought in
Dr SFP: Net investment in lease/Lease receivable Z
Cr Cost of sales Z
Where “Z” is the present value of any unguaranteed residual value
The profit or loss should be the same as the profit or loss that would have resulted from a ‘normal’
sale.
ACCA SBR Course Notes 71

ILLUSTRATION: LESSOR ACCOUNTING (FINANCE LEASE)

Parry arranges financing agreements for its customers for bespoke equipment purchased from
manufacturers. Parry leased an item of equipment to a customer on 1 January 2020. The expected
economic life of the asset is 8 years. There are 8 annual payments of $200,000 beginning on
31 December 2020. The lessee guarantees that a residual value at the end of the lease of $100,000
although Parry expects to be able to sell it for parts for $150,000. On 1 January 2020, the present value
of the lease payments (including the residual value guarantee) discounted at the interest rate implicit
in the lease of 10% is $1,113,700. This was equivalent to the purchase price. The eight-year 10% simple
discount factor is 0.467.
Required:
(a) Discuss the accounting treatment of the above lease in the financial statements of Parry for the
year ended 31 December 2020, including any relevant calculations.
(b) Explain how the accounting treatment would have been different if Parry had manufactured the
equipment at a cost of $900,000. (Assume the fair value of the equipment is the same as the
present value of the lease payments.)
SOLUTION
(a) This is a finance lease because the lease asset is specialised (bespoke), the lease term for the
whole of the asset’s economic life and the present value of lease payments is the same as the
fair value of the asset. Therefore, the risks and rewards are substantially transferred to the
lessee.
Parry (the lessor) should derecognise the asset and record a lease receivable at the present
value of future lease payments plus the present value of the unguaranteed residual value:
$
Present value of future lease payments 1,113,700
Present value of unguaranteed residual value ([$150,000 ‒ $100,000] × 0.467) 23,350
Initial lease receivable 1,137,050
Parry should recognise finance income of $113,705 ($1,137,050 × 10%) in its statement of profit
of loss for the year ended 31 December 2020. The lease receivable must be increased by the
finance income and reduced by the first instalment, resulting in a lease receivable of $1,050,755
at 31 December 2020:
Year Receivable b/f Interest @ 10% Instalment Receivable c/f
$ $ $ $
2020 1,137,050 113,705 (200,000) 1,050,755
(b) If Parry had been a manufacturer-lessor, it would have recognised revenue of $1,113,700 (the
present value of lease payments) and cost of sales of $876,650 ($900,000 – $23,350). The lease
receivable and the finance income would still be recognised at the same amounts as part (a).

4.3 Lessor accounting for an operating lease

The lessor recognises lease payments as income on a straight-line basis over the lease term.
The lessor continues to recognise the asset in the statement of financial position and to depreciate it
in line with its normal accounting policy under IAS 16. Any direct costs incurred in obtaining the lease
are added to the carrying amount of the asset.
72 Course Notes ACCA SBR

4.4 Accounting for subleases

Subleases are when a lessee subleases a leased asset to another company so the lessee becomes the
lessor for the sublease.

Original
lessee / Lessee /
Lessor Head Sub-

intermediate sub-lessee
Lease lease

lessor
Intermediate lessor accounting
The original lessee continues to account for the original lease (head lease) as a lessee and accounts for
the sub-lease as a lessor (intermediate lessor), following the normal IFRS 16 lessee and lessor
accounting rules.
The intermediate lessor classifies the sublease as a finance lease or operating lease as follows:
(a) If the head lease is a short-term lease and the entity, as a lessee, has applied the short-term
recognition exemption, the sublease is classified as an operating lease;
(b) Otherwise, the sub-lease should be classified by reference to the right-of-use asset arising from
the head lease, rather than by reference to the underlying asset (e.g. the item of property, plant
& equipment that is the subject of the lease).

ILLUSTRATION: CLASSIFICATION OF A SUBLEASE

Entity S (original lessee / intermediate lessor) leases a property for property for six years. Entity S
subleases the property to another company for five years. The property has an economic life of
40 years.
To assess whether the sublease is a finance lease or an operating lease, the sublease term of five years
is compared with the six year right-of-use asset in the head lease and not with the 40 year economic
life of the property which may result in the sublease being classified as a finance lease.

ILLUSTRATION: SUBLEASE CLASSIFIED AS A FINANCE LEASE

Head lease – An intermediate lessor enters into a seven-year lease for 6,000 square metres of office
space (head lease) with Entity H (head lessor).
Sublease – At the start of Year 2, the intermediate lessor subleases the 6,000 square metres of office
space for the remaining six years of the head lease to a sub-lessee.
The intermediate lessor correctly classifies the sublease as a finance lease. When the intermediate
lessor enters into the sublease, the intermediate lessor:
(a) derecognises the right-of-use asset that relates to the head lease that it transfers to the
sublessee and then recognises the net investment in the sublease;
(b) recognises any differences between the right-of-use asset and the net investment in the
sublease in profit or loss; and
(c) retains the lease liability relating to the head lease in its statement of financial position, as this
represents the lease payments owed to the lead lessor.
ACCA SBR Course Notes 73

Therefore, during the six-year term of the sublease, the intermediate lessor recognises both finance
income on the sublease and interest expense on the head lease.

ILLUSTRATION: SUBLEASE CLASSIFIED AS AN OPERATING LEASE

Head lease – An intermediate lessor enters into an eight-year lease for 8,000 square metres of office
space (head lease) with Entity H (head lessor).
Sublease – At the start of the head lease, the intermediate lessor subleases the 8,000 square metres of
office space for two years to a sub-lessee.
The intermediate lessor correctly classifies the sublease as an operating lease.
When the intermediate lessor enters into the sublease, the intermediate lessor:
(a) recognises a depreciation charge on the right-of-use asset and interest on the lease liability; and
(b) recognises the lease income from the sublease.

5 Sale and leaseback

Sometimes, a cash-poor company may need to raise finance quickly, but will not want to give up the
use of its major non-current assets. One solution here is to sell an asset and lease it back.
The first step with a sale and leaseback is to determine whether the transaction should be accounted
for as a sale under IFRS 15 Revenue from Contracts with Customers. This normally occurs when the
buyer obtains control in the form of the remaining benefits of the asset.

5.1 Transfer is not a sale

If control of the asset has not passed and no sale has taken place, the seller continues to recognise the
asset and sale proceeds are treated as a loan:
Dr Cash
Cr Financial liability (IFRS 9 applies)

5.2 Transfer is a sale

If control of the asset has passed, the seller / lessee must measure the right of use asset in relation to
the rights retained and recognise a profit or loss based on the rights transferred.

ILLUSTRATION: SALE AND LEASEBACK (1)

On 30 September 2017, Woodlands sold a property which had a carrying amount of $700,000 to a
property company for $1 million (its fair value).
Part of the terms of the sale are that Woodlands will lease the property for a period of five years at an
annual rental of $80,000. The present value of the lease payments is $319,000. At 30 September 2017,
no rental had yet been paid. This transaction qualifies as a sale in accordance with IFRS 15 Revenue
from Contracts with Customers.
Required:
How should the transaction be recorded?
74 Course Notes ACCA SBR

SOLUTION
This transaction is a sale and leaseback. According to IFRS 16 Leases, Woodlands must recognise a right
of use asset (a proportion of the previous carrying amount of the property relating to the right of use
retained by the company) and a lease liability (the present value of the lease payments).
The right-of-use asset is calculated as: the carrying amount of the property ($700,000) multiplied by
the present value of the lease payments ($319,000) divided by the fair value of the property
($1 million).
Woodlands does not recognise the whole of the gain of $300,000, only the part that relates to the
rights that it has transferred to the property company. The accounting entry to record the transaction
is as follows:
$000 $000
Dr Cash 1,000
Dr Right-of-use asset (0.7m x 319,000/1m) 223
Cr Property (carrying amount) 700
Cr Lease liability (present value) 319
Cr Profit or loss – gain on rights transferred to buyer (bal. figure) 204

The sale proceeds may not be equal to the fair value of the asset.

Sale proceeds are less than fair value

The seller-lessee treats the difference between the sales proceeds and the fair value as a prepayment
of lease payments (by adding it to the right-of-use asset in the same way as any other payment on the
lease commencement date).

Sale proceeds are more than fair value

The seller-lessee treats the difference between the sales proceeds and the fair value as additional
financing (within the lease liability).

ILLUSTRATION: SALE AND LEASEBACK (2)

On 30 September 2017, Timber sold a property which had a carrying amount of $500,000 to a property
company for $750,000. The fair value of the property was $650,000.
Timber will lease the property back for a period of five years at an annual rental of $70,000. The
present value of the lease payments is $280,000. At 30 September 2017, no rental had yet been paid.
This transaction qualifies as a sale in accordance with IFRS 15 Revenue from Contracts with Customers.
Required:
How should the transaction be recorded?
SOLUTION
The difference of $100,000 between the sales proceeds and the fair value of the property is treated as
an additional loan over and above the ‘normal’ payments for the lease.
This affects the calculation of the right-of-use asset, which is based on discounted lease payments of
$180,000 (280,000 less 100,000). As before, the right-of-use asset is calculated as: carrying amount of
the property × present value of lease payments/fair value of property.
It also affects the gain on the rights transferred to the buyer.
ACCA SBR Course Notes 75

The accounting entry to record the transaction is as follows:

$000 $000
Dr Cash 750
Dr Right-of-use asset (500 × 180/650) 138
Cr Property (carrying amount) 500
Cr Lease liability (present value) 280
Cr Profit or loss – gain on rights transferred to buyer (bal. figure) 108

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand the definition of a lease and can you apply it to determine whether
an agreement contains a lease?
Can you explain how to measure the lease liability and the right-of-use asset at the
beginning of a lease and in subsequent periods in the financial statements of a lessee?
Do you understand how to account for (a) a contract that contains both a lease and a
non-lease component and (b) the effect of changes in a lease agreement during the
life of the lease?
Can you present amounts relating to leases correctly in the financial statements?
Do you understand the difference between a finance lease and an operating lease?
Do you understand how to account for both these types of lease in the financial
statements of a lessor?
Can you explain how to account an intermediate lessor should account for a sublease?
Do you understand how to account for a sale and leaseback agreement?
76 Course Notes ACCA SBR
 77

C5

Employee benefits

1 Introduction
When an employee provides work for a company, the company should recognise an expense for that
service.

1.1 Short-term benefits

These are the most common form of benefits that a company should account for and include:
 Salaries
 Profit-sharing and bonuses.
 Non-monetary benefits (health care, cars, housing, for example).
The accounting treatment for these benefits is very straightforward – a simple accruals basis so that
any wages, bonuses etc earned in a year but not paid by the year end should be accrued by the
company.

2 Post-employment benefits
Post-employment benefits are employee benefits which are payable after the completion of
employment.
A pension plan (or pension scheme) is a separate legal entity from the employer. It holds assets
(usually financial asset investments) from which pensions are paid to employees.
The two most common types of pension plan are:
(a) Defined contribution plans – where a company promises to put $x per year into a Pension Fund
for the benefit of each relevant employee. The employee bears the risk of the Fund, such that
the size of the post-employment benefits paid to the former employee depends upon how well
or badly the plan’s investments perform. If the Pension Fund performs poorly, then the
employee will receive a poor pension. The company has no obligation to make up any shortfall
of funds.
78 Course Notes ACCA SBR

The accounting for defined contribution plans is straightforward – simple accruals accounting,
so if a company is $300 behind in its payments to its pension fund, it simply needs to accrue
that amount.
(b) Defined benefit plans – similarly to above, the company sets up a Pension Fund into which it
agrees to make regular payments. However, in a defined benefit plan, the employer
GUARANTEES the final pension of the employee – the benefits are “defined”. If the fund
performs poorly, the company will need to put more money into the Fund.
This type of plan therefore covers any pension plan where the employer cannot show that the
risk of the Fund has been transferred to another party. The employer therefore bears the risk
of the Fund relating to a defined benefit plan.
With a defined benefit plan, the amount recognised in the statement of financial position is
essentially the net of two figures:
Pension Liability, representing the present value of future obligations X
Pension Plan Assets shown at fair value X
Net figure shown in statement of financial position X

The accounting for defined benefit plans is more complex and is probably helped with an
illustration and some journals:

2.1 Pension plan asset

Pay contributions in Pay pensions out

Growth of fund

This “pot” is measured at fair value every year.

The company puts cash/contributions into the Pension Fund each year and this is generally invested in
stocks and bonds. This is then expected to grow by x% per year. The pensions paid to former
employees are taken from the Fund to give an expected year end figure.
The journals relating to the pension fund are:
(1) Contributions
Dr Plan assets (SFP)
Cr Cash
These contributions are made to a separate legal entity (the pension plan).
(2) Expected return/ Interest on plan assets (estimate made on first day of year)
Dr Plan assets (SFP) (x% × b/f plan assets)
Cr Interest on plan assets (SPL)
This “return” figure is netted off against the interest figure in journal (5) below to form a “net
interest cost” in the statement of profit or loss.
ACCA SBR Course Notes 79

This figure is an estimate. The difference between this estimate and the actual interest on
assets will be reported as part of the “remeasurement gain or loss” in reserves – see section 3
of this chapter.
Note: The % used here will be the same percentage used in journal 5 below.
(3) Benefits paid to former employees
Dr Pension liability (SFP)
Cr Plan assets (SFP)
Note that it is not the company that “pays the final pension” to the former employees. It is the
pension scheme/plan.

2.2 Pension plan liability

Imagine a company with just two employees in its pension fund.
Year end David retires in 3 yrs Victoria retires in 6 yrs

For simplicity’s sake, we will assume that David and Victoria will each receive a lump sum on
retirement. We could therefore work out the present value of these two pension payments. This
would represent the company’s obligation with respect to its pension payments.
The accounting for the Pension Liability can again be summarised with some journals:
(4) Current service cost
The current service cost works in a very similar way to your monthly salary. For each additional
month that you work for your company, the company makes an accrual for that month’s salary.
It then pays off this accrual at the end of every month. Similarly, if you are part of the company
pension scheme, the company will make an accrual at the end of every month for the pension
that you have earned that month. Unlike the salary cost, this is not paid off every month, the
accrual/liability simply grows and grows until you retire, at which point it is paid.
For each month’s pension cost:
Dr Current service cost (SPL)
Cr Pension liability (SFP)
(5) Interest cost/”Unwinding of discount” (estimate made on first day of year)
At each subsequent year end, the present value of each employee’s pension will increase, due
to the time value of money.
Dr Interest cost (SPL) (y% × b/f Pension liability)
Cr Pension liability (SFP)
This “interest cost” should be netted off against journal (2). The discount rate used should be
related to market yields on “high quality fixed-rate corporate debt” (or government debt if no
market in corporate debt exists).
Understanding the five journals above will help you to deal with most questions that involve a pension
plan – learn them!
80 Course Notes ACCA SBR

2.3 Past service costs and curtailments

Past service costs normally arise when the rules of the Pension Scheme change in some way, such that
an additional obligation now exists in the company.
It can also arise if there is a curtailment in the scheme (i.e. a significant reduction by the entity in the
number of employees).
For example, imagine David lives with Susan, but they are not married. Under the present company
rules, the company will pay David his pension until he dies, but will pay Susan nothing after this death.
Had they been married; Susan would have received his pension until her death.
The company now changes its Pension Scheme so that unmarried couples have the same rights as
married couples. The company now has an additional obligation relating to David.
For this type of past service cost, there is now an additional obligation (and expense) which should be
recognised immediately.
Dr Past service cost (SPL)
Cr Pension liability (SFP)
A curtailment occurs when the entity significantly reduces the number of employees covered by a plan
(e.g. through the closing of a division).
If the scheme is curtailed, then there will be a reduction in the obligation (and income):
Dr Pension liability
Cr Profit or loss

2.4 Settlements
A settlement occurs when an entity enters into a transaction that eliminates all or part of the further
obligations in relation to a defined benefit plan. For example, a company and employee might reach a
mutual agreement to pay the employee a lump sum now and eliminate any future rights to a pension.
The gain or loss on a settlement is the difference between:
 The present value of the net defined benefit obligation being settled; and
 The settlement price.
Here, the company has a reduced pension liability. The double entry would therefore be:
Dr Pension liability (as advised by the actuary)
Cr Plan assets (any assets transferred)
Cr Cash (paid directly by the entity)
Cr/Dr Profit or loss (the difference = gain/loss on settlement)
(i.e. reverse the original entry).

2.5 Remeasurement due to plan amendment, curtailment or settlement

If there is any change to a pension plan (e.g. there are past service costs, a curtailment or a
settlement), a recent amendment to IAS 19 requires that:
 The entity updates its assumptions and remeasures its net defined benefit liability or asset
 The updated assumptions are used to measure current service cost and net interest expense
for the remainder of the reporting period.
ACCA SBR Course Notes 81

Prior to the amendment, there was no specific requirement for entities to revise the assumptions for
the calculation of current service cost and net interest, even if an entity remeasured the net defined
pension liability or asset. The calculations were therefore based on the actuarial assumptions at the
start of the accounting period. The IASB concluded that this was inappropriate and that their
amendment will:
 Provide more useful information to users of financial statements; and
 Enhance understandability of financial statements.

ILLUSTRATION: REMEASUREMENT DUE TO PLAN CURTAILMENT

Lever is preparing its financial statements for the year ended 31 December 2020. Lever provides a
defined benefit pension plan for its employees. From 1 May 2020, Lever decided to limit the number
of participants and curtail the plan. The employees were paid compensation from the plan assets. As a
result of the curtailment, the monthly current service cost changed from $12 million to $9 million.
Details of the pension plan are shown below:
Net defined Discount
benefit liability rate
$m %
1 January 2020 60 2
1 May 2020 72 2.5
31 December 2020 78 2.7
Required:
Calculate the current service cost and net interest expense for Lever’s pension plan for the year ended
31 December 2020.
SOLUTION
Current service cost = ($12 million × 4 months) + ($9 million × 8 months) = $120 million
Net interest expense = ($60 million × 2% × 4/12) + ($72 million × 2.5% × 8/12) = $1.6 million

3 The role of the actuary

The estimates involved in Pension Fund accounting are complex and require the use of an expert. The
actuary calculates the statement of profit or loss charge for the year (current service cost), provides
the rate for expected return on plan assets and discount factor for liabilities (interest cost), determines
contributions required and values the assets and liabilities of the scheme on an annual basis.
Any difference between the actuarial values for the asset and liability and the accounting values is
treated as a remeasurement gain or loss (see below).

Remeasurement gains and losses

Remeasurement gains and losses (previously called “actuarial gains and losses”) effectively deal with
the differences which arise between the actuarial assumptions (e.g. interest on assets) and what
actually occurred.
IAS 19 states that these gains or losses should be recognised immediately through retained earnings
(and shown in “other comprehensive income”).
82 Course Notes ACCA SBR

LECTURE EXAMPLE C5.1: DEFINED BENEFIT PLAN

Oldie Co has a defined benefit plan for its employees. The present value of the future benefit
obligations at 1 January 2011 was $790m and fair value of the plan assets was $900 million.
Further data concerning the year ended 31 December 2011:
$m
Current service cost 110
Benefits paid to former employees 140
Contributions paid to plan 108
Present value of benefit obligations at 31 December 1,200 As valued by
Fair value of plan assets at 31 December 1,300 professional
actuaries
31.12.10 31.12.11
Interest rate on high quality corporate bonds 10% 11%
On 1 January 2011, Oldie changed the rules of the Pension scheme with the effect that additional
benefits of $40m were granted to existing pensioners, vesting immediately. The effect of this change is
included in the actuarial valuation at 31 December 2011.
Required:
Prepare the required notes to the statement of profit or loss and statement of financial position for
the year ended 31 December 2011.
(Assume that all contributions and benefits were paid on 31 December 2011.)
SOLUTION
Statement of profit or loss and other comprehensive income note

Defined benefit expense recognised in the statement of profit or loss 2011

$m
Current service cost
Net interest on the defined benefit plan
Past service cost

Other comprehensive income

Remeasurement (gains)/losses on defined benefit obligation
Remeasurement (gains)/losses on defined benefit asset
Statement of financial position notes

Net pension asset recognised in the statement of financial position 2011 2010
$m $m
Present value of pension liability
Fair value of plan assets
ACCA SBR Course Notes 83

Workings
Pension asset Pension liability
$m $m
Bal b/f 900 790
Current service cost

4 The 'asset ceiling' test

Amounts recognised as a net pension asset in the statement of financial position must not be stated at
more than their recoverable amount.
Consequently, IAS 19 requires any net pension asset to be measured at the lower of:
 Net pension plan asset (calculated in the normal way), and
 The present value of any refunds/reduction of future contributions available from the pension
plan (the ‘asset ceiling’)
The difference is treated as a remeasurement and recognised immediately in other comprehensive
income.

ILLUSTRATION: ASSET CEILING TEST

Using the figures from Oldie above, you are now told that the present value of future refunds and
reductions in future contributions at the year end was $80m.
The “asset ceiling” of $80m will become the figure that appears in the financial statements as an asset,
with the difference of $20m going through “other comprehensive income”.
84 Course Notes ACCA SBR

5 Termination benefits
Termination benefits are benefits provided when an employee’s employment is terminated (e.g.
through redundancy).
The entity recognises a liability and an expense for termination benefits at the earlier of the dates
when:
 the entity can no longer withdraw the offer; and
 restructuring costs (including termination benefits) are recognised (IAS 37).
Termination benefits are measured (on initial recognition and in subsequent periods) in accordance
with the nature of the benefit provided:
 Enhancements of the employee’s pension plan: treat according to the accounting requirements
for the plan.
 Benefit settled wholly within twelve months after the year-end: treat as a short-term employee
benefit.
 Benefit not expected to be wholly settled within twelve months after the year-end: treat as
other long-term employee benefits (i.e. in a similar manner to a pension plan but with any
remeasurement components recognised in profit or loss rather than in other comprehensive
income).

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand the difference between a defined contribution plan and a defined
benefit plan?
Can you explain how to account for a defined contribution plan?
Do you understand how to account for a defined benefit plan using the five journals
explained above and how the amounts relating to the plan should be presented in the
financial statements?
Do you understand how to account for past service costs, curtailments and
settlements?
Can you explain how to account for termination benefits?
ACCA SBR Course Notes 85

Chapter C5 – Lecture example solution

Lecture example C5.1
Statement of profit or loss and other comprehensive income note
Defined benefit expense recognised in the statement of profit or loss 2011
$m
Current service cost 110
Net interest on the defined benefit plan: (7)
Interest cost (10% × (790 + 40 PSC)) = 83 expense
Interest on plan assets (10% × 900) = 90 income
Past service cost 40
143
Other comprehensive income: remeasurement of defined benefit plans)
Remeasurement (gains)/losses on defined benefit obligation 342 Cr
Remeasurement (gains)/losses on defined benefit asset Dr (317)
Net gain 25

Statement of financial position notes

Net pension asset recognised in the statement of financial position 2011 2010
$m $m
Present value of pension liability 1,200 790
Fair value of plan assets (1,300) (900)
Net asset (100) (110)
Workings
Pension Pension
asset liability
$m $m
Bal b/f 900 Dr 790 Cr
Current service cost 110
Pensions paid (140) (140)
Contributions 108
Interest (10% × (790 + 40 PSC)) 83
Interest on plan assets (10% × 900) 90
Past Service Cost 40
Gain on remeasurement – BAL 342 Dr
Loss on remeasurement – BAL 317 Cr
Bal c/f 1,300 1,200

Reconciliation of b/f to c/f figures:

Net Pension
asset
$m
Bal b/f 110 Dr
Current service cost (110)
Pensions paid –
Contributions 108
Interest (10% × (790 + 40 PSC)) (83)
Interest on plan assets (10% × 900) 90
Past Service Cost (40)
Net gain on remeasurement – BAL 25 Dr
Bal c/f 100 Dr
86 Course Notes ACCA SBR
 87

C6

Income taxes

1 IAS 12 – Income taxes

1.1 Current tax

KEY TERM
Current tax. Current tax is the amount of income taxes payable (or recoverable) by a
company in respect of its taxable profit or loss for a period. Current tax is therefore a direct
tax.

An entity will estimate how much tax is due on its profits for the year and will record this estimate
with the following journal:
Dr Current tax expense (SPL)
Cr Current tax liability (SFP)

1.2 Deferred tax

You have already covered the basics of deferred tax in the Financial Reporting paper. Here, we focus
on the elements of deferred tax which are more likely to appear in this exam.
Deferred tax is not a “real” tax, but is simply an accounting adjustment which matches recorded
accounting transactions with the related tax effect where these occur in different periods.
Deferred tax is recognised on temporary differences.
88 Course Notes ACCA SBR

1.3 Temporary differences and the tax base

1.3.1 Temporary differences

KEY TERMS
Temporary differences are differences between the carrying amount of an asset or liability
in the statement of financial position and its tax base: the value of the asset or liability for
tax purposes.

There are two types of temporary differences:

TAXABLE temporary differences DEDUCTIBLE temporary differences

Result in taxable amounts in Result in amounts that are deductible

determining taxable profit of future in determining taxable profit of future
periods (when carrying amount of periods (when carrying amount of
asset/liability is recovered/settled) asset/liability is recovered/settled)

Result in a deferred tax LIABILITY Result in a deferred tax ASSET

ACCA SBR Course Notes 89

1.3.2 Tax base of an asset and a liability

Tax base of an ASSET Tax base of a LIABILITY

Amount that will be deductible

The carrying amount of the
for tax purposes against any
liability less any amount that will
taxable economic benefits that
be deductible for tax purposes in
will flow to the entity when it
respect of the liability in future
recovers the carrying amount of
periods.
the asset

If there will be no tax consequences, the tax base will equal the carrying amount
and no deferred tax will arise.

EXAM SMART
In the exam:
 The question will state what the tax treatment for the relevant item is and you will have
to work out what the tax base is; or
 The question will give you the figure for the tax base.
The exam is sat internationally so is not based on any one particular real-life tax regime. The
examining team will make up the tax treatment and tell you what that is in the question or
alternatively, they will provide the figure for the tax base.

1.3.3 Examples of the tax base

Carrying amount Tax treatment Tax base Deferred tax
Accrued income (e.g. Taxed when accrued for Accrued income No deferred tax
interest receivable)
Accrued income Taxed on a cash receipts Zero Deferred tax liability (will
basis pay tax when receive
income)
Accrued expenses and Deductible for tax Accrued expense or No deferred tax
provisions purposes when accrued provision
for (or when the
provision is recognised)
90 Course Notes ACCA SBR

Carrying amount Tax treatment Tax base Deferred tax

Accrued expenses and Deductible for tax Zero Deferred tax assets (will
provisions purposes when paid get tax relief when pay
the expense)
Loan receivable or No tax consequences on Loan receivable or No deferred tax
payable repayment payable

1.4 Calculation of deferred tax

Deferred tax is calculated as follows:
$
Carrying amount of asset/(liability) X/(X)
Tax base (X)/X
Temporary difference X/(X)
Deferred tax (liability)/asset [tax rate × temporary difference] (X)/X

EXAM SMART
If you always include the carrying amount of an asset as positive and a liability as negative,
deferred tax will always be the opposite sign of the temporary difference i.e.
 For an asset:
– Carrying amount > Tax base = Deferred tax liability
– Carrying amount < Tax base = Deferred tax asset
 For a liability:
– Carrying amount > Tax base = Deferred tax asset
– Carrying amount < Tax base = Deferred tax liability

2 Recognition of deferred tax

Deferred tax is recognised on temporary differences unless they arise from:
(a) The initial recognition of goodwill; or
(b) The initial recognition of an asset or liability in a transaction which
(i) Is not a business combination; and
(ii) At the time of the transaction, affects neither accounting profit nor taxable profit; and
(iii) Does not create equal taxable and deductible temporary differences. (See Section 5 on
deferred tax and leases.)
ACCA SBR Course Notes 91

3 Taxable temporary differences

Examples of taxable temporary differences (resulting in a deferred tax liability) are shown below.

3.1 Accelerated capital allowances

Often the accounting depreciation differs from the tax depreciation. However, by the end of the useful
life of the asset, it will have been fully depreciated both from an accounting and taxation perspective,
resulting in temporary differences each year during the life of the asset.

ILLUSTRATION: ACCELERATED CAPITAL ALLOWANCES

A company has a non-current asset:

 Carrying amount = cost – accumulated depreciation = $1,000 – $300 = $700
 Tax value/tax base = cost – accumulated tax depreciation = $1,000 – $500 = $500
The tax rate is 30%.
$
Carrying amount of asset 700
Tax base (500)
Temporary difference 200
Deferred tax (liability) (30% × 200) (60)

This results in a deferred tax liability as effectively the company has been granted too much tax relief
(on $500 rather than the $300 in the accounts), so needs to reverse this excess tax relief.

3.2 Development costs

According to IAS 38, development costs must be capitalised if they meet certain criteria. As they will
be amortised over their useful life, the cost will be spread over the statement of profit or loss over a
number of years.
A temporary difference arises if tax relief is granted when the costs are incurred rather than when the
asset is amortised. This is because the tax authorities will not recognise the treatment of this “cost” as
an “asset” and will therefore deduct the development costs immediately when incurred in the
calculation of taxable profits.

ILLUSTRATION: DEVELOPMENT COSTS

A company has an intangible asset in relation to development costs of $10,000. The tax authorities
grant tax relief on the development costs when they are incurred. The tax rate is 30%.
$
Carrying amount of asset 10,000
Tax base (0)
Temporary difference 10,000
Deferred tax (liability) (30% × 10,000) (3,000)
92 Course Notes ACCA SBR

This results in a deferred tax liability because the company has been granted tax relief but has not yet
recognised the associated expense in the statement of profit or loss through amortisation. Therefore,
the tax relief needs to be reversed.

3.3 Revaluations to fair value

IFRS Standards allows some assets to be revalued to their fair value e.g. property, plant and equipment
under IAS 16. This “gain” will often not be acknowledged by tax authorities, again leading to a
difference between the accounting carrying amount and the tax value or tax base.
A revaluation gain results in a deferred tax liability because the gain will not be taxed until the asset
generates taxable economic benefits in the future (either when it is used in the business or sold).

3.4 Fair value adjustments on consolidation

Similar to revaluations above, a fair value adjustment in group accounts will lead to a difference
between that asset’s carrying amount and its tax base. If the fair value of the asset is greater than its
tax base, this will result in the recognition of a deferred tax liability in the group accounts.

3.5 Undistributed profits of subsidiaries and associates

Where a subsidiary (or associate) has earned (undistributed) profits that essentially “belong” to the
parent company, a temporary difference arises. The carrying amount of the investment in the financial
statements (the parent/investor’s share of the subsidiary’s net assets) is different from the tax base
(which is normally the cost of the investment).
A deferred tax liability is recognised in the group financial statements unless:
 the parent company is able to control the dividend policy of the subsidiary; and
 it is probable that the temporary difference will not reverse in the foreseeable future.
For example, if a subsidiary earns a profit of $10m, it is assumed that this profit will be sent to the
parent and that the parent will pay tax on that income UNLESS the parent intends to instruct the
subsidiary not to pay that profit over as a dividend, in which case, no tax will be payable in the future
and hence no deferred tax liability will be realised.

3.6 Defined benefit pension plans

As covered in Chapter C5, a defined benefit plan results in a net pension asset or liability on the
statement of financial position.
 A net pension asset represents a surplus in the pension scheme which will be addressed in the
future by reducing pension contributions or receiving a refund.
 A net pension liability represents a deficit which will be addressed in the future by increasing
pension contributions.
A temporary difference arises if the tax authorities treat contributions as a tax deduction when paid
because the surplus or deficit is recognised immediately in the accounts but the related tax deduction
will not be recognised until the adjusted contributions are paid in the future. This results in a tax base
of zero making the temporary difference simply the amount of the net pension asset or liability.
ACCA SBR Course Notes 93

ILLUSTRATION: DEFINED BENEFIT PENSION PLAN

A company has a net pension asset of $1,000. The tax authorities treat pension contributions as a tax
deduction when they are paid. The tax rate is 30%.
$
Carrying amount of net pension asset 1,000
Tax base 0
Temporary difference 1,000
Deferred tax (liability) (30% × 1,000) (300)

This is a deferred tax liability because in the future, the company will pay lower contributions to
recoup the surplus, which will result in a higher future tax bill.
(Had there been a net pension liability of $1,000, then a deferred tax asset of $300 would have been
recognised. This would represent the fact that the company would have to increase its future pension
contributions to address the deficit, resulting in a lower future tax bill.)

3.7 Accounting for a deferred tax liability

Normally, to create a deferred tax liability and to account for an increase in a deferred tax asset, the
double entry is:
Dr Deferred tax expense (SPL) *
Cr Deferred tax liability (SFP)
And for a decrease in a deferred tax liability:
Dr Deferred tax liability (SFP)
Cr Deferred tax expense (SPL) *
* There are some exceptions to recognising the deferred tax expense in profit or loss:
 If the deferred tax relates to a transaction that is recorded in other comprehensive income (e.g.
a revaluation gain on property, plant and equipment), then the deferred tax should also be
recognised in other comprehensive income (rather than profit or loss).
 If the deferred tax relates to a fair value adjustment in the group accounts, the other side of the
double entry is to goodwill (rather than the deferred tax expense in profit or loss).

4 Deductible temporary differences

Deductible temporary differences will lead to a deferred tax asset (representing a future tax saving).
Deferred tax assets should only be recognised to the extent that they are regarded as recoverable i.e.
where it is more than likely that there will be suitable taxable profits from which the future tax savings
can be deducted. Essentially, this means that you should not record a deferred tax asset unless you
anticipate sufficient future taxable profit (and hence future tax payable) against which you can save
future tax.
94 Course Notes ACCA SBR

Examples of deductible temporary differences are shown below.

4.1 Fair value adjustments

For group accounts, new liabilities may be recognised as a fair value adjustment on acquisition of a
subsidiary (e.g. recognising a contingent liability previously disclosed in the subsidiary’s individual
accounts). Also, there may be assets whose fair value is less than their book value (carrying amount).
Both of these group adjustments would lead to a deferred tax asset arising in the group accounts.

4.2 Unrealised profits on intragroup trading

You may remember provisions for unrealised profits or “PUPs” from your earlier studies. Where there
an intragroup transfer of inventory and the goods are still in inventory at the year end, the profit
element is eliminated from the group accounts. The profit will be recognised eventually in the group
accounts when the goods are sold on to third parties.
The tax authorities typically tax the profit immediately (regardless of whether it is intragroup). This
results in a temporary difference as the profit will not be recognised in the group accounts until the
goods are sold on to third parties.
This will result a deferred tax asset in the group accounts equal to the PUP multiplied by the tax rate
of the receiving company (i.e. the company holding the inventory at the year end). It is a deferred tax
asset as effectively the group has been taxed on a ‘non-existent’ profit so the tax charge needs to be
reversed (until the goods have been sold onto third parties and the profit recognised).

4.3 Unused tax losses

A deferred tax asset will be created when an entity has unused tax losses/credits to the extent that it
is probable that future taxable profits will be available against which to use the tax losses.

ILLUSTRATION: UNUSED TAX LOSSES

A company has tax losses of $120,000 in the year ended 31 December 2019. In the country in which it
operates, tax losses can be carried forward for two years to reduce future tax bills and the tax rate is
30%. The company estimates that its cumulative taxable profits over the next two years will be
$100,000.
Therefore, the company can only recognise a deferred tax asset on $100,000 of its $120,000 losses.
This will result in a deferred tax asset of (30% × $100,000) = $30,000.

4.4 Accounting for the deferred tax asset

It should be remembered that normally to create a deferred tax asset and to account for an increase in
a deferred tax asset, the double entry is:
Dr Deferred tax asset (SFP)
Cr Deferred tax expense (SPL) *
And for a decrease in a deferred tax asset:
Dr Deferred tax expense (SPL) *
Cr Deferred tax asset (SFP)
ACCA SBR Course Notes 95

* There are some exceptions to recognising the deferred tax expense in profit or loss:
 If the deferred tax relates to a transaction that is recorded in other comprehensive income,
then the deferred tax should also be recognised in other comprehensive income (rather than
profit or loss).
 If the deferred tax relates to a fair value adjustment in the group accounts, the other side of the
double entry is to goodwill (rather than the deferred tax expense in profit or loss).

ILLUSTRATION: DEFERRED TAX ASSET OR LIABILITY

Carter has two subsidiaries: Crompton and Whitmore. The year end is 31 December 2019.
(a) In the year ended 31 December 2019, Carter acquired a new 90% subsidiary, Grant. The fair
value of the identifiable net assets of Grant at acquisition was $150 million (excluding deferred
tax assets and liabilities). The tax base of the identifiable net assets of Grant was $138 million.
(b) During the year ended 31 December 2019, Carter sold goods to Whitmore at a price of
$30 million at a margin of 20%. Whitmore still has two thirds of these items in inventory at the
year end.
(c) Crompton has unremitted profits of $20 million which would give rise to additional tax payable
of $4 million if sent to Carter. Carter intends to instruct Crompton not to send the profits to it.
Assume a tax rate of 30% for Carter and 25% for its subsidiaries.
Required:
For each of the above, explain the deferred tax implications for the Carter group of companies for the
year ended 31 December 2019.
SOLUTION
(a) The carrying amount of the net assets of Grant at acquisition of $150 million is based on their
fair values. As this is different to the tax base of the net assets of $138 million, this will result in
a temporary difference and deferred tax liability, calculated using Grant’s tax rate of 25%:
$m
Carrying amount of Grant’s net assets (fair value) 150
Tax base of Grant’s net assets (138)
Temporary difference 12
Deferred tax (liability) (25% × 12) (3)

This deferred tax liability will be recognised in Carter’s group accounts with a corresponding
increase in goodwill:
Dr Goodwill $3m
Cr Deferred tax liability $3m
(b) The profit on the goods left in inventory at the year end will be eliminated in the group
accounts. However, the tax authorities will tax the profit immediately (regardless of whether it
is intragroup). This gives rise to a temporary difference as the profit is recognised immediately
by the tax authorities but will not be recognised in the group accounts until the goods have
been sold onto third parties.
The provision for unrealised profit (PUP) is calculated as: $30m × 20% margin × 2/3 in inventory
= $4m. Deferred tax is calculated using the tax rate of the company holding in the inventory.
Here, this is the subsidiary, Whitmore, so its tax rate of 25% should be used.
96 Course Notes ACCA SBR

$m
Carrying amount of inventory in group accounts ([$30m × 2/3] ‒ $4m PUP) 16
Tax base of Grant’s net assets ($30m × 2/3) (20)
Temporary difference (4)
Deferred tax asset (25% × 4) 1

The required accounting entry in the group accounts is:

Dr Deferred tax asset $1m
Cr Deferred tax expense $1m
(c) No deferred tax liability is required for the potential additional tax payable of $4 million since
Carter controls the dividend policy of Crompton and does not intend to receive the profits in the
future.

5 Share-based payments
Deferred tax may arise on share-based payments. This will be covered in the share-based payments
chapter (Chapter C8) as an understanding of accounting for share-based payments in required in order
to be able to account for the deferred tax effect.

6 Leases
When a lessee enters into a lease, it recognises:
 a right-of-use asset (the lease asset); and
 a lease liability
Temporary differences may arise on initial recognition of the right-of-use asset and the lease liability.
This depends on the tax laws in the jurisdiction in which the entity operates.
Some tax authorities grant tax relief based on the leased asset and others grant relief based on the
lease liability.

EXAM SMART
An exam question will probably say whether tax relief is granted on the lease asset or on the
lease liability.

Initial recognition of the right-of-use asset and the lease liability does not affect accounting profit or
taxable profit. But if equal taxable and deductible temporary differences are created, deferred tax
should be recognised.
ACCA SBR Course Notes 97

ILLUSTRATION: TAX RELIEF RELATES TO THE LEASE ASSET

Harper Co enters into a lease agreement and recognises:

 a right-of-use asset of $1 million
 a lease liability of $1 million
Because the tax relief relates to the lease asset:
 the right-of-use asset has a tax base of $1 million (the future allowable tax deduction)
 the lease liability has a tax base of $1 million (carrying amount of $1 million less any amount
that will be deductible for tax purposes in future periods, i.e. $Nil)
Because the carrying amount of the asset and the liability are equal to their tax base, no temporary
differences arise at this stage (on initial recognition) and there is no deferred tax.
If temporary differences arise subsequently, deferred tax will be recognised.

ILLUSTRATION: TAX REFLIEF RELATES TO THE LEASE LIABILITY

Harper Co enters into a lease agreement and recognises:

 a right-of-use asset of $1 million
 a lease liability of $1 million
Because the tax relief relates to the lease liability:
 the right-of-use asset has a tax base of $Nil (the future allowable tax deduction)
 the lease liability has a tax base of $Nil (carrying amount of $1 million less any amount that will
be deductible for tax purposes in future periods, i.e. $1 million)
Because the carrying amount of the asset and the liability are both $1 million and the tax base of both
is $Nil, equal taxable and deductible temporary differences arise and deferred tax is recognised.

7 Presentation
Deferred tax liabilities and assets are presented as non-current assets and liabilities in the statement
of financial position.
IAS 12 allows deferred tax assets and liabilities to be offset as long as:
 The entity has a legally enforceable right to set off current tax assets and current tax liabilities
 The deferred tax assets and liabilities relate to tax levied by the same tax authority.

8 Disclosure
An entity must disclose:
 The major components of its tax expense (e.g. current tax expense, adjustments to current tax
of prior periods, deferred tax expense from temporary differences/changes in tax rates/write
downs of deferred tax assets)
 Tax relating to each component of other comprehensive income (e.g. deferred tax on
revaluation gains on property)
98 Course Notes ACCA SBR

 Tax relating to items recognised directly in equity (e.g. a prior period adjustment)
 An explanation of the relationship between the tax expense and accounting profit in either or
both of the following forms:
– A numerical reconciliation between the tax expense and the accounting profit multiplied
by the tax rate; or/and
– A numerical reconciliation between the average effective tax rate (tax expense divided by
profit before tax) and the applicable tax rate.

EXAM SMART
Section B of the exam often tests the investor perspective. Investors and other users of
financial statements may struggle to understand why the tax expense is not equal to the
accounting profit multiplied by the tax rate. The disclosure of the explanation of the
relationship between the tax expense and accounting profit enhances the understandability
of the financial statements for investors. Reasons for differences between the tax expense
and accounting profit multiplied by the tax rate could include:
 Disallowable expenses
 Non-taxable gains
 Adjustments to current tax in respect of prior years
 A change in tax rate resulting in an adjustment to the opening deferred tax liability
 A group operating in several different tax jurisdictions

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand and can you explain the concept of deferred tax?
Can you calculate the temporary difference and the deferred tax liability or asset
where there are: accelerated capital allowances; development costs; revaluations: and
unused tax losses?
Can you account for deferred tax liabilities and assets in the financial statements?
Can you explain the deferred tax implications of transactions relating to groups,
including fair value adjustments; undistributed profits; and unrealised profits on intra-
group transactions?
Can you explain how deferred tax assets and liabilities should be presented in the
financial statements?
Do you understand the disclosure requirements relating to income taxes?
 99

C7

Provisions, contingencies and

events after the reporting date

1 IAS 37 – Provisions

KEY TERM
Provision. A provision is a liability of uncertain timing or amount.

IAS 37 covers those provisions which an entity may need to cover future payments that it is obliged to
pay to third parties.
The standard does not apply to provisions (allowances) for doubtful debts or provisions for depreciation
(accumulated depreciation). These are accounting estimates, rather than ‘true’ provisions.

1.1 Background
Prior to the introduction of this standard, companies could effectively include, increase and decrease a
provision in their accounts if they felt it was prudent to do so. This led to the manipulation of profits,
as companies could effectively provide for “future costs” that they thought they may one day incur.
This led to the so-called “big bath” provisions which meant that companies could “smooth out” their
profit trends, which investors took as a sign of steady, reliable growth. IAS 37 aimed to reduce this
manipulation.

1.2 Recognition
The recognition criteria are the same as those in the Conceptual Framework for all liabilities i.e. a
provision must be recognised when all of the following criteria are met:
 When an entity has a present obligation (legal or constructive) as a result of a past event (the
“obligating event”);
100 Course Notes ACCA SBR

 It is probable (“more likely than not”) that an outflow of economic resources will be required
to settle the obligation, and
 The amount can be estimated reliably.

1.3 Present obligations and obligating events

An obligating event is an event that creates a legal or constructive obligation and, therefore, results in
an entity having no realistic alternative but to settle the obligation. A constructive obligation arises if
past practice creates a valid expectation on the part of a third party.
The amount recognised should be the best estimate of the expenditure required to settle the
obligation at the end of the reporting period. Where the effect of the time value of money is material,
the provision must be discounted to the present value of the future expenditure.
The provision should be calculated each year end, with the movement being taken to the statement of
profit or loss.

1.4 Legal and constructive obligations

An obligation can either be legal or constructive:

KEY TERMS
 Legal obligation. A legal obligation is one that derives from a contract, legislation or
any other operation of law.
 Constructive obligation. A constructive obligation arises if past practice creates a valid
expectation on the part of a third party.

2 Specific types of provision

2.1 Restructuring
A provision for restructuring costs is recognised only when the entity has a constructive obligation to
restructure. Such an obligation only arises where an entity:
 Has a detailed formal plan for the restructuring, and
 Has raised a valid expectation in those affected that it will carry out the restructuring by starting
to implement the plan or announcing its main features to those affected by it.

ILLUSTRATION: RESTRUCTURING PROVISION

On 19 December 2014, the board of an entity decided to close down a division.

(a) Assuming that no steps were taken to implement the decision and the decision was not
communicated to any of those affected by the end of the reporting period of 31 December
2014, explain the appropriate accounting treatment.
(b) Assuming that a detailed plan had been agreed by the board on 19 December 2014, letters sent
to notify customers and the staff of the division have received redundancy notices, explain the
appropriate accounting treatment.
ACCA SBR Course Notes 101

SOLUTION
(a) There is no “constructive obligation” as the decision has not been communicated to any
outside party. Therefore, no provision should be recognised.
(b) The communication of the plan to customers and staff gives rise to a constructive obligation
because it creates a valid expectation that the division will be closed. Therefore, a provision is
required.

2.2 Warranty provisions

An entity that sells goods “under warranty” will have a legal obligation to repair those goods should
any faults occur. The entity should make a provision based on its best estimate of the repair costs.

ILLUSTRATION: WARRANTY PROVISION

Sonny sells goods with a one-year warranty. If all of the goods sold required minor repairs, the total
cost would be $1.2m. If all of the goods sold required major repairs, the total cost would be $8m. The
entity expects that 80% of the goods will have no faults, 15% will have minor faults and 5% will have
major faults.
The provision that Sonny should include in its financial statements will be the expected value of the
repair costs =
Provision required
$
No repairs needed 80% × nil cost Nil
Minor repairs needed 15% × $1.2m $180,000
Major repairs needed 5% × $8m $400,000
$580,000

Therefore, Sonny should include a provision of $580,000 in its financial statements.

2.3 Decommissioning costs

In many industries, where raw materials are extracted, the entity may only be granted a licence if it
repairs any damage made during the extraction process.
If there is an obligation to make these repairs, the entity should make a provision for them. If the costs
relate to a non-current asset, they can be included as part of the cost of that asset.

ILLUSTRATION: DECOMMISSIONING PROVISION

Messy has constructed an oil rig in the North Sea. The UK government included a clause in the licence
that Messy had to remove the rig and restore the seabed to its previous state at the end of the
extraction process, in 10 years’ time.
The rig cost $20m, with drilling starting on 1 January 2015. Messy has estimated at 1 January 2015 that
it will cost $5m (present value) to restore the seabed to its original condition, using a discount factor of
10%.
80% (i.e. $4m) of this amount relates to the removal of the rig and restoration of damage caused by
building it and 20% ($1m) relates to the damage caused by the extraction of the oil.
Messy started extracting oil on 1 January 2015.
102 Course Notes ACCA SBR

Required:
What amounts should be included in Messy’s financial statements in the year ended
31 December 2015?
SOLUTION
The construction of the rig creates a legal obligation and so Messy should recognise a provision for the
removal of the rig. This provision ($4m as at 1 January 2015) should be included as part of the cost of
the non-current asset.
The journal for this would be:
Dr Non-current assets $4m  therefore, the total cost =$20m + $4m = $24m
Cr Provision $4m
The $24m will then be depreciated over 10 years.
Therefore, the carrying amount at 31.12.15 = $24m – $2.4m = $21.6m
The provision of $4m will increase to $4.4m over the year ended 31 December 2015. This “unwinding
of discount” will be 10% × $4m= $0.4m
Dr Finance cost (SPL) $0.4m
Cr Provision $0.4m
Drilling starts Year end End of extraction process

9 years

1.1.15 31.12.15 31.12.24

PV of future clean-up costs
= $5m

$4m $1m

Removal damage
of rig caused by
extraction
The $1m relating to the damage caused by the extraction will not be capitalised but a provision and an
expense will be created as soon as drilling commences (i.e. when the company creates an obligation).
Therefore, a provision of $1m will be set up on 1 January 2015. Then, as above, this provision could be
“unwound” each year.
Therefore, at 31 December 2015, the provision will be $1m + (10% × $1m) = $1.1m

2.4 Future operating losses

Provisions should not be recognised for future operating losses as future operating losses do not meet
the definition of a liability or the Conceptual Framework recognition criteria.
ACCA SBR Course Notes 103

2.5 Onerous contracts

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.
Where there is an onerous contract, the provision should be measured as the lower of the net cost of
fulfilling the contract and any penalties payable as a result of exiting from it.
The costs required to fulfil a contract include:
 incremental costs (e.g. materials and direct labour); and
 the allocation of other necessary costs (e.g. a proportion of the depreciation expense relating to
plant and equipment used to fulfil the contract).

3 Contingent liabilities
A contingent liability is either:
(a) A possible obligation arising from past events whose existence will be confirmed only by the
occurrence of one or more uncertain future events not wholly within the control or the entity;
or
(b) A present obligation that arises from past events but is not recognised because
(i) It is not probable that an outflow of economic benefit will be required to settle the
obligation; or
(ii) Because the amount of the obligation cannot be measured with sufficient reliability.
Contingent liabilities are not recognised on an entity’s statement of financial position – they are
merely disclosed in the notes.

ILLUSTRATION: CONTINGENT LIABILITIES

Bell sells wedding cakes. After a wedding in Bristol, eight people suffered from food poisoning which
has been directly linked to the wedding cake. The married couple are now suing Bell. Bell’s solicitor
advises it that there is a 40% chance that it will lose the case. If the case is lost, damages of $200,000
will be payable.
Accounting treatment
Since this is a single event, the most likely outcome will dictate whether a provision is needed or not.
Since there is only a 40% chance of losing the case, Bell should NOT provide for the possible damages,
but may disclose the matter as a contingent liability note in its financial statements.

4 Contingent assets
A contingent asset is a possible asset arising from past events whose existence will only be confirmed
by the occurrence of one or more uncertain future events not wholly within the control of the entity.
An entity should only recognise an asset on its statement of financial position when the realisation of
the profit is virtually certain. If the realisation is merely probable, then we can refer to that asset as a
contingent asset and disclose it in the notes to the financial statements.
104 Course Notes ACCA SBR

ILLUSTRATION: CONTINGENT ASSETS

A company has an internal flood because one of the staff members left a tap running overnight. The
insurance company has visited and agreed the claim and has stated that the company will definitely
receive a cheque in the post in the next few weeks to cover the cost of the damage done, an estimated
$10,000.
The company could include an asset/receivable in their statement of financial position for the $10,000
as the receipt is virtually certain.
If the insurance company had suggested that the receipt of the $10,000 is merely probable, then the
company could disclose a contingent asset in the notes to the financial statements.
A brief description of the nature of the contingent asset and, where practicable, an estimate of the
financial effect should be disclosed.

5 Events after the reporting period

IAS 10 relates to events taking place between the last day of the reporting period (the year end date)
and the date on which the financial statements are approved and signed by the directors. There are
two types of event: adjusting events; and non-adjusting events.
Adjusting events are events taking place after the reporting period which provide further evidence of
conditions existing at the end of the reporting period. Adjusting events require adjustment to be
made to the financial statements.
Examples of adjusting events:
 Evidence received after the reporting date indicating that an asset was impaired at the
reporting date.
 Discovery of theft, fraud or accounting errors that show that the financial statements are incorrect.
Non-adjusting events provide evidence of conditions arising after the end of the reporting period. If
material, these should be disclosed by note, but they do not require that the financial statements be
adjusted.
Examples of non-adjusting events:
 Destruction of an asset, e.g. by fire, after the reporting date.
 Announcement of plan to close a manufacturing plant made after the reporting date.
 Dividends declared.
Any event that suggests that the entity may no longer be a going concern (e.g., deterioration in
operating results) may result in changes to the financial statements, even if it does not occur until
after the reporting date. If the entity is no longer a going concern, the financial statements must be
prepared on a break-up basis. If there are material uncertainties regarding the going concern
assumption, this must be disclosed in accordance with IAS 1.
ACCA SBR Course Notes 105

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain and apply the criteria for recognising a provision?
Do you understand how to deal with: a future operating loss; a restructuring; warranty
provisions; decommissioning costs; and onerous contracts?
Can you determine when to disclose a contingent liability or a contingent asset?
Can you explain the difference between an adjusting event after the reporting period
and a non-adjusting event?
106 Course Notes ACCA SBR
 107

C8

Share-based payment

1 IFRS 2 – Share-based payments: introduction

IFRS 2 applies to all share-based payment transactions.
The standard states that when a company issues shares in consideration for an asset purchase or
employee services, it is appropriate to recognise an asset or expense.
There are two main types of share-based payment transaction.

KEY TERMS
 Equity-settled share-based payment transaction: the entity receives goods or services
as consideration for its own equity instruments (including shares or share options).
 Cash-settled share-based payment transaction: the entity acquires goods or services by
incurring a liability to transfer cash or other assets to the supplier for an amount based
on the price of its equity instruments.

Share-based payments are normally given to employees in return for services rendered, but can also
be used, for example, to pay suppliers for goods.

1.1 Recognition
IFRS 2 requires an expense to be recognised for the goods or services received by a company
Dr Expense/Non-current asset/Inventory
Cr Equity (if equity-settled)
Cr Liability (if cash-settled)
Often, the employee will have to wait a period of time before they become unconditionally entitled to
the shares/cash – this is known as the “vesting period”. For example, FiT might offer share options to
its employees, which the employees can only exercise if they work for the company for three years. If
this is the case, we would spread the expense over the three-year vesting period.
108 Course Notes ACCA SBR

1.2 Measurement
The expense should be measured at the fair value of the goods or services received. If this cannot be
determined (which is often the case for employee services), then the fair value of the instrument
granted should be used.
For equity-settled instruments – the fair value of the equity instrument at the grant date should be
used – this remains fixed for the life of the instrument.
For cash-settled instruments – the fair value of the liability is used. This should be updated at each
year end, with changes going to the statement of profit or loss.
The c/f equity/liability for employee services is therefore calculated as follows:

No. of employees Fair value

No. of
entitled to benefits (at grant date if
× instruments × × Portion
(remove estimated equity-settled; at
per vested
leavers over whole year end if cash-
employee
vesting period) settled)

2 Equity-settled share-based payment transactions

This is where the entity receives goods or services as consideration for equity instruments of the entity
(e.g. shares or share options). Equity-settled transactions with employees and directors are expensed
and the expense is based on the fair value of the goods and services received at the grant date.

ILLUSTRATION: EQUITY-SETTLED TRANSACTIONS

A company issued share options on 1 June 2016 to pay for the purchase of inventory.
The inventory is eventually sold on 31 December 2016 for $9m.
The value of the inventory on 1 June 2016 was $5m and this value was unchanged up to the date of
sale.
The shares issued have a market value of $5.6m.
How will this transaction be dealt with in the financial statements?
SOLUTION
Dr Inventory $5m
Cr Equity $5m
(the market value of the shares is irrelevant)
The inventory value will be expensed on sale.
ACCA SBR Course Notes 109

ILLUSTRATION: EQUITY-SETTLED TRANSACTION

An entity grants 100 share options to each of its 400 employees on 1 January 2015. Each grant is
conditional upon the employee working for the entity over the next three years. The fair value of each
share option as at 1 January 2015 is $12. This increases to $15 at 31 December 2015, to $20 at
31 December 2016 and to $30 at 31 December 2017.
The entity estimates that 25% of employees (i.e. 100 in total) will leave during the three-year period
and therefore forfeit their rights to share options.
Show the accounting entries which will be required over the three-year period if:
 10 employees leave during 2015 and another 65 employees are expected to leave in the future
(i.e. total estimated employee departures over the three-year period = 75)
 20 employees leave during 2016 and another 30 employees are expected to leave in the future
(i.e. total estimated employee departures over the three-year period = 60)
 12 employees leave during 2017, so a total of 42 employees left and forfeited their rights to
share options. A total of 35,800 share options (358 employees × 100 options) vested at the end
of 2017.
SOLUTION
2015: Equity c/f = (400 – 75 employees) × 100 options × $12 × 1/3 years = $130,000
Dr Expense $130,000
Cr Equity $130,000

2016: Equity c/f = (400 – 60 employees) × 100 options × $12 × 2/3 years = $272,000
Less: equity b/f ($130,000)
$142,000

Dr Expense $142,000
Cr Equity $142,000

2017: Equity c/f = (400 – 42 employees) × 100 options × $12 × 3/3 years = $429,600
Less: equity b/f ($272,000)
$157,600

Dr Expense $157,600
Cr Equity $157,600
When the employee converts these options into shares, the company will:
Dr Equity
Dr Cash
Cr Share capital
Cr Share premium

3 Accounting for cash-settled share-based payment transactions

Instead of issuing shares or share options, the entity will ultimately pay the cash equivalent of the
movement in the share price over a certain period (or an amount based on this).
For example, “share appreciation rights” entitle employees to cash payments equal to the increase in
the share price of a given number of the company’s shares over a given period.
110 Course Notes ACCA SBR

This creates a liability, and the recognised cost is based on the fair value of the instrument at the
reporting date.
The fair value of the liability is re-measured at each reporting date until settlement.

ILLUSTRATION: CASH-SETTLED TRANSACTION

An entity grants 100 share appreciation rights (SARs) to each of its 400 employees on 1 January 2016.
Each grant is conditional upon the employee working for the entity over the next 2 years. The fair
value of each SAR as at 1 January 2016 is $12. This increases to $15 at 31 December 2016 and to $20 at
31 December 2017.
Initially, the entity estimates that 100 employees will leave during the two-year period and therefore
forfeit their rights to SARs.
Show the accounting entries which will be required over the two-year period if:
 10 employees left during 2016 and another 15 employees are expected to leave in the future
 Another 20 employees left during 2017, so a total of 30 employees left and forfeited their rights
to the SARs.
SOLUTION
2016: The total fair value of the SARs = (400 – 25 employees) × 100 SARs × $15 = $562,500
Amount to be recognised as an expense in 2016 is $562,500 divided by the vesting period of two years
= $281,250
Dr Expense $281,250
Cr Liability $281,250
2017: Liability c/f = (400 – 30 employees) × 100 SARs × $20 × 2/2 years = $740,000
Less: liability b/f ($281,250)
$458,750
Dr Expense $458,750
Cr Liability $458,750

4 Transactions with a choice of settlement

4.1 If the company has the choice
Treat as an equity-settled transaction unless there is a present obligation to settle in cash, in which
case, treat as a cash-settled transaction. This “obligation” could be a constructive obligation if, for
example, the company has always traditionally settled in cash, then they have effectively created a
valid expectation that they will always settle in cash. Therefore, treat it as cash-settled.

4.2 If the other party has the choice

The entity has granted a compound financial instrument. Treat this in a similar way to convertible
debt i.e. split the credit between a debt and an equity component. Then, treat the equity component
in the same way as an equity-settled share-based payment transaction (measure at the fair value at
the grant date) and the debt component in the same way as a cash-settled share-based payment
transaction (remeasure the liability at each period end).
ACCA SBR Course Notes 111

ILLUSTRATION: CHOICE OF SETTLEMENT

On 31 May 2012, the company’s year end, Ennis purchased property, plant and equipment for
$4.5 million. The supplier has agreed to accept payment for the property, plant and equipment either
in cash or in shares.
The supplier can either choose 1.5 million shares of the company to be issued in six months’ time or to
receive a cash payment in three months’ time equivalent to the market value of 1.3 million shares. It is
estimated that the share price will be $3.50 in three months’ time and $4 in six months’ time.
The share price of Ennis at 31 May 2012 was $3 per share.
SOLUTION
Under IFRS 2, the purchase of property, plant and equipment would be treated as a share-based
payment in which the counterparty has a choice of settlement, in shares or in cash.
It is treated as the issue of a compound financial instrument, with a debt and an equity element.
Similar to IAS 32 Financial Instruments: Presentation, IFRS 2 requires the determination of the liability
element and the equity element.
The fair value of the equity element is the fair value of the goods or services (in this case the property)
less the fair value of the debt element of the instrument. The fair value of the property is $4.5m.
The journal entries are:
Dr Property, plant and equipment $4.5m
Cr Liability (1.3 million shares × $3 year end share price) $3.9m
Cr Equity (balancing figure) $0.6m
In three months’ time, the debt component is remeasured to its fair value. Assuming the estimate of
the future share price was correct at $3.50, the liability at that date will be 1.3 million × $3.5 = $4.55m.
An adjustment must be made as follows:
Dr Expense ($4.55m – $3.9m) $0.65m
Cr Liability $0.65m

5 Vesting conditions
Sometimes, the shares or cash equivalent of the shares will only be issued once certain “conditions”
have been met.

5.1 Market conditions

Market conditions, such as achieving a certain share price, are ignored when calculating the number of
equity instruments expected to vest.
This is because the “fair value” of any equity instruments (i.e. shares or share options) granted already
acknowledge the market conditions.

5.2 Non-market conditions

Sometimes the performance conditions relate to non-market conditions such as achieving a certain
growth in profit. In this case, the amount recognised as a share-based payment is based on the best
estimate of the number of equity instruments expected to vest, revised at each year end.
112 Course Notes ACCA SBR

ILLUSTRATION: VESTING CONDITIONS (MARKET)

On 1 January 2016, Bruce granted 10,000 options to Bobby Jean, a senior employee. One of the
conditions of the scheme was that Bobby Jean must work for the entity for three years (and Bobby
Jean met this condition).
A second condition for vesting is that the share price increases at 25% per annum compound over the
three-year period. At the date of grant, the fair value of each share option was $18, which took into
account the probability that the share price growth of 25% p.a. being met.
The share price rose by 30% during the year ended 31 December 2016, and by 26% per annum
compound over the two years to 31 December 2017. However, the increase over the three-year period
to 31 December 2018 was only 24% per annum.
Required:
How should this transaction be recognised over the three years?
SOLUTION
Bobby Jean satisfied the three-year service condition but the share price growth was not met in year 3.
The share price growth is a market condition and the probability of achieving the share price growth
was taken into account in estimating the fair value of the options at the grant date of $18 (If there had
been no chance of achieving the required growth, the fair value of the option would have been nil).
No adjustment is made to the annual double entry, even if the target is not met. Therefore, in years 1,
2 and 3, the double entry is:
Dr Expense (10,000 options × $18 / 3 years) $60,000
Cr Equity $60,000
This equity reserve will build up to $180,000 over 3 years but will never actually be utilised to issue the
options.

Sometimes, it is the vesting period which is dependent on performance conditions. For example, the
instruments may be issued at the end of 1, 2 or 3 years, depending on whether profit targets are met
in Year 1, 2 or 3.
If the performance condition is a market condition the length of vesting period is not revised.
If the performance condition is a non-market condition, the total expense is divided by the number of
years which is most likely to be the relevant period, revised at each year end.
If the vesting period turns out to be shorter than estimated, the charge will be accelerated in the period in
which the entity must fulfil its obligations by delivering shares or cash to the employee or supplier.
If the actual vesting period is longer than estimated, the expense is recognised over the original
vesting period.
ACCA SBR Course Notes 113

ILLUSTRATION: VESTING CONDITIONS (NON-MARKET)

Coe granted 100 options to each of its 4,000 employees at a fair value of $10 each on 1 December 2009.
The options vest upon the company’s earnings increasing by 20%, provided the employee has
remained in the company’s service until that time.
The terms and conditions of the options are that the performance condition can be met in either Year
3, 4 or 5 of the employee’s service.
At the grant date, Coe estimated that the expected vesting period would be four years (which is
consistent with the assumptions used in estimating the fair value of the options granted).
The company’s earnings had increased by 20% at 30 November 2012.
Required:
Discuss, with suitable computations where applicable, how the above transaction would be dealt with
in the financial statements of Coe for the year ending 30 November 2012.
SOLUTION
Where the vesting period is linked to a non-market performance condition, an entity should estimate
the expected vesting period. If the actual vesting period is shorter than estimated, the charge should
be accelerated in the period that the entity delivers the instruments to the counterparty.
Coe expects the performance condition to be met in 2013 (4 years after the grant date) and thus
anticipates that it will charge $1 million per annum until that date (100 × 4,000 × $10 divided by
4 years).
As the performance condition has been met in the year to 30 November 2012, the expense charged in
the year would be $2 million ($4 million – $2 million already charged) as the remaining expense should
be accelerated and charged in the year.

6 Deferred tax and share-based payments

Deferred tax was covered in Chapter C6. Deferred tax may arise on share-based payments such as
share options.
This is because in some jurisdictions, a tax allowance may be available on exercise of the share
options. This gives rise to a temporary difference because an entity will recognise an expense for the
share options over the vesting period but the tax allowance will not be received until the options are
exercised.
It is unlikely that the amount of tax deducted will equal the amount charged to the statement of profit
or loss under IFRS 2. Often, the tax deduction is based on the option’s “intrinsic value”.
The “intrinsic value” is what the share option is inherently “worth” and is calculated as the difference
between the share price at the year end and the exercise price, where the exercise price is the price
the employee has to pay to obtain the shares.
A deferred tax asset will therefore arise:
Carrying amount of the share-based payment expense nil
Less: tax base of the share-based payment expense (estimated amount tax authorities will
allow as a deduction in future periods, based on year end information) (X)
Temporary Difference (X)
Deferred tax asset X
The carrying amount for share options is nil (because they do not result in an asset or liability but
instead result in equity).
114 Course Notes ACCA SBR

The tax base will normally be based on the “intrinsic value” of the share options and can be calculated
as follows:

No. of employees No. of share

entitled to × options per × Intrinsic value × Portion vested
benefits employee

This is effectively the same as the formula for calculating the share-based payment equity c/f figure
but the fair value has been replaced with the intrinsic value.
For cash settled share-based payment transactions, the standard requires the estimated tax deduction
to be based on the current share price.

ILLUSTRATION: SHARE-BASED PAYMENT

On 1 January 2020, a company granted 4,000 share options to a director, vesting two years later. The
fair value of each share option at the grant date was $1.
The tax authorities in the company’s jurisdiction allows a tax deduction of the intrinsic value of the
options on exercise. The intrinsic value of the share options at 31 December 2020 was $1.30 and on
31 December 2021 was $1.80, on which date the options were exercised.
The corporate tax rate is 30%.
SOLUTION
First, calculate the temporary difference by comparing the tax base of the share-based payment and
the carrying amount of the share-based payment expense.
31.12.20 31.12.21
$ $
Carrying amount of the share-based payment expense (no asset therefore nil) Nil Nil
Less: Tax base of share-based payment expense
4,000 options × $1.30 intrinsic value × ½ (2,600)
4,000 options × $1.80 intrinsic value × 2/2 (7,200)
(2,600) (7,200)
Deferred Tax Asset @ 30% 780 2,160
Therefore, there will be a deferred tax asset of $780 in 2020 and $2,160 in 2021.
Normally a deferred tax asset is recorded as follows:
Dr Deferred tax asset (SFP)
Cr Deferred tax expense (SPL)
However, there is a rule for share-based payments that if amount of the estimated future tax
deduction (based on the intrinsic value) is greater than the cumulative expense recognised in the
statement of profit or loss relating to the share-based payment, the excess must be recorded in equity.
In 2020, the estimated future tax deduction (based on the intrinsic value) is $2,600. The cumulative
expense is based on the fair value at the grant date: 4,000 options × $1 fair value × ½ = $2,000.
Therefore, the required double entry in 2020 is:
Dr Deferred tax asset $780
Cr Deferred tax expense (SPL) ($2,000 expense × 30%) $600
Cr Equity (i.e. reserves) (($2,600 – $2,000) × 30%) $180
The logic is that the expense of $2,000 that went through the statement of profit or loss is “matched”
to the corresponding deferred tax income relating to it.
ACCA SBR Course Notes 115

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand what is meant by equity-settled share-based payment and cash-
settled share-based payment?
Can you account for an equity-settled share-based payment transaction?
Can you account for a cash-settled share-based payment transaction?
Do you understand how to treat a transaction where there is a choice of settlement?
Do you understand how to recognise a share based payment transaction where there
are vesting conditions?
Do you understand the deferred tax implications of share-based payment?
116 Course Notes ACCA SBR
 117

C9

Fair value measurement

1 IFRS 13 Fair Value Measurement

IFRS 13 was issued for several reasons; the main reason being to reduce complexity and improve
consistency in application when measuring fair value.
Many IFRS Standards require or permit entities to measure or disclose the “fair value” of assets,
liabilities, or equity instruments, but prior to the issue of IFRS 13, the description of how to measure
fair value was limited and, in some cases, the requirements were conflicting.
For example, the investment properties standard (IAS 40), the financial instrument standard (IAS 39)
and the standard on business combinations (IFRS 3) all used different definitions of “fair value”.
Another reason was to enhance disclosures about fair value.

1.1 Fair value

Fair value is defined as 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 (an “exit price”)  this
is essentially an “arm’s length price”.
Market participants are independent, knowledgeable, and are able to enter into the transaction but
are not forced to do so.
Other points to note:
 The “exit price” applies regardless of the entity’s intent and/or ability to sell the asset or
transfer the liability as of the measurement date; it is not entity-specific.
 The price is specific to the particular asset or liability; it should take into account the condition
and location of the asset and any restrictions on its use.
118 Course Notes ACCA SBR

1.2 The market

The fair value is an exit price in either:
 the principal market, which is the market with the greatest volume of activity; or
 (in the absence of a principal market) the most advantageous market.
Other points to note:
 There is a presumption that the principal market is the one in which the entity would normally
enter into a transaction to sell the asset or transfer the liability, unless there is evidence to the
contrary.
 The most advantageous market is the market which would maximise the amount which would
be received to sell an asset (or minimise the amount which would be paid to transfer a liability).
 In either case, the entity must have access to the market on the measurement date.
 The principal (or most advantageous) market price for the same asset or liability might be
different for different entities and therefore, the principal (or most advantageous) market is
considered from the entity’s perspective which may result in different prices for the same asset.
 The price used to measure fair value does not include transaction costs (these are specific to
the transaction, not the asset).
 But the price does include transport costs if appropriate. (Transport costs are specific to the
asset; for example, one company might have to transport the asset to a different location to sell
it, while another company might not).

1.3 Non-financial assets: highest and best use

For non-financial assets (e.g. buildings), management must consider the highest and best use of the
asset by market participants. (even if the entity intends to use it in a different way).
The highest and best use of an asset is the use that a market participant would adopt in order to
maximise its value.
IFRS 13 requires the entity to consider uses which are:
 physically possible
 legally permissible; and
 financially feasible.
For example, if land is protected in some way by law and a change of law is required, then it cannot be
the highest and best use of the land.
An entity’s current use of a non-financial asset is presumed to be its highest and best use unless there
is evidence to the contrary. For example, a company that currently owns a factory in a city centre uses
the revaluation model permitted by IAS 16. Many of the surrounding properties, which are similar in
size and layout, have been developed into high-rise apartment buildings, which generally sell for a
large premium. This would mean that, under IFRS 13, the “fair value” of the factory would have to
reflect what the building would be worth as a block of apartments.
ACCA SBR Course Notes 119

1.4 The ‘fair value hierarchy’

An entity should use valuation techniques that are appropriate in the circumstances and should
maximise the use of observable inputs (i.e. inputs based on market data).
IFRS 13 seeks to increase consistency and comparability through a ‘fair value hierarchy’, which
categorises the inputs used in valuation techniques into three levels:
 Level 1 inputs are unadjusted quoted prices in active markets (e.g. “share prices on the stock
market”) for items identical to the asset or liability being measured. This provides the most
reliable evidence of fair value.
 Level 2 inputs are inputs other than quoted prices in level 1 that are observable for that asset or
liability, e.g. quoted prices for similar assets or liabilities in active markets.
 Level 3 inputs are unobservable inputs, based on the best information available (e.g. the
estimated present value of the future cash flows relating to an item or the entity’s own internal
data).

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the definition of fair value?
Do you understand how to identify the principal or most advantageous market?
Do you understand what is meant by ‘highest and best use’?
Can you explain the ‘fair value hierarchy’ and which valuation techniques are used in
each of the three levels?
120 Course Notes ACCA SBR
 121

C10

Reporting requirements of small

and medium-sized entities (SMEs)

1 The IFRS for SMEs

IFRS Standards were originally designed with quoted entities in mind. Therefore, many SMEs, usually
owner-managed business with few complex transactions, have argued that IFRS imposes a burden on
them — a burden that has been growing as IFRS Standards have become more detailed and more
countries have begun to use them.
The IASB has issued an IFRS for Small and Medium Sized Entities (SMEs) that may be applied by eligible
SMEs instead of the full suite of IFRS Standards in issue. SMEs are estimated to represent more than
95% of all companies.
The IFRS for SMEs is intended by the IASB for use by entities that have no public accountability e.g.
their debt or equity instruments are not publicly traded.
The aim of the standard is to provide a simplified, shorter, self-contained set of accounting principles
that are appropriate for smaller, non-listed entities and that are based on full IFRS.
Because full IFRS were designed to meet the needs of shareholders in quoted companies, they cover a
wide range of issues and contain a sizeable amount of disclosures appropriate for public companies.
Users of the financial statements of SMEs do not have those needs, but, rather are more focused on
assessing shorter-term cash flows, liquidity and solvency.
The IFRS for SMEs leaves out topics which are not generally relevant to SMEs, such as:
 Earnings per share;
 Interim financial reporting;
 Segment reporting;
 Assets held for sale.
122 Course Notes ACCA SBR

Where IFRS has options, only the simpler option is included in the IFRS for SMEs.
Key differences between the IFRS for SMEs and full IFRS include:
 Intangibles:
– All intangible assets are measured at cost less accumulated amortisation and impairment
losses (the revaluation model permitted by IAS 38 is not allowed)
– Development costs must be expensed, rather than capitalised (as required by IAS 38)
– Useful life cannot exceed 10 years unless evidence to prove otherwise
 Purchased goodwill: amortised over its useful life (presumed to be 10 years), rather than being
subject to annual impairment tests.
 Borrowing costs – All borrowing costs are expensed as incurred.
 Financial instruments – simplified reporting. ‘Basic’ financial instruments (other than those that
are publicly traded or whose fair value can be measured reliably) are measured at amortised
cost. Other financial instruments are measured at fair value through profit or loss.
 Defined benefit pension schemes – simplified reporting. An entity may choose to recognise all
its actuarial (remeasurement) gains/losses in profit or loss, rather than other comprehensive
income.
 Consolidated financial statements: only the partial/proportionate method may be used to
calculate goodwill and non-controlling interests
 Foreign operations (see Chapter D4): exchange differences on retranslation of a foreign
operation are recognised in other comprehensive income and are not subsequently reclassified
to profit or loss when the operation is sold.
 Investments in associates and joint ventures: in the consolidated financial statements an entity
may choose whether to measure these at cost/fair value, or to use the equity method. (IAS 28
and IFRS 11 do not allow a choice; the equity method must be used.)
Pros and cons of the Standard
Advantages Disadvantages
Provides a “one-stop shop” for SMEs Still onerous for very small companies (‘micro-
entities’)
Significantly fewer disclosure requirements Could go further e.g. abolish the need for group
accounts entirely
More relevant for the users of the accounts of It creates a “two-tier” system of reporting
smaller entities
Easier to compare different companies in different
countries

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the purpose of the IFRS for SMEs and its advantages and
disadvantages?
Can you explain the main differences between the requirements of IFRS Standards and
the requirements of the IFRS for SMEs?
 123

C11

Other reporting issues

1 IAS 20: Accounting for Government Grants and Disclosure of

Government Assistance
A company should only recognise a grant when there is reasonable assurance that:
 it will comply with the conditions attaching to the grant; and that
 the grant will be received.

1.1 Types of grant

There are two types of grant:
(1) Those relating to income (e.g. a grant towards training costs). The grant should be recognised as
“other income” in the same periods as the related costs, so as to match them. Alternatively, the
grant can be deducted from the related expense.
(2) Those relating to assets (e.g. a grant towards the purchase of a non-current asset). At the
discretion of the company these grants should either be presented as:
(i) “Deferred income” on the SFP and then amortised over the asset’s life, or
(ii) By deducting the grant from the cost of the asset acquired and reporting the net amount
in the SFP, thus leading to a lower annual depreciation charge.

EXAM SMART
IAS 20 allows a choice of presentation methods, so this is an area that could feature in
Section B of the exam (appraisal of financial information). You may be asked to discuss
whether an entity has chosen the method that results in the fairest presentation, taking into
account the nature of the business and the transactions affected.
The choice of method does not affect an entity’s overall profit or net assets, but could affect
its key ratios.
Interpreting financial statements is covered in Chapter E.
124 Course Notes ACCA SBR

1.2 Repayment of grants

Any government grant that becomes repayable should be accounted for as a revision to an accounting
estimate as per IAS 8.
Repayment of grants relating to income should be recognised as an expense.
Repayments of grants relating to assets should be recorded by increasing the carrying amount of the
asset or reducing the deferred income balance, whichever is more appropriate.

2 IAS 41 Agriculture
IAS 41 Agriculture relates to entities that grow or rear biological assets such as cows and plants.
Taking the simple example of a farm, the activities that the farm performs on a daily basis are referred
to as “agricultural activity”. This would include the growing of plants / trees or the rearing of livestock.
This agricultural activity will give rise to “biological assets” such as the cow or tree and the harvested
produce (“agricultural produce”) such as milk or grapes.
The main focus of the standard for exam purposes is the valuation of the assets and produce.

Key points
 Biological assets are measured on initial recognition and at each year end at their fair value less
costs to sell. Fair value is essentially the price that that asset could be sold for in an active
market. The movement in fair value is shown in the statement of profit or loss.
 Agricultural produce is measured, at the point of harvest, at fair value less costs to sell. It then
becomes “inventory” and is subsequently valued in accordance with IAS 2 Inventories, at the
lower of cost / initial fair value less costs to sell and net realisable value.
 The sale of agricultural produce such as milk is dealt with as revenue per IFRS 15 Revenue from
Contracts with Customers.

Bearer plants
IAS 41 does not apply to bearer plants. Bearer plants are living plants that are: used in the production or
supply of agricultural produce; are expected to bear produce for more than one period; and have a
remote likelihood of being sold as agricultural produce. They are treated as tangible non-current assets in
accordance with IAS 16. However, their produce is treated as agricultural produce under IAS 41.
For example, an apple tree is a bearer plant and is treated as a tangible non-current asset, but the
apples are agricultural produce.

3 IAS 34 Interim financial reporting

An interim financial report is a financial report that has been prepared for a period shorter than a full
financial year.
Entities whose shares or debt instruments are publicly traded are often required to prepare interim
financial reports. IAS 34 does not state which entities should prepare interim reports.
The standard sets out the minimum content of an interim report and prescribes the principles that
should be followed when preparing them.
ACCA SBR Course Notes 125

3.1 Minimum components of an interim financial report

An interim financial report should include at least the following:
 A condensed statement of financial position as at the end of the interim period, (with
comparative figures as at the end of the previous financial year)
 A condensed statement (or statements) of profit or loss and other comprehensive income for
the current interim period and cumulatively for the current financial year to date (with
comparatives for the comparable interim periods of the previous financial year). For example: A
prepares quarterly interim reports. Its financial year ends on 31 December and the interim
financial statements are for the three months to 30 June. A prepares a statement for the three
months to 30 June and a statement for the six months to 30 June.
 A condensed statement of changes in equity showing cumulative changes for the current
financial year to date (with comparatives for the comparable year-to-date period in the
previous year)
 A condensed statement of cash flows for the year to date (with comparatives for the
comparable period in the previous year); and
 Selected explanatory notes
An entity may choose to prepare a full set of financial statements for the interim period.

3.2 Accounting policies

An entity should apply the same accounting policies in its interim financial statements that it applies in
its annual financial statements.
Seasonal revenues should be recognised when they occur.
Costs that are incurred unevenly during the year should be recognised when they occur.

4 IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors

4.1 Accounting policies
Accounting policies are the significant principles, bases, conventions, rules and practices applied by an
entity in preparing and presenting the financial statements.
IAS 8 requires that an entity selects its accounting policies by applying the relevant IFRS.
Where IFRS Standards do not specifically apply to a transaction, judgment should be used in
developing or applying an accounting policy, which results in financial information which is relevant to
the decision-making and assessment needs of users.
In making that judgement, entities must refer to guidance in IFRS Standards, which deals with similar
issues and then subsequently to definitions, and criteria in the Conceptual Framework. Additionally,
entities can refer to recent pronouncements of other standard setters who use similar conceptual
frameworks.
Entities should select and apply their accounting policies consistently for similar transactions. If IFRS
specifically permits different accounting policies for categories of similar items, an entity should apply
an appropriate policy for each of the categories in question and apply these accounting policies
consistently for each category.
For example, for different classes of property, plant and equipment, some may be carried at fair value
and some at historical cost.
126 Course Notes ACCA SBR

4.2 Changes in accounting policy

A change in accounting policy is only allowed if:
 It is required by an IFRS Standard; or
 It results in the financial statements providing reliable and more relevant information about the
effects of transactions on the entity’s financial position, financial performance or cash flows.
Changes in accounting policy are applied retrospectively (as if the new policy had always been in
place).
This means that the current year’s figures are adjusted, and also, as far as practicable, the
comparative amounts for the prior period.
But note that when an entity changes its accounting policy as the result of a new IFRS, it follows any
transitional rules set out in that IFRS. The IASB recognises that some changes may be difficult to apply
retrospectively, for example, if the information that is needed was not recorded in earlier periods.

4.3 Changes in accounting estimates

Accounting estimates are monetary amounts in financial statements that are subject to measurement
uncertainty.
Changes in accounting estimates result from new information or new developments.
Examples of changes in accounting estimate: warranty provisions are increased from 5% of sales to
10%; the depreciation method changes from straight-line to reducing balance; the useful life of a
depreciable asset changes.
Changes in accounting estimates are simply adjusted in the financial statements of the period in which
they arise.

4.4 Prior period errors

Prior period errors are omissions from, and misstatements in, the entity’s financial statements for one
or more prior periods arising from a failure to use, or misuse of, reliable information that:
 Was available when the financial statements for those periods were authorised for issue; and
 Could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements.
Prior period errors are adjusted retrospectively.

5 IFRS 1 First-time adoption of international financial reporting

standards
An entity applies IFRS 1 when it prepares its first IFRS financial statements.
 An entity must prepare and present an opening IFRS statement of financial position at the date
of transition to IFRS Standards.
 An entity should use the same accounting policies in its opening IFRS statement of financial
position and throughout all periods presented in its first IFRS financial statements. Those
accounting policies shall comply with each IFRS effective at the end of its first IFRS reporting
period (i.e. it should not apply different versions of IFRS Standards that were effective at earlier
dates).
ACCA SBR Course Notes 127

ILLUSTRATION: FIRST-TIME ADOPTION

ABC prepares its first IFRS financial statements for the year ended 31 December 2015.
Its date of transition to IFRS is 1 January 2014, so it applies the IFRS Standards effective for the year
ended 31 December 2015 in preparing:
 The opening IFRS statement of financial position at 1 January 2014;
 The financial statements for the year ended 31 December 2014 (i.e. the comparative figures); and
 The financial statements for the year ended 31 December 2015.
The accounting policies used in the opening IFRS statement of financial position will probably be
different from the ones that were used under previous (national) GAAP. All adjustments are
recognised directly in retained earnings (or another category of equity, if appropriate).

 Estimates made in accordance with IFRS at the date of transition to IFRS Standards must be
consistent with estimates made at the same date under previous GAAP, unless there is
objective evidence that those estimates were in error.
 For the purpose of preparing the opening IFRS statement of financial position, IFRS 1 allows a
number of exemptions from some of the requirements of other IFRS Standards. For example: an
entity may use fair value or a valuation under the previous GAAP as ‘deemed cost’ when
measuring property, plant or equipment, investment property and some intangible assets.
 An entity’s first IFRS financial statements should include disclosures that explain how the
transition from previous GAAP has affected its reported financial position, performance and
cash flows. In particular, IFRS 1 requires reconciliations of:
– equity reported under previous GAAP to equity reported under IFRS at both the date of
transition to IFRS and the end of the latest period in the entity’s most recent financial
statements in accordance with previous GAAP
– total comprehensive income reported under IFRS for the latest period in the entity’s most
recent financial statements to total comprehensive income reported under previous GAAP

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the two main types of government grant and how to account for each
of them?
Do you understand what is meant by biological assets and agricultural produce, and
how each of these is treated in the financial statements?
Can you explain the main financial reporting requirements in relation to interim
financial reports?
Can you explain when a change in accounting policy is allowed and how changes in
accounting policies and changes in accounting estimates are reported in the financial
statements?
Do you understand how to prepare an entity’s first IFRS financial statements?
128 Course Notes ACCA SBR
 129

D1

Group accounting – revision

of basic groups

1 Introduction
It is essential that you master the basics of group accounting examined in the Financial Reporting
paper. It is ESSENTIAL that you go through this chapter and understand everything in it before you
proceed onto the other group chapters. This chapter is largely home study and revisits some of the key
group concepts from FR.

EXAM SMART
Groups are examined in a very different way in Strategic Business Reporting (SBR) compared
to Financial Reporting.
In SBR, groups are tested in Question 1 of the exam. You will never be asked to prepare a
full consolidated primary statement (e.g. statement of financial position or statement of
profit or loss). Instead, you will be required to adjust a draft statement or an extract from a
primary statement and you will have to prepare calculations and/or workings in relation to
a consolidated primary statement. Most importantly, you will need to provide narrative
explanations to accompany your numerical answer. The marks are typically split
approximately 50%:50% between numerical and written parts of your answer.
Therefore, it is essential that you know and understand the principles behind group
accounting so that you can explain your calculations.
Chapter H covers the exam technique for approaching Question 1 in more detail.
130 Course Notes ACCA SBR

1.1 Different investments

There are three types of investments that you are likely to encounter in a group accounting question:
Typical
Investment Definition shareholding
Subsidiaries An entity that is controlled by the parent company >50%
Associates An entity over which the investor has significant 20% to 50%
influence
Joint venture An entity over which the parent has joint control Depends, but often
20% to 50%

1.2 Accounting for the investment in the parent’s separate financial

statements
In the parent’s separate financial statements, an investment in a subsidiary, associate or joint venture
can be measured in one of three ways:
 At cost;
 At fair value (as a financial asset under IFRS 9 Financial Instruments); or
 Using the equity method (as described in IAS 28 Investments in Associates and Joint Ventures).

2 Subsidiaries
2.1 Control
According to IFRS 10 Consolidated financial statements, a subsidiary is an entity that is controlled by
another entity. There are three elements in the definition of control:
 Power over the investee (whether or not that power is used)
 Exposure or rights to variable returns from the investee
 The ability to use power over the investee to affect the reporting entity’s returns from the other
company.
Using the concept of substance over form, it is possible to consolidate a company for which less than
50% of the shares are held, particularly if the other shares are held by a large number of non-
controlling (minority) shareholders. New disclosure requirements mean that even if it is determined
that an entity does not control another entity, management should disclose the information that is
considered in reaching that decision, so its judgement becomes more transparent.
This is considered particularly important in situations where companies may want to “hide” loss-
making subsidiaries and therefore not include them in their group accounts.
ACCA SBR Course Notes 131

ILLUSTRATION: DEFINITION OF CONTROL

Neilson purchases 35% of the ordinary shares of Green. Each ordinary share carries one voting right. The
remaining investors each own 4% or less of the ordinary shares of Green. A shareholder agreement gives
Neilson the right to appoint, remove and set the remuneration of management responsible for the key
business decisions of Green. Consent of 75% of the voting rights of shareholders is required to change
this agreement.
Even though Neilson does not have a majority shareholding, Neilson controls Green and Green would
be treated as a subsidiary of Neilson because the IFRS 10 three-part definition of control has been met:
 Neilson has power over Green – although Neilson does not have a majority shareholding, it has
power over Green through the shareholder agreement. This shareholder agreement cannot be
changed without Neilson’s consent as the 75% majority required to change the agreement
cannot be achieved without Neilson’s vote.
 Neilson is exposed to variable returns in the form of potential dividends and futures
increases/decreases in the share price.
 Neilson has the ability to use its power over Green – even if Neilson decides not to exercise its
right to appoint, remove and set the remuneration of management, the shareholder agreement
still gives it the power to do so.

2.2 Consolidated statement of financial position (CSFP)

2.2.1 Principles
As the parent (P) controls its subsidiaries (S), it is as if they are a single economic entity (substance
over form). This is what the group accounts are trying to represent.
Consolidation of subsidiaries into the group accounts is revision from Financial Reporting and the
approach to the CSFP is recapped below:
Section of CSFP Treatment Reason
Goodwill Intangible non-current This represents assets of the acquired subsidiary
asset (positive goodwill) that are not separately identified/recognised e.g.
reputation.
Assets and liabilities Add P + 100% S line by P controls all of S’s assets and liabilities (it is as if
line they are a single economic entity)
Share capital and share P’s only Group accounts are prepared for P’s shareholders
premium
Consolidated reserves P + Group % of S’s post- To show reserves generated under the control of
acquisition reserves the parent
Non-controlling interests Include in the equity To show the proportion of the net assets of S
(NCI) section of CSFP owned by external shareholders
132 Course Notes ACCA SBR

2.3 Consolidated statement of profit or loss and other comprehensive

income (CSPLOCI)
The parent (P) and 100% of the subsidiary’s (S) income, expenses and other comprehensive income
(OCI) are added across line by line to show control.
If the subsidiary is acquired part-way through the year, its income, expenses and OCI must be time-
apportioned based on the assumption that profits accrue evenly (e.g. if the group accounts are
prepared to a 31 December year-end and a subsidiary is acquired on 1 October, 3/12 of its income,
expenses and OCI must be included).
At the bottom of the CSPLOCI, an ownership reconciliation apportions group profit and total
comprehensive income between the owners of the parent and the non-controlling interests (NCI).
Section of CSPLOCI Treatment
Revenue P + 100% S X
Cost of sales P + 100% S (X)
Gross profit X
Distribution costs P + 100% S (X)
Administrative expenses P + 100% S (X)
Finance costs P + 100% S (X)
Profit before tax X
Income tax expense P + 100% S (X)
Profit for the year (PFY) A
Other comprehensive income P + 100% S X
Total comprehensive income (TCI) B

Profit (PFY) attributable to:

Owners of the parent (balancing figure) X
Non-controlling interests S’s PFY × NCI% X
A

TCI attributable to
Owners of the parent (balancing figure) X
Non-controlling interests S’s TCI × NCI% X
B
ACCA SBR Course Notes 133

The following working is required to calculate non-controlling interests:

PFY attributable to TCI attributable to
NCI NCI
PFY/TCI of the subsidiary for the year X (X)
(pro-rated for mid-year acquisition)
Provision for unrealised profit (if S is the seller) (X) (X)
Movement in fair value adjustment in the year (X)/X (X)/X
Impairment of goodwill in the year (under fair value method) (X) X
X X
NCI share × NCI % × NCI %
PFY/TCI attributable to NCI X X

2.4 Intragroup transactions and balances

Intragroup balances: Cancel intragroup sales/purchases:

(1) Make the balances agree Dr (↓) Revenue

Cr (↓) Cost of sales
Cash in transit
Dr (↑) Cash
Cr (↓) Receivables Elimination of unrealised profit on
Goods in transit inventories or property, plant on
equipment (if still held at the year end):
Dr (↑) Inventory
Cr (↑) Payables Dr (↑) Cost of sales/(↓) Retained earnings
Cr (↓) Inventory/PPE
(2) Cancel intragroup balances
Notes:
Dr (↓) Payables
Cr (↓) Receivables • Adjust the seller’s column in the
consolidated retained earnings working
(if balances agree, go straight to • If the subsidiary is the seller, the
step 2)
adjustment affects the NCI

2.5 Fair value adjustments to the subsidiary’s net assets

Examples of assets/
liabilities requiring fair Movement (e.g.
value adjustments At acquisition depreciation/sale) At year end
PPE X (X) X
Intangible e.g. brand X (X) X
Contingent liability (X) X (X)
X (X) X

To goodwill working To retained earnings To individual

working (sub’s column) assets/liabilities in CSFP
134 Course Notes ACCA SBR

2.6 Measuring non-controlling interests (NCI) at acquisition

There is a choice of two possible methods for measuring NCI at acquisition (an entity can choose on a
transaction by transaction basis). The two methods and the knock-on effects on other workings are
summarised below using an example of buying an 80% subsidiary.

Measure NCI at the proportionate

Measure NCI at fair value (no. of
share of the subsidiary’s net assets
shares × share price)
(sub’s net assets × NCI %)

Full goodwill method Partial goodwill method

(recognise 100% of goodwill) (recognise group goodwill only)
[e.g. 80% group + 20% NCI] [e.g. 80%]

CSFP:
 Deduct all of cumulative
impairment in goodwill working CSFP:
 Deduct group share (e.g. 80%)  Deduct all of cumulative
of cumulative impairment in impairment in goodwill working
consolidated retained earnings  Deduct all of cumulative
working impairment in consolidated
 Deduct NCI share (e.g. 20%) of retained earnings working
cumulative impairment in NCI
working

CSPL:
 Add all of the impairment loss CSPL:
for the year to expenses
Add all of impairment loss for the
 Deduct impairment loss for year to expenses
the year from sub’s PFY in NCI
working
ACCA SBR Course Notes 135

ILLUSTRATION: GOODWILL

Beaumont acquired 80% of the six million $1 equity shares of Carter on 1 January 2020 for cash of
$40 million. At that date, the fair value of the non-controlling interests (NCI) at acquisition was
$10 million and Carter had retained earnings of $25 million and no other reserves. The fair value of the
identifiable net assets was the same as the carrying amount with the exception of a property which
had a fair value of $4 million in excess of its carrying amount.
During the year ended 31 December 2020, Carter incurred losses and an impairment review was
performed, treating Carter as a cash-generating unit (CGU). The recoverable amount of the CGU was
$38 million. The carrying amount of the net assets of Carter at 31 December 2020 (including fair value
adjustments but excluding goodwill) was $30 million.
Required:
(a) Explain, with suitable workings, how the goodwill in Carter should be calculated at acquisition
under each of the following methods:
(i) Fair value method
(ii) Proportionate share of net assets method
(b) Discuss the calculation of the impairment loss at 31 December 2020 and why the impairment
loss of Carter would differ depending on how non-controlling interests are measured. Your
answer should include a calculation of the impairment loss and an explanation of the impact on
the consolidated financial statements of Beaumont.
SOLUTION
(a) Under both methods, consideration transferred is included at its fair value (here, the $40 million
cash paid) and the fair value of identifiable net assets are deducted. The difference is in the
measurement of non-controlling interests which will either be at fair value resulting in
recognising 100% of the goodwill of Carter or at the proportionate share of net assets resulting
in recognising only the group goodwill in Carter (relating to Beaumont Co’s 80% holding).
Fair value method Proportionate method
$m $m $m $m
Consideration transferred 40 40
Non-controlling interests 10 (20% × 35) 7
Net assets at acquisition:
Share capital 6 6
Retained earnings 25 25
Fair value adjustment 4 4
(35) (35)
15 12

The difference in the two goodwill figures of $3m ($15m ‒ $12m) relates to the goodwill in
Carter belonging to the non-controlling interests (fair value of $10m ‒ NCI share of net assets
$7m).
(b) The impairment is calculated by comparing the recoverable amount to the carrying amount
(including goodwill). As the recoverable amount relates to 100% of the subsidiary, goodwill
(when included in the carrying amount) must also relate to 100% of the subsidiary. Therefore,
where the proportional method of measuring NCI is used, the goodwill of $12 million, which is
the group goodwill only, needs to be grossed up from 80% to 100% ($12 million × 100/80 = $15
136 Course Notes ACCA SBR

million). This extra goodwill of $3 million ($15 million less $12 million) is known as ‘notional
goodwill’ because it is just used to calculate the impairment and is not recognised in the group
accounts. This is not necessary for the fair value method as the $15 million recognised already
represents 100% of goodwill. The impairment is calculated as follows:
$m $m
Carrying amount:
Net assets 30
Goodwill 15
45
Recoverable amount (38)
Impairment 7

When a cash-generating unit is impaired, the impairment is allocated first against goodwill.
Here, all $7 million can be allocated to the goodwill of $15 million. Under the fair value method,
this will result in goodwill of $8 million ($15 million ‒ $7 million). However, when allocating the
impairment against the goodwill using the proportionate method, the impairment needs to be
netted back down to 80% of the $7 million (80% × $7 million = $5.6 million) and the resulting
goodwill will be $6.4 million ($12 million ‒ $5.6 million).

EXAM SMART
In your Computer-Based Exam, the ACCA SBR examining team recommend the following:
 Numerical answers – answer in the spreadsheet
 Written answers – answer in the word processor
You should try and avoid narrative parts of answers in the spreadsheets but if you do write a
small amount of narrative in the spreadsheet, avoid writing it all in one cell as it is hard for
the marker to read. Write each sentence in a new cell.
It is also important to show your calculations. This can be done in one of three ways:
 In separate workings
 In brackets on the face of your proforma
 With an excel formula.

LECTURE EXAMPLE D1.1: MEASUREMENT OF NCI

On 1 January 2019, Beswick acquired a 75% subsidiary, Hamdi. At acquisition, the fair value of Hamdi
Co’s net assets was $100 million, Hamdi’s retained earnings were $60 million and the fair value of the
non-controlling interests (NCI) in Hamdi Co was $30 million. At acquisition the fair value of Hamdi’s net
assets was the same as the carrying amount with the exception of a property which had a fair value of
$5 million in excess of its carrying amount and a remaining useful life of 5 years.
During the year ended 31 December 2020, Hamdi sold goods to Beswick for $10 million at a margin of
20%. Half of these goods are still inventory at the year end. At the current year end of 31 December
2020, Beswick has retained earnings of $250 million and Hamdi has retained earnings of $83 million.
Beswick has no other subsidiaries.
ACCA SBR Course Notes 137

Goodwill in Hamdi amounts to $20 million under the fair value method and $15 million under the
proportionate method. An impairment review of Hamdi’s goodwill at 31 December 2020 revealed that
a 10% write down was necessary.
Required
(a) Calculate non-controlling interests in Hamdi under both the fair value method and the
proportionate method.
(b) Calculate the consolidated retained earnings for inclusion in the consolidated statement of
financial position of the Beswick group as at 31 December 2020.
SOLUTION
(a) Non-controlling interests
Fair value Proportionate
method method
$m $m
NCI at acquisition
NCI share of post-acquisition reserves

NCI share of impairment of goodwill

(b) Consolidated retained earnings

Beswick Hamdi
$m $m
At the year end
Fair value depreciation
Provision for unrealised profit (PUP)

At acquisition

Group share of Hamdi post-acquisition

Impairment of goodwill
(fair value method: )
(proportionate method: )
138 Course Notes ACCA SBR

3 Further detail on goodwill

Goodwill is calculated as:
 The fair value of consideration transferred; plus
 Non-controlling interests; less
 The fair value of the net identifiable assets acquired and liabilities assumed

3.1 Consideration transferred

The consideration transferred is measured at fair value at the date of acquisition.
Item Treatment
Deferred consideration Discount to present value to measure its fair value
Contingent consideration Measure at fair value at the acquisition date
Account for any changes in the estimate as follows:
(a) If the change arises from additional information about facts and
circumstances that existed at the acquisition date (e.g. numerical
error), adjust goodwill (if within 12 months of acquisition)
(b) If there is any other reason for the change (e.g. meeting profit
targets)
(i) Liability (e.g. contingent consideration = cash) – remeasure
to fair value with gains or losses through profit or loss
(ii) Equity (e.g. contingent consideration = ordinary shares) – do
not remeasure

Acquisition-related costs
 Acquisition related costs (e.g. legal fees) are recognised as expenses (rather than included in
the goodwill calculation).
 The exception is costs to issue debt or equity instruments which are deducted from the
financial liability or equity.

3.2 Fair value of net identifiable assets acquired and liabilities assumed

KEY TERMS
Fair value: 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. (IFRS 3 and IFRS 13)

The subsidiary's identifiable assets, liabilities and contingent liabilities are recognised when they meet
the following criteria:
 In the case of an asset or liability (other than an intangible asset), when it is probable that future
economic benefits will flow to / from the acquirer, and its fair value can be measured reliably;
 In the case of an intangible asset or a contingent liability, its fair value can be measured
reliably.
This means that you should include contingent liabilities as an actual liability when calculating the net
assets of the subsidiary at acquisition in the goodwill working and include these contingent liabilities in
the group accounts.
Equally, internally generated intangible assets not recognised in the subsidiary’s financial statements
as prohibited by IAS 38 e.g. brands, should also be included in the net assets of the subsidiary at
acquisition in the goodwill working and included as intangible assets in the group accounts.
ACCA SBR Course Notes 139

Changes to provisional initial measurement figures

Adjustments to provisional figures for the cost of the combination and fair value of assets, liabilities,
contingent liabilities acquired and contingent consideration may only be made within the
measurement period.
The measurement period is the period during which an acquirer can adjust any provisional amounts
used in the goodwill calculation. It cannot exceed 12 months from the acquisition date.
For example, the finalisation of an estimate of an acquired asset’s fair value can be adjusted through
the goodwill calculation if the revised figure is received within 12 months of the date of acquisition.
Adjustments can only be made as a result of new facts and circumstances that existed at the
acquisition date.
After the measurement period, goodwill is only adjusted to correct errors (IAS 8).

3.3 Gain on a bargain purchase

It is possible to pay less for the company than the net assets of the company the company is worth.
For example:
A business buys 100% of the share capital of another for $1,000. The net assets of the business
acquired are $1,200. There is therefore a gain on a bargain purchase (“negative goodwill”) of $200. A
gain of $200 is immediately recognised in profit or loss (and therefore, in consolidated retained
earnings).
Bargain purchases may happen in a forced sale (where the seller acts under compulsion). Bargain
purchases are relatively rare. Before recognising a gain, the acquirer should review the calculation:
 Have all the subsidiaries assets and liabilities been recognised?
 Are all the elements of the calculation (assets and liabilities; NCI; consideration) correctly
measured?

4 Requirements for a group to prepare consolidated financial

statements
4.1 Exemption from preparing group accounts
Not all groups have to prepare group accounts. A parent need not prepare group accounts if:
 It is itself a wholly-owned subsidiary, or partially-owned with the consent of the non-controlling
interest and
 Its debt or equity instruments are not publicly traded and
 The ultimate or any intermediate parent produces group accounts that comply with IFRS
Standards.

4.2 Exclusion of a subsidiary from the group accounts

Directors may want to exclude a subsidiary from the group accounts, particularly if its results would
worsen the financial position of the group. IFRS 10 does not allow entities which meet the definition of
a subsidiary to be excluded from consolidated financial statements.
140 Course Notes ACCA SBR

5 Associates
5.1 Definition
According to IAS 28 Investments in associates, an associate is an entity over which the investor has
significant influence.

KEY TERMS
Significant influence is the power to participate in the financial and operating policy
decisions of the associate but is not control or joint control over those policies.

Significant influence is normally presumed where an investor holds more than 20% of the voting
power of the investee. According to IAS 28, significant influence can also be shown by:
 Representation on the board of directors
 Participation in policy making processes
 Material transactions between the investor and investee
 Provision of essential technical information
It is important to consider the substance of the relationship. It is possible for an investor to have
significant influence with less than 20% of the voting power; an investor may not be able to exercise
significant influence with more than 20% of the voting power.

5.2 Accounting for associates

Associates are included in the consolidated financial statements using the equity method. This involves
including the group share of the associate in two lines in each of the CSFP and CSPLOCI.

5.2.1 Consolidated statement of financial position

In non-current assets, ‘investments in associates’ should be included, calculated as follows:
$
Cost of associate X
Share of post-acquisition retained earnings (and other reserves) X
Share of unrealised profits if the parent is the seller (X)
Less: Impairment losses on associate to date (X)
X

In consolidated retained earnings (and other consolidated reserves), the group share of the associate’s
post-acquisition retained earnings (and other reserves) would be included. The consolidated retained
earnings working would have another column for the associate.
The impairment loss on the associate would also be deducted in the consolidated retained earnings
working (in the parent’s column).

5.2.2 Consolidated statement of profit or loss and other comprehensive income

The two lines to include are:
 Group share of associate’s profit for the year (shown above profit before tax)
 Group share of associate’s other comprehensive income
ACCA SBR Course Notes 141

The group share of the associate’s profit for the year is calculated as follows:
$
Group share of associate’s profit for the year X
Less: Current year impairment loss (X)
Less: Group share of unrealised profits if associate is the seller (X)
X

5.2.3 Unrealised profit

The group share of unrealised profit on transactions between the associate and the group should be
eliminated.
If the parent makes the sale:
Dr (↑) Cost of sales/(↓) Retained earnings *
Cr (↓) Investment in associate
If the associate makes the sale:
Dr (↓) Share of associate’s profit/(↓) Retained earnings *
Cr (↓) Inventory
Always make the adjustment to retained earnings in the parent’s column, otherwise you will end up
multiplying by the group share twice.

6 Joint arrangements – IFRS 11

A joint arrangement is an arrangement over which two or more parties have joint control, i.e. where
the unanimous consent of those parties sharing control is required to make decisions about the
relevant activities.
After determining that joint control exists, joint arrangements are divided into two types, each with
different accounting.

ILLUSTRATION: JOINT CONTROL

Three parties establish an arrangement. X has 55% of the voting rights, Y has 35% of the voting rights
and Z has 10% of the voting rights. The contractual arrangement between X, Y and Z states that at least
80% of voting rights are required to make key business decisions about the arrangement.
Even though X can block any decision, it does not have outright control of the arrangement because it
needs the agreement of Y. The requirement in the arrangement for at least 80% of the voting rights for
key business decisions implies that X and Y have joint control because between them, they have 90%
of the voting rights (greater than the 80% threshold). However, Z does not have joint control because
decisions can be made without Z’s consent. The arrangement would still qualify as a joint arrangement
with X and Y sharing control.
142 Course Notes ACCA SBR

6.1 Joint operation

This is where the jointly controlling parties (the “joint operators”) have rights to the assets and
obligations for the liabilities, relating to the arrangement.
Generally speaking, there is no separate entity. An example of this might be two restaurants that
jointly control a farm, sharing the costs and revenues and each taking a share of the farm’s output or
two oil companies sharing an oil pipe in the North Sea.
In this situation, in its separate financial statements, a joint operator will recognise its own assets,
liabilities, income, expenses and transactions (e.g. for the purchase of assets), including its share of
those incurred jointly.

6.2 Joint venture

A joint venture is a joint arrangement whereby the jointly controlling parties (the ‘joint venturers’)
have rights to the net assets of the arrangement.
In this instance a separate entity is established, in which each venturer has an interest. The entity
operates in the same way as any other entity, i.e. it earns income, incurs expenses and controls its own
assets and liabilities.
Since a separate entity is established, separate accounting records are kept.
Joint ventures must be accounted for under the “equity method” in the consolidated accounts i.e.
treat the joint venture in the same way as an associate:
 CSFP:
– Investment in joint venture (Cost + Share of post-acquisition reserves ‒ Impairment)
– Include group share of joint venture’s post-acquisition retained earnings in consolidated
retained earnings
 CSPLOCI:
– Group share of joint venture’s profit for the year
– Group share of joint venture’s other comprehensive income
In a similar way to the requirements for associates, IFRS 11 states that the venturer’s share of any
unrealised profit to or from the joint venture should be eliminated on consolidation.

LECTURE EXAMPLE D1.2: JOINT VENTURES

On 1 January 2017, Hill set up a joint arrangement with Wilson. The joint arrangement was set up as a
separate entity, Jones. Hill and Wilson each paid $10m to acquire a 50% stake in the equity shares in
Jones. The two parties have joint control and they have rights to the net assets of Jones.
At the current year end of 31 December 2020, Jones has retained earnings of $30 million. In the year
ended 31 December 2020, Jones made a profit for the year of $8 million and recognised other
comprehensive income for the year of $2 million.
Required
Explain how Hill should account for its investment in Jones in its consolidated financial statements for
the year ended 31 December 2020.
ACCA SBR Course Notes 143

SOLUTION

7 Disclosure of interests in other entities – IFRS 12

IFRS 12 requires companies to disclose:
 The nature and extent of any interest held in other entities
 Any assumptions and judgements used in determining that nature
 Any risks associated with the interest
 The effects of the interest on their financial position, performance and cash flow.

8 Definition of a business
How we define a business is important, because the acquisition of a business is dealt with differently
from the purchase of a group of assets that do not constitute a business. If an entity acquires a
business IFRS 3 applies: the entity measures identifiable assets and liabilities at fair value and
recognises goodwill. But if an entity acquires a group of assets that are not a business, the entity
accounts for an asset acquisition.

Acquisition of a group of assets (that

Acquisition of a business are not a business)

• Measure identifiable assets Account for as an asset acquisition:

and liabilities at fair value Dr Assets
• Recognise goodwill Cr Cash/Payable
144 Course Notes ACCA SBR

KEY TERMS
 A business is an integrated set of activities and assets that is capable of being
conducted and managed for the purpose of providing goods or services to customers,
generating investment income (dividends or interest) or generating other income from
ordinary activities.

A business consists of inputs and processes applied to those inputs that have the ability to contribute
to the creation of outputs.
 Inputs are economic resources, e.g. non-current assets, intellectual property, the ability to
obtain access to necessary materials, rights and employees.
 Processes are systems, standards, protocols and rules, e.g. strategic management processes,
operational processes and resource management processes.
 Outputs are the result of inputs and the processes applied to the inputs, e.g. goods or services
to customers, investment income.
Assessing whether a transaction is the acquisition of a business is essentially a two-stage process:

STAGE 1:
Is substantially all of the fair value of the gross assets acquired in a
single identifiable asset or group of similar identifiable assets?

Yes No

STAGE 2:
Does the acquired set of activities and assets include an
input and a substantive process that together contribute
to the ability to create outputs?

No Yes

Acquisition of assets Acquisition of a

(not a business) business
ACCA SBR Course Notes 145

ILLUSTRATION: STAGE 1

An entity purchases a set of newly built three-bedroomed family houses that can be leased, but no
employees, other assets, or other activities are transferred. The houses are in the same geographical
areas with similar potential occupants.
Stage 1:
The entity has purchased a group of similar identifiable assets because the assets are similar (three-
bedroomed family houses in the same geographical area with similar potential occupants). Therefore,
substantially all the fair value of the gross assets acquired is concentrated in this group of similar
tangible assets. This means that the purchase should be treated as an acquisition of assets (not a
business).

ILLUSTRATION: STAGE 2

An entity purchases a manufacturing facility and the related equipment. It also hires the employees.
The manufacturing facility was closed down before it was purchased.
Stage 1:
The manufacturing facility and related equipment are not similar assets because they are in different
classes of tangible assets. There is significant fair value in both the manufacturing facility and related
equipment so the fair value of the gross assets acquired is not substantially all concentrated in a
group of similar assets.
Therefore, the entity should move onto Stage 2.
Stage 2:
As the manufacturing facility is not currently creating outputs, to qualify as a business, the process is
only considered substantive if the inputs include an organised workforce and other inputs that can be
developed into outputs. Here, there is a workforce and equipment which could be used to generate
outputs, but there are no other acquired inputs (such as raw materials) that could be developed or
converted into outputs (such as goods for resale).
Therefore, the acquired set of activities and assets do not include an input and a substantive process
that together contribute to the ability to create outputs. This means that the set of activities and assets
purchased is not a business. Instead, it should be treated as an acquisition of assets.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you deal confidently with any FR level group financial statements question
including both subsidiaries and associates?
Do you understand the difference between a joint operation and a joint venture?
Do you understand how to treat joint operations and joint ventures in the
consolidated financial statements?
Can you explain the definition of a business and identify whether a purchase
transaction is a business combination or simply an asset acquisition?
146 Course Notes ACCA SBR

Chapter D1 – Lecture example solution

Example D1.1
(a) Non-controlling interests
Fair value Proportionate
method method
$m $m
NCI at acquisition 30 (25% 25
×
100)
NCI share of post-acquisition reserves
25% × (83 ‒ 60 ‒ [5 × 2/5] ‒ [10 × ½ × 20%]) 5 5
NCI share of impairment of goodwill
25% × (10% × 20) (0.5) (0)
34.5 30

(b) Consolidated retained earnings

Beswick Hamdi
$m
At the year end 250 83
Fair value depreciation (5 × 2/5) (2)
Provision for unrealised profit (PUP)
(10 × ½ × 20%) (1)
At acquisition (60)
20
Group share of Hamdi post-acquisition
(75% × 20) 15
Impairment of goodwill
(fair value method: 75% × 10% × 20 = 1.5)
(proportionate method: 10% × 15 = 1.5) (1.5)
263.5
ACCA SBR Course Notes 147

Example D1.2
Hill has joint control of Jones and rights to its net assets. Therefore, Jones is a joint venture of Hill.
Hill should equity account for Jones in its consolidated financial statements which involves bringing in
the group share (50%) of Jones. In the consolidated statement of financial position, this means
recognising an investment in the joint venture (cost plus share of post-acquisition reserves less any
impairment). The calculation is shown below:
Investment in joint venture:
$m
Cost of joint venture 10
Share of post-acquisition reserves (50% × [30 – 0]) 15
25

The group share of Jones’ post-acquisition reserves of $15m will also be included in consolidated
retained earnings. Note that as Hill acquired its interest in Jones on incorporation, its retained earnings
at acquisition were zero.
In the consolidated statement of profit or loss and other comprehensive income, Hill Co should include
the group share of Jones’ profit for the year of $4m (50% × $8m) and the group share of Jones’ other
comprehensive income of $1m (50% × $2m).
148 Course Notes ACCA SBR
 149

D2

Group statements of cash

flows

1 Indirect method statement of cash flows: proforma

31.12.2017
$000 $000
Cash flows from operating activities
Profit before taxation 3,265
Adjustment for:
Depreciation 520
Impairment of goodwill 55
Profit on disposal of property, plant and equipment (30)
Profit on disposal of subsidiary (40)
Share of associate’s profit (15)
Investment income (600)
Interest expense 400
3,555
Increase in trade and other receivables (600)
Decrease in inventories 950
Decrease in trade payables (1,630)
Cash generated from operations 2,275
Interest paid (390)
Income taxes paid (850)
Net cash from operating activities 1,035
150 Course Notes ACCA SBR

31.12.2017
$000 $000
Cash flows from investing activities
Acquisition of subsidiary X, net of cash acquired (460)
Disposal of subsidiary Y, net of cash disposed of 190
Purchase of property, plant and equipment (320)
Dividends received from associate 6
Interest received 214
Dividends received 150
Net cash used in investing activities (220)
Cash flows from financing activities
Proceeds from issue of share capital 350
Proceeds from long-term borrowings 164
Dividends paid to non-controlling interests (7)
Dividends paid by parent company (1,197)

Net cash used in financing activities (690)

Net increase in cash and cash equivalents 125

Cash and cash equivalents at beginning of period 135
Cash and cash equivalents at end of period 260

EXAM SMART
This proforma is the same as for individual company statements of cash flows that you saw
in your Financial Reporting studies. The only difference for a group statement of cash flows
is the addition of the six shaded headings. (You only need the heading to remove the profit
on disposal of the subsidiary, if the subsidiary sold is treated as a ‘continuing operation’.)

1.1 Definitions

KEY TERMS
 Cash Comprises cash on hand and demand deposits. (Note: overdrafts are considered
to be “negative cash” and should be netted off against any cash balances.)
 Cash equivalents These are short-term, highly liquid investments that are readily
convertible into known amounts of cash and which are subject to an insignificant risk of
changes in value.
ACCA SBR Course Notes 151

1.2 Direct method

You may recall from the Financial Reporting paper that there is an alternative to the indirect method
of presenting cash flows, the “direct method”. This technique uses a different approach to the
operating activities section:
Cash flows from operating activities $000
Cash receipts from customers 28,990
Cash paid to suppliers and employees (26,715)
Cash generated from operations 2,275
Interest paid (390)
Income taxes paid (850)
Net cash from operating activities 1,035
And then continue using exactly the same headings as before…
Only use the direct method when the question specifically requests you to do so.

EXAM SMART
 The SBR exam has a significant emphasis of the usefulness of financial information to
stakeholders, in particular, investors.
 A question could ask you to discuss the usefulness of the direct and indirect methods to
stakeholders.

Usefulness of indirect method to stakeholders Disadvantages of indirect method to stakeholders

More disaggregated information – provides Risk of information overload – only three lines in
stakeholders with additional useful information direct method
Adjustments clearly show the difference between Complex accounting adjustments to profit under the
accruals accounting and cash accounting indirect method – direct method is easier to
understand
Enables stakeholders to assess the impact of Harder to compare to other companies due to
accounting policies on profit (e.g. depreciation) different accounting policies – direct method is more
directly comparable
Enables stakeholders to assess working capital Less helpful than direct method in predicting future
management (changes in receivables, inventories cash flows
and payables)
Provides an indication of the quality of operating
profit (e.g. effect of ‘one off’ transactions such as
profits/losses on disposal of assets/subsidiaries)

1.3 Interest and dividends

IAS 7 allows interest and dividends (paid and received) to be classified as operating, investing or
financing activities, provided the classification is consistent from period to period. The practice
adopted in these notes is:
 Interest received – investing activities
 Interest paid – operating activities
 Dividends received – investing activities
 Dividends paid – financing activities.
152 Course Notes ACCA SBR

2 Consolidated statement of cash flows

A consolidated statement of cash flows only deals with cash movements external to the group.

Therefore, a dividend paid by a subsidiary to its parent will not affect the group’s cash flow.
However, the following cash flows ARE relevant:
 Dividends paid to non-controlling interests
 Dividends received from associates
 Payments to acquire subsidiaries
 Proceeds from sale of subsidiaries

2.1 Non-controlling interests (NCI)

The only payment of cash to non-controlling interest shareholders will be dividends. Such payments
are normally included under the ‘Cash flows from financing’ heading.

P NCI

Dividends paid

S
ACCA SBR Course Notes 153

LECTURE EXAMPLE D2.1: DIVIDENDS PAID TO NON-CONTROLLING INTERESTS

Consolidated statement of profit or loss and other comprehensive income for the year ended
31 December 2017
$m
Group profit before tax 40
Income tax expense (10)
Profit for the year 30

Other comprehensive income:

Gains on property revaluation 15
Income tax expense to gain on property revaluation (5)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 40

Profit attributable to:

Owners of the parent 22
Non-controlling interests 8
30

Total comprehensive income attributable to:

Owners of the parent 29
Non-controlling interests 11
40

Consolidated statement of financial position

2017 2016
$m $m
Non-controlling interests 104 100
During the year, the parent acquired a new partly owned subsidiary. The group elected to measure the
non-controlling interests in the new subsidiary at their fair value of $2 million.
Required:
Calculate the dividend paid to non-controlling interests.
SOLUTION
Non-controlling interests $m
Bal b/f
TCI Non-controlling interests
On acquisition of new subsidiary
Dividend paid to non-controlling interests (balancing figure)
Bal c/f
154 Course Notes ACCA SBR

2.2 Dividends from Associates and Joint Ventures

Dividends received from associates and joint ventures are normally included as a separate item in
‘Cash flows from investing activities’.

P
Dividends received

A/JV S

Under the indirect method, in the ‘operating activities’ section of the statement of cash flows, the
share of the profit of the associate or joint venture must be removed from profit before tax as an
adjustment.

LECTURE EXAMPLE D2.2: DIVIDENDS RECEIVED FROM ASSOCIATES

Consolidated statement of profit or loss and other comprehensive income for the year ended
31 December 2017
$m
Profit before interest and tax 60
Share of profit of associate 15
Profit before tax 75
Income tax expense (25)
Profit for the year 50

Other comprehensive income:

Gains on property revaluation 20
Share of other comprehensive income of associate 5
Income tax relating to other comprehensive income (4)
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 71

Profit attributable to:

Owners of the parent 40
Non-controlling interests 10
50

Total comprehensive income attributable to:

Owners of the parent 51
Non-controlling interests 20
71

Consolidated statement of financial position for the year ended 31 December 2017
2017 2016
$m $m
Investment in associate 94 80
ACCA SBR Course Notes 155

Required:
Calculate the dividend received from associates and complete the profit before tax and associate lines
in the extract from the operating activities section of the consolidated statement of cash flows.
SOLUTION
Investment in associate $m
Bal b/f
Share of associate’s profit and other comprehensive income
Dividends received from associate (balancing figure)
Bal c/f

Extract from statement of cash flows (operating activities) $m

Profit before tax
Adjustment for:
Share of profit of associate

3 Acquisition and disposal of subsidiaries

3.1 Cash flows on acquisition or disposal of a subsidiary
There are two cash flows associated with the acquisition or disposal for a subsidiary:

Acquisition

P (1) Cash paid to buy the

Cash (1) shares

New
subsidiary (2) Cash or overdraft
Cash (2) balance consolidated
S for the first time

Disposal

(1) Cash received from

P Cash (1) selling the shares
Buyer of
subsidiary
(2) Cash or overdraft
S1 S2
Cash (2) balance deconsolidated
156 Course Notes ACCA SBR

The two cash flows should be netted off and shown as a single line for an acquisition and a single line
for a disposal, under the heading ‘cash flows from investing activities’.
For a disposal of a subsidiary, under the indirect method, the treatment in the ‘operating activities’
section depends on whether the subsidiary sold has been classified as a ‘continuing operation’ or a
‘discontinued operation’ under IFRS 5 Non-current Assets Held for Sale and Discontinued Operations:
 Subsidiary sold classified as a ‘continuing operation’ – eliminate the group profit or loss on
disposal of the subsidiary as an adjustment in the ‘operating activities’ section of the group
statement of cash flows
 Subsidiary sold classified as a ‘discontinued operation’ – in the consolidated SPL, the subsidiary
sold will be presented in a single line combining the subsidiary’s profit or loss up to the disposal
date and the group profit or loss on disposal. The question will give you a breakdown of this
figure.
– Add together the profit before tax of the continuing operations and the discontinued
operation (this will be the starting point of the ‘operating activities’ section)
– You do not need to eliminate the group profit or loss on disposal figure as this will not be
included in the profit before tax figure above

ILLUSTRATION: ACQUISITION OF SUBSIDIARY

Hughes buys a new subsidiary in the year. Consideration comprises 1 million shares with a fair value of
$2.50 each and cash of $6 million. At the acquisition date, Hughes Co had a cash balance of $3 million
and an overdraft of $1 million.
Required:
Show how the acquisition of the new subsidiary be presented in the ‘cash flow from investing
activities’ section of the consolidated statement of cash flows of Hughes Co.
SOLUTION
Extract from the consolidated statement of cash flows
Cash flows from investing activities $m
Acquisition of subsidiary, net of cash acquired (4)

Working $m
Cash paid to acquire subsidiary (6)
Cash consolidated for the first time 3
Overdraft consolidated for the first time (1)
(4)

Note: The share consideration is not cash so it is excluded from the statement of cash flows. It would
be included in the combined share capital and share premium working to calculate cash received from
share issues in the year.
ACCA SBR Course Notes 157

LECTURE EXAMPLE D2.3: DISPOSAL OF SUBSIDIARY

Norton Group sold its 100% owned subsidiary Sambridge during the year for cash proceeds to
$26 million. Sambridge has a cash balance of $7 million at the disposal date. The group profit on
disposal of Sambridge amounted to $3 million. Consolidated profit before tax was $50 million.
Sambridge was classified as part of ‘continuing operations’ in the consolidated statement of profit or
loss as it did not meet the IFRS 5 definition of a ‘discontinued operation’.
Required:
Show how the cash flows associated with the disposal of Sambridge and the profit on disposal of the
subsidiary should be presented in the consolidated statement of cash flows of the Norton Group.
SOLUTION
Extract from the consolidated statement of cash flows
Cash flows from operating activities $m
Profit before tax
Adjustments:
Group profit on disposal

Cash flow from investing activities

Disposal of subsidiary, net of cash disposed

Working $m
Cash received on disposal of subsidiary
Cash deconsolidated

3.2 Effect on asset and liability workings

Each of the individual assets and liabilities of the subsidiary acquired or disposed of must be shown as
a non-cash movement in the relevant asset and liability workings when comparing group statements
of financial position to calculate cash flows (e.g. change in inventories; purchase of property, plant and
equipment).
Acquisition Disposal
Treatment in workings Add acquisition date assets and Deduct disposal date assets and
liabilities of subsidiary acquired in liabilities of subsidiary sold in the
the relevant workings. relevant workings.
Reason The new subsidiary’s assets and The sold subsidiary’s assets and
liabilities are consolidated for the liabilities are deconsolidated as the
first time (this is a non-cash subsidiary is no longer part of the group
increase in assets and liabilities). (this is a non-cash decrease in assets
and liabilities).
158 Course Notes ACCA SBR

ILLUSTRATION: ASSET AND LIABILITY WORKINGS (FOR A DISPOSAL)

On 30 September 2019, Mason Group disposed of an 80% subsidiary, Grainger. At the disposal date,
Grainger had a current tax liability of $12 million and a deferred tax liability of $5 million. The balances
in Mason Group’s consolidated statement of financial position as at 31 December were as follows:
2019 2018
$m $m
Current tax liability 90 95
Deferred tax liability 14 20

The tax expense in the consolidated statement of profit or loss for the year was $40 million. No tax
had been recognised in other comprehensive income.
Required:
Calculate the amount of tax paid for inclusion in the ‘operating activities’ section of the consolidated
statement of cash flows of the Mason Group for the year ended 31 December 2019.
SOLUTION
Tax (current and deferred) $m
Bal b/f (95 + 20) 115
Tax expense 40
Disposal of subsidiary (12 + 5) (17)
Tax paid (balancing figure) (34)
Bal c/f (90 + 14) 104

Note: Even though Grainger Co was an 80% sub, group accounting requires 100% of assets and
liabilities to be consolidated (and therefore, deconsolidated) for a partially-owned subsidiary to show
control. Therefore, 100% of Grainger Co’s current and deferred tax balances are deconsolidated in the
above working.

LECTURE EXAMPLE D2.4: ASSET AND LIABILITY WORKINGS (FOR AN ACQUISITION)

On 1 November 2019, Knowles Group acquired a 90% subsidiary, Williams. At that date, Williams has
property, plant and equipment with a carrying amount of $6 million.
During the year ended 2019, Knowles Group charged depreciation of $7 million and acquired new
equipment under lease agreements totalling $9 million.
Property, plant and equipment in the Knowles Group statement of financial position at 31 December
2019, amounted to:
2019 2018
$m $m
Property, plant and equipment 100 80
Required:
Calculate the cash paid to purchase property, plant and equipment for the Knowles Group for the year
ended 31 December 2019.
ACCA SBR Course Notes 159

SOLUTION
Property, plant and equipment $m
Bal b/f
Acquisition of subsidiary
Acquired under lease agreements
Depreciation
Cash purchases (balancing figure)
Bal c/f

LECTURE EXAMPLE D2.5: EXTRACT FROM CONSOLIDATED STATEMENT OF CASH FLOWS

Background
The following are extracts from the consolidated statements of financial position of the Peter Group.
Extracts from the group statement of financial position as at 31 December:
2017 2016
$m $m
Goodwill 184 ‒
Inventories 1,500 1,100
Trade receivables 1,420 900
Trade payables 1,610 1,390
Extract from the group statement of profit or loss for the year ended 31 December 2017:
$m
Revenue 11,800
Cost of sales (8,500)
Gross profit 3,300
Distribution costs and administrative expenses (2,257)
Profit before tax 1,043
Depreciation charged for the year ended 31 December 2017 was $720 million.
On 1 October 2017 Peter acquired 80% of Hazel by issuing 100 million shares at an agreed value of
$2.50 per share and $200 million in cash. Non-controlling interests on acquisition of Hazel Co were
calculated using the proportionate method.
At the acquisition date, the carrying amount (and fair value) of Hazel’s net assets was as follows:
$m
Property, plant and equipment 210
Inventories 80
Trade receivables 40
Cash and cash equivalents 20
Trade payables (20)
Tax payables (10)
320

Required:
Draft an explanatory note to the directors of Peter which should include:
(a) A calculation of cash generated from operations using the indirect method for the year ended
31 December 2017; and
(b) An explanation of the specific adjustments required to the group profit before tax to calculate
the cash generated from operations.
160 Course Notes ACCA SBR

SOLUTION
(a) Cash generated from operations for the year ended 31 December 2017
$m
Cash flows from operating activities
Profit before tax
Adjustments for:
Depreciation
Impairment of goodwill (W2)
Increase in inventories
Increase in trade receivables
Increase in trade payables
Cash generated from operations

Workings
(W1) Goodwill on acquisition of Hazel Co
$m
Consideration transferred:
Shares
Cash
Non-controlling interests
Less: Fair value of net assets at acquisition

(W2) Goodwill (to find impairment loss for the year)

$m
Bal b/f
Acquisition of subsidiary (W1)
Impairment (balancing figure)
Bal c/f

(W3) Movements in working capital

Inventories Receivables Payables
$m $m $m
Bal b/f
Acquisition of subsidiary
Increase/(decrease) [balancing figure]
Bal c/f

(b) Explanation of adjustments to profit before tax

ACCA SBR Course Notes 161

LECTURE EXAMPLE D2.6: DISPOSAL

Background
Below are extracts from the consolidated financial statements of the Trafford Group.
Extracts from the consolidated statement of financial position as at 30 June
2016 2015
$m $m
Inventories 638 450
Receivables 701 328
Trade payables 350 400
Pension liability 50 40
Extract from the consolidated statement of profit or loss for the year ended 30 June 2016
$m
Continuing operations
Profit before tax 1,134
Income tax expense (340)
Profit for the year 794
Discontinued operations
Profit for the year from discontinued operations 350
You are given the following information:
(1) Trafford sold its entire interest in Anfield on 31 March 2016 for $500 million cash. Trafford
acquired an 80% interest in Anfield on incorporation several years ago. The net assets at the
date of disposal were:
$m
Property, plant and equipment 380
Inventories 60
Receivables 42
Cash and cash equivalents 30
Trade payables (62)
450

Anfield has been classified as a discontinued operation in the consolidated statement of profit
or loss. The profit for the year from discontinued operations can be analysed as follows:
$m
Profit before tax 300
Income tax expense (90)
Group profit on disposal of Anfield 140
350

(2) The depreciation charge for the year was $100 million.
(3) The pension liability comprises the following
$m
Pension liability b/f 40
Expense for the period 20
Contributions paid in the period (15)
Remeasurement losses 5
Pension liability c/f 50

(4) There has been no impairment of goodwill in the year.

162 Course Notes ACCA SBR

Required:
Draft an explanatory note to the directors of Trafford which should include:
(a) A calculation of cash generated from operations using the indirect method for the year ended
30 June 2016; and
(b) An explanation of the treatment of the pension in the statement of cash flows.
SOLUTION
(a) Cash generated from operations for the year ended 30 June 2016

$m
Cash flows from operating activities
Profit before tax
Adjustments for:
Depreciation
Pension expense
Pension contributions paid
Increase in inventories
Increase in trade receivables
Increase in trade payables
Cash generated from operations

Workings
(W1) Movements in working capital
Inventories Receivables Payables
$m $m $m
Bal b/f
Disposal of subsidiary
Increase/(decrease) [balancing figure]
Bal c/f

(b) Explanation of the treatment of the pension

ACCA SBR Course Notes 163

4 Acquisitions and disposals of associates and joint ventures

Receipts and payments of cash from selling or acquiring associates and joint ventures should be
included under the heading ‘Cash flows from investing activities’.
Any dividends received from associates and joint ventures would also be included under ‘investing
activities’.
Under the indirect method, in the ‘operating activities’ section of the statement of cash flows, the
share of the profit of the associate or joint venture must be removed from profit before tax as an
adjustment.

EXAM SMART
As explained in Chapter D1, you will never have to prepare a full consolidated statement of
cash flows (or any other primary statement), in the Strategic Business Reporting exam. If
Question 1 tests consolidated statement of cash flows, you will be asked to adjust a draft
consolidated statement of cash flows or an extract from the statement of cash flows with
accompanying explanations (rather than a full consolidated statement of cash flows). See
Chapter H for more information.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you prepare a statement of cash flows for a group, including dividends paid to
non-controlling interests and dividends received from associates and joint ventures?
Do you know how to calculate and present cash flows where a group has acquired or
disposed of a subsidiary during the period?
164 Course Notes ACCA SBR

Chapter D2 – Lecture example solutions

Lecture example D2.1
Non-controlling interests $m
Bal b/f 100
TCI Non-controlling interest 11
On acquisition of new subsidiary 2
Dividend paid to non-controlling interests (balancing figure) (9)
Bal c/f 104

Lecture example D2.2

Investment in associate $m
Bal b/f 80
Share of associate’s profit and other comprehensive income (15 + 5) 20
Dividends received from associate (balancing figure) (6)
Bal c/f 94

Extract from statement of cash flows (operating activities) $m

Profit before tax 75
Adjustment for:
Share of profit of associate (15)

Lecture example D2.3

Extract from the consolidated statement of cash flows
Cash flows from operating activities $m
Profit before tax 50
Adjustments:
Group profit on disposal (3)

Cash flow from investing activities

Disposal of subsidiary, net of cash disposed 19

Working $m
Cash received on disposal of subsidiary 26
Cash deconsolidated (7)
19

Lecture example D2.4

Property, plant and equipment $m
Bal b/f 80
Acquisition of subsidiary 6
Acquired under lease agreements 9
Depreciation (7)
Cash purchases (balancing figure) 12
Bal c/f 100
ACCA SBR Course Notes 165

Lecture example D2.5

(a) Cash generated from operations for the year ended 31 December 2017
$
Cash flows from operating activities
Profit before tax 1,043
Adjustments for:
Depreciation 720
Impairment of goodwill (W2) 10
Increase in inventories (320)
Increase in trade receivables (480)
Increase in trade payables 200
Cash generated from operations 1,173

Workings
(W1) Goodwill on acquisition of Hazel Co
$m
Consideration transferred:
Shares (100 × $2.50) 250
Cash 200
Non-controlling interests (20% × 320) 64
Less: Fair value of net assets at acquisition (320)
194

(W2) Goodwill (to find impairment loss for the year)

$m
Bal b/f 0
Acquisition of subsidiary (W1) 194
Impairment (balancing figure) (10)
Bal c/f 184

(W3) Movements in working capital

Inventories Receivables Payables
$m $m $m
Bal b/f 1,100 900 1,390
Acquisition of subsidiary 80 40 20
Increase/(decrease) [balancing figure] 320 480 200
Bal c/f 1,500 1,420 1,610

(b) Explanation of adjustments to profit before tax

Cash flows from operating activities are principally derived from the key trading activities of the
entity. This would include cash receipts from the sale of goods, cash payments to suppliers and
cash payments to and on behalf of employees. The indirect method adjusts profit or loss for the
effects of transactions of a non-cash nature, any deferrals or accruals from past or future
operating cash receipts or payments and any items of income or expense associated with
investing or financing cash flows.
Depreciation of property, plant and equipment (PPE) and impairment of goodwill are both non-
cash expenses as the double entry is to record an expense and reduce the non-current asset.
These items are removed by adding them back to profit before tax. Cash paid to buy PPE and
cash received from selling PPE are recorded in the ‘investing activities’ section of the statement
of cash flows. Cash paid to acquire a subsidiary (net of cash of the subsidiary acquired) is also
recorded in ‘investing activities’.
The movements in receivables, payables and inventories are adjusted because financial
statements are prepared on the accruals basis. They recognise income and expenses when they
166 Course Notes ACCA SBR

occur, rather than when cash is actually received or paid. The adjustments remove the effect of
the resulting timing differences so that the statement records actual cash flows.

Lecture example D2.6

(a) Cash generated from operations for the year ended 30 June 2016
$m
Cash flows from operating activities
Profit before tax (1,134 continuing + 300 discontinued) 1,434
Adjustments for:
Depreciation 100
Pension expense 20
Pension contributions paid (15)
Increase in inventories (248)
Increase in trade receivables (415)
Increase in trade payables 12
Cash generated from operations 888

Workings
(W1) Movements in working capital
Inventories Receivables Payables
$m $m $m
Bal b/f 450 328 400
Disposal of subsidiary (60) (42) (62)
Increase/(decrease) [balancing figure] 248 415 12
Bal c/f 638 701 350

(b) Explanation of the treatment of the pension

The pension expense for the year of $20 million will comprise the current service cost, interest
on the net pension liability and past service cost (if any). The other side of the double entry for
these items is to the net pension liability. Therefore, they have no cash effect and must be
removed from profit by adding back the expense.
The actual cash paid by Trafford is the amount of contributions paid into the scheme of $15
million. This is recorded as a cash outflow in the ‘operating activities’ section of the statement
of cash flows. Any pensions actually paid in the year will be a cash flow of the pension scheme
rather than of Trafford so they would not feature in the statement of cash flows of Trafford.
The remeasurement loss of $5 million is ignored because it is neither a cash flow nor an
operating expense (it is recognised in other comprehensive income, rather than in profit or
loss).
 167

D3

Changes in group structure

1 Introduction
This chapter covers two main types of changes in group structure:
 Step acquisitions – purchasing additional shareholdings
 Disposals – selling all or some of a shareholding
The accounting treatment depends on whether:
(1) Control is retained; or
(2) Control is achieved or lost.

2 Step acquisitions and disposals where control is retained

The accounting treatment is the consolidated financial statements is driven by the concept over
substance over form and is illustrated with the following diagram.
168 Course Notes ACCA SBR

0% FIN. (20%) ASSOCIATE 50% SUBSIDIARY 100%

ASSET
S
i
g Step acquisition (buy 20%)
n
i
f
i
c C
60% 80%
a o
(NCI 40%) (NCI 20%)
n n
t t
r
I o
n l
f Disposal (sell 20%)
l
u
e
n
c
e

In substance, there has been no acquisition or disposal because the entity is still a subsidiary (both
before and after the purchase/sale of shares).

2.1 Step acquisition

Instead of an acquisition, this is a transaction between group shareholders as the parent is buying
shares (e.g. 20%) from the non-controlling interests. Therefore, it is recorded in equity:
(a) Decrease non-controlling interests in the consolidated statement of financial position (e.g.
from 40% to 20%); and
(b) Record an adjustment to equity (in the parent’s column in the consolidated retained earnings
working).
$
Consideration paid (X) Cr Cash
Decrease in non-controlling interests * X Dr NCI
Adjustment to parent’s equity (X)/X Dr/Cr Retained earnings

* The calculation of this figure depends on how NCI is measured at acquisition:

 NCI at fair value = NCI % of net assets + NCI % of goodwill
 NCI at proportionate share of net assets = NCI % of net assets
ACCA SBR Course Notes 169

2.2 Disposal
As for a step acquisition, this is a transaction between group shareholders. The parent is selling shares
(e.g. 20%) to the non-controlling interests. Therefore, it should be recorded in equity:
(a) Increase non-controlling interests in the consolidated statement of financial position (e.g. from
20% to 40%); and
(b) Record an adjustment to equity (in the parent’s column in the consolidated retained earnings
working).
$
Consideration received X Dr Cash
Increase in non-controlling interests * (X) Cr NCI
Adjustment to parent’s equity X/(X) Cr/Dr Retained earnings

* The calculation of this figure depends on how NCI is measured at acquisition:

 NCI at fair value = NCI % of net assets + NCI % of goodwill
 NCI at proportionate share of net assets = NCI % of net assets

2.3 Treatment in consolidated statement of profit or loss and other

comprehensive income for the year
 Consolidate the income, expenses and other comprehensive income of the parent and
subsidiary for the whole period.
 The non-controlling interest must be time apportioned as it will have been different sizes during
the period.
 No profit or loss on disposal is recognised.

2.4 Treatment in the consolidated statement of financial position as at the

year end
 Consolidate the assets and liabilities of the subsidiary in full at the year-end as normal.
 Do not adjust the goodwill figure.
 Decrease NCI (for a step acquisition) or increase NCI (for a disposal).
 In the NCI and retained earnings workings the post-acquisition profits of the subsidiary will need
to be time apportioned with reference to the different shareholdings.
 The difference between the cash paid/received and the decrease/increase in NCI is accounted
for in equity as a transaction between the owners. This called an “adjustment to parent’s
equity”.

ILLUSTRATION: STEP ACQUISITION WHERE CONTROL IS RETAINED

Vernon has acquired its shareholding in Hart as follows:

Percentage of ordinary Consideration
Date of acquisition shares acquired Retained earnings transferred
1 January 2017 65% $50 million $60 million
30 September 2019 5% $70 million $5 million

Hart has 10 million $1 shares, no share premium and no other reserves. Hart’s profit for the year ended
31 December 2019 was $8 million. There were no fair value adjustments at acquisition.
170 Course Notes ACCA SBR

Vernon elected to measure non-controlling interests of Hart at acquisition at the proportionate share of
net assets.
Required:
Explain how the investment in Hart should be accounted for in the consolidated financial statements of
Vernon Group for the year ended 31 December 2019. Show your calculations for the adjustment to
equity and non-controlling interests in both the consolidated statements of financial position and profit
or loss.
SOLUTION
Hart Co was a subsidiary for the full year as Vernon controlled Hart with a majority shareholding for the
entire year, increasing from 65% to 70%. Therefore, in the consolidated statement of profit or loss, the
income and expenses of Hart should be included for the full year but non-controlling interests must be
time-apportioned, with a percentage of 35% for the first nine months of the year (35% × $8 million ×
9/12 = $2.1 million) and a percentage of 30% for the remaining three months (30% × $8 million × 3/12
= $0.6 million). Hart should also be included in the consolidated statement of financial position by
aggregating its assets and liabilities with Vernon’s.
In substance, there has not been an acquisition as Hart was already a subsidiary before it acquired the
additional 5% shareholding. Therefore, no new goodwill should be calculated – goodwill is only
calculated once when control is achieved (here, on 1 January 2017 on acquisition of the 65%). Instead,
it should be treated as a transaction between group shareholders as the parent is buying a 5%
shareholding from the non-controlling interests (NCI). This is recorded in equity by:
 Decreasing NCI from 35% to 30%; and
 Recording an adjustment in equity in consolidated retained earnings (calculated below).
$m
Consideration paid (5) Cr Cash
Decrease in non-controlling interests (5% × [10 + 70]) 4 Dr NCI
Adjustment to parent’s equity (1) Dr Retained earnings

The decrease in NCI just reflects their share of the net assets as there is no goodwill in relation to the
NCI because NCI was measured at the proportionate share of net assets at acquisition.
Non-controlling interests in the consolidated statement of financial position is calculated as follows:
$m
NCI at acquisition (35% × [10 + 50]) 21
NCI share of post-acquisition reserves up to 30.09.19 (35% × [70 ‒ 50]) 7
Decrease in NCI on 30.09.19 (5% × [10 + 70]) (4)
NCI share of post-acquisition reserves from 30.09.19 to 31.12.19 (30% × $8m × 3/12) 0.6
24.6

LECTURE EXAMPLE D3.1: DISPOSAL WHERE CONTROL IS RETAINED

Wallace acquired 80% of Clark’s 30 million $1 ordinary shares on 1 January 2018 for $100 million. At
1 January 2018, Clark had retained earnings of $75 million and no other reserves. Wallace elected to
measure non-controlling interests in Clark Co at its fair value $25 million at acquisition. No fair value
adjustments were required to Clark’s net assets at acquisition.
On 30 June 2019, Wallace sold a 10% shareholding in Clark for $16 million. At that date, the retained
earnings of Clark amounted to $80 million. Clark Co’s profit for the year ended 31 December 2019 was
$2 million.
There has been no impairment of goodwill in Clark.
ACCA SBR Course Notes 171

Required:
Explain how the investment in Clark should be accounted for in the consolidated financial statements of
Wallace Group for the year ended 31 December 2019. Show your calculations for goodwill, the
adjustment to equity and non-controlling interests (in both the consolidated statements of financial
position and profit or loss).
SOLUTION
Explanation

Calculations
Goodwill:
$m $m
Consideration transferred
Non-controlling interests at fair value
Less: Fair value of net assets at acquisition
Share capital
Retained earnings

Adjustment to equity:
$m
Consideration received
Increase in NCI
Adjustment to parent’s equity

Non-controlling interests (SFP):

$m
NCI at acquisition (fair value)
NCI share of post-acquisition reserves up to 30.06.19
Increase in NCI on 30.06.19
NCI share of post-acquisition reserves from 30.06.19 to 31.12.19
172 Course Notes ACCA SBR

3 Step acquisitions where control is gained

3.1 Scenarios

0% FIN. (20%) ASSOCIATE 50% SUBSIDIARY 100%

ASSET
S
i
g Buy 50%
n
i
f
i
c 30% C
80%
a o
(NCI 20%)
n n Buy 70%
t t
r
I o
n l
f
10% l 80%
u (NCI 20%)
e
n
c
e

In both instances, the control accounting boundary has been crossed. Therefore, in substance:
Scenario 1
 A 30% associate has been sold – remeasure investment in associate to fair value at the date of
control (this will result in a profit or loss on derecognition); and
 An 80% subsidiary has been purchased – calculate goodwill on the whole 80% shareholding and
start consolidating.
Scenario 2
 A 10% financial asset has been sold – remeasure investment to fair value at the date of control
(the remeasurement gain or loss will be posted to profit or loss or other comprehensive
income); and
 An 80% subsidiary has been purchased – calculate goodwill on the whole 80% shareholding and
start consolidating.
ACCA SBR Course Notes 173

3.2 Treatment in consolidated statement of profit or loss and other

comprehensive income for the year
 Time apportion and consolidate the subsidiary’s income, expenses, other comprehensive
income and non-controlling interests (NCI) from the date that control is gained e.g. 9 months.
 If the investment is an associate before the acquisition include two lines for the share of the
associate’s profit and the share of the associate’s other comprehensive income up to the date
when control is gained e.g. 3 months.
 If the shareholding is a financial asset (a simple investment) up to the date control is gained
include dividend income earned and any remeasurement gains/losses during this period.
 The existing equity investment is remeasured to fair value upon derecognition and any gain or
loss is taken to the consolidated statement of profit or loss and other comprehensive income.

3.3 Treatment in consolidated statement of financial position as at the year

end
 As there is a subsidiary at the year-end the assets and liabilities will be included in the
consolidated SFP.
 The existing equity investment is revalued to fair value and then derecognised.
 Goodwill and the NCI are calculated and recognised.
Note that goodwill is only calculated ONCE, at the date when control is obtained. For a step
acquisition where control is achieved, there will be two lines for the two investments purchased (both
at fair value at the date of control). The calculation for goodwill is shown below (e.g. going from a 10%
investment to an 80% subsidiary):
$
Consideration transferred (e.g. for 70%) X
Fair value of previously held investment (e.g. for 10%) X
Non-controlling interests (at fair value or at NCI % of net assets) X
Less: Fair value of net assets at acquisition (X)
GOODWILL X

LECTURE EXAMPLE D3.2: ASSOCIATE TO SUBSIDIARY STEP ACQUISITION

Glazer acquired Ferguson in stages as follows:

Acquisition date Holding acquired Purchase consideration Retained earnings
% $m $m
30 June 2016 30% 120 200
30 September 2017 An additional 50% 560 500
(total shareholding now 80%)

Ferguson has share capital of 400 million $1 shares and no reserves other than retained earnings.
Glazer elects to measure the non-controlling interests in Ferguson at fair value.
The fair value of the 20% NCI in Ferguson on 30 September 2017 was $180 million. The fair value of
the original 30% shareholding at that date was $270 million.
There has been no impairment of goodwill in Ferguson. Ferguson’s profit for the year ended 30 June
2018 was $320 million. The retained earnings of Glazer and Ferguson at 30 June 2018 were $980
million and $740 million respectively.
174 Course Notes ACCA SBR

Required:
(a) Explain the accounting treatment for Ferguson in the consolidated financial statements of
Glazer for the year ended 30 June 2018.
(b) Calculate the goodwill on the acquisition of Ferguson for inclusion in the consolidated
statement of financial position at 30 June 2018.
(c) Calculate the profit on the derecognition of the previously held investment in Ferguson for
inclusion in the consolidated statement of profit or loss for the year ended 30 June 2018.
(d) Calculated consolidated retained earnings for inclusion in the consolidated statement of
financial position at 30 June 2018.
SOLUTION
(a) Explanation of accounting treatment of Ferguson

(b) Goodwill
$m $m
Consideration transferred
Fair value of the previously held investment
NCI (at fair value)
Less: Fair value of net assets at acquisition
Share capital
Reserves

(c) Profit on derecognition of investment (basically “selling an associate”)

$m
Fair value at date control is obtained
Carrying amount of original investment (see below)
Gain to go through statement of profit or loss (and retained earnings)

(W) Carrying amount of investment at date of disposal:

$m
Original cost of investment
Plus: share of post-acquisition reserves
ACCA SBR Course Notes 175

(d) Consolidated retained earnings

Ferguson Ferguson
Glazer (30%) (80%)
$m $m $m
At year end/date control obtained
Gain on remeasurement of associate
At acquisition

Group share of Ferguson post-acquisition:

(30% ×
(80% ×

4 Disposals where control is lost

4.1 Scenarios

0% FIN. (20%) ASSOCIATE 50% SUBSIDIARY 100%

ASSET
S Sell 80%
i
g
n
i
0% f 80%
i Sell 50% (NCI 20%)
c C
a o
n n
t t 80%
30%
r (NCI 20%)
I o
n Sell 70%
l
f
l
u
e
10% n 80%
c (NCI 20%)
e

In all three instances, the control accounting boundary has been crossed. Therefore, in substance:
Scenario 1 – Full disposal
 An 80% subsidiary has been sold – calculate group profit or loss on disposal
176 Course Notes ACCA SBR

Scenario 2 – Partial disposal (subsidiary to associate)

 An 80% subsidiary has been sold – calculate group profit or loss on disposal
 A 30% associate has been purchased – remeasure the remaining 30% investment to fair value
Scenario 3 – Partial disposal (subsidiary to financial asset)
 An 80% subsidiary has been sold – calculate group profit or loss on disposal
 A 10% financial asset has been purchased – remeasure the remaining 10% to fair value

4.2 Group profit or loss on disposal

$ $
Sale proceeds X
Fair value of any investment retained X
X
Less: Carrying amount of subsidiary disposed of:
Net assets at disposal date X
Goodwill at disposal date X
Less: NCI at disposal date (X)
(X)

Group profit/(loss) X

4.3 Treatment in consolidated statement of profit or loss and other

comprehensive income for the year
4.3.1 Up to the date of disposal
There are two ways of presenting the results of the disposed subsidiary:
(1) Time-apportionment line by line
(i) Time apportion and consolidate the subsidiary’s income, expenses and non-controlling
interest (NCI) up to date of disposal e.g. 9 months.
(ii) Include the group profit or loss on disposal on the face of the statement of profit or loss
(using the calculation shown above).
(2) Discontinued operation (if subsidiary qualifies as discontinued under IFRS 5)
In a single line on the face of the consolidated statement of profit or loss, show the sum of:
(i) The profit or loss of the subsidiary up to the disposal date (time-apportioned for a mid-
year disposal); and
(ii) The profit or loss on disposal of a subsidiary

4.3.2 From disposal to the year end

If the shareholding is an associate after the date of the disposal, include two lines for the group share
of the associate’s profit and the associate’s other comprehensive income for the remainder of the year
e.g. 3 months.
If the shareholding is a financial asset (a simple investment) after the date of disposal, include dividend
income earned and any remeasurement gains/losses in the post-disposal period.
ACCA SBR Course Notes 177

4.4 Treatment in consolidated statement of financial position as at the year

end
 As there is no subsidiary at the year-end the assets and liabilities are not included in the
consolidated SFP.
 Goodwill and the NCI are derecognised.
 For, a partial disposal where significant influence is retained (e.g. 80% to 30%), the remaining
shareholding is revalued to fair value at the date of disposal and is treated as an associate
thereafter, using the fair value as the deemed “cost”.
 For a partial disposal where no significant influence is retained (e.g. 80% to 15%), the remaining
shareholding is revalued to fair value at the date of disposal and then treated as a financial asset
(at fair value) under IFRS 9 thereafter.
 Group retained earnings will include those generated by the subsidiary up to the date of
disposal. If significant influence is retained then the group share of the retained earnings of the
associate will also be included from the disposal date.

ILLUSTRATION: SUBSIDIARY TO ASSOCIATE DISPOSAL

Allen purchased 80% of the shares of Bridge on 1 January 2014, creating purchased goodwill of
$10 million, calculated using the full fair value method.
On 30 June 2015, Allen disposed of a 50% shareholding for $80 million, meaning that it lost control of
Bridge. The net assets of Bridge at this date were $120 million, goodwill remained at $10 million and
non-controlling interests amounted to $26 million. The fair value of the remaining 30% shareholding
was $48m.
Allen prepares its financial statements to 31 December. Bridge’s profit for the year ended
31 December 2015 was $8 million.
Required:
(a) Calculate the group profit on disposal of the shares in Bridge.
(b) Explain how Bridge should be accounted for in the consolidated financial statements for the
year ended 31 December 2015.
SOLUTION
(a) Group profit on disposal
$m $m
Proceeds 80
Fair value of remaining 30% shareholding 48
Less: Carrying amount of net assets disposed of
Net assets at disposal date 120
Goodwill at disposal date 10
NCI at disposal date (26)
(104)

Group profit on disposal 24

178 Course Notes ACCA SBR

(b) Explanation of accounting treatment for Bridge

In the consolidated statement of profit or loss, as well as recognising the group profit on
disposal of $24 million, Allen would consolidate Bridge for the first six months of the year on a
time-apportioned basis i.e. include 6/12 of Bridge’s income and expenses (with an NCI of 20%
time-apportioned). Then Allen would equity account for Bridge for the next six months of the
year i.e. include the share of the associate’s profit of $1.2 million (30% × $8 million × 6/12).
In the consolidated statement of financial position, Allen would recognise an investment in
associate in respect of Bridge:
$m
Cost of associate = fair value of remaining 30% at 1 June 2015 48
Share of post-acquisition reserves (30% × 8 × 6/12) 1.2
49.2

LECTURE EXAMPLE D3.3: SUBSIDIARY TO FINANCIAL ASSET DISPOSAL

Purcell purchased a 60% equity interest in Smith for $160 million on 1 January 2018 when the fair
value of identifiable net assets was $200 million. Purcell elected to measure the non-controlling
interests in Smith at the proportionate share of net assets at acquisition. An impairment review on
31 December 2019 revealed an impairment loss of $8 million in relation to the goodwill in Smith.
Purcell sold a 50% equity interest in Smith for $150 million on 31 December 2019. The fair value of
Purcell’s remaining investment in Smith at that date was $30 million. Purcell had carried the
investment at cost in its separate financial statements.
The finance director calculated that a gain of $20 million arose on the sale of the shares in Smith in the
group financial statements, being the proceeds to $150 million less $130 million (being the percentage
of identifiable net assets sold (50% × $260 million).
Required:
Explain to the directors of Purcell, with suitable calculations, how the group profit or loss on disposal
should have been accounted for.
SOLUTION
Explanation
ACCA SBR Course Notes 179

Calculations
(W1) Group profit or loss on disposal
$m $m
Proceeds
Fair value of remaining 10% shareholding
Less: Carrying amount of net assets disposed of
Net assets at disposal date
Goodwill at disposal date (W2)
NCI at disposal date (W3)

Group loss on disposal

(W2) Goodwill
$m
Consideration transferred
Non-controlling interests
Less: Fair value of net assets

Impairment

(W3) Non-controlling interests

$m
NCI at acquisition
NCI share of post-acquisition reserves

5 Subsidiaries acquired exclusively with a view to resale

A subsidiary acquired exclusively with a view to resale must be consolidated.
If it meets the ‘held for sale’ criteria in IFRS 5 Non-current assets held for sale and discontinued
operations:
 It is presented as a discontinued operation in the group statement of profit or loss (either as a
separate column or as a single line with a breakdown in the notes to the accounts).
 It is presented as a disposal group held for sale in the group statement of financial position. Its
assets are shown in one line under current assets and its liabilities are shown in one line under
current liabilities.
 In the group statement of financial position, the subsidiary is measured at the lower of:
– its carrying amount i.e. the subsidiary’s net assets at the year end (incorporating any
remaining fair value adjustments) plus goodwill; and
– the subsidiary’s fair value less costs to sell at the year end.
180 Course Notes ACCA SBR

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain, with calculations, how to prepare group accounts where there has
been a step acquisition or a disposal during the period and control has been retained?
Can you explain, with calculations, how to prepare group accounts where there has
been a step acquisition during the period and control has been gained?
Can you explain how to prepare group accounts where there has been a disposal
during the period and control has been lost, including the calculation of the profit or
loss on disposal?
Do you understand how to treat a subsidiary acquired exclusively with a view to
resale?
ACCA SBR Course Notes 181

Chapter D3 – Lecture example solution

Example D3.1
Explanation
Clark was a subsidiary for the full year as Wallace controlled Clark with a majority shareholding for the
entire year, decreasing from 80% to 70%. Therefore, in the consolidated statement of profit or loss,
the income and expenses of Clark should be included for the full year but non-controlling interests
must be time-apportioned, with a percentage of 20% for the first six months of the year (20% × $2 million
× 6/12 = $200,000) and a percentage of 30% for the remaining three months (30% × $2 million × 6/12
= $300,000). Clark should also be included in the consolidated statement of financial position by
aggregating its assets and liabilities with Wallace’s.
In substance, there has not been disposal as Clark is still a subsidiary. Therefore, no profit on disposal
should be recognised. Instead, it should be treated as a transaction between group shareholders as
the parent is selling a 10% shareholding to the non-controlling interests (NCI). This is recorded in
equity by:
 Increasing NCI from 20% to 30%; and
 Recording an adjustment in equity in consolidated retained earnings (calculated below).
As NCI was measured at fair value at acquisition, the increase in NCI will include the percentage of
goodwill as well as net assets.

Calculations
Goodwill:
$m $m
Consideration transferred 100
Non-controlling interests at fair value 25
Less: Fair value of net assets at acquisition
Share capital 30
Retained earnings 75
(105)
20

Adjustment to equity:
$m
Consideration received 16 Dr Cash

Increase in NCI: 10% × ([30 + 80] net assets + 20 goodwill) (13) Cr NCI
Adjustment to parent’s equity 3 Cr Retained earnings

Non-controlling interests (SFP):

$m
NCI at acquisition (fair value) 25
NCI share of post-acquisition reserves up to 30.06.19 (20% × [80 ‒ 75]) 1
Increase in NCI on 30.06.19: 10% × ([30 + 80] net assets + 20 goodwill) 13
NCI share of post-acquisition reserves from 30.06.19 to 31.12.19 (30% × $2m × 6/12) 0.3
39.3
182 Course Notes ACCA SBR

Example D3.2
(a) Explanation of accounting treatment of Ferguson
For the first three months of the year ended 30 June 2018 (1 July 2017 – 30 September 2017),
Ferguson is a 30% associate so should be equity accounted in the consolidated statement of
profit or loss. This involves including 30% of Ferguson’s profit for the year, pro-rated for three
months which amounts to $24 million (30% × $320 million × 3/12).
For the remaining nine months, Ferguson is a subsidiary and so should be consolidated. This
involves aggregating Ferguson’s income and expenses pro-rated for nine months to the parent’s
(and any other subsidiaries’). This will result in consolidating a profit of $240 million (9/12 ×
$320 million). Non-controlling interests of 20% in Ferguson’s profits should be recognised for
the nine months Ferguson was a subsidiary. This amounts to $48 million (20% × $320 million ×
9/12).
A profit on derecognition of the associate will also be recognised in the consolidated statement
of profit or loss (see part (c) below).
As Ferguson is an 80% subsidiary at 30 June 2018, Ferguson will be consolidated in the group
statement of financial position by aggregating 100% of its assets and liabilities with Glazer’s
(and those of any other subsidiaries), including the group share of post-acquisition reserves,
goodwill and non-controlling interests of 20%.
(b) Goodwill (when control is gained on 30 June 2017)
$m $m
Consideration transferred 50% 560
Fair value of the previously held interest 30% 270
NCI (at fair value) 20% 180
Less: Fair value of net assets at acquisition
Share capital 400
Reserves 500
(900)
110

(c) Profit on derecognition of investment (basically “selling an associate”)

$m
Fair value at date control is obtained 270
Carrying amount of original investment (see below) (210)
Gain to go through statement of profit or loss (and retained earnings) 60

(W) Carrying amount of investment at date of disposal:

$m
Original cost of investment 120
Plus: share of post-acquisition reserves (30% × (500 – 200)) 90
210
ACCA SBR Course Notes 183

(d) Consolidated retained earnings

Glazer Ferguson Ferguson
(30%) (80%)
$m $m $m
At year end/date control obtained 980 500 740
Gain on remeasurement of associate 60
At acquisition (200) (500)
300 240

Group share of Ferguson post-acquisition:

(30% × 300) 90
(80% × 240) 192
1,322

Example D3.3
Explanation
The finance director has calculated the group profit on disposal incorrectly. Prior to the disposal, Smith
was a 60% subsidiary of Purcell. After selling a 50% stake, Purcell has a 10% financial asset (or simple
investment) in Smith. In substance, on 31 December 2019, Purcell ‘sell’s a 60% subsidiary so Smith
should be deconsolidated and a group profit on disposal should be recognised. At the same date, in
substance, Purcell ‘purchases’ a 10% financial asset, so this remaining investment should be
remeasured to its fair value of $30 million.
The finance director was correct to calculate a group profit on disposal but they made three errors in
their calculations:
(1) They deconsolidated the portion of net assets sold rather than deconsolidating 100% of net and
the 40% non-controlling interests.
(2) They did not deconsolidate goodwill – as Smith is no longer a subsidiary, goodwill should no
longer be recognised.
(3) They did not remeasure the remaining 10% investment to fair value.
The corrected profit or loss on disposal is calculated below. When corrected, it results in a group loss
on disposal.
Calculations
(W1) Group profit or loss on disposal
$m $m
Proceeds 150
Fair value of remaining 10% shareholding 30
Less: Carrying amount of net assets disposed of
Net assets at disposal date 260
Goodwill at disposal date (W2) 32
NCI at disposal date (W3) (104)
(188)

Group loss on disposal (8)

184 Course Notes ACCA SBR

(W2) Goodwill
$m
Consideration transferred 160
Non-controlling interests (40% × 200) 80
Less: Fair value of net assets (200)
40
Impairment (8)
32

(W3) Non-controlling interests

$m
NCI at acquisition (40% × 200) 80
NCI share of post-acquisition reserves (40% × [260 ‒ 200 *]) 24
104

* The movement in net assets is used as the movement in reserves is not given. As net assets =
equity and assuming that there has been no share issue by the subsidiary since acquisition, the
movement in equity and net assets is solely due to the movement in reserves.
 185

D4

Foreign transactions and

entities

1 Functional currency and presentation currency

IAS 21 The Effects of Changes in Foreign Exchange Rates mentions two currency concepts:

1.1 Functional currency

Functional currency is the currency of the primary economic environment in which the entity
operates. It is the currency in which the financial statement transactions are measured and in which it
primarily generates and spends cash. This is largely a matter of FACT, but in determining its functional
currency, an entity will consider, amongst other things:
 The currency in which sales prices for its goods and services are denominated and settled
 The currency that most influences operating costs (i.e. labour, material and other costs of
providing goods or services)
 The currency in which an entity’s finances are denominated (e.g. if the entity has an overseas
loan)
 The autonomy of a foreign operation from the reporting entity
For most companies operating in the UK, their functional currency is the £ pound.
When determining the functional currency of a foreign subsidiary, an entity should consider:
 Whether the activities of the foreign operation are carried out as an extension of the reporting
entity, rather than being carried out with a significant degree of autonomy (an autonomous
company will not necessarily use the same currency as the parent company).
 Whether transactions with the parent company represent a high or low proportion of the
foreign subsidiary’s activities.
186 Course Notes ACCA SBR

1.2 Presentation currency

Presentation currency is the currency in which the financial statements are presented. This is largely a
matter of CHOICE.
Again, most UK companies will choose to present their financial statements in £ sterling, but they may
choose to present them in, for example, the US $, particularly if their parent company is American.
If an entity wishes to present its financial statements in a different presentation currency:
 All assets and liabilities (whether monetary or non-monetary items) are translated at the closing
rate at the date of that statement of financial position;
 All items in the statement of profit or loss are translated at an average rate for the period;
 Resulting exchange differences are recognised in other comprehensive income.

ILLUSTRATION: FUNCTIONAL AND PRESENTATION CURRENCY

AB prepares its financial statements in dollars. AB acquired 80% of the equity share capital of FG on
1 January 20X3. FG operates in country C, which has the Crum as its currency. FG sources the majority of its
raw materials locally and is subject to local taxes and corporate regulations. The current workforce is
recruited locally, although the majority of its sales are to customers in other countries. During the year FG
secured a four-year term loan from a bank in C to fund its own capital investment requirements.
What is the functional currency of FG?
SOLUTION
The functional currency of FG will be determined by the currency that dominates the primary
economic environment in which operates. FG pays for its materials and labour in Crum and is subject
to local regulations. Despite the fact that the majority of its sales revenue is generated outside C, this
suggests that the FG’s functional currency is the Crum.
FG operates autonomously and raises its own finance, which also indicates that its functional currency
is the Crum.
However, FG may choose the dollar as its presentation currency, because it is a subsidiary of a
company that presents its financial statements in dollars.

1.3 Translating foreign currency amounts into the functional currency

Initial recognition
Translate each transaction by applying the relevant spot exchange rate at the date of transaction.

At subsequent statement of financial position dates (i.e. at future year ends)

 Monetary assets and liabilities (e.g. trade receivable and payables) should be restated at closing
rate (i.e. the year end rate). This will lead to an exchange gain/loss, which is recorded in the
statement of profit or loss.
 Non-monetary assets measured at historical cost (e.g. non-current assets, inventories) should
not be restated at the year end (i.e. they remain at historical rate).
 However, where there is a change in the underlying value of a non-monetary asset (for
example, an impairment, a revaluation or a fair value adjustment), the asset is retranslated
using the exchange rate at the date on which the change occurred. (See the lecture example
later in this chapter).
ACCA SBR Course Notes 187

ILLUSTRATION: TRANSLATING INDIVIDUAL TRANSACTIONS

The functional currency of AW is the $. On 1 September 2016, AW purchased some goods for resale
from a foreign entity for R$20,000. At the year end of 30 September 2016, the goods had not been
paid for or sold on to third parties.
The following exchange rates apply:
1 September 2016 $1 = R$5.4
30 September 2016 $1 = R$5.6
Required:
According to IAS 21 at what amounts should the trade payables and inventories be included in AW’s
financial statements? Calculate the exchange gain or loss.
SOLUTION
(a) Payables are a monetary item so should be retranslated at the year-end exchange rate:
$R20,000/5.6 = $3,571
(b) Inventories are a non-monetary item so should remain at the historic rate:
$R20,000/5.4 = $3,704
(c) An exchange GAIN of $3,704 – $3,571 = $133 should be recognised in the statement of profit or
loss.

2 Group accounting – translation of foreign operations

When a group prepares its financial statements, all of the elements of those financial statements must
be in the same currency, normally the functional currency of the parent company.
Therefore, if a parent company has a foreign operation (i.e. an overseas subsidiary, associate or joint
venture) with a different currency presented, it will have to translate those financial statements into
the currency of the group prior to consolidation.
The financial statements of the foreign operation are translated as follows:

2.1 Statement of financial position

 All assets and liabilities are translated @ the year-end Closing Rate (CR).
 Goodwill is calculated at acquisition in the subsidiary’s local currency and subsequently
translated every year-end @ the Closing Rate. The exchange gain or loss is taken to reserves.
 Share capital, share premium and pre-acquisition reserves are translated @ the Historic Rate
(HR) at the date of acquisition.
 Post-acquisition retained earnings comprise profits less dividends for all the years the subsidiary
has been owned. Profits are translated at the average rate for relevant year and dividends are
translated at the actual rate.
 Exchange differences on net assets to date can then be found as a balancing figure (post the
group share to the translation reserve working and the NCI share to the NCI working).
188 Course Notes ACCA SBR

2.2 Statement of profit or loss and other comprehensive income

All items are translated @ average rate (AR).

2.3 Goodwill calculation

Functional Functional Presentation
currency currency Rate currency
Consideration transferred X X
NCI (FV or NCI % net assets) X X
Less: Fair value of net assets at HR at date
acquisition of control
Share capital X
(e.g. 1.1.18)
Share premium X
Retained earnings X
Fair value adjustments X
(X) (X)
At acquisition (e.g. 1 January 2018) X X
Impairment losses 2018 (X) AR/CR 2018 (X)
Exchange differences 2018 ‒ Bal. figure β
At 31 December 2018 X CR 2018 X
Impairment losses 2019 (X) AR/CR 2019 (X)
Exchange differences 2019 ‒ Bal. figure β
At 31 December 2019 X CR 2019 X

EXAM SMART
Impairment losses on goodwill may be translated at:
 The average rate; or
 The closing rate.
In the exam, for calculations, the question will either specify which exchange rate to use or
you will get credit for using either rate.

2.4 Exchange differences on goodwill

2.4.1 Consolidated statement of financial position
The treatment of exchange differences on goodwill in the consolidated SFP depends on whether NCI is
measured at fair value or the proportionate share of net assets at acquisition:
 NCI at fair value:
– Post group share of exchange differences to the translation reserve
– Post NCI share of exchange differences to the NCI working
 NCI at proportionate share of net assets
– Post all exchange differences to the translation reserve (no impact on NCI)
ACCA SBR Course Notes 189

2.4.2 Consolidated statement of profit or loss and other comprehensive income

(SPLOCI)
 NCI at fair value:
– Post 100% of exchange differences to other comprehensive income
– Allocate NCI in total comprehensive income their share of the exchange differences in
the ownership reconciliation at the foot of the consolidated SPLOCI
 NCI at proportionate share of net assets:
– Post all of exchange differences to other comprehensive income (no impact on NCI)

LECTURE EXAMPLE D4.2: GOODWILL

Barber purchased 80% of the equity shares of its foreign subsidiary, Scott on 1 January 2019. The
functional currency of Scott is the dinar. The presentation currency of the group accounts is the $.
Barber paid 172 million dinars to acquire its 80% shareholding. At acquisition, Scott had share capital
of 10 million dinars, share premium of 24 million dinars and retained earnings of 146 million dinars.
The fair value of the net assets at that date was 200 million dinars.
Barber elected to measure non-controlling interests in Scott at fair value at acquisition. The fair value
of the non-controlling interests in Scott at 1 January 2019 was 40 million dinars.
At the year end of 31 December 2019, an impairment review revealed an impairment loss of
3.6 million dinars.
The exchange rates were as follows:
1 January 2019 $1: 5 dinars
31 December 2019 $1: 4 dinars
Average exchange rate for year ended 31 December 2019 $1: 4.5 dinars
The finance director of Barber is unsure how to account for goodwill so has measured it as the exchange
rate on 1 January 2019 in the consolidated financial statements. No adjustment has been made since
that date.
It is group policy to translate impairment of goodwill at the average rate.
Required:
Explain the correct accounting treatment of goodwill, showing any relevant calculations and any
adjustments necessary to correct the consolidated financial statements.
SOLUTION
Explanation of correct accounting treatment
190 Course Notes ACCA SBR

Calculation
Dinars m Dinars m Rate $m
Consideration transferred
Non-controlling interests (FV)
Less: Fair value of net assets at acquisition
Share capital
Share premium
Retained earnings
Fair value adjustments

At acquisition (1 January 2019)

Impairment losses 2019
Exchange differences 2019
At 31 December 2019

Adjustments

2.5 Exchange differences in the year

Exchange differences will arise on the translation of the subsidiary’s net assets and goodwill at each
year end due to movements between the opening and closing exchange rates.

ILLUSTRATION: EXCHANGE DIFFERENCES IN THE YEAR

Imagine a foreign subsidiary whose functional currency is the dinar. In the year ended 31 December
2019, the subsidiary had opening net assets of 440 million dinars, a profit of 180 million dinars and
closing net assets of 620 million dinars. The presentation currency of the group accounts is the $. The
relevant exchange rates are:
1 January 2019 $1: 5 dinars
31 December 2019 $1: 4 dinars
Average exchange rate for year ended 31 December 2019 $1: 4.5 dinars
ACCA SBR Course Notes 191

Exchange gain
$5m
Profit: 180m/4.5 = $40m

1.1.19 31.12.19
Exchange
gain $22m
Opening NA: 440m/4 = $110m
Opening NA: 440m/5 = $88m Profit: 180m/4 = $45m
Closing NA: 620m/4 = $155m

In dinars: 440m + 180m = 620m

In $: 88m + 40m ≠ 155m

Because of exchange gains on opening net assets $110m ‒ $88m = $22m and exchange
gains on profit $45m ‒ $40m = $5m. When you bring in these exchange gains, net assets
add across:
In $: 88m + 40m + Exchange gains [22m + 5m] = 155m

This exchange difference is not included in profit or loss but reported in other comprehensive income.
It is calculated as follows:
$ $

On translation of S’s net assets:

Closing net assets @ closing rate (CR) X
Less: opening net assets @ opening rate (OR) (X)
X
Less: profit for the year @ average rate (AR) (per P/L) (X)
X
On translation of goodwill: X/(X)
Total exchange difference for the year X/(X)

The group share of these exchange differences (for each year the subsidiary has been owned) is
presented as a separate translation reserve within equity in the consolidated statement of financial
position:
 The exchange difference on net assets is always split between the group (in the consolidated
translation reserve) and the NCI in the equity section of the consolidated statement of financial
position.
 The exchange difference on goodwill is only split between the group and the NCI if the fair value
method is used, otherwise it is all included in the consolidated translation reserve.
192 Course Notes ACCA SBR

EXAM SMART
Be careful when posting exchange differences to consolidated financial statements:
 Consolidated SPLOCI – exchange difference for the year
 Consolidated SFP – cumulative exchange differences

LECTURE EXAMPLE D4.3: EXCHANGE DIFFERENCES

Prentis purchased a 90% foreign subsidiary, Sawyer, on 1 January 2019 for 9 million dinars. The
functional currency of Sawyer is the dinar. The presentation currency of the group accounts is the $.
Sawyer had net assets of 8 million dinars on 1 January 2019. No fair value adjustments were required
at acquisition. Prentis elected to measure non-controlling interests in Sawyer at the proportionate
share of net assets at acquisition. There has been no impairment of the goodwill in Sawyer.
Sawyer’s net assets were 10.7 million dinars at 31 December 2019. Sawyer made a profit for the year
of 2.7 million dinars and did not pay any dividends. Sawyer had no other comprehensive income in the
year ended 31 December 2019.
The exchange rates were as follows:
1 January 2019 $1: 5 dinars
31 December 2019 $1: 4 dinars
Average exchange rate for year ended 31 December 2019 $1: 4.5 dinars
Required:
(a) Calculate the exchange differences on translation of Sawyer’s net assets and goodwill to be
recognised in the consolidated statement of profit or loss and other comprehensive income for
the year ended 31 December 2019.
(b) Explain how the above exchange differences should be accounted for in the consolidated
financial statements for the year ended 31 December 2019.
(c) Calculate non-controlling interests in Sawyer’s profit for the year (PFY) and total comprehensive
income (TCI) for inclusion in the consolidated statement of profit or loss and other
comprehensive income for the year ended 31 December 2019.
SOLUTION
(a) Calculations
Goodwill (to find exchange differences):
Dinars 000 Rate $’000
Consideration transferred
NCI
Less: Fair value of net assets
Goodwill at 1 January 2019
Exchange differences
Goodwill at 31 December 2019
ACCA SBR Course Notes 193

Exchange differences for the year

$’000 $’000

On translation of Sawyer’s net assets:

Closing net assets @ closing rate (CR)
Less: opening net assets @ opening rate (OR)

Less: profit for the year @ average rate (AR)

On translation of goodwill:
Total exchange difference for the year

(b) Explanation

(c) Non-controlling interests in profit for year (PFY) and total comprehensive income (TCI)
NCI in NCI in
PFY TCI
$’000 $’000
Sawyer’s profit for the year/total comprehensive income
Exchange gains on net assets in other comprehensive income (part (a))

NCI share
194 Course Notes ACCA SBR

LECTURE EXAMPLE D4.4: TRANSLATION RESERVE AND NON-CONTROLLING INTERESTS

Birdy acquired 70% of Worm, a foreign company, for 5 million dinars on 31 December 2016 when the
reserves of Worm were 4 million dinars. The functional currency of Worm is the dinar. The
presentation currency of the group accounts is the $.
The fair value of Worm’s net assets on 31 December 2016 was 4.5 million dinars. No fair value
adjustments were required to Worm’s net assets. Birdy elected to measurement the non-controlling
interest in Worm at its fair value of 2 million dinars at acquisition.
There have been no issues of shares since acquisition and goodwill suffered an impairment of
0.9 million dinars at 31 December 2017. Goodwill impairment is translated at the average rate.
Worm made a profit for the year ended 31 December 2017 of 2.7 million dinars. No dividend was paid
by Worm.
As at 31 December 2017, Birdy had retained earnings of $7 million.
Worm has the following statement of financial position as at 31 December 2017:
Dinars ‘000
Property, plant and equipment 5,400
Current assets 2,200
7,600

Share capital 500

Retained earnings 6,700
Current liabilities 400
7,600

The following exchange rates are relevant to the preparation of the group financial statements:
31 December 2016 $1: 5.0 dinars
31 December 2017 $1: 4.0 dinars
Average exchange rate for year ended 31 December 2017 $1: 4.5 dinars
Required:
(a) Calculate the cumulative exchange differences on translation of Worm’s goodwill and net assets
to be recognised in the consolidated statement of financial position at 31 December 2017.
(b) Calculate consolidated retained earnings for inclusion in the consolidated statement of financial
position at 31 December 2017.
(c) Calculate the translation reserve for inclusion in the consolidated statement of financial position
at 31 December 2017.
(d) Calculate non-controlling interests for inclusion in the consolidated statement of financial
position at 31 December 2017.
ACCA SBR Course Notes 195

SOLUTION
(a) Exchange differences
Exchange differences on goodwill
Dinars ‘000 Rate $’000
Consideration transferred
NCI (at fair value)
Less: Fair value of net assets at acquisition
Goodwill @ 31 December 2016
Impairment for 2017
Exchange difference 2017
Goodwill @ 31 December 2017

Exchange differences on net assets

[As Worm has only been a subsidiary for one year, cumulative exchange differences on net
assets can be calculated using the exchange differences for the year working]
$’000 $’000
On translation of net assets:
Closing net assets @ CR
Less: opening net assets @ OR
Less: retained profit as translated

On translation of goodwill (see above)

Total exchange differences for the year

(b) Consolidated retained earnings

$’000
Birdy’s retained earnings
Group share of Worm’s post-acquisition retained earnings
Group share of impairment loss on goodwill

(c) Consolidated translation reserve

$’000
Exchange differences on net assets
Exchange differences on goodwill

(d) Non-controlling interests

$’000
NCI at acquisition
Plus: NCI share of post-acquisition retained earnings
Less: NCI share of impairment of goodwill
NCI share of exchange differences on net assets
NCI share of exchange differences on goodwill
NCI at 31 December 2017
196 Course Notes ACCA SBR

3 Associates and joint arrangements

Foreign operations may include associates and joint arrangements, as well as subsidiaries and the
same principles apply:
 Assets and liabilities are translated @ the year-end Closing Rate (CR).
 Income and expenses are translated @ average rate
 Exchange differences are recognised in other comprehensive income

ILLUSTRATION: TRANSLATING AN ASSOCIATE

On 1 January 2020 Plume purchased 40% of March for 80 million dinar.

The profit of March for the year ended 31 December 2020 was 15 million dinar.
The following exchange rates are relevant to the preparation of the group financial statements:
1 January 2020 $1: 5.0 dinars
31 December 2020 $1: 4.3 dinars
Average exchange rate for year ended 31 December 2020 $1: 4.8 dinars
Required:
Show how Plume’s investment in March will be translated for inclusion in the group financial
statements for the year ended 31 December 2020.
SOLUTION
Statement of profit or loss and other comprehensive income for the year ended 31 December 2020
(extracts)
$’000
Share of associate’s profit 1,250
Other comprehensive income:
Exchange differences on translating foreign operations 2,750
Statement of financial position as at 31 December 2020 (extracts)
$’000
Investment in associate 20,000

Translation reserve 2,750

Working: Investment in March
Dinars ‘000 Rate $’000
Cost at 1 January 2020 80,000 5 16,000
Share of associate’s profit (40% × $15m) 6,000 4.8 1,250
86,000 17,250
Exchange difference (gain) Bal.fig. 2,750
Investment in associate at 31 December 2020 86,000 4.3 20,000

4 Disposal of foreign operations

On disposal, the cumulative amount of the exchange differences relating to the foreign operation
recognised in other comprehensive income and accumulated in equity (i.e. the parent’s share of the
exchange differences), is reclassified to profit or loss at the same time as the disposal gain/loss is
recognised.
ACCA SBR Course Notes 197

ILLUSTRATION: DISPOSAL OF FOREIGN SUBSIDIARY

Carmel had an 80% foreign subsidiary, Dexter. Dexter’s functional currency is the crown. Carmel sold
its entire shareholding in Dexter on 30 September 2019 for $350 million. The following figures (which
have been translated at the exchange rate on 30 September 2019) relate to Dexter:
$m
Carrying amount of net assets at 30 September 2019 360
Carrying amount of goodwill at 30 September 2019 40
Carrying amount of non-controlling interests at 30 September 2019 80
Cumulative exchange gains on Dexter’s net assets and goodwill recognised in other comprehensive
income (from the acquisition date to the disposal date) are $25 million. Carmel elected to measure the
non-controlling interest in Bakelite at fair value at acquisition.
Required:
Calculate the group profit of loss on disposal of Dexter for inclusion in the consolidated statement of
profit or loss for the year ended 31 December 2019.
SOLUTION
$m $m
Proceeds 350
Less: Carrying amount of net assets deconsolidated
Net assets 360
Goodwill 40
Non-controlling interests (80)
(320)
30
Exchange gains reclassified to profit or loss (25 × 80% parent’s share) 20
Group profit on disposal 50

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you explain the difference between functional and presentation currency and
identify the functional currency of an entity?
Do you understand how to account for individual transactions in a foreign currency,
including how to calculate and present exchange differences in the financial
statements?
Can you translate the financial statements of a foreign operation into the presentation
currency used for the group financial statements?
Do you understand how to calculate exchange differences, including on the
retranslation of goodwill, when preparing group financial statements that include a
foreign subsidiary?
Do you understand how to calculate the balance on the translation reserve?
Can you explain how to account for the disposal of a foreign operation?
198 Course Notes ACCA SBR

Chapter D4 – Lecture example solutions

Example D4.1
Crowns
’000 Rate $’000
Property, plant and equipment 14,560 8 1,820
Current assets 11,200 8 1,400
25,760 3,220

Share capital 2,400 10 240

Pre-acquisition retained earnings 13,980 10 1,398
Post-acquisition retained earnings:
 Profit for 2019 4,080 8.5 480
 Dividend paid on 30 June 2019 (2,700) 9 (300)
Exchange differences on net assets ‒ Balancing figure 402
17,760 2,220
Liabilities 8,000 8 1,000
25,760 3,220

Example D4.2
Explanation of correct accounting treatment
Goodwill should be calculated in the functional currency of Scott (the dinar) then translated into the
presentation currency of the group accounts (the $). The finance director was correct to initially
translate it at the acquisition date rate on 1 January 2019. However, impairment for the year then
needs to be deducted and translated at the average rate per the group policy. At the year end,
goodwill then needs to be retranslated at the closing rate.
Calculation
Dinars m Dinars m Rate $m
Consideration transferred 172
Non-controlling interests (FV) 40
Less: Fair value of net assets at acquisition
Share capital 10
Share premium 24
Retained earnings 146
Fair value adjustments (200 ‒ 10 ‒ 24 ‒ 146) 20
(200)
At acquisition (1 January 2019) 12 5 2.4
Impairment losses 2019 (3.6) 4.5 (0.8)
Exchange differences 2019 ‒ β 0.5
At 31 December 2019 8.4 4 2.1

Adjustments
The finance director has recorded goodwill at $2.4 million in the consolidated financial statements. It
should have been recorded at $2.1 million. A reduction of $0.3 million is required.
An impairment loss of $0.8 million must be added to expenses in the consolidated statement of profit
or loss with the NCI being allocated their share in the ownership reconciliation at the foot of the
consolidated SPL since NCI is measured at fair value at acquisition.
In the consolidated statement of financial position, as NCI is measured at fair value, the group share of
the impairment of $0.64 million (80% × $0.8 million) should be recorded in consolidated retained
ACCA SBR Course Notes 199

earnings and the NCI share of $0.16 million (20% × $0.8 million) should be recorded in the NCI
working.
The exchange difference for the year of $0.5 million is recorded in other comprehensive income in the
consolidated statement or profit or loss and other comprehensive income (SPLOCI) with the NCI being
allocated their share in the ownership reconciliation of the foot of the consolidated SPLOCI since NCI is
measured at fair value at acquisition.
In the consolidated statement of financial position, as NCI is measured at fair value, the group share of
the exchange difference on goodwill of $0.4 million (80% × $0.5 million) should be posted to the
translation reserve and the NCI share of $0.1 million (20% × $0.5 million) to the NCI working.
The correcting double entry in the consolidated statement of financial position would be:
Dr Consolidated retained earnings $0.64m
Dr Non-controlling interest ($0.16m – $0.1m) $0.06m
Cr Translation reserve $0.4m
Cr Goodwill $0.3m

Example D4.3
(a) Calculations
Goodwill (to find exchange differences):
Dinars 000 Rate $’000
Consideration transferred 9,000
NCI (10% × 8,000) 800
Less: Fair value of net assets (8,000)
Goodwill at 1 January 2019 1,800 5 360
Exchange differences ‒ β 90
Goodwill at 31 December 2019 1,800 4 450

Exchange differences for the year

$’000 $’000

On translation of Sawyer’s net assets:

Closing net assets @ closing rate (CR) (10,700/4) 2,675
Less: opening net assets @ opening rate (OR) (8,000/5) (1,600)
1,075
Less: profit for the year @ average rate (AR) (2,700/4.5) (600)
475
On translation of goodwill: 90
Total exchange difference for the year 565

(b) Explanation
The exchange difference for the year of $565,000 should be reported in other comprehensive
income in the consolidated SPLOCI. In the ownership reconciliation, the NCI will be allocated
their share of the exchange difference on net assets (10% × $475,000 = $47,500) but they will
not be allocated any of the exchange differences on goodwill as NCI is measured at the
proportionate share of net assets so no goodwill is recognised in respect of the NCI.
The exchange difference for the year is also the cumulative exchange difference as the
subsidiary has only be owned for one year. In the consolidated statement of financial position,
the group share of the cumulative exchange difference on net assets (90% × $475,000 =
$427,500) will be recognised in the translation reserve and the remaining 10% will be allocated
to the NCI in the NCI working (10% × $475,000 = $47,500). The full cumulative exchange
difference on goodwill of $90,000 will be recognised in the translation reserve as no goodwill
200 Course Notes ACCA SBR

arises in relation to NCI when NCI is measured at the proportionate share of net assets at
acquisition.
(c) Non-controlling interests in profit for the year (PFY) and total comprehensive income (TCI)
NCI in
PFY NCI in TCI
$’000 $’000
Sawyer’s profit for the year/total comprehensive income (2,700/4.5) 600 600
Exchange gains on net assets in other comprehensive income (part (b)) ‒ 475
600 1,075
NCI share × 10% × 10%
60 107.5

EXAM SMART
As NCI is measured at the proportionate share of net assets at acquisition, there is no
goodwill recognised in relation to NCI so none of the exchange gain on goodwill of $90,000
relates to NCI. However, if NCI had been measured at fair value at acquisition, the exchange
difference on goodwill in the year would have been included in the NCI working in the TCI
column (in the same way as the exchange differences on net assets).

Example D.4.4
(a) Exchange differences
Exchange differences on goodwill
Dinars ‘000 Rate $’000
Consideration transferred 5,000
NCI (at fair value) 2,000
Less: Fair value of net assets at acquisition (4,500)
Goodwill @ 31 December 2016 2,500 5.0 500
Impairment for 2017 (900) 4.5 (200)
Exchange difference 2017 – Bal 100
Goodwill @ 31 December 2017 1,600 4.0 400

Exchange differences on net assets

[As Worm has only been a subsidiary for one year, cumulative exchange differences on net
assets can be calculated using the exchange differences for the year working]
$’000 $’000
On translation of net assets:
Closing net assets @ CR (500 + 6,700)/4 1,800
Less: opening net assets @ OR ((500 + 4,000)/5) (900)
Less: retained profit as translated (2,700/4.5) (600)
300
On translation of goodwill (see above) 100
Total exchange differences for the year 400
ACCA SBR Course Notes 201

EXAM SMART
If Worm had been a subsidiary for more than one year, you would need to calculate
cumulative exchange differences as follows:
Dinars ‘000 Rate $000
Property, plant and equipment 5,400 4.0 1,350
Current assets 2,200 4.0 550
7,600 1,900

Share capital 500 5.0 100

Pre-acquisition retained earnings 4,000 5.0 800
900
Profit for the year ended 31.12.17 2,700 4.5 600
1,500
Exchange difference (bal.) 300
1,800
Current liabilities 400 4.0 100
7,600 1,900

Alternatively, the question would give you the exchange differences on net assets.

(a) Consolidated retained earnings

$’000
Birdy’s retained earnings 7,000
Group share of Worm’s post-acquisition retained earnings (70% × [2,700/4.5]) 420
Group share of impairment loss on goodwill (70% × 200 [part (a)]) (140)
7,280

(b) Consolidated translation reserve

$’000
Exchange differences on net assets (70% × 300 [Part (a)]) 210
Exchange differences on goodwill (70% × 100 [Part (a)]) 70
280

(c) Non-controlling interests

$’000
NCI at acquisition (2m dinars/5 HR) 400
Plus: NCI share of post-acquisition retained earnings (30% × [2.7m dinars/4.5]) 180
Less: NCI share of impairment of goodwill (30% × 200 [Part (a)]) (60)
NCI share of exchange differences on net assets (30% × 300 [Part (a)]) 90
NCI share of exchange differences on goodwill (30% × 100 [Part (a)]) 30
NCI at 31 December 2017 640
202 Course Notes ACCA SBR
 203

Interpreting financial
statements

1 Introduction
Section B of your exam will always include either a full question, or part of a question, that requires
appraisal of financial and/or non-financial information from either the preparer’s or another
stakeholder’s perspective. A stakeholder is any person or organisation with an interest in any of the
activities (not just financial performance) of a business entity.
A commonly examined stakeholder is the investor. For questions with an investor focus, you need to
appreciate that investors do not just look at the reported profit and statement of financial position
(SFP) to guide their investment decisions. They may also base their decisions on the company’s
business model or on its intangibles, (some of which may not be on the SFP). These days, companies
are providing more non-financial information, including information about environmental and social
issues. (These topics are covered in more detail later in this chapter.)
Interpreting financial statements will not be tested by asking for the calculation of a standard set of
ratios and comments thereon (like it was in the Financial Reporting exam). Instead, you are likely to
have to consider the impact that transactions will have on key performance indicators (KPIs) which
may be based on non-standard measures. You will be asked not just to calculate the impact on the KPI
but will also be asked to discuss the impact on the view taken by investors.
Additionally, you may be asked to discuss the meaning of specific KPIs before and after adjustment for
accounting errors or inaccuracies.
You will need to demonstrate your understanding of:
 the information in the question; and possibly
 the issues faced by (for example) an investor in understanding the information.
See Question 4 in the SBR Specimen Exam 1, which features a potentially misleading performance
measure (‘underlying profit’).
204 Course Notes ACCA SBR

2 Business model

KEY TERMS
Business model
 ‘An organisation’s system of transforming inputs, through its business activities, into
outputs and outcomes that aim to fulfil the organisation’s strategic purposes and create
value over the short, medium and long term.’
(International Integrated Reporting Framework)

Information about a company’s business model is useful in investor analysis as it provides a context for
the annual report and can increase investor trust by demonstrating an entity’s understanding of its
business.
Detail about a company’s business model is often provided in the annual report but outside the
financial statements (e.g. in a management commentary). However, the business model is also
considered in preparation of the financial statements as it is implicit in several accounting standards:
Accounting standard How business model features
IAS 2 Inventories Commodity traders can measure inventory at fair value less costs to sell with
changes recognised in profit or loss – this is because the business model of
commodity traders is to sell in the near future, making a profit from price
fluctuations.
IFRS 9 Financial Measurement of investments in debt instruments: depends on a company’s
Instruments business model:
 Held to collect contractual cash flows of interest and principal – measure
at amortised cost (reflects company’s intention to keep the asset)
 Held to collect contractual cash flows of interest and principal and to sell
– measure at fair value through OCI (reflects company’s intent to sell
before maturity)
Measurement of investment in equity instruments is at fair value through P/L
(unless not ‘held for trading’ and election made to take changes in fair value
to OCI). This could discourage long-term investment and recognising fair value
changes in P/L may not reflect the business model of long-term investors.
IFRS 8 Operating The definition of an operating segment is a ‘component of an entity that
Segments engages in business activities from which it can earn revenue and incur
expenses’.
IAS 40 Investment An investment property is held to earn rentals and/or for capital appreciation.
Properties The option to hold these properties at fair value with changes in P/L reflects
the entity’s business model. Whereas owner-occupied properties, are held at
cost (or fair value under the revaluation model) and depreciated, reflecting
their use in the business.

The business model is not specifically defined or discussed in the Conceptual Framework and this could
result in inconsistency of its use in IFRS Standards.
ACCA SBR Course Notes 205

3 Approach to interpreting financial statements

Ratio analysis on its own is not sufficient for interpreting a set of company accounts. There are other
pieces of information which should be considered, for example:
 Absolute figures, e.g. this year’s sales revenue or profits compared to last year’s.
 The content of any accompanying commentary on the accounts and other statements (e.g.
management commentary/financial review; environmental/social/sustainability reports).
 The background of the company or industry information.
 Current and future developments in the company's markets, at home and abroad, recent
acquisitions or disposals of a subsidiary by the company.
 Events after the end of the reporting period.
 The accounting policies used and significant judgements and estimates made.
 Impact of one-off costs or transactions e.g. large profit on disposal of PPE.
Other things to bear in mind when interpreting financial statements:
 Seasonality or year-end figures may not be representative e.g. major non-current assets
purchased just prior to the year end will not necessarily have incurred a full year’s depreciation
charge yet.
 Related party transactions (for example, transactions between group companies) may not be at
arm’s length.
 Year-on-year comparisons may be distorted by inflation.
 Many businesses (e.g. service industries and technology companies) depend on intangible
assets that are not recognised in the statement of financial position.

4 The key ratios

Four major categories:
Profitability
 Gross profit How profitable is a company?
 Operating profit How well is a company run?
 Return on capital employed What return can shareholders expect?
 Asset turnover
Liquidity
 Current ratio How easily can a company meet its debts
 Quick ratio (acid test) and obligations?

Working capital management

 Receivables collection period How effectively does a company manage
 Payables payment period its working capital?
 Inventory turnover
Investor ratios What proportion of profits have been
 Earnings per share distributed as a dividend? How does the
 Dividend yield and cover market view the future performance of
 P/E ratio the company?
206 Course Notes ACCA SBR

Solvency
 Gearing How much borrowing does a company
 Interest cover have? Can it meet its interest payments?

These ratios are assumed knowledge from Financial Reporting. However, the formulae for these ratios
have been included in an Appendix to this chapter.

4.1 Alternative performance measures (APMs)

IAS 1 allows an entity to present additional line items, headings and subtotals in the statement of
profit or loss and other comprehensive income if these are relevant to understanding the entity’s
financial performance.
Examples: subtotal for profit from operations; additional line items disclosing material/non-recurring
income/expenses.
Many entities present alternative performance measures in the financial statements or outside the
financial statements (e.g. in press releases and briefings to providers of finance and analysts).
The European Securities and Market Authority (ESMA) has issued Guidelines on Alternative Measures
for listed companies. The guidelines aim to promote the usefulness and transparency of APMs. ESMA
defines an APM as follows:

KEY TERMS
Alternative performance measure (APM)
 A financial measure of historical or future financial performance, financial position or
cash flows, other than a financial measure defined in the applicable financial reporting
framework.

Examples of alternative performance measures:

 EBITDA (earnings before interest, tax, depreciation and amortisation). Variations include EBITDA
less non-recurring and/or abnormal and/or ‘non-operating’ items such as gains or losses on
financial instruments (sometimes called ‘underlying profit’).
 ‘Like-for-like’ sales revenue or ‘organic revenue growth’: changes in revenue that exclude the
effect of acquisitions and disposals in the year, or (for a retailer) stores opened or closed in the
year.
 Free cash flow (usually operating cash flow less net cash flows from purchase and sales of non-
current assets).
 Non-financial performance measures (discussed below).

EXAM SMART
In your exam you will probably be asked to deal with an APM that you have not seen before.
But the examiners have said that questions will explain how any APM has been (or should
have been) calculated.
ACCA SBR Course Notes 207

Advantages and disadvantages

EBITDA and similar measures can provide useful information:
 EBITDA adds back non-cash expenses to operating profit to show estimated operating cash flow
 depreciation and amortisation are accounting estimates and judgement errors can distort the
profit figure
 excluding gains/losses in the fair value of financial instruments removes volatility and may help
users to focus on ‘true’ profit from operations
 stripping out non-recurring items such as exceptional impairment losses or profits on disposal of
assets can help users to predict future performance
 additional profit measures may help users to compare the performance of different entities
(e.g. depreciation reflects accounting policy choices such as cost v revaluation)
 additional measures help users to appreciate the different components of performance;
profit/loss is too complex to be summed up in one figure
 additional measures may help users to view the business through the eyes of management
But alternative performance measures can cause problems for users and/or be open to manipulation:
 they may not be calculated consistently year-on-year or with similar measures used by other
entities
 there may be little or no information as to how an additional measure has been calculated
 they will probably not have been audited (not required by IFRS Standards/likely to be presented
outside the financial statements)
 too much additional information can make the financial statements more confusing, rather than
less
 what constitutes a ‘non-recurring’ or an ‘abnormal’ item can be highly subjective and therefore
open to abuse
 they can be used to present the entity’s performance in the most favourable light (e.g. by
distracting users from ‘bad news’).

Overcoming the problems

The IASB is looking at how disclosure in financial statements can be improved. One of its projects has
suggested that additional performance measures (e.g. EBITDA) should be:
 no more prominent than IFRS information
 reconciled to IFRS information
 clearly labelled, with relevance explained
 neutral and consistently measured and presented over time
 accompanied by comparatives.
Consider the Conceptual Framework:
 Objective of financial reporting: to provide information that is useful to primary users in making
economic decisions
 What makes financial information useful: relevance; faithful representation; comparability;
understandability
208 Course Notes ACCA SBR

4.2 Non-financial performance measures

Entities are increasingly choosing to disclose non-financial performance measures in their annual
reports or in separate environmental and social or integrated reports. The Management Commentary
(covered later in this chapter) includes critical performance measures and indicators which may be
non-financial.
Non-financial performance measures are not expressed in monetary units. Examples: employee
turnover, employee satisfaction, customer satisfaction, units sold per employee, market share, and
pollution levels.
Non-financial indicators help to overcome the limitations of traditional financial measures by providing:
 forward-looking information (financial indicators are based on historic information).
 information about key issues that affect the entity’s long-term prospects, such as productivity.
 information about the way in which management assesses the performance of the entity (some
key performance measures are non-financial e.g. average delivery times)
 information that is relevant to a wider range of stakeholders than the ‘primary users’: (i.e.,
investors and lenders).
But because non-financial measures are not covered by IFRS Standards:
 An entity can choose which measures to disclose.
 Measures may not be presented consistently, so that users cannot assess an entity’s
performance over time.

LECTURE EXAMPLE E.1

Wesley operates in the retail sector and owns a large number of high street stores. Currently, the
properties are held under the cost model. However, Wesley operates in a country where property prices
are rising rapidly and the directors are wondering whether they should adopt the revaluation model.
They are aware that IAS 16 Property, Plant and Equipment offers a choice of the cost model and the
revaluation model but they are worried about the impact that moving to the revaluation model will have
on the analysis of Wesley’s financial performance, position and cash flows by current and potential
investors.
Required:
Discuss the potential impact of switching to the revaluation model on investors’ analysis of Wesley’s
financial statements. Your answer should refer to key ratios where relevant.
ACCA SBR Course Notes 209

SOLUTION

5 Earnings per Share: IAS 33

IAS 33 applies to all companies with shares which are publicly traded. EPS figures must be disclosed on
the face of the statement of profit or loss.
You should already be familiar with these calculations from your earlier studies.

5.1 Basic earnings per share

𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄
EPS (in cents) = × 100
𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖𝐖 𝐚𝐚𝐚𝐚𝐚𝐚 𝐧𝐧𝐧𝐧. 𝐨𝐨𝐨𝐨 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬

 Earnings: Profit or loss for the period attributable to ordinary equity holders of the parent i.e.
consolidated profit after tax, non-controlling interests and preference dividends
 No. of shares: The weighted average number of equity shares in issue.
IAS 33 allows additional EPS figures (e.g. based on EBIT or EBITDA) provided that:
 they are not more prominent than IAS 33 EPS;
 they are fully explained in the notes;
 if the earnings measure used is not a line item reported in the SPLOCI, a reconciliation is
provided.
210 Course Notes ACCA SBR

5.2 Diluted earnings per share

Diluted EPS acts as a “warning sign” for investors in that it shows what the EPS could become if all
“potential shares” were actually in issue.
To protect shareholders and investors, companies must disclose diluted EPS figures.

Convertible loan notes

Calculate EPS as if the loan notes do not exist and the shares have been issued instead:
 Increase profit by adding back interest net of tax
 Increase number of shares by adding number of potential shares issued on conversion.
 Use adjusted profits and adjusted number of shares to recalculate EPS.

ILLUSTRATION: CONVERTIBLE LOAN NOTES

Faringdon made a profit after tax of $20 million for the year ended 30 September 2014.
At 30 September 2014, Faringdon had in issue 50 million equity shares and a $15 million convertible
loan note. The loan note will mature in 2016 and will be redeemed at par or converted to equity
shares on the basis of 25 shares for each $100 of loan note at the loan-note holders’ option.
Faringdon’s income tax rate is 25%. The effective rate of interest on the loan note is 8%.
Required:
Calculate the diluted EPS for the year ended 30 September 2014.
SOLUTION
Basic EPS:
($20 million/50 million × 100) 40.0 cents
Diluted EPS:
($20.9 million/53.75 million × 100) 38.9 cents

Adjusted earnings
20 million basic earnings + (15 million × 8% × 75% after tax) $20.9 million

Adjusted number of shares

50 million basic no. of shares + (15 million × 25/100) 53.75 million

Share options or warrants

Step 1: Calculate the cash receivable on the exercise of the options.
Step 2: Calculate the number of shares that would have been issued if the cash received had
been used to buy shares at average market price for the period.
Step 3: Deduct the figure in (2) above from the actual number of shares issued – this gives you
the number of shares that have effectively been “given away”.
Step 4: Add these “free” shares to the average number of shares for the period to derive the
diluted EPS.
Note that earnings (the numerator in the EPS calculation) does not change.
ACCA SBR Course Notes 211

ILLUSTRATION: SHARE OPTIONS

Arran made a profit after tax of $2,300,000 for the year ended 30 September 2014.
At that date, Arran had $2 million of equity shares of 25 cents each in issue. There had been no
changes to issued share capital for many years.
At 30 September 2014, there were outstanding share options to purchase 3 million equity shares at
$1.60 each. The average market value of Arran’s equity shares during the year ended 30 September
2014 was $4 per share.
Required:
Calculate the diluted EPS for the year ended 30 September 2014.
SOLUTION
Diluted EPS = 23.5 cents ($2,300,000/9,800,000 shares)
Step 1: Calculate the cash receivable on the exercise of the options: 3,000,000 shares at $1.60
exercise price = $4.8 million
Step 2: Calculate the number of shares that would have been issued if the cash received had
been used to buy shares at average market price for the period: $4.8 million/4 = 1,200,000 shares
Step 3: Deduct the figure in (2) above from the actual number of shares issued: 3,000,000 –
1,200,000 = 1,800,000 shares
Step 4: Add these “free” shares to the average number of shares for the period to derive the
diluted EPS: 2,000,000 × 4 + 1,800,000 = 9,800,000 shares

6 The impact of environmental, social and ethical factors on

performance measurement
The traditional view is that companies exist only to make a profit for their shareholders. But in recent
years there has been increasing acknowledgement that companies have a much wider range of
stakeholders: not only investors and loan creditors but also employees, customers, suppliers, auditors,
other regulators and society as a whole.
As a result, some investors may not financially support entities that they perceive to be unethical or
harmful to the environment.
Investors are increasingly considering non-financial factors such as corporate social responsibility and
sustainability when assessing companies ‘long-term prospects.
For example:
 What are its main activities? Does it trade in arms, or tobacco? Does it test products on
animals?
 Does it support local charities or otherwise make a positive contribution to the community?
 Does it monitor and take steps to reduce harmful emissions and clean up contamination?
 Where are its products made and how are the staff treated there?
 Are its goods and services purchased from entities that have high ethical standards?
212 Course Notes ACCA SBR

 How complete are its disclosures about its social and environmental impact?
 Does it use tax avoidance schemes?
Ethical behaviour may reduce profits (e.g. through higher wages, clean-up costs, etc.). On the other
hand, corporate social responsibility may improve employee morale, increase consumer confidence
and enhance an entity’s reputation, which may indirectly lead to greater revenues and profits.

7 Developments in sustainability reporting

7.1 The issue
A sustainability report is a report published by a company or organisation about the economic,
environmental and social impacts caused by its everyday activities. (Global Reporting Initiative)
Sustainable development balances the needs of society, the economy and the natural environment.
United Nations (UN) member states have agreed 17 Sustainable Development Goals (SDGs). These
include no poverty, affordable and clean energy, reduced inequalities, climate action and decent work
and economic growth.
Investors and other stakeholders are becoming increasingly interested in sustainability issues and the
actions that companies take to contribute to the SDGs. If an entity is seen to be committed to
sustainable development this can have a positive effect on its financial performance and prospects.
Sustainability reports provide useful information that is relevant to investment decisions.
Some jurisdictions, (e.g. The EU and the UK), require large and listed companies to disclose non-
financial information about particular aspects of sustainability, such as employee diversity and carbon
emissions.

7.2 Reporting standards and guidance

In recent years, a number of organisations have produced guidelines on sustainability reporting,
including:
 The Global Reporting Initiative (GRI) produced its first set of Sustainability Reporting Standards
in 1997. These enable an entity to disclose balanced information about its impacts on the
economy, the environment and society. The GRI Standards focus on the topics that represent
the most significant impacts of the entity and are most important to its stakeholders – which
supports sustainability reporting that is tailored to each individual company.
 The International Integrated Reporting Council (IIRC) was formed in 2010 and published the
International Integrated Reporting Framework in 2013.
 The International Standard Sustainability Board (ISSB) was formed in 2021 with the objective of
developing a global set of sustainability reporting standards to help investors and other market
participants make informed decisions.
 The European Commission published its own set of twelve European Sustainability Reporting
Standards (ESRS) in 2023.
Different companies and jurisdictions may have different objectives for sustainability reporting and
may concentrate on different aspects of it (e.g. the impact on the company v the impact on the
environment). This has led to a lack of comparability between the reports provided by different
entities.
ACCA SBR Course Notes 213

7.3 The International Sustainability Standards Board (ISSB)

The ISSB is separate from the International Accounting Standards Board (IASB), but works alongside it.

IFRS Foundation

IASB ISSB

Issues International Issues International

Financial Reporting Sustainability
Standards Sandards

The ISSB has issued two standards to date:

 IFRS S1 General requirements for Disclosure of Sustainability-related Financial information
 IFRS S2 Climate-related disclosures

7.3.1 IFRS S1 General requirements for Disclosure of Sustainability-related Financial

information
Scope Primarily for profit-orientated entities, including public sector entities but can be adapted
for other types wishing to use the standard.
Excludes sustainability-related risks and opportunities where it is unreasonable to
assume they will affect the entity’s prospects.
Conceptual  Fair presentation (complete, neutral, accurate disclosures)
foundations  Materiality (disclose material information affecting entity’s prospects)
 Reporting entity (same reporting entity as for the financial statements)
 Connected information (between sustainability-related risks and opportunities;
between sustainability disclosures and other reports)
 Judgement, uncertainty, and errors (so readers can understand these)
Objective To require an entity to disclose information about its sustainability-related risks and
opportunities that is useful to primary users of general purpose financial reports in
making decisions about providing resources to the entity….. that could reasonably be
expected to affect the entity’s cash flows, its access to finance of cost of capital over the
short, medium or long term.
Core content  Governance – to understand processes, controls and procedures entity uses to
monitor, manage and oversee sustainability-related risks and opportunities (e.g. the
body charged with this responsibility – board, committee or individual).
 Strategy – for managing sustainability related risks and opportunities (e.g. effects on
entity’s prospects, effects on business model and value chain).
 Risk management – to enable users to under the entity’s processes and to assess
the entity’s risk profile and risk management process.
 Metrics and targets – to enable users to assess performance and progress.
214 Course Notes ACCA SBR

7.3.2 IFRS S2 Climate-related disclosures

Scope Applies to:
 Climate-related risks to which the entity is exposed, which are:
– Climate-related physical risks; and
– Climate-related transition risks
 Climate-related opportunities
Excludes climate-related risks and opportunities where it is unreasonable to assume they
will affect the entity’s prospects.
Objective To require an entity to disclose information about its climate-related risks and
opportunities that is useful to primary users of general purpose financial reports in
making decisions about providing resources to the entity….. that could reasonably be
expected to affect the entity’s cash flows, its access to finance of cost of capital over the
short, medium or long term.
Core content  Governance (e.g. the individual or body with overall responsibility for climate-
related risks and opportunities and their terms of reference)
 Strategy (e.g. effects on entity’s prospects, business model and value chain; effects
on strategy, decision-making and transition plans; resilience of strategy).
 Risk management (e.g. disclose risk management process including assessment of
nature, likelihood and magnitude, methods of prioritisation and use of data and
other assumption).
 Metrics and targets (e.g. greenhouse gas emissions, the proportion of assets and
business activities relating to transition and physical risks, capital deployed and
executive remuneration linked to climate-related risks and opportunities)

EXAM SMART
A member of the SBR Examining Team has written an article that explains the reasons for
setting up the ISSB in more detail. This can be found on the ACCA website:
Sustainability reporting | ACCA Global

7.3.3 Usefulness of corporate disclosures of climate-related risks and opportunities

LECTURE EXAMPLE E.2: USEFULNESS OF CLIMATE-RELATED DISCLOSURES TO INVESTORS

Morgan Co is a telecommunications company. It discloses a summary of its climate scenario analysis

results in its annual report:
Risk or opportunity Time horizon Potential financial impact
Increase in intensity, duration and Long-term Reduced revenue due to network disruption
frequency of extreme weather Increased costs to repair damaged assets
events
Change in consumer preferences Long-term Reduced revenue from loss of customers due to
and perceived reputation failure to meet rising customer expectations on
climate targets
Increased costs associated with Medium-term Increased direct compliance costs from regulatory
carbon pricing, offsets and and government policy changes.
taxation Increased indirect costs from supply chain players
affected by carbon prices who then pass costs onto
Morgan Co.
ACCA SBR Course Notes 215

Risk or opportunity Time horizon Potential financial impact

Increased cost of capital due to Medium-term Increased cost of capital (reduced access to capital
insufficient climate action by and increased interest expense) due to decline in
Morgan Co sustainability credentials and reputation.
Improvement in energy efficiency Medium-term Reduced costs associated with transitioning to
energy efficient technologies.
Strengthening Morgan Co’s Long-term Increased revenue from improved reputation
reputation as a climate change around climate change.
leader
Expanding service offerings Medium-term Increased revenue from new green products and
improved brand reputation.

Required:
Discuss the usefulness to investors of Morgan Co’s climate scenario analysis results.
SOLUTION

7.3.4 Differences between IFRS Sustainability Disclosure Standards and the European
Sustainability Reporting Standards
IFRS Sustainability Disclosure European Sustainability Reporting
Standards (ISSB Standards) Standards (ESRS)
Enforceability Voluntary basis unless jurisdiction Mandatory for all companies already
authorities decide to require subject to a reporting obligation under
application the NFRD
Effective date From 2024 (first reports in 2025) From 2024 (first reports in 2025) for
EU large Public Interest Entities and
large non-EU companies listed on an
EU market. All other EU entities
progressively after 2025.
Scope Suitable for all profit-orientated and As above
public sector entities
216 Course Notes ACCA SBR

IFRS Sustainability Disclosure European Sustainability Reporting

Standards (ISSB Standards) Standards (ESRS)
Target users Investors, lenders and creditors Wider range of users
Coverage There are two ISSB Standards: IFRS S1 There are 12 ESRS: Two cross cutting
General Requirements for Disclosure of standards ESRS 1 General
Sustainability-related Financial Requirements and ESRS 2 General
Information; and IFRS S2 Climate- Disclosures; and 10 topical standards.
related Disclosures
Materiality approach Financial materiality Double materiality
Materiality assessment Disclosure dependant on materiality Some mandatory disclosure
assessment requirements always to be applied and
some dependant on materiality
assessment
Location of reports No prescribed approach Prescribed structure within entities'
corporate reports
Sector-specific Included in ISSB Standards To be developed from 2024
disclosures

8 Integrated Reporting
8.1 Integrated reports
An integrated report is a report to stakeholders on the strategy, performance and activities of an
organisation to create and sustain value over the short, medium and long term.
Traditional financial statements have some important limitations:
 They are normally based on historical information. They do not include forecasts or other
forward-looking information that investors, lenders and other users might need in order to
predict future performance.
 They do not recognise all an entity’s assets and resources: e.g. internally generated brands,
goodwill, the technical knowledge, experience and skill of the company’s workforce.
 They do not include information about non-financial factors that affect an entity’s performance:
e.g. sustainability, corporate social responsibility, the risks that the entity faces.
An integrated report goes further than traditional financial statements. It incorporates non-financial
information, providing a complete picture of a company.
The International Integrated Reporting Council (IIRC) is a global coalition of regulators, investors,
companies, standard setters, the accounting profession and non-government organisations (NGOs).
The IIRC has developed The International Integrated Reporting Framework. This sets out:
 principles and concepts which govern the overall content of an integrated report and
 the elements that should be included within an integrated report.
ACCA SBR Course Notes 217

8.2 The six capitals

An entity creates value through all its resources and relationships, called capitals: stocks of value that
are affected by the activities of an organisation.
Traditional financial reporting only considers financial capital.
An integrated report considers all six capitals (memory aid: ‘FISHMAN’).
 F inancial capital: the pool of funds available to an entity (provided by debt, equity, grants or
generated from operations or investments)
 I ntellectual capital: knowledge-based intangibles e.g. patents, licenses, copyrights, software
 S ocial and relationship capital: key stakeholder relationships and trust (including shared
values and the entity’s reputation)
 H uman capital: people’s competencies, experience, loyalties and motivations
 MA anufactured capital: buildings, equipment and infrastructure available for use in
operations
 N atural capital: access to environmental resources that support the future prosperity of the
organisation, e.g. air, water, land, minerals, forests

8.3 Guiding principles

 Strategic focus and future orientation: the report should provide insight into the entity’s
strategy, and how this relates to its ability to create value
 Connectivity of information: the report should show a holistic picture of the factors (and their
inter-relationships) that affect the entity’s ability to create value over time
 Stakeholder relationships: the report should provide insight into the nature and quality of the
entity’s relationships with its key stakeholders
 Materiality: the report should disclose information about matters that substantively affect the
entity’s ability to create value
 Conciseness: the report should be concise
 Reliability and completeness: the report should include all material matters, both positive and
negative, in a balanced way and without material error
 Consistency and comparability: information should be presented on a basis that is consistent
over time; and in a way that enables comparison with other entities.

8.4 The content of an integrated report

 Organisational overview and the external environment under which the entity operates
 Governance structure and how this supports the entity’s ability to create value
 Business model (what are the entity’s activities and how does the business create value?)
 Risks and opportunities and how these affect the entity’s ability to create value
 Strategy and resource allocation (what does the entity want to achieve and how does it intend
to do it?)
 Performance and achievement of strategic objectives for the period and outcomes in terms of
effects on the capitals
 Outlook and challenges facing the entity and their potential implications
 Basis of presentation: how the entity determines what matters should be included in the report
and how these are quantified or evaluated.
218 Course Notes ACCA SBR

8.5 Benefits and limitations of Integrated Reporting <IR>

Traditional financial statements are prepared to meet the information needs of providers of finance:
current and potential investors (and their advisors), lenders and other creditors.
Integrated reports cater for a much wider group of stakeholders.

Benefits of <IR>
 It presents a more forward-looking, holistic and long-term view of company performance
(contrasts with traditional financial statements which are historical and only report financial
information)
 It provides better information about non-financial factors that can affect financial performance:
e.g. labour standards, employee satisfaction, customer feedback, community relations and
government regulatory track records
 It helps stakeholders to identify and manage risks
 The process of preparing the report improves management decision making and encourages
longer-term strategic planning
 It can improve employee engagement and motivation through better communication (‘telling
the story of the company’)

Limitations of <IR>
Integrated Reporting is voluntary. Entities that publish an Integrated Report should comply with the
guiding principles of the Framework or explain why they have not done so.
The Framework is principles based. It recognises that different entities can have widely varying
individual circumstances, e.g. it does not prescribe specific key performance indicators (KPIs), detailed
disclosures or measurement methods. Therefore:
 to some extent preparers can choose the information that they disclose
 the report may not be sufficiently balanced between positive and negative aspects
 it may be difficult to compare the information with that of other entities
 the report may not be audited, meaning that the information is less reliable
 in practice the report can be time consuming and difficult and costly to prepare
 integrated reports are not always concise, which reduces their usefulness to some stakeholders

LECTURE EXAMPLE E.3: INTEGRATED REPORTING

Entities operating in the services sector often consider their employees to be their key asset. However,
unlike manufacturing companies which recognise their key assets (e.g. factories, plant and machinery
and inventory) in their statement of financial position, IFRS Standards prohibit recognition of staff skills
as an asset.
This could deter potential investors from investing in entities in the services sector if they are unable
to appreciate the value of the entity’s employees.
Required:
Discuss whether the information available to investors would be improved by a services entity
preparing an integrated report.
ACCA SBR Course Notes 219

SOLUTION

9 IFRS 8 Operating Segments

IFRS 8 is compulsory for quoted companies. Its aim is to ensure that an entity discloses information to
enable users of its financial statements to evaluate the nature and financial effects of the types of
business activities in which it engages and the economic environments in which it operates.
One of the main issues surrounding the standard is the fact that it requires operating segments to be
identified on the basis of the internal reports of the entity that are regularly reviewed by the chief
operating decision maker. These reports may or may not be based on the same accounting policies
used to prepare the financial statements.
There is therefore some scope for the manipulation of data to present the accounts in a more
favourable light.

9.1 What is an “operating segment”?

An “operating segment” is defined as a component of an entity:
 That engages in business activities from which it may earn revenues and incur expenses
(including intercompany revenues and expenses);
 Whose operating results are reviewed regularly by the entity’s chief operating decision maker
to make decisions about resources to be allocated to the segment and assess its performance;
and
 For which discrete financial information is available.
Operating segments may be aggregated together into one reportable segment as long as the segments
have similar economic characteristics, and are similar in the following respects:
 The nature of the products and services
 The nature of the production processes
 Classes of customer
 Distribution methods or methods used to provide services; and
 If applicable, the nature of the regulatory environment (e.g. banking).
220 Course Notes ACCA SBR

9.2 Reportable segments

Which segments are big enough to report on?
Segment information is required to be disclosed about any operating segment that meets any of the
following quantitative thresholds:
 Its revenue (both intercompany and with external customers) is 10% or more of the combined
revenue (internal and external), of all operating segments; or
 Its profit or loss is 10% or more of the greater of
(i) The combined reported profit of all segments that did not report a loss and
(ii) The combined reported loss of all loss-making segments; or
 Its assets are 10% or more of the combined assets of all segments.
If the total external revenue reported by segments constitutes <75% of the entity’s revenue,
additional operating segments must be identified as reportable segments (even if they do not meet
the quantitative thresholds set out above) until >75% of the entity’s revenue is included in reportable
segments.

ILLUSTRATION: OPERATING SEGMENTS

A company operates in the following divisions:

Mobile Other
Train phones Airline Bank sales Total
$m $m $m $m $m $m
Revenue from external
customers 210 270 65 50 55 650
% of total 32% 42% 10% 7.5% 8.5%
Inter-segment revenue 40 5 – 8 2 55
% of total 73% 9% – 14.5% 3.5%
Total revenue 250 275 65 58 57 705
% of total 35% 39% 9% 8.5% 8.5%
Reported profit 55 45 10 9 11 130
% of total 42% 35% 8% 7% 8%
Total assets 5,000 4,100 250 450 610 10,410
% of total 48% 39% 2% 5% 6%
Which of the divisions are reportable segments under IFRS 8 Operating Segments?
Given the criteria on the previous page, both the train and the mobile phone division meet the revenue
criteria (>10% of the total revenue). None of the other three divisions meet any of the three criteria.
However, the train and the mobile phone division’s external revenue combined only accounts for 74%
(480/650) of the total external revenue. Therefore, we should also include segmental analysis on the
airline division (the next biggest division) to meet the 75% threshold required by IFRS 8.
ACCA SBR Course Notes 221

9.3 Disclosure
An entity should disclose:
 How the entity identified its operating segments;
 Information about the reported segment profit or loss, including revenue (external and inter-
segment), material items of income/expense, income tax expense, final profit/loss, assets,
liabilities
 Reconciliations of the totals of segment revenues, reported segment profit or loss, segment
assets, segment liabilities and other material items to corresponding items in the entity’s
financial statements.
Geographical area – An analysis of revenues and non-current assets by country of domicile and by
individual foreign country (if material),
Major customers – The company should disclose information about transactions with “major”
customers (i.e. those whose revenues >10% of the entity’s revenues). The entity need not disclose the
identity of a major customer.

9.4 Common costs

Many large companies will incur costs such as head office costs, pension costs and interest which
supports more than one segment.
Clearly, the allocation of such expenses is an area where the basis chosen by an entity can have a
significant effect on the segment results.
IFRS 8 therefore require that such “common costs” are allocated on a “reasonable basis”.
For example, head office costs could be allocated on the basis of revenue or net assets and pension
expenses may be allocated on the number of employees or salary expense of each segment.

10 Practice Statement: Management commentary

Financial statements do not provide all the information that users may need to make economic
decisions, since they largely portray the financial effects of past events and do not necessarily provide
non-financial information.
To bridge the gap between what financial statements are able to achieve and the needs of users of
those financial statements, the IASB has issued a Practice Statement for a type of narrative report
referred to as management commentary (sometimes called the Operating and Financial Review).
The Practice Statement is not an IFRS standard; it is intended to provide guidance on good practice.
Consequently, an entity need not comply with the Practice Statement to comply with IFRS Standards.
A management commentary enables preparers to provide meaningful disclosures about the most
important resources, risks and relationships that can affect an entity’s value and how they are
managed. It also explains the main trends and factors that might affect its future performance,
financial position and progress (i.e., how an entity has and expects to grow or change in current and
future periods). Hence, management commentary combines information about the past, present and
future.
222 Course Notes ACCA SBR

10.1 Principles
The management commentary should:
 Provide management’s view of the entity’s performance, position and progress, using
information that is important to management and relative to stated strategies and plans; and
 Supplement and complement the financial statements with explanations of the amounts
presented in the financial statements and information that is not presented in the financial
statements but is important to the management of the entity.
To align with those principles, management commentary should include:
 Forward-looking information. Such information should set out management’s objectives for
the entity and its strategies for achieving those objectives, rather than predict the future; and
 Information that possesses the qualitative characteristics of relevance and faithful
representation described in the Conceptual Framework.

10.2 Presentation
A management commentary should be:
 Clear and straightforward;
 Focused on matters that are most important to the entity, avoiding immaterial, boilerplate and
generic disclosures; and
 Consistent with the disclosures in the financial statements, including any segmental
information, but not duplicating those disclosures if practicable.

10.3 Elements (content)

The practice statement is not intended to include a checklist of content. However, it does identify the
following elements that the IASB would expect to be included in management commentary, based on
the needs of identified primary users:
 The nature of the business, – e.g. products and services, overall structure, and the markets in
which the entity operates;
 Management’s objectives and its strategies for meeting those objectives;
 The entity’s most significant:
(i) Resources, which might include an analysis of liquidity, cash flows, financing
arrangements, and capital structure,
(ii) Risks – e.g. strategic, commercial, operational and financial risks, but not all possible
risks;
(iii) Relationships, in particular those with stakeholders;
(iv) The results of operations and prospects, including whether performance may be
indicative of future performance; and
(v) The critical performance measures and indicators that management uses to evaluate the
entity’s performance against stated objectives, and whether those used in the past
continue to be relevant.
The aim is to provide more forward-looking information aimed at the shareholders of the company.
ACCA SBR Course Notes 223

10.4 Advantages and disadvantages of producing a management

commentary
Advantages Disadvantages
 Viewed favourably by shareholders as providing  Time and cost involved in producing the
more detailed information on the performance of information
the company
 System already in place should the management  Management bias
commentary/OFR ever become compulsory in
the future
 Can use graphs and pictures  Unsuitable

11 Specialised, not-for-profit and public sector entities

The primary aims of public sector and not-for-profit entities such as charities are likely to differ from
“normal” profit-making entities in that their goals will revolve around a strategy other than the
maximisation of revenue and the minimisation of costs. For example:
 A local council will focus on providing value for money for the local community in the provision
of libraries, schools and hospitals.
 A charity will have a non-financial target such as the protection of wildlife or the promotion of
healthy eating.
 A hospital will aim to treat as many patients as possible with the available resources.
Although such organisations do not exist to increase the wealth of shareholders, that does not mean
that they should act inefficiently. Cost control, inventory management and providing “value for
money” are core features of almost all organisations and so some of the ratios outlined earlier in this
chapter will still be relevant.
Most issued IFRS Standards are relevant for both profit-making and not-for-profit organisations.
However, standards such as gross profit margin and Earnings per Share are not relevant for not-for-
profit organisations as “performance” is not a key indicator for such entities.
There is no requirement for public sector entities to use IFRS Standards although there are moves to
promote their use to aid the comparability of accounts across the globe.

12 Appendix (home study)

12.1 Profitability ratios
𝐆𝐆𝐆𝐆𝐆𝐆𝐆𝐆𝐆𝐆 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩
Gross profit margin (%) =
𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑

𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏 𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢 𝐚𝐚𝐚𝐚𝐚𝐚 𝐭𝐭𝐭𝐭𝐭𝐭

Operating profit margin (%) =
𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑𝐑

𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏 𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢 𝐚𝐚𝐚𝐚𝐚𝐚 𝐭𝐭𝐭𝐭𝐭𝐭

Return on capital employed (ROCE) (%) =
𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 + 𝐍𝐍𝐍𝐍𝐍𝐍-𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜𝐜 𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥
224 Course Notes ACCA SBR

12.2 Liquidity ratios

𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚
Current ratio =
𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥

𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚𝐚 ‒ 𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢

Quick ratio =
𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥𝐥

12.3 Working capital ratios

𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓 𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫𝐫
Receivables collection period = × 𝟑𝟑𝟑𝟑𝟑𝟑
𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒

𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓𝐓 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩
Payables payment period = × 𝟑𝟑𝟑𝟑𝟑𝟑
𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐨𝐨𝐨𝐨 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬

𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈
Inventory days = × 𝟑𝟑𝟑𝟑𝟑𝟑
𝐂𝐂𝐂𝐂𝐂𝐂𝐂𝐂 𝐨𝐨𝐨𝐨 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬

12.4 Investor ratios

𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐩𝐩𝐩𝐩𝐩𝐩 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬
Dividend cover =
𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃 𝐩𝐩𝐩𝐩𝐩𝐩 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬

𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃𝐃 𝐩𝐩𝐩𝐩𝐩𝐩 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬

Dividend yield (%) =
𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌 𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬𝐬 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩

𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒𝐒 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩
P/E ratio =
𝐄𝐄𝐄𝐄𝐄𝐄

12.5 Solvency ratios

𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈-𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐝𝐝𝐝𝐝𝐝𝐝𝐝𝐝 𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈-𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐝𝐝𝐝𝐝𝐝𝐝𝐝𝐝
Gearing (%) = OR
𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄 𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈-𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐝𝐝𝐝𝐝𝐝𝐝𝐝𝐝 + 𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄𝐄

𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏𝐏 𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛𝐛 𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢𝐢 𝐚𝐚𝐚𝐚𝐚𝐚 𝐭𝐭𝐭𝐭𝐭𝐭

Interest cover =
𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈𝐈 𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞𝐞
ACCA SBR Course Notes 225

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Do you understand why information about an entity’s business model might be useful
to investors?
Can you explain what information should be considered when interpreting financial
statements, in addition to ratios?
Can you explain the advantages and disadvantages of alternative performance
measures for investors and other stakeholders?
Can you calculate basic and diluted earnings per share and explain why diluted
earnings per share is useful to investors?
Can you discuss the impact of environmental, social and ethical factors on
performance reporting?
Can you discuss recent developments in sustainability reporting?
Do you understand what is meant by an integrated report and how and why an
integrated report provides useful information about an entity?
Can you explain how to identify an entity’s operating segments and how to determine
which segments should be separately reported?
Can you explain the main principles that should govern the preparation of a
management commentary, and what kind of information it should contain?
226 Course Notes ACCA SBR

Chapter E – Lecture example solutions

Lecture Example E.1
Impact on statement of financial position
Under the revaluation model, the properties would be measured at fair value which is defined by IFRS
13 as the prices that would be received to sell an asset in an orderly transaction between market
participants.
As property prices are rising, adopting the revaluation model is likely to result in revaluation gains. This
could make Wesley appear more asset-rich. Some investors may place importance on an entity’s asset
base, as it can be used as security for obtaining new debt finance. However, reporting higher assets
can sometimes be perceived negatively. For example, asset turnover ratios will deteriorate, making
Wesley appear less efficient.
The revaluation gain is reported in the revaluation surplus in equity. Therefore, the revaluation model
is likely to reduce gearing which is likely to be viewed positively by investors (particularly equity
investors) as an indication of a decrease in risk, encouraging further investment.
Impact on statement of profit or loss
An increase in the value of the properties will result in a higher depreciation charge and therefore a
lower reported profit. Therefore, earnings per share, a key stock market and investor ratio, is likely to
be lower if the revaluation model is adopted. This could deter investment.
However, entities now present alternative performance measures, such as EBITDA (earnings before
interest, tax, depreciation and amortisation). This would remove the distorting effect of the higher
depreciation on the profit figure and would encourage investors to view profits in a more favourable
light.

Lecture example E.2

Usefulness
Investors are interested in future-looking information to assess how likely future dividends and
increases in share price will be.
This climate-scenario information is all future looking and is categorised into medium or long-term so
depending on how long the investor is planning to hold their shares will be relevant to the investor’s
decision in whether to buy, sell or keep their shares.
Investors are also increasingly interested in a company’s sustainability credentials as well as its
profitability so these disclosures will help the investors assess the environmental aspect of these
credential to ensure that they make an ethically-sound investment.
The scenario analysis includes risks and opportunities allowing the investor to assess both potential
decreases and increases to its share price in the future.
Investors are increasingly interested in non-financial information as well as financial information to be
fully informed when making their investment decision. These climate scenario disclosures are non-
financial information which could not be ascertained from the financial statements alone so add value
to the investor.
Limitations
These climate-related disclosures will add to the length of Morgan Co’s annual report and could result
in information overload resulting in reduced understandability by investors.
As the disclosures relate to the medium and long-term, they will not be of interest to a short-term
investor.
ACCA SBR Course Notes 227

The potential financial impact is not quantified which could make it difficult for the investor to assess
the future impact on their share price and dividends.
The scenarios are not clearly categorised as a ‘risk’ (e.g. increased extreme weather events) or
‘opportunity’ (e.g. expanding service opportunities) making it harder for the investor to assess which
will have positive impacts and which will have negative impacts.

Lecture example E.3

Financial statements primarily contain financial information that is backward-looking. Integrated
reports have the benefit of containing both financial information and non-financial information and
they are forward-looking (considering value creation in the short, medium and long term). As investors
will be concerned with future dividends and share price increases, an integrated report would provide
useful extra information for investment decisions.
For a services entity, where the key asset (employees’ skills) is not reported in the statement of
financial position, an integrated report is even more valuable. The International Integrated Reporting
Framework requires entities to consider a wide variety of capitals, beyond those reported on in the
financial statements.
The two capitals particularly relevant to a services entity are:
 Intellectual capital – this includes an entity’s intellectual property (e.g. patents, copyrights,
software, rights, licences) and organisational capital (e.g. knowledge, systems, procedures,
protocol). The organisational capital in terms of the knowledge of employees is particularly
relevant to the services sector.
 Human capital – this relates to people’s competencies, capabilities and experience so is
particularly relevant to the services sector.
The International Integrated Reporting Framework requires entities to disclose information about its
capitals. Therefore, for a services entity, an integrated report would add additional very useful
information for a potential investor over and above what is included in the financial statements. This
additional information should assist with the investment decision.
228 Course Notes ACCA SBR
 229

The impact of changes in

accounting regulation

1 Introduction
The main topics relevant to the current syllabus are covered below:
 Accounting for cryptocurrency and other digital assets
 Accounting for the effects of a natural disaster or global event
 Accounting for the effects of climate change
 Going concern assessments
To help here, you should ensure that you read the technical articles on the ACCA website.
You also need to be aware of weaknesses within existing examinable accounting standards. For
example, many older standards are not consistent with the current version of the Conceptual
Framework. More information on this topic is provided in Appendix 2.

2 Cryptocurrency and other digital assets

2.1 What is cryptocurrency?

KEY TERMS
Cryptocurrency
 An intangible digital token recorded using a distributed ledger infrastructure. The
tokens provide various rights of use e.g. of other assets or services, or can represent
ownership interests.
230 Course Notes ACCA SBR

Distributed ledger infrastructure

 A digital system for recording transactions of assets in which transactions and details
are recorded in multiple places at the same time (e.g. blockchain for recording
cryptocurrencies).

The tokens are owned by an entity that owns the key that allows it to create a new entry in the ledger.
Access to the ledger allows the ownership of the token to be reassigned. Only the key to the
blockchain (rather than the token itself) is stored on the entity’s IT system.
The tokens represent specific amount of digital resources which the entity has the right to control,
and whose control can be reassigned to third parties.

2.2 Accounting for cryptocurrency

Currently, there is no specific accounting standard for cryptocurrency. Therefore, in the exam, you
may be required to discuss which existing accounting standards may be relevant.
Accounting standard Is it relevant to cryptocurrency?
IAS 7: Statement of Is it cash?
Cash Flows  No – it cannot be readily exchanged for any good or service as digital
currencies are not yet widely accepted.
Is it a cash equivalent?
 No – it is subject to significant volatility in value.
IAS 32: Financial Is it a financial instrument?
Instruments:  It is not cash
Presentation  It is not an equity interest in an entity
 It is not a contract establishing a right or obligation to deliver or receive cash
(or another financial instrument)
 It is not a debt security or equity security
IAS 38: Intangible Intangible asset = ‘an identifiable non-monetary asset without physical substance’
Assets Identifiable = separable (capable of being separated or divided from the entity and
sold, transferred, rented or exchanged) or arises from contractual or other legal
rights
Non-monetary asset = absence of right to receive fixed or determinable number of
units of currency
Cryptocurrency appears to meet the definition of an intangible asset:
 It can be separated from its holder
 It can be sold or transferred
 It does not give the holder the right to receive fixed or determinable number
of units of currency (as it is subject to major variations in value)
 There is an expectation of inflow of economic benefits as it can be traded on
an exchange
Measurement
 Cost model or revaluation model (if there is an active market – as
cryptocurrencies are often traded on an exchange, an active market may exist)
 If use revaluation model, use IFRS 13: Fair Value Measurement definition of
fair value (e.g. daily trading of Bitcoin provides a quoted market price = Level 1
input)
Useful life
 Likely to be indefinite
 Do not amortise
 Annual impairment review
ACCA SBR Course Notes 231

Accounting standard Is it relevant to cryptocurrency?

IAS 2: Inventories If an entity holds cryptocurrencies for sale in the ordinary course of business, they
should be treated as inventory.
Normally inventory is measured at the lower of cost and net realisable value but
IAS 2 states that if the entity is the broker-trader, inventory should be valued at
fair value less costs to sell.
IAS 1: Presentation of Disclosure is required of judgements management has made in accounting for
Financial Statements holdings of assets (e.g. cryptocurrencies), if they have a significant effect on
amounts recognised in the financial statements.
IAS 10: Events after Disclosure is required of material non-adjusting events e.g. changes in fair value of
the Reporting Period cryptocurrency after the reporting period if it would influence users’ decisions.

EXAM SMART
In the exam, it is possible that you will have to deal with a scenario that you have not
encountered before. But the approach used for cryptocurrencies above can be used to
analyse other digital assets that you might encounter in a scenario question.
For example, the Examiner has written an article that demonstrates how candidates should
use accounting principles (such as control) and existing IFRS standards to suggest potential
accounting treatments for a type of digital asset called an Initial Coin Offering (ICO). You are
strongly advised to read this article:
https://www.accaglobal.com/gb/en/student/exam-support-resources/professional-exams-
study-resources/strategic-business-reporting/technical-articles/asset-ceiling.html.

3 Accounting for the effects of a natural disaster or global event

Recently, there have been a high number of natural disasters, some of which have been attributed to
climate change. Therefore, the possible financial reporting effect for entities that operate in or provide
goods/services to these locations has become increasingly relevant.
Accounting standard Application to a natural disaster
IAS 37: Provisions, Decommissioning provisions
Contingent Liabilities For decommissioning obligations where an entity is required to dismantle or
and Contingent remove an asset at the end of its useful life and to restore the site, IAS 37 requires
Assets a provision (and a corresponding increase to the related non-current asset) to be
recognised when the obligation arises which is usually when operations
commence.
Therefore, at the time of a natural disaster, a provision has often already been
recognised but the timing and amount of cash flows are likely to change, requiring
a revision to the amount of a provision. The other side of the double entry depends
on whether the related asset is held under the cost model or revaluation model:
 Cost model – Add an increase in the liability to the cost of the related asset
and test the asset for impairment. Deduct a decrease in the liability from the
cost of the asset but if the decrease exceeds the carrying amount of the asset,
recognise the excess in profit or loss.
 Revaluation model –Recognise an increase in the liability: (1) in other
comprehensive income (to the extent of any revaluation surplus on the related
asset) (2) in profit or loss. Recognise a decrease in the liability in other
comprehensive income (unless it reverses a previous revaluation deficit in
profit or loss).
232 Course Notes ACCA SBR

Accounting standard Application to a natural disaster

Restructuring provisions
An entity may decide to sell or abandon assets or restructure as a result of a
natural disaster. To recognise a provision, IAS 37 requires that the entity:
 Has a detailed formal plan; and
 Has raised a valid expectation in affected parties that it will carry out the
restructuring (by starting to implement the plan or by announcing the main
features)
Future operating losses
A natural disaster may result in future losses (e.g. repair costs, lost revenue).
However, IAS 37 prohibits recognition of a provision for future operating losses.
Onerous contracts
An onerous contract may arise as the result of a natural disaster (e.g. a
manufacturing entity might not be able to fulfil a contract to sell goods at a fixed
price without buying them from a third party resulting in a loss to the entity). A
provision should be recognised at the lower of:
 The penalty for terminating the contract
 The present value of the net cost of fulfilling the contract.
Environmental provisions (constructive obligation)
An entity might have a constructive obligation for an environmental clean-up as a
result of past practice or published policies. In this case, a provision should be
recognised as long as the IAS 37 criteria are met (present obligation, probable
outflow and reliable measurement).
Contingent asset
Damage to assets, repairs, maintenance work, temporary relocation costs and lost
revenue as a result of a natural disaster could result in insurance claims. The
accounting treatment for the potential inflow is as follows:
 Virtually certain – recognise an asset
 Probable – disclose the claim
 Not probable – do nothing
IAS 36: Impairment of A natural disaster is likely to result in impairment of non-current assets (e.g.
Assets damage to a manufacturing facility). If the recoverable amount of the asset (higher
of fair value less costs of disposal and value in use) is lower than the carrying
amount, the asset must be written down for the impairment.
If the asset is completely destroyed, it must be derecognised.
IAS 2: Inventories IAS 2 requires inventory to be measured at the lower of cost and net realisable
value. A natural disaster may result in an economic recession requiring an
inventory write down.
IFRS 5: Non-current An entity may have to close down and sell a division or subsidiary as a result of a
Assets Held for Sale natural disaster. Provided the IFRS 5 criteria are met, the affected division of a
and Discontinued subsidiary would be classified as held for sale in the statement of financial position
Operations and as a discontinued operation in the statement of profit or loss.
ACCA SBR Course Notes 233

Accounting standard Application to a natural disaster

IAS 1: Presentation of As a result of a natural disaster:
Financial Statements  There may be material uncertainties causing significant doubt over the
entity’s ability to continue as a going concern – this must be disclosed in a note
to the accounts; or
 The going concern basis may no longer be appropriate – in this case, the
accounts must be prepared on a break-up basis.
IAS 1 also requires the nature and amount of material items of income and
expense to be disclosed separately on the face of the statement of profit or loss or
in the notes. Examples could include:
 Write-downs of inventory or property, plant and equipment
 Restructuring costs
 Disposals of property, plant and equipment or investments
 Discontinued operations
 Settlements as a result of litigation.
IAS 10: Events after If the natural disaster occurs after the end of the reporting period but before the
the Reporting Period date of issuing financial statements, the entity is likely to have to disclose the
nature of the event and an estimate of its financial effect (a non-adjusting event).
However, if there is doubt about the entity’s ability to continue as a going concern,
the entity may need to disclose material uncertainty over going concern or to
prepare its accounts on a break-up basis.

ILLUSTRATION: NATURAL DISASTER

As a result of a natural disaster, it is determined that an oil rig will have to be closed earlier than
expected. The remaining useful life of the oil rig is reduced from 20 years to 5 years.
The present value of the decommissioning provision will increase (due to the shorter period over
which cash flows are discounted). The increase is added to the carrying amount of the oil rig, which is
then tested for impairment. The remaining carrying amount of the oil rig must be depreciated over
5 years.

EXAM SMART
Similar considerations would apply when dealing with a global event such as the COVID-19
pandemic or an economic downturn.
The Examiner has said that candidates often only apply one IFRS Standard in response to a
scenario-based question. In practice, you would have to address a number of different
accounting issues.
A recent article on the ACCA website (https://www.accaglobal.com/gb/en/student/exam-
support-resources/professional-exams-study-resources/strategic-business-
reporting/technical-articles/pandemic.html) lists all the standards above, plus others
including:
 IAS 12 (consequences of accounting losses)
 IAS 19 (redundancies, possible changes to pension plans etc)
 IAS 20 (government grants)
 IAS 23 (possible interruptions to construction projects, changes in interest rates)
 IFRS 2 (losses might affect vesting conditions for share-based payments)
 IFRS 5 (asset sales may be delayed)
234 Course Notes ACCA SBR

 IFRS 9 (expected credit losses)

 IFRS 13 (fair values may change)
 IFRS 15 (problems with collectability)
 IFRS 16 (impairment of right-of-use assets, remeasurement of lease liability)

4 Accounting for the effects of climate change

Investors and other stakeholders need to be able to assess the impact of climate change on an entity’s
activities. There are two aspects of this:
 How climate change affects the business (including its financial performance and position and
the risks that it faces) or could affect it in future
 How the activities of the business contribute to climate change

IFRS Standards
Information must be disclosed where the effect of climate change is material to the financial
statements.
There is no single IFRS Standard that deals with climate change, but IAS 1 requires an entity to disclose
any information that is material and relevant to an understanding of the financial statements.

EXAM SMART
You should approach any questions in which the scenario includes climate change in the
same way as questions that feature a natural disaster or similar event. The scenario will lead
you towards the areas that the Examiner wants you to consider. You are likely to have to
deal with a number of different accounting issues.
For example:
 Management will need to make judgements and assumptions about the effect of
climate change (e.g. about future profits and cash flows); these should be disclosed
(IAS 1)
 Assets (including inventories) may be impaired or their expected useful lives may
change (IAS 2, IAS 16, IAS 36)
 Governments may impose penalties for not meeting targets; contracts may become
onerous; there may be obligations to limit consumption of resources or avoid causing
environmental damage; these may give rise to additional liabilities or provisions (IAS 37)
Other accounting issues and standards that may be relevant: deferred tax consequences of
accounting losses (IAS 12); possible exposure to credit losses (IFRS 9); assumptions made in
arriving at fair values may change (IFRS 13).

Non-financial reporting
In some jurisdictions (for example, the UK) some companies may be legally required to disclose
narrative information on climate-related issues.
Entities may voluntarily disclose information (for example, the management commentary should
provide information on the principal risks facing the company, which may include the effect of climate
change).
ACCA SBR Course Notes 235

Relevant reporting frameworks and guidelines include:

 The Integrated Reporting (IR) Framework (covered in Chapter E)
 Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD)
 IFRS Sustainability Disclosure Standards (currently being developed; covered later in this
chapter)

5 Going concern assessments

An entity’s financial statements are prepared on the basis that it is a going concern (i.e. it will continue
in operation for the foreseeable future).
If an entity has been affected by a natural disaster or a global event such as a pandemic or an
economic downturn, there may be significant doubt as to whether it can continue as a going concern.
IAS 1 states that:
 Management must assess an entity’s ability to continue as a going concern – this assessment
should cover a period of at least 12 months from the end of the reporting period.
 Any material uncertainties causing significant doubt over the entity’s ability to continue as a
going concern must be disclosed in a note to the accounts. Management should disclose
information about significant judgements and assumptions made in assessing going concern.
 If the going concern basis is no longer appropriate, the entity must disclose this fact, the reason
why the entity is not a going concern, and the basis on which the financial statements have
been prepared.

Assessing going concern

Management should consider all information about the future, including:
 current and expected future profitability;
 the timing of repayments of finance (e.g. loans, redeemable shares);
 whether future finance will be available, if needed;
 whether government grants or any other support will be available;
 the effect of any temporary shut-down or scaling back of the entity’s operations (e.g. due to a
lockdown);
 any possible future restrictions on the entity’s business (e.g. as a result of legislation to protect
the environment);
 any longer-term changes to the business or the market in which it operates (e.g. because of
wider use of new technology or changes in customer behaviour)
The assessment should include the effect of events that occur after the end of the reporting period.
236 Course Notes ACCA SBR

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No
Can you discuss the issues around accounting for cryptocurrency and other digital
assets?
Can you discuss the implications of a natural disaster or a global event such as a
pandemic for the financial statements?
Can you discuss the implications of reporting on climate-related issues?
Can you explain the issues that management would need to consider in carrying out a
going concern assessment?
 237

Question 1 exam technique

1 Exam format – question 1

Question 1 in the Strategic Business Reporting exam will test your understanding of consolidated
financial statements and other accounting issues.
You will be asked to explain the accounting treatment of transactions and events and provide
workings, calculations and journal entries to support your explanation.
You will also be asked to show how these items should be reported in a set of financial statements. To
do this, you will use a prepopulated spreadsheet response option containing a draft consolidated
financial statement. You will be asked to correct or adjust this spreadsheet for the accounting
treatments you have outlined.
This reflects how finance professionals use spreadsheets in a working environment.

EXAM SMART
Adjusting the draft consolidated financial statements requires you to think carefully about
the two effects of any adjustment you make.
Each adjustment requires an equal debit and credit in the financial statements.
If you are adjusting the consolidated statement of profit or loss or the consolidated
statement of cash flows you may only need to reflect one side of the adjustment.
If you are adjusting the consolidated statement of financial position, any adjustment that
affects profit or other comprehensive income will need to be reflected in retained earnings
or reserves to ensure the statement of financial position balances.
238 Cour s e Not es ACCA SBR

2 Adjusting the draft financial statements

You will be asked to adjust a draft consolidated statement of profit or loss, a draft consolidated
statement of financial position or a draft consolidated statement of cash flows.
This requirement will be worth 10 to 14 marks.
You may have to deal with a variety of issues such as accounting errors, changes in accounting policies
or the acquisition or disposal of a subsidiary.
Alternatively, there may be unrecorded transactions that require recognition or adjustment. This could
relate to several technical accounting issues in the SBR syllabus such as defined benefit pension plans,
share-based payments or foreign exchange issues.
As well as recording or adjusting for these transactions you may have to discuss the impact on the
financial statements of these adjustments from the perspective of a user of the financial statements.
This requirement will not ask you to prepare a consolidated financial statement from the single entity
financial statement of the group companies.

EXAM SMART
Adjusting draft financial statements should represent easy marks in the exam. Even if your
adjustments or calculations are incorrect, if you correctly adjust the financial statements for
your adjustments you will still pick up marks in this requirement.

ILLUSTRATION: PREPOPULATED CONSOLIDATED STATEMENT OF FINANCIAL POSITION

Earlier we saw the following example:

Glazer acquired Ferguson in stages as follows:
Purchase
Acquisition date Holding acquired consideration Retained earnings
% $m $m
30 June 2016 30% 120 200
30 September 2017 An additional 50% 560 500
(total shareholding now 80%)
Ferguson has share capital of 400 million $1 shares and no reserves other than retained earnings.
Glazer elects to measure the non-controlling interests in Ferguson at fair value.
The fair value of the 20% NCI in Ferguson on 30 September 2017 was $180 million. The fair value of
the original 30% shareholding at that date was $270 million.
Required:
The directors of Glazer have prepared a spreadsheet of the draft consolidated statement of financial
position as at 30 September 2017. The investment in Ferguson is currently shown at cost. The net
assets of Ferguson have already been consolidated and the equity of Ferguson has also been included
as a balancing figure.
Using the pre-populated spreadsheet response option within the below exhibit, adjust the spreadsheet
prepared by the directors of Glazer to prepare the corrected consolidated statement of financial
position as at 30 September 2017.
ACCA SBR Cour s e Not es 239

You should reflect the following:

 Accounting for the associate using the equity method
 The change in classification from associate to subsidiary as a result of the transaction on
30 September 2017
 Goodwill using the fair value method to calculate the non-controlling interest
Consolidated statement of financial position for Glazer group as at 30 June 2018
ASSETS
Non-current assets
Property, plant and equipment 2,850
Investment in Ferguson 680
Investment in associate
Goodwill
Other non-current assets 758
4,288
Current assets 556

TOTAL ASSETS 4,844

EQUITY AND LIABILITIES

Equity
Attributable to shareholders of the parent company
Share capital 100
Share premium 500
Other components of equity 350
Retained earnings 1,349

Non-controlling interest
Ferguson’s equity 900
Total equity 3,199

Liabilities
Non-current liabilities:
Loans payable 200
Deferred tax liabilities 550
Net pension deficit 320
1,070
Current liabilities 575

Total equity and liabilities 4,844

240 Cour s e Not es ACCA SBR

SOLUTION
 Accounting for the associate using the equity method:
To reflect the equity method, the $120m cost of the associate needs to be moved from the
investment line to the investment in associate line, i.e. DR Investment in associate $120m,
CR Investment in Ferguson $120m.
The investment in the associate should be increased by $90m and the retained earnings of the
group increased by $90m, i.e. DR Investment in associate $90m, CR Retained earnings $90m
(the retained earnings of Ferguson have increased by $300m between 30 June 2016 and
30 September 2017. The group share of this increase is 30% x £300m = $90m).
 The change in classification from associate to subsidiary as a result of the transaction on
30 September 2017
The gain on the derecognition of the previously held associate is calculated as follows:
$m
Fair value at date control is obtained 270
Carrying amount of original investment (see below) (210)
Gain to go through statement of profit or loss (and retained earnings) 60

(W) Carrying amount of investment at date of disposal:

$m
Original cost of investment 120
Plus: share of post-acquisition reserves (30% × (500 – 200)) 90
210

This will be recorded as an increase in the investment in associate and an increase in retained
earnings, i.e. DR Investment in associate $60m, CR Retained earnings $60m.
The carrying amount of the investment in the associate then needs to be derecognised and
replaced with goodwill, i.e. DR Goodwill $270m, CR Investment in associate $270m.
 Goodwill using the fair value method to calculate the non-controlling interest
The goodwill calculation is as follows:
$m $m
Consideration transferred 50% 560
Fair value of the previously held interest 30% 270
NCI (at fair value) 20% 180
Less: Fair value of net assets at acquisition
Share capital 400
Reserves 500
(900)
110
ACCA SBR Cour s e Not es 241

The adjustments to the consolidated statement of financial position for the above items are shown
below:
Consolidated statement of financial position for Glazer group as at 30 June 2018
Record Equity Derecognise
associate method for Gain on step investment
at cost associate acquisition in associate Goodwill Total
$m $m $m $m $m $m
ASSETS
Non-current assets
Property, plant and
equipment 2,850 2,850
Investment in Ferguson 680 (120) (560) –
Investment in associate 120 90 60 (270) –
Goodwill 270 (160) 110
Other non-current assets 758 758
4,288
Current assets 556 556

TOTAL ASSETS 4,844 4,274

EQUITY AND LIABILITIES

Equity
Attributable to shareholders
of the parent company
Share capital 100 100
Share premium 500 500
Other components of
equity 350 350
Retained earnings 1,349 90 60 1,499
Non-controlling interest 180 180
Ferguson’s net assets 900 (900) –
Total equity 3,199 2,629

Liabilities
Non-current liabilities:
Loans payable 200 200
Deferred tax liabilities 550 550
Net pension deficit 320 320
1,070 1,070
Current liabilities 575 575

Total equity and liabilities 4,844 4,274

EXAM SMART
The above illustration is one way to arrive at the adjusted statement of financial position but
an alternative solution could score full marks if the statement is correctly adjusted and it is
clear how your adjustments relate to your explanation of the accounting treatment.
242 Cour s e Not es ACCA SBR

ILLUSTRATION: PREPOPULATED STATEMENT OF PROFIT OR LOSS AND STATEMENT OF CASH FLOWS

Oldie Co has a defined benefit plan for its employees. The present value of the future benefit
obligations at 1 January 2011 was $790m and fair value of the plan assets was $900 million.
Further data concerning the year ended 31 December 2011:
$m
Current service cost 110
Benefits paid to former employees 140
Contributions paid to plan 108
Present value of benefit obligations at 31 December 1,200 As valued by
Fair value of plan assets at 31 December 1,300 professional
actuaries
31.12.10 31.12.11
Interest rate on high quality corporate bonds 10% 11%
On 1 January 2011, Oldie changed the rules of the Pension scheme with the effect that additional
benefits of $40m were granted to existing pensioners, vesting immediately. The effect of this change is
included in the actuarial valuation at 31 December 2011.
The corporate tax rate in the jurisdiction in which Oldie operates is 20%. Tax deductions are available
when contributions are paid into the pension plan.
You should assume that all contributions and benefits were paid on 31 December 2011 but that
corporate taxes are paid after the end of the period.
Required:
Using the draft Statement of Profit or Loss and Statement of other comprehensive income and the
Statement of Cash Flows below, show how the pension plan and the associated tax impact should be
reflected in the consolidated financial statements for the year ended 31 December 2011.
ACCA SBR Cour s e Not es 243

Consolidated statement of profit or loss for the year ended 31 December 2011

$m

Revenue 2,057
Cost of sales (895)
Gross profit 1,162

Other income 55
Distribution costs (237)
Administrative expenses (452)
Operating profit/(loss) 528

Finance income/(costs) (140)

Profit/(loss) before tax 388

Income tax expenses (79)

Profit/(loss) for the year 309

Profit attributable to:

Owners of Oldie Co 292
Non-controlling interests 17
309

Other comprehensive income

Remeasurement of defined benefit pension asset –
Income tax related to other comprehensive income –
Other comprehensive income for the year

Total comprehensive income for the year –

Total comprehensive income for the year attributable to:

Owners of Oldie Co 292
Non-controlling interests 17
309
244 Cour s e Not es ACCA SBR

Consolidated statement of cash flows for the year ended 31 December 2011

$m
Operating activities
Profit before tax 388
Adjustments for:
Depreciation 27
Finance costs 140
Defined benefit pension expense
Contributions to defined benefit pension plans
Increase in inventories (42)
Increase in trade and other receivables (17)
Increase in trade and other payables 38
Cash flows from/(used in) operating activities 534

Interest paid (131)

Income taxes paid (54)
Net cash from/(used in) operating activities 349

Investing activities:
Purchase of property, plant and equipment (114)
Interest received 9
Net cash from/(used in) investing activities (105)

Financing activities
Proceeds from the issue of share capital 100
Repayment of loans (75)
Dividends paid (50)
Net cash from/(used in) financing activities (25)

Net change in cash and cash equivalents 219

Cash and cash equivalents at the beginning of the year 157
Cash and cash equivalents at the end of the year 376
ACCA SBR Cour s e Not es 245

SOLUTION
Workings
Pension Pension
asset liability
$m $m
Bal b/f 900 Dr 790 Cr
Current service cost 110
Pensions paid (140) (140)
Contributions 108
Interest (10% × (790 + 40 PSC)) 83
Interest on plan assets (10% × 900) 90
Past Service Cost 40
Gain on remeasurement – BAL 342 Dr
Loss on remeasurement – BAL 317 Cr
Bal c/f 1,300 1,200

Reconciliation of b/f to c/f figures:

Net Pension Deferred tax Tax effect
asset liability at 20% through:
$m
Bal b/f 110 Dr 22
Current service cost (110) (22) SPL
Pensions paid – SPL
Contributions 108 21.6 SPL
Interest (10% × (790 + 40 PSC)) (83) (16.6) SPL
Interest on plan assets (10% × 900) 90 18 SPL
Past Service Cost (40) (8) SPL
Net gain on remeasurement – BAL 25 Dr 5 OCI
Bal c/f 100 Dr 20

Current tax
There is no impact on the current tax expense for the income and expenses in the statement of profit
or loss (they would be disallowed in the tax computation). The amount deductible is the paid amount
of $108m.
This will reduce the current tax expense by $21.6m, i.e. DR Current tax liability CR Tax expense.
Deferred tax
The total decrease to the deferred tax liability is $2m.
The deferred tax effect through the statement of profit or loss is a net decrease to the deferred tax
liability of $7m. The total deferred tax effect through the statement of other comprehensive income is
a net increase to the deferred tax liability of $5m. I.e. DR Deferred tax liability $2m, DR OCI $5m,
CR Tax expense $7m
246 Cour s e Not es ACCA SBR

Consolidated statement of profit or loss for the year ended 31 December 2011
Current and Remeasurement
past service Net of net pension
cost interest asset Tax Total
$m $m $m $m $m $m

Revenue 2,057 2,057

Cost of sales (895) (895)
Gross profit 1,162 1,162

Other income 55 55
Distribution costs (237) (237)
Administrative expenses (452) (150) (602)
Operating profit/(loss) 528 378

Finance income/(costs) (140) 7 (133)

Profit/(loss) before tax 388 245

Income tax expenses (79) 28.6 (50.4)

Profit/(loss) for the year 309 194.6

Profit attributable to:

Owners of Oldie Co 292 177.6
Non-controlling interests 17 17
309 194.6

Other comprehensive
income
Remeasurement of defined
benefit pension asset – 25 25
Income tax related to other
comprehensive income – (5) (5)
Other comprehensive
income for the year 20
Total comprehensive
income for the year – 214.6
Total comprehensive
income for the year
attributable to:
Owners of Oldie Co 292 197.6
Non-controlling interests 17 17
309 214.6
ACCA SBR Cour s e Not es 247

Consolidated statement of cash flows for the year ended 31 December 2011
Pension
adjustments Total
$m $m $m
Operating activities
Profit before tax 388 388
Adjustments for:
Depreciation 27 27
Finance costs 140 (7) 133
Defined benefit pension expense 150 150
Contributions to defined benefit pension plans (108) (108)
Increase in inventories (42) (42)
Increase in trade and other receivables (17) (17)
Increase in trade and other payables 38 38
Cash flows from/(used in) operating activities 534 569

Interest paid (131) (131)

Income taxes paid (54) (54)
Net cash from/(used in) operating activities 349 384

Investing activities:
Purchase of property, plant and equipment (114) (114)
Interest received 9 9
Net cash from/(used in) investing activities (105) (105)

Financing activities
Proceeds from the issue of share capital 100 100
Repayment of loans (75) (75)
Dividends paid (50) (50)
Net cash from/(used in) financing activities (25) (25)

Net change in cash and cash equivalents 219 254

Cash and cash equivalents at the beginning of the year 157 157
Cash and cash equivalents at the end of the year 376 411

EXAM SMART
To gain further practice in adjusting financial statements you could use the templates shown
in this chapter in conjunction with further worked examples in your notes. For every
adjustment you make you must think about both sides of the accounting entry.
248 Cour s e Not es ACCA SBR

3 Exam technique
Before your exam, you must practise questions using the ACCA’s practice platform so that you are
familiar with the exam software. We recommend the following step-by-step approach:
Step 1: Read the background information. This will provide you with the context of the question.
Step 2: Read the requirements. There will be a separate exhibit detailing the requirements. Note
the key verbs used, e.g. discuss, explain, calculate or adjust.
Step 3: Match the requirements to the relevant exhibits. The question will often tell you which
exhibit you need to use to answer each requirement.
Step 4: Copy and paste the requirement into the Word Processor response area. You can then
easily remind yourself of the requirement without the need to reopen the requirement exhibit.
Step 5: Open the relevant exhibit and resize the windows. This will enable you to view the
exhibit and the student response area side by side.
Step 6: Write up your answer. Cross-reference to any calculations you prepare in the spreadsheet
response area, e.g. “see spreadsheet for calculation of…”. Clearly label the calculation in the
spreadsheet response area, e.g. “goodwill on the acquisition of…”. Use headings and write in
short sentences using professional English.
Step 7: For each adjustment you explain in Step 6, adjust the prepopulated financial statements
as required. This is likely to be quicker and easier to do as you explain each adjustment. Be careful
to only adjust for the items requested.
We have already covered all the accounting issues that you may need to explain or discuss in your
exam. This chapter focussed on how to adjust the prepopulated financial statements although short
explanations or workings are included to aid your understanding.

Knowledge diagnostic
Complete the following knowledge diagnostic and check you are able to confirm you possess the
following essential learning from this chapter. If not, you are advised to revisit the relevant learning
from this chapter.
Confirm your learning Yes/No
Can you adjust the consolidated statement of financial position setting out each
adjustment in a separate column to arrive at a revised consolidated statement of
financial position?
Can you adjust the consolidated statement of profit or loss setting out each
adjustment in a separate column to arrive at a revised consolidated statement of
profit or loss?
Can you adjust the consolidated statement of cash flows setting out each adjustment
in a separate column to arrive at a revised consolidated statement of cash flows?
Can you remember the step-by-step approach for answering question 1 of the
Strategic Business Reporting exam?

© With thanks to Kaplan Publishing Limited for permission to reproduce excerpts from their text in these notes.
For references and acknowledgements of materials used in these notes, please see the back of the Study Text
provided on your online course.