Financial reporting revision

Chapter 14

Financial reporting revision

IAS 1 Presentation of Financial Statements: This standard provides formats for the statement of profit or loss and other comprehensive income, statement of financial position, and statement of changes in equity.

Accounting policies should be selected so that the financial statements comply with all international standards and interpretations. IAS 1 requires that other comprehensive income is presented in two categories, namely items that:

• will not be reclassified to profit or loss, and

• may be reclassified to profit or loss in future reporting periods.

IAS 2 Inventories: Inventories should be valued 'at the lower of cost and net realisable value' (IAS 2, para 9). IAS 2 says that the cost of inventory includes:

• Purchase price including import duties, transport and handling costs

• Direct production costs e.g. direct labour

• Direct expenses and subcontracted work

• Production overheads (based on the normal levels of activity)

• Other overheads, if attributable to bringing the product or service to its present location and condition.

IAS 2 specifies that cost excludes:

• Abnormal waste

• Storage costs

• Indirect administrative overheads

• Selling costs.

Some entities can identify individual units of inventory (e.g. vehicles can be identified by a chassis number). Those that cannot should keep track of costs using either the first in, first out (FIFO) or the weighted average cost (AVCO) assumption.

Some entities may use standard costing for valuing inventory. Standard costs may be used for convenience if it is a close approximation to actual cost, and is regularly reviewed and revised.

IAS 7 Statement of Cash Flows: IAS 7 requires a statement of cash flow that shows cash flows generated from:

• Operating activities

• Investing activities

• Financing activities.

IAS 10 Events After the Reporting Period

Definitions: Events after the reporting period are 'those events, favourable and unfavourable, that occur between the statement of financial position date and the date when the financial statements are authorised for issue' (IAS 10, para 3).

Adjusting events after the reporting period are those that 'provide evidence of conditions that existed at the reporting date' (IAS 10, para 3a).

Non-adjusting events after the reporting period are 'those that are indicative of conditions that arose after the reporting period' (IAS 10, para 3b).

Accounting treatment: Adjusting events affect the amounts stated in the financial statements so they must be adjusted.

Non-adjusting events do not concern the position as at the reporting date so the financial statements are not adjusted. If the event is material then the nature and its financial effect must be disclosed.

IAS 16 Property Plant and Equipment

Cost and depreciation of an asset: IAS 16 states that property, plant and equipment is initially recognised at cost.

An asset’s cost is its purchase price, less any trade discounts or rebates, plus any further costs directly attributable to bringing it into working condition for its intended use.

Subsequent expenditure on non-current assets is capitalised if it:

• Enhances the economic benefits of the asset e.g. adding a new wing to a building.

• Replaces part of an asset that has been separately depreciated and has been fully depreciated; e.g. furnace that requires new linings periodically.

• Replaces economic benefits previously consumed, e.g. a major inspection of aircraft.

The aim of depreciation is to spread the cost of the asset over its life in the business.

• IAS 16 requires that the depreciation method and useful life of an asset should be reviewed at the end of each year and revised where necessary. This is not a change in accounting policy, but a change of accounting estimate.

• If an asset has parts with different lives, (e.g. a building with a flat roof), the component parts should be capitalised and depreciated separately.

Revaluation of property, plant and equipment: Revaluation of PPE is optional. If one asset is revalued, all assets in that class must be revalued.

Valuations should be kept up to date to ensure that the carrying amount does not differ materially from the fair value at each statement of financial position date.

Revaluation gains are credited to other comprehensive income unless the gain reverses a previous revaluation loss of the same asset previously recognised in the statement of profit or loss.

Revaluation losses are debited to the statement of profit or loss unless the loss relates to a previous revaluation surplus, in which case the decrease should be debited to other comprehensive income to the extent of any credit balance existing in the revaluation surplus relating to that asset.

Depreciation is charged on the revalued amount less residual value (if any) over the remaining useful life of the asset.

An entity may choose to make an annual transfer of excess depreciation from revaluation reserve to retained earnings. If this is done, it should be applied consistently each year.

IAS 27 Separate Financial Statements: This standard applies when an entity has interests in subsidiaries, joint ventures or associates and either elects to, or is required to, prepare separate non-consolidated financial statements.

If separate financial statements are produced, investments in subsidiaries, associates or joint ventures can be measured:

• At cost

• using the equity method

• In accordance with IFRS 9 Financial Instruments.

IAS 28 Investments in associates and joint ventures

Joint ventures: A joint venture is a 'joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement' (IAS 28, para 3). This will normally be established in the form of a separate entity to conduct the joint venture activities.

Associates: An associate is defined as an entity 'over which the investor has significant influence' (IAS 28, para 3).

Significant influence is the 'power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies' (IAS 28, para 3).

It is normally assumed that significant influence exists if the holding company has a shareholding of 20% to 50%.

Equity accounting: In the consolidated financial statements of a group, an investment in an associate or joint venture is accounted for using the equity method.

The consolidated statement of profit or loss will show a single figure in respect of the associate or joint venture. This is calculated as the investor’s share of the associate or joint venture's profit for the period.

In the consolidated statement of financial position, the ‘investment in the associate/joint venture’ is presented in non-current assets. It is calculated as the initial cost of the investment plus/(minus) the investor's share of the post-acquisition reserve increase/(decrease).

The associate or joint venture is outside the group. Therefore transactions and balances between group companies and the associate or joint venture are not eliminated from the consolidated financial statements.

IAS 37 Provisions, Contingent Liabilities and Contingent Assets: IAS 37 provides the following definitions:

• A provision is 'a liability of uncertain timing or amount' (IAS 37, para 10).

• A contingent liability is a possible obligation arising from past events whose existence will only be confirmed by an uncertain future event outside of the entity's control.

• A contingent asset is a possible asset that arises from past events and whose existence will only be confirmed by an uncertain future event outside of the entity’s control.

Provisions: Provisions should be recognised when:

• An entity has a present obligation (legal or constructive) as a result of a past event

• It is probable that an outflow of economic benefits will be required to settle the obligation, and

• A reliable estimate can be made of the amount of the obligation.

Measurement of provisions:

• The provision amount should be the best estimate of the expenditure required to settle the present obligation.

• Where the time value of money is material, the provision should be discounted to present value.

Restructuring provisions:

• Provisions can only be recognised where an entity has a constructive obligation to carry out the restructuring.

• A constructive obligation arises when there is a detailed formal plan which identifies:

− The business concerned

− The principal location, function and approximate number of employees being made redundant

− The expenditures that will be incurred

− When the plan will be implemented

− There is a valid expectation that the plan will be carried out by either implementing the plan or announcing it to those affected.

Specific guidance:

• Future operating losses should not be recognised.

• Onerous contracts should be recognised for the present obligation under the contract.

Contingent liabilities should not be recognised. They should be disclosed unless the possibility of a transfer of economic benefits is remote.

Contingent assets should not be recognised. If the possibility of an inflow of economic benefits is probable they should be disclosed.

IAS 38 Intangible Assets: IAS 38 says that an intangible asset is 'an identifiable non-monetary asset without physical substance' (IAS 38, para 8).

Initial recognition: IAS 38 states that an intangible asset is initially recognised at cost if all of the following criteria are met.

(1) It is identifiable – it could be disposed of without disposing of the business at the same time.

(2) It is controlled by the entity – the entity has the power to obtain economic benefits from it, for example patents and copyrights give legal rights to future economic benefits.

(3) It will generate probable future economic benefits for the entity – this could be by a reduction in costs or increasing revenues.

(4) The cost can be measured reliably.

If an intangible does not meet the recognition criteria, then it should be charged to the statement of profit or loss as expenditure is incurred.

Items that do not meet the criteria are internally generated goodwill, brands, mastheads, publishing titles, customer lists, research, advertising, start-up costs and training.

Subsequent treatment: Intangible assets should be amortised over their useful lives.

If it can be demonstrated that the useful life is indefinite no amortisation should be charged, but an annual impairment review must be carried out.

Intangible assets can be revalued but fair values must be determined with reference to an active market. Active markets have homogenous products, willing buyers and sellers at all times and published prices. In practical terms, most intangible assets are likely to be valued using the cost model.

Research and development: The recognition of internally generated intangible assets is split into a research phase and a development phase.

Costs incurred in the research phase must be charged to the statement of profit or loss as they are incurred.

IAS 38 says that costs incurred in the development phase should be recognised as an intangible asset if they meet the following criteria:

(a) The project is technically feasible

(b) The asset will be completed then used or sold

(c) The entity is able to use or sell the asset

(d) The asset will generate future economic benefits (either because of internal use or because there is a market for it)

(e) The entity has adequate technical, financial and other resources to complete the project

(f) The expenditure on the project can be reliably measured.

Amortisation of development costs will occur over the period that benefits are expected.

IFRS 3 Business Combinations: On acquisition of a subsidiary, the purchase consideration transferred and the identifiable net assets acquired are recorded at fair value.

Fair value is 'the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date' (IFRS 13, para 9).

Purchase consideration: Purchase consideration is measured at fair value. Note that:

• Deferred cash consideration should be discounted to present value using a rate at which the acquirer could obtain similar borrowing.

• The fair value of the acquirer’s own shares is the market price at the acquisition date.

• Contingent consideration is included as part of the consideration at its fair value, even if payment is not probable.

Goodwill and the non-controlling interest: The non-controlling interest (NCI) at acquisition is measured at either:

• Fair value, or

• The NCI's proportionate share of the fair value of the subsidiary’s identifiable net assets.

Gain on bargain purchase: If the net assets acquired exceed the fair value of consideration, then a gain on bargain purchase (negative goodwill) arises.

After checking that the calculations have been done correctly, the gain on bargain purchase is credited to profit or loss.

Other adjustments: Other consolidation adjustments need to be made in order to present the parent its subsidiaries as a single economic entity. Transactions that require adjustments include:

• Interest on intragroup loans

• Intragroup management charges

• Intragroup sales, purchases and unrealised profit in inventory

• Intragroup transfer of non-current assets and unrealised profit on transfer

• Intragroup receivables, payables and loans.

IFRS 10 Consolidated Financial Statements: IFRS 10 states that consolidated financial statements must be prepared if one company controls another company.

Control, according to IFRS 10, consists of three components:

(1) Power over the investee: this is normally exercised through the majority of voting rights, but could also arise through other contractual arrangements.

(2) Exposure or rights to variable returns (positive and/or negative), and

(3) The ability to use power to affect the investor's returns.

It is normally assumed that control exists when one company owns more than half of the ordinary shares in another company.

IFRS 15 Revenue from Contracts with Customers: Revenue recognition is a five step process.

(1) Identify the contract: A contract is an agreement between two or more parties that creates rights and obligations.

(2) Identify the separate performance obligations within a contract: Performance obligations are, essentially, promises made to a customer.

(3) Determine the transaction price: The transaction price is the amount the entity expects to be entitled in exchange for satisfying all performance obligations. Amounts collected on behalf of third parties (such as sales tax) are excluded.

(4) Allocate the transaction price to the performance obligations in the contract: The total transaction price should be allocated to each performance obligation in proportion to stand-alone selling prices.

(5) Recognise revenue when (or as) a performance obligation is satisfied: For each performance obligation an entity must determine whether it satisfies the performance obligation over time or at a point in time.

An entity satisfies a performance obligation over time if one of the following criteria is met:

(a) 'the customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs

(b) The entity’s performance creates or enhances an asset (for example, work in progress) that the customer controls as the asset is created or enhanced, or

(c) The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date' (IFRS 15, para 35).

For a performance obligation satisfied over time, an entity recognises revenue based on progress towards satisfaction of that performance obligation.

If a performance obligation is not satisfied over time then it is satisfied at a point in time. The entity must determine the point in time at which a customer obtains control of the promised asset.